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September 12, 2022 | In this issue of The Institutional Risk Analyst, we feature a conversation with David Stevens , a two decade veteran of the residential mortgage market. David served as Assistant Secretary of Housing and Federal Housing Commissioner for the United States Department of Housing and Urban Development and later head of the Mortgage Bankers Association until 2018. We focus on the latest capital rule for mortgage banks from federal regulators. We also talk about the proposed acquisition of Black Knight (BKI) by Intercontinental Exchange (ICE) . The IRA: David, thanks for taking the time during a very hectic period in residential mortgages. Our friends at Ginnie Mae and the Federal Housing Finance Agency disrupted everyone’s Labor Day holiday for the second year in a row by dropping a new eligibility rule for MBS issuers in mid-August. The latest version, which we’ve dubbed the “McCargo Rule,” originates inside the risk function of Ginnie Mae. The rule is far more draconian than the Basel III treatment of residential loans and mortgage servicing rights (MSRs) for commercial banks. What is your take on this bizarre curveball from the Biden Administration ? Stevens: I have seen the numbers from several large nonbank lenders and what the new Ginnie Mae capital rule from Alanna McCargo means for their servicing books. One CEO told me last week that the one-year implementation schedule will put just about every Ginnie Mae servicer out of business. Oddly, the Ginnie Mae rule focuses on MSRs, which have never caused a single issuer to fail. Yet we don’t impose higher capital on non-QM loans or exotic residuals, which have caused firms to fail in the past. The IRA: Under the McCargo Rule, according to the work done by the trades, several large IMBs fail and most of the correspondent channel for smaller government lenders disappears. How does this serve the mission of HUD to assist low income borrowers? In the definition of "net worth," Ginnie Mae's risk function proposes to subtract the excess MSR from capital? This is totally nonsensical. We worked on the early iterations of Basel. This imitation is an embarrassment. Does Ginnie Mae want us all to get out of government lending? Stevens: The Ginnie Mae issuer rule is pretty draconian . A 20bp move in MSR valuations under even a modest stress test puts most IMBs out of compliance with the rule, which is an event of default under their warehouse and debt indentures. The IRA: Several large investors called us last week to ask if they should not be selling Ginnie Mae servicing before the McCargo Rule is made final. Without a change in the Ginnie Mae issuer rule proposed by President McCargo, we think many clients will attempt to exit investments in Ginnie Mae MSRs. A sale assumes a buyer, however. Do the people at Ginnie Mae understand how thin the secondary market is for government MSRs? You're lucky to have two bidders on most bulk sales. This proposal will kill the government MSR market. Stevens: Ginnie Mae used an outside consultant for the issuer capital proposal, so the RBC model does not make sense. If you subtract excess MSRs from net assets and get a negative number, that obviously is a problem. Your proposal in NMN earlier this week for Ginnie Mae to allow a 50% weight for excess MSRs is constructive but does not help several large issuers. President McCargo is not technical at all. I doubt she went through this model in detail, issuer by issuer. Frankly, she and HUD Secretary Marcia Fudge seems to have been sold a bill of goods by the career staff at Ginnie Mae. The IRA: Several issuers proposed an interesting idea after the NMN column was posted: Keep the proposed rule, as is, but allow two ways to meet the requirement: (1) The current rule with 6% adjusted net worth, exclude the excess MSR; or (2) require higher net worth of 9% and include the “excess MSR" and term unsecured debt with > 1 year to maturity in net worth calculation. Bank holding companies are allowed to use term unsecured debt to fund Tier 1 capital investments in bank affiliates. The table below illustrates the idea: Stevens: The implicit message from Ginnie Mae seems to be that they want net worth for government issuers closer to 10% than the 6% minimum in the rule, so let’s just raise the net worth number for the handful of big issuers that own most of the servicing and declare success. The FHFA proposal with the add-ons for pipeline hedging, for example, is the same thing. Let's put the net worth number for complex, large issuers where everyone is comfortable. The IRA: Agreed. The all-in cost of capital for most non-banks is in mid-double digits, so 9 or 10 percent minimum net worth for large issuers is fine. Moving right along from the sublime to the ridiculous, you’ve had a lot to say about the prospective acquisition of BKI by ICE. We wrote back in May of this year about the investment prospects ( " Does ICE + Black Knight = Shareholder Value? " ) , which seem a stretch given ICE’s lofty P/E multiple. BKI is a higher risk, lower P/E multiple busines than ICE. But the folks at ICE make so much money on the financial markets that taking over residential mortgages perhaps makes sense? What’s the deal? Stevens: This is one of the most high risk business takeovers that nobody is talking about. I am amazed that more institutions are not realizing what ICE + BKI implies for the industry, including OptimalBlue loan trading platform and the Encompass point-of-sale, and how much influence ICE will have on the entire mortgage finance system. Many issuers have strong views about this transaction, but the market power of ICE and BKI intimidates most into silence. There is naturally a bit of paranoia, which our industry is known for, and also some outright fear of what this combination could mean in terms of access