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January 25, 2023 | Watching the markets in recent days, it occurs to us that the fascination of the F ederal Reserve Board with employing “confidence” as a mechanism of monetary policy begins to backfire. Consider the righteous indignation of the mob denied the right to gamble their worthless fiat currency on crypto tokens and other products of the imagination. The anger is most pronounced among the losers in the group, those sitting in the audience not sufficiently clued in to sell in mid-2021, when speculative icons like Silvergate Capital (SI) traded at many times book value. Source: Goggleh One especially savvy colleague in the advisory community reports that some clients are positively outraged by the growing official focus on SI and other insured depository institutions, banks that were foolish enough to touch crypto tokens. For financial professionals, crypto always has been an AML and KYC train wreck waiting to happen. Advisors also report being incredulous at the desire of some clients to double down on the crypto mirage, even as the various crypto "exchanges" go bust, as though confidence and faith were all that is required to breathe life into these barren possessions. Crypto, of course, is not an asset as much as a bad idea that was given life by the Fed via Quantitative Easing. Like the shareholders of the GSEs, who have finally been put out of our misery by the courts, the crypto faithful are now full-fledged American victims. Crypto faithful really believe that people are way too bearish on crypto. We are reminded of the crowd in the classic 1956 Cecil B.DeMille film "Moses," with Edward G. Robinson playing Dathan, who encouraged the idolators to turn away from God and worship the Golden Calf. The basic view of Silvergate among the faithful, including a number of prominent people in the religious community, is that the bank was doing a legit business and FHLB bailout was "kosher." No, it was not. Seeing a bank need to fund one third of its assets at the FHLB is a sign of impending default and resolution. Hello. Kate Berry of American Banker nailed this story last week . Once upon a time, Silvergate was actually in the mortgage business , providing warehouse finance for jumbo lenders in Southern California. After shooting most of the personnel on the well-regarded mortgage team at the start of 2023, CEO Alan Lan e is now left with a small bank that apparently has pledged all of its salable assets for a loan with the Federal Home Loan Bank of San Francisco . Once the $4 billion repo transaction unwinds, we assume that the bank shuts down. Looking at the bank’s Q4 earnings results and the actions of Lane and SI management over the past year, we have a hard time understanding why the State of California and the Federal Deposit Insurance Corp have not closed institution to protect the remaining depositors and the bank insurance fund. Book value of the SI common has fallen from $46.55 at the end of 2021 to below $13 at 12/31/2022. Tier one capital has fallen from 11% of assets at the end of 2021 to below 5.5% today (including $200 million in negative AOCI), a serious red flag for regulators. Deposits are down by more than 50% over the past year and the bank reported a $800 million loss in Q4 2022. The $4.3 billion in short-term borrowings from the FHLB shown at year-end, up from $700 million in Q3 2022, represents the last desperate effort by Lane to save the bank. And yes, having 1/3 of bank assets financed with the FHLBs is another moral hazard red flag for regulators. Beyond the ugly financials, however, it is important to understand that the fall of Silvergate is a larger story about the end of the “theology of prosperity” that was a key driver of the crypto confidence game. Think of SI as evangelical Christianity and Opus Dei meets party poker/FX trader, with a dash of millennialism thrown in for added flavor. Many players in the world of crypto believed that their focus on this pretty standard form of financial fraud would actually bring them wealth and economic freedom. Instead, the holders of crypto are likely to be disappointed, over and over again. The larger and possibly more significant mess involving crypto and Signature Bank (SBNY) in New York is another case of confidence c/o QE causing real world damage to banks and investors. Unlike SI, which is too small to care in a systemic sense, SBNY is a $110 billion asset commercial lender that is systemically important. The fact that SBNY’s management team would allow this valuable banking franchise to be put at risk by involvement in crypto fraud demands attention from regulators, shareholders and policy makers. As lenders like SBNY back away from crypto exchanges and their “affiliates,” the wreckage among the community of faithful grows. CoinDesk reports that SBNY is refusing to process transfers on its crypto platform of less than $100,000 for Binance , effectively cutting off the giant crypto casino from the Fedwire. Given the still unknown risk to SBNY and other banks in terms of KYC and AML violations, this move is probably the first step toward an exit by all US banks from facilitating cash transfers for all crypto. Last week Jemimah Kelly wrote in the Financial Times that some of the worst offenders in the world of crypto fraud are busily building a new game even as many financial regulators around the world continue to, well, do nothing. Su Zhu and Kyle Davies, co-founders of the bankrupt crypto hedge fund Three Arrows Capital , are apparently erecting a new vehicle for crypto fraud called GTX, Kelly reports. Yet despite these efforts by hardened crypto grifters to steal yet more money from credulous retail investors, the faith in crypto assets is slowly wanning. Of greater concern than the end of crypto is the risk to market confidence more generally as QE becomes quantitative tightening or QT. Investors believe as an act of faith that the FOMC is going to reduce inflation and put the markets back to a happy place something like Q1 of 2020 before COVID. The only trouble is that the Fed has essentially lost control of its own balance sheet, leaving open the question whether the US central bank can continue to tighten for much longer and how global markets will react to this public failure. Bill Nelson of Bank Policy Institute asks precisely this question in a recent missive, wherein he notes that the failure by the FOMC to force down the use of reverse repurchase agreements (RRPs) by money market funds and banks has created a structural problem. RRPs are effectively a form of T-bills created by the Fed without Congressional authorization to subsidize money market funds and banks. Now the Fed cannot take away the duration it provided with these ersatz T-bills. In order to shrink the Fed’s balance sheet, RRPs need to decline – a lot – from the current level over $2 trillion. The chart below from FRED shows the major assets in Fed’s portfolio of Treasury debt and MBS on the left scale and liabilities in terms of RRPs on the right. Or maybe another way to put the Fed's dilemma is that those MBS on the NY Fed's balance sheet need to repay before the balance sheet shrinks significantly. During a recent conclave at the Council on Foreign Relations, Federal Reserve Governor Christopher Waller said roughly $2 trillion of reserves could be taken out of the banking system without disrupting banks . Waller, an academic economist with no financial markets experience , does not address when and how the FOMC is going to tell money market funds to exit RRPs. Keep in mind that those MBS on the Fed’s balance sheet have fallen to low single-digit levels of prepayments annually. The problem is that the Fed via RRPs has essentially decided to issue $2 trillion in T-bills without explicit fiscal authority from Congress. The MM funds and banks certainly prefer holding RRPs with the Fed and will not exit unless forced to do so. But given the current issuance schedule for the US Treasury, forcing MM funds and banks out of RRPs will have the effect of lowering short-term interest rates as investors scramble to buy a limited supply of T-bills. Nelson notes: “In September 2022, Patricia Zobel, the acting System Open Market Account Manager, gave a speech (available here) in which she stated “Overall, as the Federal Reserve’s balance sheet declines, I expect money market interest rates to rise relative to the ON RRP rate, and for market participants to shift investments away from the facility moderating the decline in reserves.” Nelson reports that the FOMC seems to believe that as the Fed’s balance sheet gets smaller, money market rates will rise relative to the interest rates it pays on reserves and ON RRPs. But sadly the markets are not cooperating. He continues: “As rates on repos with non-Fed counterparties and treasury bills rise relative to the ON RRP rate, money funds should switch from ON RRPs at the Fed to other investments. However, so far, the process is barely working. On September 8, when Zobel gave the speech, the market repo rate was 2 basis points below the ON RRP rate and the ON RRP facility was $2.2 trillion. Currently, the market repo rate equals the ON RRP rate and the ON RRP facility is $2.1 trillion.” When it becomes clear that the FOMC is unable to significantly shrink its balance sheet, investors are going to surge back into the equity markets. Stocks are, after all, one of the few true havens from inflation unlike crypto tokens. But if inflation in housing costs and other key areas of consumption do not decline, then what? When the Fed cannot force down housing prices, then QT has failed. If the Fed cannot reduce its balance sheet back down to pre-COVID levels, then the inflation in stocks, home prices and other tangible assets is going to become permanent. Consumer will go from chasing happy dreams of free money c/o crypto and QE, to being crushed by continued inflation in key asset classes like housing and financial investments. As the shrinking population of equity investors ride the updraft up, consumers will increasingly ask “what’s in this for me?” As and when the American political process produces a candidate able to frame the policy failure on the part of the Fed regarding inflation into terms understandable to consumers, then the faith in the entire system will come into question. We will not destroy the dollar system because of the resurgence of gold or the evil machinations coming from Beijing and Moscow. We will destroy the dollar system because of hubris on the part of central bankers, who think that they can control the workings of the world’s largest economy by playing God with the Fed’s balance sheet. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

January 23, 2023 | Premium Service | As we navigate through bank earnings, one trend clearly visible through the fog of QT is that bank funding costs are rising faster than asset returns, an arithmetic relationship that defies spin. In the case of Bank of America (BAC) , for example, interest expense rose over 400% in 2022 vs the previous year. Interest income, on the other hand, rose just 52% vs 2021. Overall, BAC saw net income fall 14% YOY vs 2021. Although net interest income rose, non-interest income fell almost $4 billion. Notice that credit loss provisions shown below swung from a $4.6 billion GAAP benefit in 2021 to a $2.5 billion expense in 2022, a stark illustration of the income statement volatility caused by the FOMC’s open market operations . BAC’s results continue to trail the other members of the top-five money center banks. This tale of glorious mediocrity is illustrated by the rising headcount and related expenses, and an efficiency ratio that is six points above JPMorgan (JPM) and the average for the 132 banks in Peer Group 1. We are fortunate to have the standardized data from the Fed for making such comparisons, however, because BAC consistently uses non-standard terms and presentation for its financials. The table below is from the Q4 2022 BAC results. For example, as of the end of Q3 2022, BAC reported accumulated other comprehensive income (AOCI) to the Fed and other regulators on Form Y-9 of -$12.7 billion, but in the GAAP financials just released the Q3 2023 AOCI number is shown as -$4.3 billion. For year end 2022, BAC shows AOCI of -$16.1 billion. Does this mean that the number reported to the Fed for Q4 will be 3x higher than the GAAP number? We’re not sure. BAC reported lower asset returns in 2022 than in 2021, a remarkable statistic that again separates the Bank of Brian from its peers. The chart below from the FFIEC shows the results for the top banks through Q3 2022. Note that all of the large banks are trailing the average of Peer Group 1, which includes all banks above $10 billion in assets. BAC is somewhere between Wells Fargo (WFC) and Citigroup (C) in terms of asset returns, even based upon the Q4 2022 results! Note too that U.S. Bancorp (USB) is just below Peer Group 1. Source: FFIEC BAC’s asset returns were down in Q4 2022, this as the rest of the industry saw earnings and asset returns expanding. Long-time readers of The Institutional Risk Analyst will not be surprised by these poor results, yet members of the financial press and the analyst community refuse to criticize BAC’s consistently mediocre performance. When Gerard Cassidy asked Brian Moynihan about BAC’s future loan loss reserve build, the BAC CEO danced beautifully: Gerard Cassidy: Alastair, on the loan loss reserving, and Brian just talked about the adverse case being about 40%. Can you guys share with us how much of the reserve building is what might be referred to as management overlay relative to what the models are specifically dictating on reserve building? Brian Moynihan: We don't disclose that. But you might assume that there's a fair amount -- 3 components to this: one is what the models say; two is basically uncertainty, imprecision and other things we overlay and then a judgmental, and you might think that there's a fair amount of that right now with the uncertainty. But -- so the model piece of that would be a portion of it. Both Moynihan and JPM CEO Jamie Dimon spent a lot of time talking about uncertainty during the earnings calls, especially when it comes to future capital requirements. We see less uncertainty in the numbers and more evidence that mean reversion is occurring with full force and more quickly than the operators or analyst community want to admit. All of the top four banks need to downsize 