to new technology. Lenders are intensely concerned about what could happen to them in terms of cost or service levels if they speak out against this transaction. The IRA: Well, BKI is the incumbent monopoly in the conventional servicing market for IMBs clearly. The legacy Fiserv (FISV) product still has a defensible position in banks, but some players like Flagstar (FBC) adopted BKI's MSP platform due to large correspondent and sub-servicing operations. We really won’t see the “new” Sagent product derived from Mr. Cooper (COOP) ’s IP for servicing until next year, according to the channel talk. Only the fact of some larger Ginnie Mae issuers using Sagent prevents BKI from having a pretty much total monopoly in IMBs now. How do you resist the irrational desire of the ICE octopus to own residential mortgage servicing? Stevens: When I was at MBA, I could beat up the GSEs and set some bright lines in terms of leaving the secondary market to the lenders. But with ICE and BKI, the MBA is conflicted because the head of ICE is on their board! This is one reason that Scott Olson of Community Home Lenders of America , who you featured earlier, has come out swinging. The acquisition of Black Knight by ICE could adversely impact many of his smaller members, banks and IMBs that could never afford the BKI product. The IRA: Over time, the smaller issuers represented by CHLA will have their market choices and data controlled by the ICE/BKI combination. This is more than a little ironic and also problematic for ICE. The Consumer Financial Protection Bureau, HUD and the FHFA are moving in the direction of mandating new, higher levels of data retention for lenders and servicers. We hear that Sagent will likely be able to meet the existing FHFA data retention standard by March . We hear in DC that BKI is actively lobbying FHFA to push the deadline for even the modest fair lending data required because of huge technology issues they will have coming into compliance. If ICE buys the Black Knight legacy platform, they will essentially control the mortgage business, front and back, correct? Stevens: For the smaller issuers that don’t have large servicing books, the ICE/EllieMae/BlackKnight monopoly won’t really impact them directly, but the indirect effect could be profound. MBA is conflicted as we mentioned and they would never stand publicly against an acquisition by a major member even if it adversely impacted smaller mortgage lenders. But perhaps more interesting is the silence from the policy community. The major political parties are focused on the midterm election. Fortunately, the Anne Schnare piece in Housing Wire got a lot of attention on Capitol Hill. The IRA: Do you think that the Biden Administration will challenge the transaction? After all, one of the biggest public mortgage issuers, PennyMac Financial Services (PFSI) , is suing BKI for antitrust violations. How does this transaction get approved by the Department of Justice with this civil litigation ongoing? That aside, the negative implications of BKI for the ICE stock may be the biggest negative in the equation. There is a reason why FISV ran away from mortgage servicing as a business. Likewise, Fidelity National (FIS) ran away from BKI, of note. FISV and FIS are much higher multiple businesses than BKI or the Fiserv mortgage servicing business that is now Sagent. What are we missing here? Stevens: You are correct. The ICE data business is not a people intensive business. Mortgage servicing, on the other hand, is entirely people intensive. The amount of manual effort involved in keeping clients compliant and following the rules from various agencies is astounding, even today a decade after Dodd-Frank and the 2012 National Mortgage Settlement . There are so many ways that BKI and ICE can get hung for being the owner of that platform in a recession, when loss mitigation is front and center for all issuers. The IRA: When we left Kroll Bond Ratings in 2017 and became a consultant to Ocwen Financial (OCN) , the CFPB basically told us to junk the Real Servicing platform in favor of the “better” Black Knight MSP platform. A decade later, we now have CFPB making noises around lender bias and servicing errors that seems to target BKI and other service providers for a future role as a responsible party in an enforcement action. And imagine if CFPB and/or FHFA mandate retention of all data used in the loan underwriting process. Significantly, Sagent does not see the consumer data as their property, but ICE and BKI do. Is that the bright future that awaits ICE if they acquire BKI? Stevens: It is no secret that Black Knight has a mixed reputation in the industry with customers, but so far the regulators have not targeted BKI directly for errors in the lending or servicing process. The danger I see for ICE is that they have a lot more cash and a far better reputation than BKI, making them a prime target for ambitious regulators in Washington. The operational and political difficulty of running a massive loan servicing platform is a far cry from the automated systems at the New York Stock Exchange, where the audience is primarily institutional investors. With residential loan servicing, ICE will be directly facing millions of consumers and sharing in the risk of the largest mortgage issuers and servicers. The entire mortgage industry will have a single point of failure with the ICE/BKI combination, a monopoly that will stifle innovation and competition even as it concentrates operational and regulatory risk in one firm. The IRA: It is amazing that BKI actually asserts ownership over legally protected consumer data in servicing. Most large Wall Street advisory shops that value loans and MSRs specifically avoid holding or claiming ownership of consumer specific data because of the legal liability. Just makes us want to run out and buy the ICE stock. Thanks David.