25-35% of assets in order to get back into line in terms of performance. One key area of “uncertainty” is future provisions for loss, but we hear in the channel that regulators are making their views of future loss probabilities very clear in guidance to the top banks. This is significant to investors and risk managers because future reserve build reduces earnings 1:1. Add on top of this the “overlay” from regulators for a significant blood letting during 2023 due to mark-to-market losses. The chart below shows net losses through Q3 2022. The results for Q4 for these banks are all up significantly, even if the absolute numbers are still low by historical standards. Source: FFIEC Total net charge-offs for BAC in Q4 2022 were $689 million or 26bp vs total loans and leases, double the previous year. Notice that three quarters of BAC’s losses come from the consumer book. The steep rate of change is where regulators are focused, one reason why Dimon has been so cautious in comments about future capital requirements. BAC added 75bp to capital in 2022 and is arguably above the new requirements. Regulators, however, expect credit losses to rise back to 2020 levels or higher during 2023. BAC CFO Alastair Borthwick framed the issue between the regulators and potential dividend and/or share repurchase increases: “I think the difficult part with Basel III endgame right now is we don't have the rules. So we got to wait, I think, until we see those. They'll go through a comment period. At that point, we'll offer much more perspective. But I'll say the obvious, banks have got plenty of capital. We were asked to take 90 basis points more in June. There's a lot of procyclicality already in things like the stress test and stress capital buffer and in CECL. And I think, look, we've shown our ability to perform and build capital, in this case, 75 basis points in 2 quarters. So we'll deal with whatever the ultimate rules come out with.” While it is great to see BAC building capital for a potential storm, we’d like the team to focus a bit more on improving earning asset returns (2.2% in Q4 2022) and lowering the bank’s efficiency ratio. Until that key operating metric efficiency starts with a “5” handle, Brian Moynihan is not in the game in terms of boosting the share price. If you want to be measured against JPM and USB, not underperformers like WFC and Citi, then BAC needs to boost asset returns and loan yields, and start cutting expenses aggressively. BAC reported an efficiency ratio of almost 65 in Q4, but JPM and USB are in the low 60s or high 50s. Source: FFIEC Disclosures: L: CS, CVX, NVDA, WMB, JPM.PRK, BAC.PRA, USB.PRM, WFC.PRZ, WFC.PRQ, CPRN, WPL.CF, NOVC, LDI 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.

January 19, 2023 | In this issue of The Institutional Risk Analyst , we speak to Mike Patterson, COO of Freedom Mortgage . Mike joined Freedom in 2006 when the firm acquired Irwin Mortgage and thereby became a government lender and Ginnie Mae issuer. Over the next two decades, Mike and other members of the Freedom Mortgage team have built one of the largest lenders and loan servicers in the US. The IRA: Mike, thank you for taking time to speak to us about market conditions. There are a lot of people predicting the apocalypse in the residential mortgage market in 2023. What do you say to investors and policy makers who ask about market conditions now, some nine months into a rising interest rate cycle from the FOMC? Patterson: We’ve been through these cycles before. This is nothing new. We went through this in 2008 and 2009. We went through this in the 1990s. We even went through this to some degree in 2018. For a while, we are going to have a period where if the loan is not a purchase, then there are simply very few transactions out there. I would want to be set up for this period the way we are here at Freedom, and this is not as a matter of self-promotion. If you don’t have a substantial servicing book that is going to provide consistent cash flows, then this is a very tough production environment for any mortgage bank. Leaders from ESGR-NJ presented the prestigious Seven Seals Award to Mike Patterson, Chief Operating Officer of Freedom Mortgage, and fellow employees and reservists. The IRA: Precisely. We have looked at a number of businesses in the past year. Most of them have good people but no servicing asset, so there really is no value in the business with volumes this low. All the consultants have the same message to smaller issuers: downsize to survival mode or simply shut down entirely. Is this market correction that severe for the industry? Patterson: If you are only an originator and not a servicer, in the next 12 to 24 months you risk giving back all of the profit made during COVID if you don’t have a servicing book to help from a cash flow perspective. The IRA: How does this period differ from 2008? You joined Freedom just before the wheels came off the cart in 2007 in private label mortgages. How is this correction different from 12 years ago? Patterson: In 2008, we saw a contracting credit market where LTVs and FICO scores were tightening. Now we see an opening of the credit box to some degree, where FICOs are going a little deeper into the 600s and LTVs are going higher. The box is widening a little bit instead of contracting dramatically. Debt-to-income (DTIs) are a little higher. You also see lenders originating loans that they usually don’t pursue, meaning that they are not proficient at it. These trends could end up being concerns down the road. The IRA: We know a guy named Stan Middleman who told us a while back that loans originated from now until the correction later in the decade will retrace in terms of home prices back to 2020 levels and be underwater for a while. Patterson: The loans will be underwater or the originators operating in unfamiliar territory will make these higher LTV, lower FICO loans until the music stops and there is nobody left to buy the loans. The IRA: The FOMC has moved mortgage rates 500bp or more in the past year. Most small issuers have given up on creating pools and are simply selling the loans on a best-efforts basis. How do you get people to think rationally about credit or loan pricing when they are literally fighting to keep the doors open? Patterson: One of the opportunities that an environment like this creates is that more and more flow deals will get set up between larger issuers, such as Freedom, and smaller lenders that are having trouble dealing with these volatile market conditions. To get long-term stability at issuers that do not retain loans or servicing, flow deals help to provide some measure of certainty. You help the small issuer preserve their operations and they give us more volume as an issuer of MBS. The IRA: How do you see the market for mortgage servicing rights (MSRs) in 2023. There are still some concerns about the Ginnie Mae risk-based capital rule. The tenor of the conversations at the IMN MSR conference at the end of last year were subdued, yet this is a market with shrinking supplies of new securities and extending durations. Most recently Wells Fargo (WFC) has announced an exit from all correspondent lending. Patterson: The MSR market is still very healthy, despite the attempts by some observers to paint the market as a problem. There is now a lot of supply out there that people were holding through year-end in order to get better pricing in the first quarter. They wanted to get through a strong 2022, but they are going to need cash in Q1 and this will bring out new bulk deals. The IRA: One of the interesting comments we’ve heard from a number of players is that the funds and banks essentially exhausted their cash in Q3 this year, leaving the room essentially empty in Q4 2022. With the start of Q1, however, new allocations will be available and the assumption is that volumes for bulk sales will pick up. Patterson: We think there will be a lot of GSE and GNMA MSR deals in Q1 that will give the industry an opportunity to continue to grow servicing AUM or raise cash. The conventional market has hovered in the 5-6x cash flow price multiple range and the government assets are also strong with a smaller number of buyers. Source: FDIC/WGA LLC The IRA: A number of regulators in Washington have made a great fuss about the risk from MSRs, but the defaults this year have come from non-agency exposures in non-QM forwards and private reverse mortgages in the case of Reverse Mortgage Funding . Some regulators like to make a great fuss about the fact that MSRs are often booked above the cash value in the secondary market, but these assets generally only trade once. Patterson: Some issuers carry their MSRs at a higher price than they can sell it today, but the premium is relatively small. We are in the market every day and the mark-down from carry value for a secondary sale is usually a good bit less than 10%. Some issuers that want to sell will take their losses from carry value in Q1 and then position for a good year. Maybe they booked the asset in the 150bp range but have to sell at 145bp. That is a completely normal and acceptable practice as the market adjusts. The IRA: So, come the end of January, we’ll have full numbers for the year and then look to sell the servicing asset at or near book value. A 5% discount is hardly a disaster. You book the GAAP loss and put the cash in the bank. Yet there are some folks at Ginnie Mae that are on a mission to prove that the government MSR is grossly overvalued by issuers, but the public record seems to suggest another conclusion. And, again, most MSRs trade once, if at all. Even if these were Level 2 assets instead of Level 3 under GAAP, there would still be a good bit of wiggle room in valuations depending on your interest rate outlook. Patterson: We were at a 6.75% loan market for a few weeks, then the market rallied and now we are down to a mid 5% market more or less. So, now we have an opportunity for home buyers to save a money on their mortgage payment. What is interesting is how adept consumers have become at judging market swings and timing purchases to maximize savings. People were closing on 6.75% loans a month ago and now they are going to make the call today when they see a 6% or lower and ask if they can refinance. There are many refinance opportunities that are created because of short-term market moves. We often forget that dynamic. The borrower always wants the lowest payment. That is the one rule that does not change in our industry. The IRA: Ginnie Mae is starting to get concerned about prepayments, an issue that goes back to the era of former Ginnie Mae President Michael Bright . Do you think that the industry has gotten religion when it comes to providing the maximum benefit to the consumer the first time around so that Ginnie Mae will not feel the need to penalize issuers for prepayments when interest rates eventually fall? There are a lot of Bright-era rules that were entirely focused on protecting the investor in the Ginnie Mae MBS from loan churning. Has the industry learned its lesson? Patterson: Those rules are a problem because they effectively deny the consumer their legal right to prepay the mortgage at any time without penalty. That family that closed on a 6.75% mortgage in September cannot get a refinance today into a 5.75% mortgage because of the seasoning rules. There is no question that responsible lenders need to make sure that they provide maximum benefit to the consumer and thereby manage the issue. But what does not get nearly enough attention is the ability of consumers to seek lower mortgage payments as soon as the market moves, within even hours or days. The IRA: It sounds like the winning strategy in the post-COVID world is to provide the maximum benefit to the consumer in a refinance the first time around and then retain the asset in portfolio. Instead of going for multiple bites at the apple in terms of refinancing the same loan over and over again, the responsible issuer will seek to provide maximum benefit the first time. Is that fair? Patterson: We have always sought to provide the maximum benefit to the consumer and then retain the asset. The reality, however, is that servicers have a limited ability to manage prepayments. Brokers and other parties are contacting that consumer constantly and especially if interest rates move lower. People used to manage portfolios based upon assets, but now we manage our portfolio based upon the customer. The IRA: Given the change in the market since 2020 and the number of loans that may not be in the money again for refinance, isn’t the competition for refinance loans going to be intense? How can issuers and regulators hope to have any impact on prepayments given the structure of coupons in the mortgage industry today? Patterson: It is not just a question of competing for the few loans available for refinance, but there is also a limited spread in terms of profitability. I am looking at the TBA market right now and 102.50 is the top bid shown on the screen. The premium pricing that was available in 2020 and 2021 has changed dramatically. CNBC Worldwide Exchange 1/17/2023 The IRA: There are some issuers based in Detroit that believe that they can drive everyone out of the wholesale market by overpaying for loans. How long does it take before we start to see rational pricing in the industry? Isn’t what United Wholesale Mortgage (UWMC) is doing today in wholesale just a repeat of what Provident and Countrywide did in the past? This is not a new story. When do we start to see rational pricing in the secondary market for residential loans? Patterson: We will see some rationalization in Q2 of this year. In Q1, people are going to slowly see spreads improve. Better execution will allow some of the more aggressive issuers to pull back, but this just means that the other issuers will come back into channels like wholesale. Every month, we have seen gain-on-sale getting better for the public companies. By Q2, things will improve enough that I think some of the more aggressive players will start to relax and you’ll see the other wholesale players back in the game. Again, remember the golden rule: the consumer does not know names or brands, they know payments. Give them a lower payment and good service, and you’ll win their business. Is market share or best execution and service the most important thing? I will tell you it is the latter every time. The IRA: Thanks Mike. 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.