September 8, 2022 | Premium Service | In this issue of The Institutional Risk Analyst , we check in on US financials after the markets essentially gave back the gains made over the summer during the month of August. The two best performers in our surveillance group remain Raymond James Financial (RJF) and Charles Schwab (SCHW) , just proving that quality is not quite dead in the land of stock investing. What’s next for financials as we head into the end of Q3 2022? In general, the mid-quarter updates from the small to medium size banking institutions are strong, with loan growth starting to appear and deposit rates remaining very low. We continue to expect the financials to report better, less volatile results in Q3 2022, but that may not impress institutional investors. The universal banks are going to suffer going forward as AUMs and new securities issuance falls sharply. The same people who were buying large caps at 2x book value a year ago are now running away from bank stocks just as the fundamentals are starting to improve for Main Street lenders. The Buy Side is generally 6 to 12 months late when it comes to the financials, in part because they focus on volatile reported earnings rather than more meaningful fundamental measures of bank profitability. We wrote about RJF and SCHW last month (“ Universal Banks | Morgan Stanley, Goldman Sachs, Charles Schwab, Raymond James & Stifel ”), but we think it is notable that some of the lowest risk platforms in the business are outperforming the largest names, by a lot. RJF is the only name on the list that is still up for the full year. Our surveillance list follows below. Source: Bloomberg (09/07/2022) The general selloff in financials starting in July tracked the increase in interest rates after the mini-rally from mid-June through most of July. The 10-year Treasury is again above 3% but the market is moving 10-15bp per day either way, adding to the cost of hedging and the general level of uncertainty about prices. On Friday September 2nd, for example, the Treasury market fell 10bp in yield going into the Labor Day holiday. Right behind RJF and SCHW in terms of recent performance is Morgan Stanley (MS) , another one of universal banks in our surveillance group that is outperforming the large money centers. With all of these names, a major positive in terms of valuations is the relatively small role that credit plays in earnings. The universal banks gather assets and occasionally make loans, creating a low-risk franchise that is being rewarded by risk averse investors. That said, we are increasingly cautious about the trading and investment banking side of the equation, one reason why MS is trailing the more focused advisory plays like RJF and SCHW. The large declines in debt and equity underwriting in 1H 2022 has led a number of analysts to issue “sell” ratings for some names, including Goldman Sachs (GS) . Dick Bove at Odeon noted with respect to MS, GS and Citigroup (C) : “These companies are facing severe problems as business dries up. Moreover, moves by the Federal Reserve to shrink its balance sheet suggests that the current tough times will extend through 2023.” With the FOMC reducing the size of the system open market account (SOMA) by $50 billion per month, the bid for Treasury debt and agency mortgage-backed securities might seem to be softening, but recession fears are likely to offset the exit of the Federal Reserve Bank of New York from the bond markets. We expect to see reasonably strong earnings for smaller banks as loan yields slowly rise, but the transaction side of the house is likely to be weak, hurting MS, C, GS and JPMorganChase (JPM) . In the chart below from SIFMA, new securities issuance through July is plummeting, good news for lenders but very bad news for the wider financial markets and the economy. Note that the Fannie Mae current coupon MBS is now +150bp to the blended yield on the Treasury 5-10 year securities, the widest spread in many weeks. Treasury yields in general are at the highest levels in 12 weeks going back to mid-June, another reason why we expect to see higher loan yields when banks report Q3 earnings. One name to watch in Q3 2022 will be Wells Fargo & Co (WFC) , which is in the process of dramatically shrinking its balance sheet. Improved earnings in Q3 2022 may be a catalyst for this long-underperforming name. As we noted in our Q2 2022 pre-earnings setup, a modest improvement in operating efficiency at WFC, which has been in the 80% range, could be quite meaningful for the stock. The alternative to common shares that we have long followed is to purchase the preferred shares of the largest banks when they are cheap, one reason why we enjoy value shopping when the markets are choppy. We have been adding to our preferred positions through the selloff and are looking to establish some new positions as market opportunities arise. We will be writing more extensively about the outlook for earnings in Q3 2022. Suffice to say that the results for smaller Main Street lenders are likely going to be a surprise, but worries about future credit losses will probably dampen the party in terms of share prices in the near term for large cap names. Disclosures | Long: CVX, CMBS, NVDA, WMB, JPM.PRK, BAC.PRA, USB.PRM, WFC.PRZ, WFC.PRQ, C.PRN, WPL.CF, NOVC, LDI The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The 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.