“There are some things so dear, some things so precious, some things so eternally true, that they are worth dying for. And I submit to you that if a man has not discovered something that he will die for, he isn’t fit to live.” Rev. Martin Luther King January 16, 2023 | Over the Martin Luther King holiday, in between playoff football games and the latest bomb from the pasta queen , we examined the most recent corporate reorganization and earnings restatement from Goldman Sachs (GS) . We also pondered the earlier debacle at JPMorgan (JPM) involving a supposed startup known as “Frank.” In celebration of MLK, our thoughts follow below for the readers of The Institutional Risk Analyst . JPMorgan Over the past few years of QE, credit did appear to have no cost – to be free of consequences or pain. But it seems that the reckoning was merely delayed. JPM invested in a company that allegedly created millions of fake user accounts . Sad to say, large banks led by Wells Fargo & Co (WFC) own the fake account thing. Maybe our friend Mike Mayo was right to berate Jamie Dimon , CEO of JPMorgan Chase (JPM), about sloppy portfolio investments during the earnings call last week. In the lawsuit filed at the end of 2022, JPM states: “Defendant Charlie Javice founded a small start-up business known as Frank that seemingly had the potential to grow and become a successful enterprise in the future, and appeared to have had had early proven success.1 But to cash in, Javice decided to lie, including lying about Frank’s success, Frank’s size, and the depth of Frank’s market penetration in order to induce JPMC to purchase Frank for $175 million. Specifically, Javice represented in documents placed in the acquisition data room, in pitch materials, and through verbal presentations…” Apparently 4 million of Frank’s 4.6 million claimed users were nonexistent. “When JPMC specifically requested proof of that claim during due diligence, Javice used ‘synthetic data’ techniques to create a list of 4.265 million fake customers,” states the complaint – “a list of names, addresses, dates of birth, and other personal information for 4.265 million “students” who did not actually exist. In reality, Frank was nearly 4 million short of its representations to JPMC.” But here’s the question: Did the managers at JPM ever even look at anything other than the documents in the “data room” or the pitch materials provided by Charlie Javice? How many deals, fellow bankers, have we seen in the past decade where diligence followed the close? Truth is, what passes for due diligence and assurance in the hyperbolic, post-COVID world of quantitative easing and tightening will shock even the most jaded market cynic. But size is also a problem, that is, asset inflation illustrated by large banks . In Q1 2009, the total assets of the US banking industry was a tad of $13 trillion. Today it is over $20 trillion. Inflation? When assets at JPM or the other money centers total into the trillions and 20% of the book rolls off every year, you got to do a lot of deals to feed the beast. This reduction in the quality of assets is another hidden cost of inflation and QE. With a balance sheet over $2 trillion, the $175 million lost by Jamie Dimon in the Frank fraud is arguably not material to investors. Indeed, there is more risk than reward in this stinky deal. Why did JPM even consider a PE investment this small? Perhaps it was the fact of a female entrepreneur? But whatever the rationale, this deal did not seem to rise to a level of significance where the Morgan bankers would actually perform due diligence prior to the close. Really? Leaving aside the tawdry details of this transaction, the Frank episode illustrates how the Fed’s de facto embrace of inflation encourages misallocation of economic resources on a grand scale, not just in the US but globally. And this is nothing new. Instead, the scope and size of the Fed’s manipulation of risk appetites has increased astronomically as the size of the federal debt has grown. Consider the judgment of Roger W. Garrison in 1994 (" The Federal Reserve: Then and Now "): “There are significant parallels between the Roaring 1920s and the Bullish 1980s. Both decades were characterized by a policy-induced artificial boom that ended with an inevitable bust. The Federal Reserve had a hand in both episodes, keeping the interest rate artificially low in the first one and keeping Treasury bills artificially risk-free in the second. Comparing the two episodes in terms of Federal Reserve policy, federal government borrowing, and the regulatory environment faced by the banking community accounts for both similarities and differences between the economic realities of the 1990s and those of the 1930s.” Notice that Garrison pays explicit attention to the key aspect of the Fed’s massive open market operations, namely subsidizing the debt costs (and liquidity) for the U.S. Treasury. Some thirty years later, observers in today’s markets barely mention that the real point of QE is subsidizing part of the Treasury’s debt issuance. If we actually performed a summation of the risks and rewards of QE to the private sector, would the balance be as positive? Goldman Sachs Risk vs reward, one of the key themes of The Institutional Risk Analyst , brings us next to the growing disarray at Goldman Sachs. Last week, the bank pre-announced a corporate restructuring and restatement of its business. This is the latest exercise in rearranging the lawn furniture in terms of presentation, but not really making any substantive changes in how the business is operated. The chart below shows the new corporate org chart for Goldman Sachs. Source: EDGAR The implicit message in the latest GS restructuring: the portions of Marcus that face wealth management clients is good, corporate banking and other stuff is a loss-leader. GS has labeled the "bad bank" Platform Solutions. We can think of some other names. Our Ukrainian babusya called it " schmatta " -- rags. Question for Mayo to ask David Solomon on Tuesday: Is Platform Solutions to be discontinued? The corporate reorganization, announced just days before the release of Q4 2022 earnings, represents the most audacious attempt at changing the subject in the storied history of Goldman Sachs. The restatement of earnings shows a $3 billion loss to date on the “build-a-bank” project known as Marcus. The organic banking strategy build has been underway at GS since it converted into a bank holding company a decade ago. These belated disclosures now answer some of the questions about Marcus and the inability of the leadership of the firm to actually run a commercial bank. Below are the restated earnings into the three new buckets. Source: EDGAR We’ve argued for years now that GS needs to combine forces with a good-sized commercial bank, Key Corp (KEY) on the small side has a strong focus on commercial real estate, a favorite asset class for GS bankers. Or perhaps PNC Financial (PNC) or even U.S. Bancorp (USB) on the high end. Why? One word: Funding. As we wrote for our Premium Service readers in December (“ Outliers: CapitalOne, Goldman Sachs & Citigroup ”), GS is leading the large banks higher in terms of cost of funds, even compared to subprime lenders like Citigroup (C) or CapitalOne (COF) . That is bad. JPM and other larger banks, of note, are down at or below the average funding costs for Peer Group 1. Source: FFIEC Notice not just the funding costs of GS, but also the outsized credit losses coming from both the Marcus bank focused on wealth management clients and also the corporate bank in the tables above. Even though GS has a smaller loan book than its asset peers, it manages to lose 2.5x as much money than JPM and Peer Group 1? How does this latest corporate reshuffling address this performance deficit in terms of credit risk management? Source: FFIEC There are three legs to the universal bank model perfected by Morgan Stanley (MS) , UBS AG (UBS) and Charles Schwab (SCHW) : 1) banker, 2) trader and 3) advisor. GS is missing a leg. On Tuesday AM, GS CEO David Solomon needs to lay out his strategy for getting GS big enough and efficient enough in an operational sense to be credible as a large universal bank. The Street has GS revenue down double digits in Q4 2022, but the bigger question is about the next five years. We are scheduled on CNBC Worldwide Exchange 5:30 ET Tuesday January 17th to talk bank earnings with Brian Sullivan. 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.