"Money, it's a crime Share it fairly but don't take a slice of my pie Money, so they say Is the root of all evil today But if you ask for a rise it's no surprise that they're giving none away" "Money" Dark Side of the Moon (1973) September 6, 2022 | Last week The Institutional Risk Analyst returned to Leen’s Lodge in Grand Lake Stream, Maine, for a Labor Day respite and some salmon fishing on West Grand Lake. This pristine cold water fishery now has so many healthy juvenile smallmouth bass that the daily limit is being raised next year to two fish up to 14” from the single 8-12” fish limit today. There are literally too many healthy, hungry smallmouth bass chasing too few smelts in the vast series of lakes that stretch from the heart of Downeast Maine at Grand Lake Stream Plantation on US Route 1 west toward Lincoln on I-95. Investment managers likewise face too few real opportunities in the world of asset allocation, too few smelts to chase to borrow the metaphor of the smallmouth bass. There are few asset classes that have not been impacted by demand-pull inflation from hungry investors. Take the market for legacy music portfolios. Valuations for old rock music catalogs have exploded in the past three years even as the population of listeners has declined. Looking at the prices paid for creative content of all descriptions, it seems that the proverbial horse has left the barn for the FOMC when it comes to controlling the inflation of valuations for creative assets. Keep in mind that the cash flows from music catalogs are a closely held secret, so there is zero visibility into past or future sales. Some of our most trusted colleagues in the world of mortgage finance get queasy when prices for conventional mortgage servicing assets drift north of 100bp or ~ 4x annual cash flow, yet in the world of legacy music portfolios, add a zero. Variety reports that 20-30x annual sales is the norm today. Yet none of the “prices” for these deals are public and the counterparties are under NDA. If you speak, you lose your LA privileges for life. Buy Side firms are said to be circling the Pink Floyd catalog, for example, specifically the Hipgnosis Songs Fund backed by Blackstone (BX) with an indicated price tag of $500 million. Is this a fair deal? Maybe by today’s standards, but the question is will this be a good deal for investors a decade from now? When was the last time you listened to Pink Floyd? Ask your children if they’ve every heard of Pink Floyd. Here’s a pretty comprehensive list of legacy music catalogs. “The truth behind the spate of music catalog sales are threefold,” opines composer and Emmy Award winner Michael Whalen , who spent the past few years curating legacy music portfolios. We consulted Michael back in 2017 about the evolution of the content over the years (“ The Economics of Content: Michael Whalen ”). Here’s his well-informed take: “First, names like Pink Floyd are really an ego buy. PF does well on streaming platforms but not enough to justify a $500 million check. Also, past sales say nothing about future streaming revenues. Therefore, the money will have to come from someone who wants ‘bragging rights.’ That said, no one under the age of 40 knows or cares about this music. Artists like Pink Floyd are ‘cashing out’ by selling the remaining sales of these catalogs now.” “Second, many artists were afraid that the Biden Administration was going to change capital gains taxes upward, putting pressure on making these deals before the change. This pressure now seems to be abating, of note. But people like BMG are pulling in more VC money to finance potential purchases like Pink Floyd, putting more pressure on prices and on monetizing the catalog.” “Third, record labels and music publishers have commoditized returns from streaming to the point that they can predict within a few hundred dollars a quarter what a music catalog will produce - especially an iconic catalog. In other words, the record companies have calculated NO MORE than 5-8 years to recoup their principal investments on the catalogs they have bought. There is very little risk.” While the risk of loss of funds invested may be low, we wonder about the real, long-term value of a catalog like Pink Floyd, especially adjusted for inflation. Michael notes that the sales so far are almost entirely and only legacy people. Also, the multiples negotiated are for what the artists are making NOW not what can be earned by the labels through licensing and other means. Michael Whalen “I am very skeptical of the valuations of the legacy catalogs and these latest sales have done nothing to change my mind,” Michael told us last week. “We’ve seen one of these hysterical ‘gold rush’ scenarios that Wall Street insists on pursuing, often fucking the investors in the name of management fees. Said another way, there is a LIMITED window to exploit this music. The labels might recoup but they won’t be ‘raking it in’ for decades.” With legacy music catalogs are going for 20-30 times annual cash flow, a mind-blowing statistic, recovering the initial cash outlay, especially with leverage, may be a more pressing concern. When Universal Music agreed last year to buy the catalog of Bob Dylan for a reported $300 million, our first reaction was to reject the price. As it turns out, the pricing of legacy music catalogs is about as transparent as the market for 19th Century American paintings sold in gallery sales. “Everybody lies about the size of their deals,” Doug Davis of the Davis Firm told Variety last year after he sold his catalog to Hipgnosis Songs Trust. “Anyone who’s sold a catalog wants to go around and say they got a bigger check than they got, so there’s pie-in-the-sky aspirations.” Pie-in-the-sky is a great description for many of the investment manias and speculations we’ve all witnessed over the past several years. Whether it is Bitcoin or meme stocks or legacy music catalogs, the investment community continues to display the collective discretion of a school of small mouth bass, chasing the shinny object hither and yon around the clear waters of West Grand Lake. No amount of analytics can prepare or protect investors when price volatility has reached double digit rates of change on a weekly or even daily basis. The assumption of price volatility on the part of consumers and business managers is at the heart of inflation expectations , a feature that was seen in the US economy a century ago during the Roaring Twenties following WWI. Ponder that parallel. Many ask how long it will take for the Fed to get inflation under control. We wonder, to paraphrase James Grant in “ The Forgotten Depression 1921: The Crash That Cured Itself ,” whether Mr. Market won’t take care of that problem in due course by ushering in a period of asset price deflation to match the recent asset inflation mania. No matter how much fiat money the Fed creates, the secular bias remains deflation. In that downturn 100 years ago, Grant describes eloquently how the Wilson and Harding administrations, and the Federal Reserve both followed policies contrary to current wisdom. Interest rates were raised and spending was cut. A strong economic recovery ensued. Somehow we don’t think that this next economic adjustment will end so well given the amount of leverage and government intervention in the system.

August 25, 2022 | Premium Service | In this issue of The Institutional Risk Analyst , we take a look at two of the more depressed equity market valuations in the world of mortgage lending and servicing and ask a basic question: Is there value in some of these companies far beyond what the markets recognize at present? Some simple arithmetic suggests that the answer is yes. First on the list is loanDepot (LDI) , a name we mentioned last week in the context of industry-wide cost cutting. We noted at the time that the new CEO Frank Martell needs to cut operating expenses in half and we believe that he will, regardless of whether the endgame is a sale or salvation. To us, even in a sale, the LDI stock should be north of $6 instead of $1.65. The market capitalization of LDI as of yesterday’s close was $510 million or so, but at the end of June 2022 the company owned mortgage servicing rights in excess of $2.2 billion fair value plus almost $1 billion in cash. If we net out the loans in pipeline and the secured bank lines, half of the debt goes away. To us, LDI looks to have substantial value whether in a sale or positioned for a rebound when the FOMC reduces interest rates. The LDI financials from the latest 10-Q are shown below. loanDepot Obviously this situation has considerable execution risk, but we have added some LDI to our portfolio as a speculative investment on the likelihood that the intrinsic value of the servicing book will be recognized one way or another. At $1.60, LDI is down ~80% YTD, but has considerable value in either a sale or rebound scenario. We see a great deal more upside potential in LDI than in some of the mortgage names that are down single digits after the recent rally. How do we measure success? If we see new CEO Martell get LDI into positive territory in terms of EBITDA by the end of Q3 2022, that will be your signal that a turnaround has begun in earnest. LDI is paying down debt and canceling unneeded bank facilities to adjust expenses to a much lower floor in terms of operating volumes. Stay tuned. Blend Labs Inc. Next on the list is Blend Labs (BLND) , the point-of-sale (POS) startup that went public in 2021 above $20 per share and is now trading around $3.00 as of yesterday’s close. In 2021, BLND acquired a Title365 from Mr. Cooper (COOP) at a crazy multiple of book value in order to add some revenue to the platform pre-IPO. Very expensive revenue. We view the Title365 transaction as public evidence that these folks at BLND have no idea about value other than consuming shareholder value with both hands. A year later, BLND has written down the goodwill associated with the Title365 business, pushing the company into $550 million loss in the first six months of Q2 2022. Title365 is now about half the revenue of BLND, a bad business in a declining residential mortgage market. The revenue segments from the Q2 2022 BLND earnings presentation are shown below. Notice in the table above that mortgage segment revenues at BLND were down seven percent in 1H 2022 while the market was down 35% on volume. We suspect that the direct revenues from the mortgage segment and the Title365 business will both decline further in 2H 2022. Mortgage transactions for BLND went from 380,000 in Q1 2022 to 348,000 in Q2 2022. Note too that the incumbent managers of BLND awarded themselves an additional $52 million in stock options in 1H 2022, one of the most bizarre examples of corporate pillaging we can ever recall. How does a management team at BLND award themselves $50 billion in stock options after flushing half a billion in shareholder funds down the toilet? The Title365 acquisition was made just a year ago. If you back out the goodwill impairments and restructuring charges, BLND “only” lost $90 million in the first six months of 2022. But it is important to recall that these “extraordinary” charges are a reflection of the general incompetence of the BLNB management team in acquiring Title365 at 4x book value in the first place. Title companies generally trade at or below book value. We do not see any catalyst for value creation in this company until there is a wholesale change in the board and management team. The message of industry change and innovation contained in the BLND investor materials does not really square with the operating environment in the channel. CEO Nima Ghamsari seems to be living in a parallel universe: “We remain optimistic in our ability to execute and delivered another solid revenue quarter as we continue to grow market share. We plan to continue to optimize our cost structure, streamline our support functions and prioritize products that generate near-term ROI such that we can generate free cash flow under a prolonged market reset. And we are positioning ourselves as a category creator as we continue to drive innovation through our software solution for digital banking.” Ghamsari then addresses the issue of expenses: “Since April, we have eliminated over 400 positions or 25% of our workforce, including the elimination of backfills. We should see the full impact of these actions by Q1 2023. In aggregate, both actions are expected to reduce our annualized expenses by approximately $60 million. We will continue to monitor and adjust this cost base as market conditions warrant. We have also significantly limited hiring, focusing on the most important positions for the company.” We view the whole strategy of BLND, both in banking and mortgage lending, as marginally additive to the customer experience, but there is no transcendent improvement in loan acquisition or time-to-close. To us, aside from selling the well-worn fiction of “transformation” in the markets addressed, the incumbent managers at BLND seem more interested in personal gain than in building shareholder value. Chief Finance Officer Marc Greenberg describes the company’s financial performance, but fails to mention the more significant equity award to the incumbent managers: “As you can see in our financial supplement, our non-GAAP loss from operations was $39.5 million versus $26.3 million in the prior year. This quarter, we also recognized approximately $392 million noncash charge to reflect impairment of Title365 goodwill and intangible assets, driven by a decline in the fair value of the Title365 reporting unit.” Of interest, during the Q&A, Greenberg suggests that business volumes from defaulted loans serviced by COOP will make up for a decline in purchase mortgage business at Title365: " So the outperformance on the Title365 side is really because they have built in countercyclical offsets, right? They have the default business as well as the home ability business. So that's where you're seeing the outperformance on the Title365 side. Otherwise, Mr. Cooper transition is going great. They've been a wonderful partner for us, and we're ready for the increase in volume in the second half of the year ." The bad news for current shareholders is that there is little real value in the BLND POS business, whether you look at the mortgage segment or banking, the latter of which has suddenly become the focus of management attention. More, we do not see any potential acquirors on the horizon for BLND or some of the other startups in the mortgage POS space. POS tools are increasingly ubiquitous and available, allowing most issuers to develop in-house POS solutions at little costs. Indeed, if the merger of Black Knight (BKI) and Intercontinental Exchange (ICE) goes through, you can expect the expanded ICE monopoly in mortgage tech and data applications to simply give away POS tools to destroy the remaining incumbents other than Sagent Lending Technologies. L: CVX, CMBS, NVDA, WMB, BACPRA, USBPRM, WFCPRZ, WFCPRQ, CPRN, WPLCF, NOVC, LDI The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The 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.