January 13, 2023 | Premium Service | Bank earnings kicking off Friday the 13th of January seems a little less than auspicious, but prices are rising even as earnings soften. JPMorganChase (JPM) closed yesterday a bit north of 1.7x nominal book, but what is the real book value ex-Fed of the large banks? Nobody seems to care about tangible value much less about premium valuations in the world of institutional equities. We are scheduled on CNBC Worldwide Exchange 5:30 ET Tuesday January 17th to talk bank earnings with Brian Sullivan. To understand the valuation of bank stocks as year one of quantitative tightening approaches, discard any concern about bank fundamentals and instead ponder the wants and needs of Buy Side advisors. Assets under management have been taking a beating over the past year, thus banks are both a shelter from the storm and a potential source of alpha, yet very expensive. Tom McClellan noted recently that i f the stock market in 2023 was going to continue following the pattern from 2008, “then we should be seeing a sharp decline right now.” Yep. Instead, he notes, “the stock market is showing nice strength in January 2023.” Especially with LT interest rates falling. One of the sectors that has been most resilient to the ill-effects of the Fed’s interest rate hikes has been financials, which have rallied as long-term rates have fallen. Falling rates are good for financials, rising rates are bad, thus as the Treasury yield curve has rallied bank stocks have risen. Remember, rising LT rates and widening spreads are bad for book value. JP Morgan Chase JPM managed to reduce accumulated other comprehensive income (AOCI) to just negative $17 billion, a reduction in less than $2 billion attributable to the bond market rally in Q4. JPM likewise is anticipating falling market rates overall, even as the FOMC continues to raise interest rates by more modest increments. The chart below shows AOCI and JPM’s capital structure. JPM CFO Jeremy Barnum cautioned investors about the timing, magnitude and direction of interest rates and guided investors to negative net interest income growth for the year due to “rising interest rates.” Of note, in Q4 JPM saw interest expense soar 59% sequentially with the YOY comparison showing almost 7x increase in funding costs, as shown in the table below from JPM's earnings release. JP Morgan | Q4 2022 Barnum focused his presentation on the wide dispersion in possible outcomes for funding costs, causing several analysts to ask follow up questions on the JPM call. CEO Jamie Dimon said he did not want to give investors a false sense of certainty as to the interest rate outlook. But Dimon put down a bullish marker for the year, saying that JPM would earn high teens ROTCE in a mild recession. But will the regulators move the goalposts on bank capital again? The same volatility that we have observed in the business models of other money centers such as U.S. Bancorp (USB) is clearly visible with JPM. As funding costs rise and the mix of interest-bearing vs non-interest-bearing deposits. Non-interest-bearing deposits were down almost 10% YOY, but total deposits were down 5% YOY. “We expect tough competition going forward,” Dimon advised. JPM continues to perform better than the other top-four banks and have even achieved its targets for regulatory capital one quarter early, in theory allowing for resumption of share repurchases. But further changes to the bank’s regulatory capital and liquidity requirements loom in the future, one risk that Dimon and his team cannot quantify. "We have never had zero rates, never had rates move up this fast," Dimon said on the investor call today. We suspect that the uncertainty cause by rapidly rising interest rates is also driving regulatory concerns about capital, even as credit costs remain at 80% of pre-COVID levels. Source: FDIC Wells Fargo & Co The cautious tone for bank earnings was set when Wells Fargo & Co (WFC) suddenly announced that it would be accelerating its withdrawal from the market for 1-4 family loans. This is a dismal development for the housing market and another example of over-reach by the Consumer Financial Protection Board. A reader of mortgage maven Rob Chrisman noted earlier this week that “Wells stepped up in 2009, 2010, 2011. At that time BofA, Citi and GMAC all shut down correspondent production. Others slowed production, like SunTrust, BB&T. Chase raised standards to slow production. Not Wells.” Ditto. Large banks have come and gone from residential mortgages. WFC actually exited mortgages in the early 1990s, but the volumes of bull market residential lending pulled them back into the game. Now there are no large banks involved in correspondent lending, a tragic outcome to progressive excesses in Washington. Of note, WFC reported a 23% drop in the fair-value of its mortgage servicing rights, this in an industry where MSR values are rising rapidly but are not yet near record levels, a shown in the chart below. Source: FDIC The multi-billion dollar fine the CFPB levied against the bank likely prompted WFC's board to immediately stop correspondent purchases of loans from smaller lenders. Correspondent production at Wells Fargo accounted for $9.1 billion of the bank's $21.5 billion total mortgage volume for the third quarter of 2022. Given the above, in Q4 2022, the bank’s results were awful. Asset and equity returns are at the bottom of Peer Group 1. Net income was down 40% YOY driven by higher credit expenses and operating expenses, as shown in the table below. Wells Fargo & Co | Q4 2022 Interest expense for WFC was up 400% YOY and 82% sequentially from Q3 2022, a stark illustration of the balance sheet volatility caused by quantitative easing. Interest income, by comparison, was up “only” 76% YOY and 23% sequentially, illustrating the revenue squeeze facing some of the largest banks. Wells Fargo & Co | Q4 2022 Although WFC has shown some signs of life in the equity markets, these latest results as well as the impending withdrawal from correspondent lending in residential mortgages are a negative for the enterprise. We look for further shrinkage in the WFC business and balance sheet, including bulk sales of all Ginnie Mae MSRs and the loss of related escrow deposits. Bottom line: We expect bank stocks to continue rising so long as medium and longer-term Treasury yields fall. Rising interest rates are bad for bank book value, asset values and therefore credit. WFC’s AOCI in Q4 2022 was down 7% sequentially, roughly tracking the improvement at JPM. But both the managers of JPM and WFC are cautioning investors to temper their expectations for future earnings. Our latest disclosures are below. SWCH is gone and we sold our CMBS position, added to our LT Nvidia (NVDA) position and picked up some Credit Suisse (CS) on the lows (h/t Alan B ). We note that our flutter in Loan Depot (LDI) has been good for almost a 100% gain as mortgage rates have fallen. But nothing lasts forever in mortgage land or in financials. Stay tuned and pay attention to LT rates and spreads. L: CS, CVX, NVDA, WMB, JPM.PRK, BAC.PRA, USB.PRM, WFC.PRZ, WFC.PRQ, CPRN, WPL.CF, NOVC, LDI So long as credit spreads continue to tighten and long-term rates are falling, banks are likely to benefit. But any sign that credit costs are rising above pre-COVID levels will be a show-stopper as far as public equity valuations are concerned. Meanwhile, as ST interest rates normalize, banks will be battling to earn higher asset returns in a shrinking market, one reason why Jamie Dimon knows that he still has gobs of excess capital in his business given a smaller balance sheet. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

January 4, 2023 | Premium Service | We begin the year 2023 with most financials down for the past year but hardly cheap by historical measures. The largest banks continue to serve as a haven for refugees from crypto fraud schemes and the fintech swoon, but this may be unwise except in limited cases. We anticipate that in the next 24 months financials will give up profits earned over the past two years, with shrinking book values, rising credit expenses and only slow return of earning assets to pre-COVID levels of return. In the punishing environment created by the FOMC, the largest banks face a difficult road since they absorbed the majority of the reserves pumped into the banking system by Fed bond purchases. As we’ve documented using the data from FDIC, new bank lending was retarded during QE. As a growing number of researchers have noticed, QE may not actually even help the financial markets by increasing general market liquidity. Archarya and Rajan ( 2022 ) write: “In times of stress, the demand for liquidity can significantly rise and liquid commercial banks, desiring to maintain unimpeachable balance sheets, may provide only limited re-intermediation of liquidity and contribute significantly to liquidity shortages.” Given the prospect of higher interest rates and shrinking liquidity, we ponder the next group of banks below the top four moneycenter institutions, what we have named the “Half Ts” for banks near $500 billion in balance sheet assets. This includes Truist Financial (TFC) , PNC Financial (PNC) , Charles Schwab (SCHW) and U.S. Bancorp (USB), a group which deserves greater attention from investors and analysts. We exclude CapitalOne Financial (COF) because it is a monoline credit card issuer better compared to Citigroup (C). We wrote about COF before the New Year (“ Outliers: CapitalOne, Goldman Sachs & Citigroup ”). We also exclude the US unit of The Toronto-Dominion Bank (TD) at $513 billion in total assets because the relative performance is so poor for this deposit laden, loan poor regional mess. When will our friends in Canada learn not to buy second-rate community banks south of the border in an effort to build enduring market share? American consumers have no brand loyalty when it comes to banks. Zero. And US consumers are smarter and more aggressive on interest rates and other product features than ever before. Just ask the folks at COF or USB who spend big on customer acquisition and retention. Since USB is consistently the best performer among the top-five money center banks, the obvious question is whether any of the other half trillion-dollar banks can compete with the $600 billion moneycenter from Minneapolis. Among the larger banks, USB typically has higher credit losses, but employs better operating efficiency to deliver above-peer results. USB is down about 25% over the past year, but is still trading at 1.6x book value as the year begins. This is not cheap, but reflects the refugee mentality affecting many managers who seek shelter in large bank stocks. Source: FFIEC As we note above, USB has historically had a higher loss rate than its larger peers and also compared to the next five banks in the group. Notice that all of these institutions saw net charge-offs fall during QE. Now we expect to see this process reversed as the Fed effectively becomes a net seller of bonds and credit. In other words, we look for banks generally to report 2x growth in net credit losses over the next 18 months. In the event, the credit loss numbers are still low by historical measures, but will impact earnings just the same. Obviously SCHW is the lowest loss institution in the group because the bank really does not take credit risk. The loan book is just over $100 billion of the bank’s $577 billion in assets, including $25 billion in 1-4 family loans. If anything, we’d like to see SCHW take a tad more risk. The table below shows operating efficiency for the largest US banks. Think of efficiency as the cost of revenue, thus a lower number means more of each dollar of revenue falls to the bottom line. Note that SCHW has the lowest efficiency ratio of the group. Source: FFIEC Compare this picture at SCHW to TD, which is primarily an investment manager outside the US, but has acquired an under-leveraged regional banking business in the US (“ Profile: Toronto Dominion Bank ”). TD USA has a small, middle market loan book and above-peer net credit losses, but just 1/3 of the balance sheet is lent out. The other 2/3s of TD USA's $500 plus billion in assets is securities. At 9/30/22, TD had negative $10 billion in unrealized losses on non-portfolio assets. If you perform a conservative mark-to-market on TD USA's retained securities portfolio, the bank is arguably insolvent. When we turn to the loan book of these institutions, the difference between large and small banks quickly becomes apparent. The comparison of gross spread on loans and leases is led by Peer Group 1, which represents the simple average of the 132 bank holding companies above $10 billion in the peer sample. Smaller banks have been gross loan yields than do larger banks, which are forced to chase larger, less