In this issue of The Institutional Risk Analyst , we feature a discussion with Scott Olson , Executive Director of the Community Home Lenders of America ( CHLA ), which reflects the recent merger of the Community Home Lenders Association and the Community Mortgage Lenders of America. Olson now represents the largest DC trade association focused on independent mortgage banks (IMBs), which is CHLA's single largest membership block. Olson worked for 20 years on Capitol Hill and served on the House Financial Services Committee as Housing Policy Director under Chairman Barney Frank (D-MA). The IRA: Scott, there is a lot going on in Washington that impacts IMBs very directly, including new capital requirements for nonbank mortgage companies from the Federal Housing Finance Agency (FHFA) and Ginnie Mae and the prospective merger of Black Knight (BKI) and Intercontinental Exchange (ICE) . What are the issues that are top of your agenda for your members? Olson: Our core members are small to medium sized independent mortgage banks. We run the gamut from the small correspondent lenders that are taking their loans to the big aggregators to larger firms that are getting their seller/servicer ticket in conventionals or maybe even becoming a Ginnie Mae issuer and building a servicing portfolio. Individual things or policy changes affect each part of the secondary market in a different way. We don’t represent the larger issuers. FHFA and Ginnie Mae just came out with new financial requirements. We’ve been saying for some time that there needs to be a distinction between the small and large IMBs. The IRA: Well, especially if both agencies and especially Ginnie Mae are going to pretend that IMBs are federally insured banks. No matter how many times we explain to Ginnie Mae, for example, why the concept of risk based capital is a complete non-sequitur for nonbank finance companies, they continue to mimic the Federal Reserve and OCC supervision functions rather than develop a truly relevant risk framework. But we must remember that this is Washington. How do we get the approach you want for smaller issuers, one that recognizes that the large aggregators and the banks have the risk? Olson: There has been an extensive amount of public comment and research that suggests that virtually all of the risk in the market is with the top-20 issuers. If one of our members that is a Ginnie Mae issuer goes out of business, we will be saddened to see that, but it will have no impact on the market for government loans. The IRA: Precisely. The public record for the past half century suggests that insolvencies of IMBs are resolved in the normal course, often without even a bankruptcy filing. This is not a surprise because even when a bank fails, the FDIC takes over the depository and the parent company is usually liquidated informally, without a bankruptcy. Yet somehow the FHFA and Ginnie Mae, and also the Financial Stability Oversight Counsel (FSOC) , see some colossal systemic risk arising from residential mortgage servicing. Given your experience on financial policy, how do you explain the strange obsession that FHFA and Ginnie Mae have with bank regulatory models? Olson: CHLA did a paper on Ginnie Mae a few years ago and it is difficult to see the risk. Ginnie Mae made money in 2008. They make money every year. They are basically reinsuring government insured loans, so there is essentially no risk. We have hammered away at the idea that having a broad range of Ginnie Mae issuers, large and small, has been a huge benefit to the Federal Housing Administration program as well as the Veterans Administration and US Department of Agriculture. Yet the policies coming from the leadership at Ginnie Mae could end up forcing out some smaller issuers and concentrate the market more on two dozen or so large aggregators and servicers. We don’t think such a strategy actually protects Ginnie Mae or the taxpayer. We are the only trade association in DC making the argument on behalf of smaller issuers. The IRA: Wells Fargo (WFC) is exiting government lending and servicing. At some point the leadership of Ginnie Mae and HUD perhaps need to admit that they are doing something wrong. Markets require diversity to function. CHLA is fighting for smaller issuers, but the other trades are conflicted on FHA and Ginnie Mae. The larger banks basically see smaller banks, IMBs and other financial institutions as commercial customers and the GSEs and large Buy Side funds like PIMCO and Black Rock (BLK) as the real competition. Large banks are government sponsored enterprises after all, as you know very well from working on these issues on Capitol Hill. The government loan market was designed with the assumption of liquidity support from commercial banks, which have now left the market. How do you get fairness for your smaller nonbank members when the deck is stacked with policy options that are really only appropriate for large depositories? Olson: It is a battle. Take an example. The FHFA wants to impose a liquidity reserve on smaller issuers that don’t retain any servicing. Originally they wanted to add a 2% surcharge on TBA hedging, now it is 50bp. This doesn’t make sense to us. The IRA: We have raised the increased margin issue with the FHFA. They do not seem able to discuss their approach, whether the tax will be imposed on net or gross exposures, or even what exposures are covered. At Ginnie Mae, likewise, we cannot find anyone who can discuss the details of the Risk Based Capital (RBC) requirements included in the joint-proposal. Small wonder that commercial banks have left the government market. Now Ginnie Mae seems bound and determined to drive the IMBs out of government