prime assets to fill balance sheets. Next comes TFC, which is finally emerging from years of operational problems involved with the merger of BB&T with SunTrust Banks. TFC is down 30% over the past year and currently trades around book value in the equity markets. USB comes next, followed by PNC near the bottom of the group and finally SCHW. Source: FFIEC During the period of QE, banks saw yields on loans and leases fall by over 1%, driving down both asset and equity returns. As interest rates now rise back towards average levels, gross yields are also rising but not quite as rapidly as funding costs. Outliers such as SCHW still have an enormous advantage in terms of funding. The chart below shows interest expense vs average assets for the group. Source: FFIEC The first thing to notice about the chart is that funding costs for USB and Peer Group 1 are rising much faster than for TFC, PNC and of course SCHW. One big reason for this is that USB has seen a dramatic shift from noninterest-bearing deposits, this even as total deposits have grown to over $470 billion. At Q3 2022, USB had $600 billion in assets, a remarkable statement about asset inflation in the industry. Whereas USB historically managed to keep assets below $500 billion and funding costs below peer, today the demand for returns is pushing up funding costs for most – but not all -- banks. The USB case is driven by acquisitions. Notice that PNC has a substantial funding advantage over the group, but relatively poor pricing on loans. SCHW is still below 15bp cost vs average assets, one of the lowest funding expense lines in the entire industry. The bottom line is shown with net income to average assets, a measure of the overall financial performance of the members of the group. This chart illustrates the compression of income across the industry during QE, a process that is only starting to reverse as 2023 begins. We expect to see additional improvements in net income in the Q4 2022 results, but the key relationship to watch continues to be rising funding costs vs asset returns, which are net of credit costs. Source: FFIEC We should note that the asset returns shown in 2019 were relatively normal, although the FOMC was in the market acquiring securities. Returns fell sharply in 2020 due to the allocation of $60 billion in provisions for future loss. The return of these loss provisions to income resulted in the sharply higher asset returns in 2021. As we have noted in previous missives, 2022-2023 performance measures for US banks are likely to be closer to normal than the preceding several years. For our money, readers pondering exposure to bank common equity might consider names such as TFC and PNC for the simple reason that they have more room to grow on the upside and less downside risk in terms of Wall Street exposures and sheer size. For many banks, QE was a tax whereby the Fed subsidized debt issuance by the Treasury and saddled banks with useless short-term reserves that the central bank is now taking back. Meanwhile, the Federal Reserve System itself is insolvent to the tune of several trillion in unrealized losses and the interest rate mismatch on reserves will ensure operating losses for years to come. Disclosure: L: CVX, CMBS, NVDA, WMB, JPM.PRK, BAC.PRA, USB.PRM, WFC.PRZ, WFC.PRQ, CPRN, WPL.CF, NOVC, LDI, SWCH 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.

January 9, 2023 | We caught up on a lot of reading over the holiday, particularly the growing pile of losses due to crypto fraud and other schemes fueled during a decade of quantitative easing (QE). The excesses displayed by our colleagues on the Federal Open Market Committee are of course massive, but the childish naiveite and ignorance displayed by American investors, their advisors and bankers, and public officials is equally monumental. “Creditors of the bankrupt cryptocurrency lending platform Celsius Network suffered a setback on Wednesday after Judge Martin Glenn determined that user funds trapped on Celsius’ Earn product belong to the debtors’ bankruptcy estate,” reports William Farrington of Proactive Investors . No dear readers, this ruling was neither shocking not disappointing. It’s just the law and it tracks the recent experience with another famous fraud, Bernie Madoff. “This is totally unsurprising,” notes our friend Fred Feldkamp , one of the fathers of the “true sale” in the 20th Century and retired partner at Foley & Lardner in Detroit. Fred muses: “In short, the judge found that investors in crypto owned by Celsius are, by contract and in law, just unsecured creditors of Celsius, the institution that owned the crypto.” There is no claim possible on the non-assets in the various crypto frauds, proof positive that there was never any substance to these electronic beanie babies. Collectibles at least qualify as "assets." The court ruling in the Celsius bankruptcy tracks the earlier finding that Madoff investors had general claims against the Madoff firm, not rights to specific assets, real or imagined. As unsecured creditors they will collectively challenge any secured creditor of Celsius, especially any insider claiming to be a secured creditor, under fraudulent transfer law. Unsecured creditors also will likely force any money insiders received to be repaid --to the extent the insiders are solvent. In other words, those residual claims on crypto issuers that have been trading at pennies on the dollar may have no value whatsoever . “If the bankruptcy is run as well as was the Madoff case, there may still be some recovery,” Fred concludes. The big question of course if how state and federal regulators, as well as elected officials in both political parties, did not see that the entire construct of crypto currency was at best a form of money laundering and at worse outright fraud. There was no segregation of accounts, no internal controls, none of the consumer protections that are already part of existing law and regulation. The crypto craze was merely a repeat of the chicanery and get rich quick schemes of the Roaring Twenties portrayed in the Great Gatsby with a tech veneer. Fitzgerald portrays 1920s America as a world where speculation and gossip about the latest investment scheme spread rapidly, often based on no actual knowledge of the situation. Fractional interests in Florida real estate and distant oil wells were just some of the come-ons of that era. In the 1920s, Charles Ponzi created a vast scheme from the simple beginnings of postage receipts. Most participants lost everything. Sound familiar? The era of the 2010s looks remarkably about the "single window" worldview in Gatsby. To expect Celsius or FTX or any other crypto scheme to end up differently from near 100% loss for the unfortunate “investors” would be unreasonable. But we live in the age of unreason, the age of the dilettante where one regulator or politician is more ignorant of the law or markets than the next. Washington is filled to the brim with articulate incompetents, conflicted agents who always put their own interests first and foremost. And federal bank regulators are still months behind the curve in terms of how the collapse of crypto could impact insured financial institutions. We expect a number of small banks to fail or be acquired as a result of crypto losses, but this is only one aspect of the crypto collapse. The losses borne by crypto investors are instructive for professional investors, particularly those foolish enough to purchase “participations” in various types of real and surreal assets since 2008. The same harsh rule imposed on victims of crypto fraud also applies to investors that buy standard “participations” in loans, mortgage servicing rights or other assets The investors think they own prior rights to the “participated” assets when, in fact, they are merely unsecured creditors of the participation “seller.” In the early 1980s, the collapse of Penn Square Bank proved that participations are often unenforceable, as we wrote in American Banker in 2016. Whether the investor faces a bank or a nonbank issuer, the likelihood of collecting on participations post-default is nil. In effect, buyers of crypto tokens issued by a corporate entity face precisely the same situation as the general creditor of a failed bank or nonbank. One of the first questions that the Federal Deposit Insurance Corp asks new receivers is about rejecting contracts, including loan participations. Trustees in bankruptcy have the same power to reject claims on behalf of the bankruptcy estate, but lack the power of a federal Receiver to pursue third parties. We’d be surprised not to see a Receiver appointed in the FTX bankruptcy and other crypto defaults given the vast array of schemes used to defraud investors. Even as the Trustee in the FTX bankruptcy rejects claims upon the failed company, they will aggressively pursue those parties that benefitted from the fraud to the detriment of the estate. Politicians that received campaign contributions from Sam Bankman Fried will soon be hearing from the Trustee in the FTX matter, demanding repayment of all funds received. News reports suggest that federal prosecutors appear to be focusing on possible wrongdoing by cryptocurrency executives , rather than by Democratic or Republican politicians, but the US Trustee is solely concerned with recovering money to the estate of bankrupt firm. Just as Irving H. Picard , a partner in the law firm BakerHostetler , recovered millions for victims of the Madoff fraud as Trustee , the professionals assigned to these new frauds will follow the very same playbook. Watching clueless politicians in Washington deal with the blowback from the collapse of crypto is likely to be a great entertainment value. Take Senator Kirsten Gillibrand (D-NY) , who reportedly “donated” the funds received from the FTX fraud to a nonprofit. The Trustee will seek repayment nonetheless. Indeed, Gillibrand may now cause the charity to be sued by the Trustee as well. Just as Sam Bankman Fried had no right to contribute stolen customer funds to political campaigns, Senator Gillibrand has no right to donate these stolen customer funds to a not-for-profit as a means of redemption. Duh. The folks at MarketWatch have assembled a handy list of politicians who took money from Sam Bankman Fried . But unlike the Madoff fraud, banks and other Wall Street institutions were forced to cooperate with Irving Picard and even write some big checks that otherwise might not have been written in a less prominent case. The Trustee in the FTX case lacks that larger stage that the Madoff fraud created and Picard played skillfully to recover funds. Since the folks on the FOMC refuse to allow a true debt deflation to flush the fraud out of the financial system and thereby inoculate investors against acts of ridiculous stupidity like “investing” in crypto tokens, we repeat the old mistakes with renewed fervor. Incredulous members of Congress held hearings about “regulating” crypto as though oversight could make fraud somehow acceptable. And now, as in the early 1920s, new era frauds are unravelling with growing collateral damage to the financial world. Ponder this excerpt from a filing in the FTX bankruptcy in Delaware: "On December 23, 2022, the Joint Provisional Liquidators filed the Motion seeking, among other things, to have $143 million of funds (the “U.S. Funds”), which are currently being held in bank accounts at Silvergate Bank and Farmington State Bank d/b/a Moonstone Bank (two small fintech banks), transferred to “one or more financial institutions that are better capitalized and/or have less direct exposure to class actions suits or other claims relating to the FTX matter.” The collapse of crypto illustrates just how conflicted and ineffective supposed “regulators” have become over the past century. Progressives fashioned regulators as a tool to protect consumers from the rapacious behavior of the Robber Barons, who controlled the courts in the 19th Century. Today, regulatory agencies are populated by aspiring politicians who lack any true understanding of how current law already regulates and arguably prohibits crypto tokens. The stunning failure of regulators and elected officials to prevent the great crypto heist shows that the courts -- not regulators -- remain the last effective institutional protection for Americans. Democrat Representative Maxine Waters (D-CA) even expressed disappointment following the arrest of Sam Bankman-Fried, the former CEO of collapsed FTX. The total failure of regulation to prevent the crypto craze is something to ponder in the weeks and months ahead as the true cost of crypto is reckoned. Fortunately, the US Bankruptcy Court will provide a documentary record of each of these transparent frauds and the victims. 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.

December 22, 2022 | Premium Service | Earlier this week, the Government National Mortgage Association (GNMA) and Federal National Mortgage Association (FNMA) exercised their legal authority to seize government-insured reverse mortgages from the estate of Reverse Mortgage Funding (RMF) , a lender that filed bankruptcy November 30th. The US government now owns the largest reverse lender in the country. We previously reported on this event of default for subscribers to our Premium Service (“ RMF Bankruptcy Signals Systemic Risk in GNMA Market ”). These involuntary transfers and extinguishment of servicing rights by GNMA and FNMA make RMF the most significant event of default in the government loan market since the collapse of Taylor, Bean & Whitaker in 2011. This busted auction and asset seizure of home equity conversion mortgage (HECM) loans involves banks and non-banks, and may be a precursor of larger disruptions in the credit markets. But the Federal Open Market Committee ultimately must take the blame for this widening mess. The unraveling of the liquidity in the reverse space began with non-agency products, which lost liquidity first and foremost as the Fed raised interest rates hundreds of basis points, widened spreads and boosted volatility 2x. This added to pressure on the liquidity of RMF and the industry as a whole. Mortgage banks face an already difficult market environment due to low origination volumes and increasingly selective buyers of mortgage paper like HECM tails. “The transfer of servicing for RMF loans should have minimal direct impact on affected borrowers," Ginnie Mae President Alanna McCargo said in a statement . "Borrowers will receive a notification about the transfer of servicing as required by law, but that will not affect the payment schedule and borrowers should expect to continue to receive payments as usual.” Last weekend, a group of parties apparently was attempting to pull together funding to recapitalize the RMF business and, more important, fund the buyout of some $90 million in HECMs that had reached maturity in GNMA pools. In addition, the ostensive buyers of RMF needed to fund hundreds of millions in existing advances to reverse mortgage borrowers. Another problem several investors cite was that junior tranche buyers had backed away from the market for HECM tail interests, making the buyout task even more problematic without a take-out for the tails and the notes. In November, RMF had only been able to finance its buyout obligations via an emergency financing provided by affiliates and existing MSR lenders Nomura (NMR) and Leadenhall Capital . A partial list of parties is shown below: When it became apparent that RMF could not meet its future obligations, this led to the bankruptcy filing at the end of November. Since the filing, a variety of existing parties and new entrants attempted to negotiate an arrangement to fund the business and particularly fund buyouts of mortgages in December and going forward. These efforts were unsuccessful. In addition, once RMF notified its customers about the bankruptcy filing, clients immediately drew the maximum amount of cash advances on the HECMs. GNMA and the US Treasury now own these notes and are on the hook for hundreds of millions in expenses to cover the cash-flow needs for RMF. Over the next six months, the RMF portfolio could cost the US Treasury hundreds of millions. When efforts failed over the past weekend, the secured parties including GNMA and FNMA moved to seize the assets from the bankruptcy estate and finance the buyouts from the pools. This process surfaced Wednesday in the filings with the Bankruptcy Court, when FNMA formally asked the Court to lift the automatic stay for the purpose of transferring assets and terminating a lending relationship. GNMA is already exempt from the automatic stay by statute and did not seek Court permission. The event of default by RMF highlights some of the more glaring structural deficiencies in the federal market for reverse mortgages. In basic terms, reverses are a difficult product in a stable rate environment, but the recent moves by the FOMC to raise rate have rendered the situation impossible. Legislation is needed to provide government liquidity support for the government loan market. Duh. In terms of immediate fallout, the two secured lenders, Texas Capital Bank (TBCI) and Credit Suisse (CS) could face significant losses as a result of the involuntary transfer of the HECM and other assets. When a transfer occurs, the "secured" lender typically then is left with an unsecured claim on the bankruptcy estate but the loan and attached servicing asset is gone. TCBI is the leader in the space and, according to the web site , provides “credit facilities to support HECM lenders, offering lines for both HECM Tail Financing and HECM Ancillary Financing.” Other than the Liberty unit of Ocwen Financial (OCN) , TCBI reportedly has most of the warehouse and buyout exposure in the reverse sector. Significantly, OCN does not deal in non-agency reverse mortgage products and is arguably the strongest issuer in the reverse market today. Another big unanswered question is what becomes of the US business of Credit Suisse. Since the bank announced a transaction with Apollo Global Management (APO) , there have been continued questions about the role of other firms in the investment and particularly the disposition of the GNMA exposures of CS. More broadly, the exodus of bankers from CS over the past six months raises big question about what Wall Street bank is willing to play the role of facilitator to to the financing market for government loans and MSRs. The trouble with all government loans, forwards or reverses, is that you as a lender never have a clear collateral lien on the asset. Since the creditor cannot bifurcate the FHA-insured loan from the arguably private servicing asset, and since HUD and GNMA have an unassailable statutory position as creditors, lenders essentially hold an unsecured asset. Indeed, all of the financing transactions for MSRs are structured as “participations” and explicitly state that the issuer is the primary credit. The big question raised by this event of default is the state of the market for government assets going forward. Several investors told The IRA that RMF was not able to float a financing of HECM tail pieces, US guaranteed paper that is routinely marketed in private transactions. If issuers cannot liquefy these government obligations in due course, then the whole government mortgage space is in jeopardy. But the bigger threat to the mortgage industry is that policy makers will see the failure of RMF and the action by GNMA as an indictment of nonbank mortgage firms instead of a call to action for legislation to fix the glaring deficiencies in the government loan program. The idea that either a bank or nonbank can provide funding to the FHA market when the Fed is moving interest rates hundreds of basis points in less than a year is absurd. The US government needs to provide liquidity support to the government loan market! Duh. 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.

December 30, 2022 | As we move into 2023 and nine months since the end of quantitative easing (QE), a few prognostications seem appropriate about the road ahead. We’ll be writing in more detail about these and related issues starting next week. Look for our first focus report on the “Half Ts” – the growing group of US banks in the $500 billion asset category. Mortgage Finance : Analysts predicting death and destruction in the world of government-insured mortgages and Ginnie Mae may be disappointed in 2023. Sure, we will definitely have some interesting asset sales and even some events of default in the government market. And yes, Uncle Sam does now own the largest government reverse mortgage portfolio in the US (“ GNMA, FNMA Seize Assets from Reverse Mortgage Funding Estate ”), but the key point is that Treasury has the cash to fix such problems. Right now, cash is king. It was more than a little amusing to see market-leader SitusAMC complaining about an “Unnamed MSR advisory firm not helping the bulk MSR market” by hitting low bids for servicing assets. The battle between bulls and bears in the loan and MSR channels will intensify in 2023. Look for buyers and sellers to converge in the second week in January. Also look for the dwindling number of lender banks to increase haircuts on both asset classes. The impending collision between buyers and sellers begs the question, namely what happens to the US banking business and the $20 billion or so in Ginnie Mae MSR exposures at Credit Suisse (CS) ? More than any real or perceived risk of contagion in the government space, the fate of this key MSR advisory business will determine how mortgages get through 2023. Note that most of the MSR financing deals brought by CS in the past five years are maturing with no roll in prospect. Forced deleveraging. Not a word yet from CS, of note, on losses due to the Ginnie Mae seizure of Reverse Mortgage Finance’s loan book. Yet while the government market may seem problematic, the $140 billion in capital behind FHA's insurance fund and the unconditional Treasury backing for Ginnie Mae says no biggie. Instead, we believe that the GSEs – Fannie Mae and Freddie Mac – will actually be a bigger source of potential systemic contagion and political blow-back on the Biden Administration in 2023 and 2024. Q: How’s it going to look for President Joe Biden’s 2024 re-election campaign if Treasury is forced to rescue Fannie Mae and/or Freddie Mac – again -- in 2023? As we’ve noted previously, the GSEs are going to redeem all of their debt capital over the next several years. Meanwhile, defaulted loans are accumulating on balance sheet of both GSEs supported by limited funding. Will the GSEs be forced to obtain commercial bank advance lines for defaulted assets held on balance sheet? Source: Bloomberg Bank Earnings : As 2023 begins, bank stocks are probably near the highs in terms of book value and actual earnings in our view. Buy Side advisors may still decide to buy JPMorgan (JPM) at 1.5x nominal book equity and tell their clients that this represents good value. Although the SOFR-OIS spread is well-off the highs of November and nowhere near 2020 much less 2008 levels, we expect that to change as default events accumulate. As we noted previously (" Is JPMorgan Insolvent " ), just what is the book value of JPM anyway? Since 2008, the swings in the SOFR-OIS spread have lessened with each liquidity crisis, perhaps due to QE. Over the course of the next year and more, as financials spend capital earned in 2021 to deal with mark-to-market losses on available-for-sale assets and credit costs (and loss-leader asset sales) from the retained portfolio, we suspect book multiples will rise as reported capital falls -- and even if stocks tread water at current levels. Bottom line: Balance-sheet shrinkage from QT and weak loan demand, along with voluntary and involuntary asset sales, will contribute to a significant shrinkage in the size of the capital and assets of the US banking sector in 2023. Banks could easily run off $2 trillion in deposits over the next 24 months as QT continues. Credit costs are rising and lending volumes are falling, two data points that suggest operating efficiency and headcount reductions will be the dominant themes on Wall Street in 2023. The trading side of the ledger will be especially sparse, one reason why Goldman Sachs (GS) and other traders are in the midst of a serious retrenchment. Credit Costs : One of the questions we hear most from readers of The Institutional Risk Analyst is when will reported credit losses revert to the LT averages and start to track the level of disruption and volatility that we all see in the real economy? Our basic answer is that the process will take at least as long as the most intense period of QE between March of 2020 and March of 2022, but we all need to remember that QE started a decade before . Our internal estimates suggest that loss-given-default for bank-owned 1-4s will not really normalize until 2024 or later. This same normalization process will also affect commercial exposures. Source: FDIC/WGA LLC Home Prices : Our favorite mortgage banker still does not expect a maxi-housing market reset until 2027. First, once the screams from the asset gatherers reach a crescendo later in 2023, the Fed will drop interest rates modestly. This easing will be followed by a mini-home price rally and lending boom through the election and into 2025. That late vintage production, however, soon thereafter will be engulfed by a big-time home price capitulation in 2026 or 2027 that takes us down to 2020 price levels. LTVs