lending as well. Olson: One of big revelations I had after leaving the House Financial Services Committee was realizing after six months of talking to smaller lenders that there was much I didn’t know about mortgage finance. I had worked in residential and commercial finance early in my career, but going to head CHLA was a baptism in the reality our members face every day. The latest issuer/seller-servicer proposals present a challenge for federal policy makers in communicating the details to our members. Take another example: indemnification. Our members must be prepared to repurchase delinquent loans, but when I worked on Capitol Hill, I did not know mortgage lenders had that liability. We thought Uncle Sam covered everything, but that is not how it works for Ginnie Mae issuers. The IRA: Ginnie Mae servicers can lose thousands of dollars on an FHA loan foreclosure. There is little risk to Ginnie Mae in terms of payments to bond holders. The custodian banks make the payments directly to the bond administrator, which is another bank, thus no counterparty risk. The real world risk to Ginnie Mae is operational and financial risk from default servicing. Why? Because GNMA provides no liquidity to the market. Policy makers tend to see risks that don’t really exist, but miss other risks that are hiding in plain sight. Remember in 2009, people were talking about Ginnie Mae being “the next shoe to drop,” but it never happened, as you’ve noted. But we digress. Talk about some of the priorities for CHLA in the coming year. Olson: First and foremost, if we are going into a market correction in residential mortgages, then it is incumbent on FHFA and Ginnie Mae not to overreact. Increasing capital and liquidity requirements for conventional and government issuers now may just end up being a countercyclical drag on the economy and the housing market. We’ve been pushing back against changes in the issuer rules that we don’t think make sense in the real world and have also been pushing for a cut in the FHA insurance premium. The IRA: The FHA should have cut the premium for low income home buyers years ago, but somehow the Biden Administration could not put a $3 billion earmark in the budget last year or this year? Really? FHFA should have reduced the 2008-era loan level pricing adjustments (LLPAs) by the GSEs on low-income buyers, but that did not happen either, somehow. What other issues are top of mind as we head into the end of 2022? Olson: This is a time when the mortgage industry needs a thoughtful, sensitive approach from regulators, not some capital plan borrowed from bank regulators with no implementation framework for the industry to follow. We should remember what happened with the S&Ls in the 1990s when I was working in private real estate. By placing limitations on new loans, the regulators made the problem worse and ultimately pushed up the cost of resolution. We told banks and S&Ls not to make any more construction loans or mortgage loans, and we made the losses worse and caused more banks to fail. If we’re seeing difficult times, we need to be careful with initiatives to regulate risk because these measure will hurt access to credit among the most vulnerable people in our society. The IRA: FHFA Director Sandra Thompson worked at the Resolution Trust Corporation in that period if we're not mistaken. But we should all remember that regulation is a coercive progressive tool that by definition is countercyclical. Regulation is about government imposing constraints and authoritarian controls on private markets. We have to somehow fight back so that our constituents can stay in business. Thank you Scott.

August 22, 2022 | Premium Service | In the almost 20-years that The Institutional Risk Analyst has been published, we can rarely recall a scenario for national finance that is more likely to end in tears. Market interest rates are rising and the Federal Open Market Committee has begun to shrink the system open market account (SOMA), some $9 trillion in Treasury debt and mortgage-backed securities (MBS). Dick Bove of Odeon Capital summarized things nicely last week: “This week the Federal Reserve reduced the size of its balance sheet by a net $29.4 billion. This brings the 4-week total decline to $49.4 billion. These numbers indicate a serious intent to reduce the money supply. This is being done, I believe, because the Federal Reserve now understands that simply raising interest rates will not kill inflation. Shrinking the money supply will.” Even as the investment community ponders whether Chairman Powell is really serious about inflation and, therefore, prepared to impose consecutive down quarters on the equity markets , the housing sector is cooling and more. Why diverting the income and gains from $3 trillion in MBS to the Treasury stimulates the economy is beyond us. Maybe somebody will ask Fed Chairman Jerome Powell at the September FOMC presser. We’ve already talked about how the prudential regulators are forcing large banks led by JPMorgan (JPM) to raise capital and/or reduce risk weighted assets. Readers of The IRA no doubt noticed the announcement by Wells Fargo (WFC) that they are withdrawing from correspondent lending entirely. Banking aficionados will appreciate that the ghost of Norwest Bank has left the building, a reference to the aggressive merger partner of Wells Fargo & Co in 1998. The decision by WFC to stop buying third party mortgages is a sesmic event for the housing market. It could take down the bank’s risk weighted assets significantly, more than $100 billion, but represents a huge decrease in market liquidity for 1-4s. Note that Bloomberg has current coupons in MBS at 4.35 as of Friday’s