will soar over 100%. Basically, mortgages made from today through the reset before the end of decade will be underwater for years thereafter. EVs, Crypto & Meme Stocks : One thing that most people still cannot see is the connection between the crypto craze and mania-related, stocks most notably Tesla Motors (TSLA) . The US markets are still recovering from 2008, yet we are unable to articulate this reality for fear of violating the progressive narrative. Stock prices don't care about narratives, so now TSLA is trading at 25% of its value a year ago, a little better than bitcoin. Now that the leading EV stock has fallen to earth and its CEO is busily destroying his latest acquisition, Twitter (TWTR) , the cost of financing EV production and infrastructure is likewise going to normalize. Progressive zealots are about to get a lesson in economics, cold-weather physics and power grid management. Fact is, without QE the EV revolution is out of gas. As we never tire of reminding our readers, 120 years ago Thomas Edison told Henry Ford to use gasoline for his cars for a very good reason. Both men wanted to build electric cars and both realized that the technology of their era made electric cars with batteries impractical. In a century since that time, nothing has changed except the efficiency of modern motors and electronics. The physics of using batteries for propulsion still sucks and EVs with lithium batteries are even worse. Without huge and continuing subsidies, it is difficult to see how the EV sector will survive – especially with electricity costs now making conventional vehicles in Europe and elsewhere more practical. We were especially delighted to see Toyota Corp (TMC) CEO Akio Toyoda reject the reckless EV narrative and reaffirm “his strategy to continue investing in a range of electrified vehicles instead of going all-in on all-electric cars and trucks,” reports CNBC . “Just like the fully autonomous cars that we are all supposed to be driving by now, EVs are just going to take longer to become mainstream than media would like us to believe,” Toyoda said in remarks to dealers. “In the meantime, you have many options for customers.” Toyoda then continued, illustrating the authoritarian nature of the progressive EV agenda on the environment : “People involved in the auto industry are largely a silent majority. That silent majority is wondering whether EVs are really OK to have as a single option. But they think it’s the trend so they can’t speak out loudly.” What is becoming clear about EVs is that governments around the world lack the financial commitment to even begin to make battery vehicles practical and reliable for consumers. Like TSLA stock, the EV industry is going to become the ward of China and other regimes willing to subsidize it. This chart of TSLA is a perfect visual representation of QE and its extraordinary effects on markets. It does not seem unreasonable to say that TSLA could retrace all the way down to pre-2020, pre-COVID craze levels. At that level, will TSLA be able to survive in the global auto industry? Tesla Motors Source: Bloomberg Interest Rates & the Dollar : Even as the Federal Open Market Committee talks about fighting inflation and further increases in short-term interest rates in 2023, the Treasury yield curve and the related market for dollar swaps is rallying. The FOMC is seeking to tighten a market that is awash in cash, thus the yield curve looks like an inverted salad bowl. What does a negative swap rate mean? Counterparties are willing to exchange fixed dollar payments for floating rate payments at yields below Treasury yields beyond about five years. You can buy a Treasury bond, swap away most of the coupon payment and pocket a profit. The Fed is holding up short-interest rates, but the swaps curve beyond five years is headed lower in yield. There is, as yet, no sign of pressure on US interest rates or the dollar. The blue line below is the Treasury yield curve, while the green line shows dollar swaps. Source: Bloomberg In the near term, we are not impressed by arguments from Zoltan Pozsar and others predicting the demise of the dollar in favor of a commodity-led cartel comprised of failed police states such as Russia, China, Iran and the OPEC nations. In fact, demand for dollars from “mainstream” nations around the world, places where investors would actually domicile assets, is growing. Nobody wants to domicile assets in China, Russia or Iran unless they are subject to US sanctions. We do, however, look forward to the day when some special act of fiscal idiocy coming from Washington will force the dollar swaps market back to a premium over Treasury yields. Timothy Geithner and Janet Yellen think that limiting access to the Treasury debt market helps boost liquidity, but in fact limiting federal deficits is more important. A change back to the pre-2008 market situation in dollar swaps will be a sign that the world is tiring of the inability of Congress to eliminate fiscal deficits and otherwise behave seriously. To paraphrase the cuckolded movie mogul in The Godfather , on that day when US swaps spreads again turn positive, that is the day that we can no longer afford to look ridiculous. On that day when US risk spreads are again positive, America will start to slide toward the status of troubled debtor nation. Yet it must be said that a US debt default, not the actions of dictators in China or Russia, will destroy the dollar system for international trade and finance. The aftermath of a US default will be something that looks like global finance prior to WWI with the added functionality of the internet and attack drones. In the event of a US sovereign debt default, the world would fall back into the dystopian world described by Poszar and many other analysts in the dollar doom community. This would be a world with zero leverage and commodity barter as the basis for global commerce. America would revisit the horrors of debt deflation of the early 1930s but with social media. Since most analysts never ponder the offshore aspects of dollar finance, the doom scenarios flourish amid a sea of sensational ignorance. Contrary to the doom crowd, in fact the dollar has become even more dominant since the 2008 financial crisis. Thus the inverted swaps market. We fancy that the market power of the private US economy and the freedom of its people will survive even the future acts of foreign dictators or bipartisan stupidity coming from Washington, and thereby preserve the dollar system a little while longer. Happy New Year. 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.

December 20, 2022 | Premium Service | A couple of readers have asked questions about some of the more volatile banks in the group, particularly Goldman Sachs (CS) and Capital One (COF) . These are two specialty banks that are long on market and credit risk and short on stable core deposit funding. Add to the list Citigroup (C) , a mostly offshore, two-legged stool of a global bank with capital markets married to consumer finance, but no asset management to add stability. This ragged band of misfit toyz comprise the outliers on our bank surveillance list as 2022 ends. COF is an obvious outlier because it is basically a national monoline credit card issuer with some purchased retail and commercial deposits. The probability of default P(D) for COF has doubled since November to 165bp or 2x JPMorgan Chase (JPM) . The equity is down 40% YTD and is trading at ~ 0.7x book value. Most of the large banks have seen CDS spreads widen as equity prices have fallen. As of Q3 2022, COF’s cost of funds was more than 2x Peer Group 1. COF makes up for this differential because the yield on its loan book is almost 10% vs 4% for the banks in Peer Group 1. Net loans losses were 1% vs less than 0.25% for most large US banks in Q3 2022. That may seem like a lot, but we can recall when COF peaked at 11% gross charge-offs in 2009 and yet survived. The loss given default number in Q4 2009 for the whole US banking industry was 3% net loss after recoveries, which gives you a sense of the risk on COF’s book at 11%. In Q3 2022, COF’s provisions for loan losses were up 54% YOY to $1.6 billion. The chart below shows the net loss rate for the outliers along with the average for Peer Group 1. Source: FFIEC As you can see in the chart above, COF has a higher net loss rate than the rest of the group. The top five money centers are well below the loss rate for GS, which we discuss below. That high loss rate is why the $440 billion asset COF has 12% capital and sufficient earnings coverage to absorb significant losses. And the good news is that COF’s core deposits, while expensive, have remained stable abound $300 billion for the past five years. When we next move on to Goldman Sachs, the picture is more troubled. GS has a credit loss rate 2.5x Peer Group 1 and far above the rest of the Wall Street group, who generally don’t take credit risk. GS manages to lose more money on loans per dollar of assets on a smaller book than its larger peers. The CDS spreads for GS are wide of JPM and the other money centers at 100bp, but the firm trades on a > 1 beta, illustrating the low volume in GS vs peers. The investment banking firm had pre-announced significant headcount reductions as well as caps on bonuses for the survivors. Part of the reason for this austerity is that like most nonbanks (and GS is predominantly a nonbank), volumes are falling and funding costs are rising. In fact, GS has higher funding costs that does Capital One or Citi on a consolidated basis and 300% of the average for Peer Group 1. Source: FFIEC Notice that Goldman is leading the outliers up in terms of funding costs, even above that of both Citi and COF. This is a remarkable distinction. While COF had good core deposit coverage of assets, Citi is still one-third offshore funded and yet still has lower funding cost than GS. When you put the planned layoffs at GS in the context of a company that is seeing its cost of doing business rise while revenue falls, then you understand the dilemma facing the CEOs of every nonbank finance company in the US. The next factor in the analysis in terms of these companies as lenders is the gross spread on the credit book. The chart below shows that COF has significantly more spread on its book that do either Citi or GS, but it also has commensurately higher credit losses. The earnings power that Citi and COF have in their double-digit yield on their credit card books makes up for a lot of sins, but rising costs for loss provisions are already starting to take a bite out of earnings. Notice the poor pricing of the GS loan portfolio during COVID. Source: FFIEC All of the financial metrics come together in net income, which is shown below as return on assets. Notice that Citi has the poorest performance in the group and has done for some time, a clear indication of the factors behind the bank’s poor performance in the debt and equity markets. Citi is currently trading below half of book value and is just below 100bp in CDS. GS is second from the bottom and below the average for Peer Group 1, another remarkable achievement. Source: FFIEC All of the outliers display the upward skew in income in 2021 due to COVID and the period of massive bond purchases by the FOMC. Now as credit costs and interest expense normalize, these firms and indeed all financials will be giving back capital to offset operating losses due to falling volumes. This trend will place increasing weight on operating efficiency, as shown in the table below. Notice that COF has a several point margin in terms of operating efficiency. Source: FFIEC Not only does COF have better operating efficiency than most of the banks above it in size, but the consumer lender has a very small footprint in the casino of OTC derivatives. While GS and Citi have derivatives books that are thousands of percent of total assets, COF is in line with the average for Peer Group 1. That is why, for our money, if push comes to shove, we like COF’s market position and liquidity better than Citi or GS. Source: FFIEC Ponder the fact that Goldman Sachs feels the need to maintain an OTC derivatives book that is 2,500% of their total assets of $1.5 trillion. Indeed, GS has the largest derivative book on Wall Street. We own the Citi TRUPS and preferred from some of the other larger banks, but continue to stay away from the common. All of these banks are likely to spend capital over the next year or two as the long strange journey know as quantitative tightening continues. Fact is, long-term interest rates have been falling for the past several months, but we think that trend is likely to reverse in the New Year. 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.

December 16, 2022 | A number of observers are providing their prognostications about 2023, but we’d like to review what we learned in 2022 and then ponder what happens next. Along the way, we’ll take a victory lap or two for continuing to focus readers of The Institutional Risk Analyst on the actuals vs the often false narrative woven by the crowds of conflicted agents that populate Wall Street. And a big thank you and Merry Christmas to all of our readers! It is important to remember that America is a commercial society, starting with the media. Everything you hear in the US media is driven by a commercial interest, either of the publisher or some large advertiser or corporate sponsor. And all retail communication, including Wall Street research, advice from financial advisors, and the opinions of credit rating agencies and other third-party service providers reflect a commercial bias. One editorial objective of The IRA since its creation in 2003 has been to describe the difference between the hopes and aspirations of Wall Street as expressed by this chorus of conflicted agents and the actual results reported in the data. Sadly, most commercial vendors care less about quality and accuracy than one might hope. In this sense, in the decades we’ve worked as consumers of financial data, nothing has changed. In June of this year we raised questions about how Wall Street data providers like Bloomberg don’t accurately resolve the charade of “non-controlling interests” in calculating equity market value and its derivatives (“ Memo to Gary Gensler: Beware the “Non-Controlling Interest ”). We wrote: " The result of errors in calculation and/or presentation, however, can also allow issuers of securities to mislead investors. Just because the presentation of the data is allowed under GAAP or industry convention does not mean that it is not misleading. Whenever you simplify a piece of data by aggregating it into a derived metric like a P/E ratio or price multiple, fidelity and context is lost. And all too often the presentation of value is incorrect because the global providers of financial data are ignorant of context and the always moving target of GAAP accounting as interpreted by accountants and lawyers." Today, for example, United Wholesale Mortgage (UWMC) and Rocket Mortgage (RKT) show MVE and price/book value ratios that are clearly wrong, yet despite several attempts by this terminal user, Bloomberg refuses to address the presentation error. As a result of this blog post, The IRA was contacted by a senior columnist at The Wall Street Journal , who prepared an article based upon our comment. That writer confirmed our research that there are dozens of public companies using the non-controlling interest canard to mislead equity investors, a ruse that the major data providers refuse to address. Fact checking was done. Yet just hours before the article was to be published, it apparently was killed by the Journal’s editorial staff. The lack of clarity and fidelity in published data on public companies helps issuers confuse retail investors, but the larger ebb and flow of interest rates and monetary policy has created some huge distortions in terms of equity market values. Add the techno babble of “fintech” which bloomed during the latest round of Fed bond purchases in 2020 and the stage was set for incredible volatility in stock prices. At the end of 2021, we asked if Block In (SQ) was really worth 25x book value “ Update: Block Inc. & Upstart Holdings .” At the time SQ was trading over $170, but today it is closer to $65. We focused on the financials, but provided context in terms of the impact of QE on this fintech name and the market more generally. SQ is down 62% YTD. In January of 2022 we began to describe the post-QE deflation and how the process of ending the Fed’s massive open market operations would hurt equity market and bond valuations at the same time (“ Powell, Yellen, Bernanke and Post-QE Deflation ”). We wrote: “It is becoming pretty clear that the FOMC has lost all credibility when it comes to financial markets or managing inflation. Market stability, lest we forget, has been a managed concept since 2009, thus when the FOMC decided to explicitly lean in the direction of "liquidity" (aka inflation) and forget the rest of the Humphrey Hawkins mandate regarding price stability, the cost was paid in credibility. Of course, there is a 1:1 correlation between the Fed's credibility and its loss of independence from the US Treasury, the primary beneficiary of QE.” By February of 2022 we revisited Silvergate Capital (SI) , a high-flying bank crypto stock that was trading at 12x book value in Q1 of 2021. Today the bank is down over 80% for the year and is at 0.45x book value. We wrote: “In the world of financials, Silvergate may be among the biggest meme stocks yet in the era of quantitative easing or QE.” A little over a year ago, we profiled Raymond James Financial (RJF) for subscribers to our Premium Service . Since last year, RJF has been leading the group we lovingly refer to as the “asset gathers,” banks that focus on the investment advisory business, eschew credit risk and amass vast amounts of liquidity as a result. Even as most financials have given up significant ground in terms of valuation, RJF has managed to actually go up slightly in 2022. Most recently, we focused our readers of the impact of the end of the Fed’s massive purchases of Treasury paper and MBS on book value reported by banks, REITs and other investors. In “ Loan Delinquency, EBOs & Ginnie Mae MSRs ” we described how rising interest rates were eroding stated book value and boosting the value of negative duration mortgage servicing assets. Two weeks later, we published our look at the entire US banking industry, showing that once accumulated losses on available-for sale securities, and a mark-to-market is done on portfolio assets, the US industry is essentially insolvent to the tune of $1.9 trillion. When we asked “ Is JPMorgan Chase Insolvent? ,” the answer sadly is yes. After the 2008 financial crisis, many banks and funds were effectively insolvent because the bid price on private mortgage assets had gone to zero. Even government mortgage assets were trading at distressed discounts. Banks were well-capitalized, but illiquid for a couple of years. The economy suffered through the 2010s as a result. As 2022 comes to a close, however, the banking industry faces a different challenge, namely a vast wave of market risk created by the FOMC and quantitative tightening (QT). The amen chorus on Wall Street likes to repeat the phrase "banks are well capitalized." Maybe not. Those in the Buy Side chorus who are looking forward to lower interest rates in 2023 ought to instead be concerned that next year could really be about a bank solvency crisis. 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.

December 12, 2022 | Premium Service | Craig Torres and Liz Capo McCormick wrote on the Bloomberg over the weekend: “Fed’s Long Hold Message At Odds With Market Bets On Rapid Ease.” So true. But the real issue facing investors and risk managers is that investment managers still choose to believe that the FOMC is in control of policy and the key derivatives, the dollar and equity market prices. When we look at the actual data, a very different picture of US interest rate trends emerges from the narrative in the financial media. The sharp drop in Treasury yields beyond two years suggests a significant shortage of available investments or duration. Indeed, since 2008, dollar swap spreads have traded below Treasury yields, suggesting a persistent demand for dollars coming from offshore. In fact, the global economy now dictates dollar interest rates. In basic terms, the difference between America under President Joe Biden in 2022 and Mexico circa 1994 is the continued use of the dollar as the means of exchange in global finance and commerce. But the role of the US as global backstop for the dollar market since 2008 is unprecedented and has accorded America a huge economic and financing advantage over the rest of the world. But for the special role of the dollar, which is fueled by new securities issuance and related money growth, the Treasury under Secretary Janet Yellen might be fighting a falling dollar with rising inflation. Instead, offshore demand for the dollar keeps LT financing rates below short-term Treasury yields and, most important, makes swap rates negative. Klingler and Sundaresan (2018) summarize the classical view: “Negative swap spreads are a pricing anomaly and present a challenge to views that have been held prior to the financial crisis that suggested that swap spreads are indicators of market uncertainty, which increase in times of financial distress… Therefore, swap spreads should increase in times of elevated bank credit risk.” Instead, no matter how much money the US borrows and spends, LT interest rates remain well- below short-term yields. The chart below shows the US dollar swaps curve as of Friday (green line) and a month ago (yellow line). Notice that the change shown below has the negative spread for longer dated dollar swap contracts moving far more than the short-term rates. Should LT US rates ever start to trade above short-term yields, then the US becomes a distressed debtor nation on the following day. Source: Bloomberg Klingler and Sundaresan posit that the negative swing in dollar swaps spreads since 2008 has to do with duration-hungry pension funds , an interesting but we think incomplete explanation of this dramatic shift in the terms of finance. Today US interest rates spike above 5% out to about 15 months, then fall dramatically with a brief upward spike at 2 years to about 4.5%, then again fall to 3.5% at ten years and then trend on down to 2.5% for 50-year dollar swaps. Does this look like a market that wants to go up in yield? No, in fact the credit markets are pushing yields down even as the FOMC talks about maintaining higher short-term rates for longer. Although the banks are net sellers of Treasury paper and MBS, and the Fed portfolio is running off, net demand for duration seems to be growing. The fact that there is no risk premium in dollars out to 50 years is both remarkable and troubling. Things do change. To us, the key question is not whether the FOMC will try to push fed funds higher but how much lower will the sheer demand for duration pull down longer maturities for bonds and swaps? We think the 10-year Treasury could again touch 3% yield, which implies LT swap rates below 2%. The same market volatility that is retarding new securities issuance could well result in significantly lower bond market yields. Looking around the financial markets, the supply of existing loans and securities is actually falling rapidly. Consider, for example, the announcement by PennyMac Mortgage Trust (PMT) that it is cutting its dividend and preparing to de-lever its balance sheet. Credit-risk transfer (CRT) deals at PMT and across the industry are headed for redemption, for example, again contributing to a net reduction in available duration. Even the banks and GSEs themselves will likely be de-levering over the rest of the decade. The false narrative that courses through the financial community says that the FOMC is raising interest rates. The markets are telling us that the rate for LT dollar financing is falling, as illustrated by a 2.5% rate for fixed to floating dollar swaps. The fact of falling issuance of new securities in the US and around the world suggests to us that Treasury yields beyond two years are more likely to fall in the months ahead. Have a great week. 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.