close, suggesting 5.5% as a breakeven loan coupon rate in conventionals. This is a full point lower in loan coupon rate than 45 days ago, a remarkable swing in price. We expect to see more banks exiting the warehouse and correspondent space, including most of last year’s late arrivals. Source: Bloomberg Meanwhile, the Federal Housing Finance Agency and the Government National Mortgage Association (Ginnie Mae) issued new eligibility requirements for issuers. Overall, the new rules are a pleasant surprise for the mortgage industry, which is fighting for its life as rates rise and volumes fall faster than operating expenses. There is, however, some bad news, namely an area where the two proposals are not aligned. The Ginnie Mae proposal includes a risk-based capital (RBC) rule that would impose a punitive 250% capital charge on government mortgage servicing rights (MSRs). This is effectively a declaration of war on the non-bank issuers with large Ginnie Mae servicing books such as Mr. Cooper (COOP) , Lakeview, Rithm (RITH) and Freedom. But should the industry sound battle stations and go to war? Maybe not quite yet. The good news, of sorts, is that Ginnie Mae staff do not seem able to discuss the risk based capital rule at all. We hear that risk function head Greg Keith , for example, told one issuer during an all hands meeting that "we don't have to discuss that now," this in response to a question about RBC. This seems a very odd comment for a senior official of Ginnie Mae. Even makes us wonder if this RBC proposal is more decorative than substantive. Much of the joint-proposal between FHFA and Ginnie Mae is aligned, a big win for FHFA Director Sandra Thompson and Ginnie Mae President Alana McCargo . But the strange, Basel-style risk weighting for MSRs in the Ginnie Mae proposal makes no sense and requires a detailed explanation from McCargo. The RBC scheme doubtless will increase visitor traffic into the office of M cCargo and HUD Secretary Marcia Louise Fudge . Did anyone in the Ginnie Mae risk function, we wonder, review the proposal with McCargo? It appears that the answer is no. One MBA official noted: “The Ginnie RBC stuff is stupid. They are keeping an RBC standard for monoline institutions with a punitive risk weight on MSRs that has driven banks out of the servicing business. Dumb.” Fortunately, the effective date of the yet-to-be-defined risk based capital rule is many months away. Many mortgage firms may simply go out of business due to horrendous market conditions, where most issuers are losing money on every loan they underwrite. The chart below contains data from the latest Mortgage Bankers Association performance survey: Source: Mortgage Bankers Association Suffice to say that the velocity of change in the money markets combined with the difficulty involved in reducing expenses as quickly as interest rates have risen has pushed many mortgage lenders into operating loss in Q2 2022. loanDepot (LDI) , for example, reported a loss of $0.51 per share and a sharp decline in volume. As usual, bank consultant Joe Garrett puts it well in a client note: “[S]ources of revenue are not steadily moving upward a little every year. So, what does this mean? It means that you have to be disciplined in managing your overhead. Period.” LDI will exit the partner (wholesale / non-delegated correspondent) channel, but will fulfill the $1 billion still in pipeline by the end of October. We’ll see. The execution in the channel remains depressed due to the beggar-thy-neighbor approach taken by United Wholesale Mortgage (UWMC) , which has already chased several weaker players out of the wholesale channel entirely. According to the earnings disclosure, LDI expects to be run-rate profitable exiting 2022, but they are assuming continued slowdown in volume through 2023. We think many weakened firms will either be put up for sale of shut-down entirely. Inside Mortgage Finance writes: “The word on the street is that loanDepot hired industry veteran Frank Martell early this spring to trim the fat at the nation’s seventh largest lender and make sure it survives. The end-game? A sale or merger perhaps…” We agree. Martell better hurry. The interest rate rally since mid-June may help some lenders in Q3 2022, but we still think that pricing remains an issue due to industry overcapacity. And to address that very issue, UWMC is clearly preparing for a war of attrition in the wholesale channel: KBW featured this little financing note recently: “United Wholesale Mortgage, LLC, which is indirectly minority owned by UWM Holdings Corporation (NYSE: UWMC), entered into a revolving credit agreement with SFS Corp. as the lender. The agreement provides for, among other things, a $500mm unsecured revolving credit facility with an initial maturity date of August 8, 2023. UWMC has an “Up-C” organizational structure whereby United Wholesale Mortgage, LLC is the operational subsidiary of UWM Holdings, LLC. As of June 30, 2022, UWM Holdings, LLC’s common units were 5.8% held by UWMC as Class A common units and 94.2% were held by SFS as Class B common units which are convertible into Class D common stock of UWMC, providing SFS with 79% of the voting power of UWMC’s common stock. Mat Ishbia , CEO and Chairman of UWMC, is President and sole director of SFS and indirectly controls all of its voting stock.” You won't see a lot of other mortgage companies taking down unsecured financing this year. The cost of revolving bank lines for mortgage lenders and other non-bank finance companies is rising fast, putting additional pressure on an industry that is already operating in extremis . The money market summary above from Bloomberg shows that 30-day benchmark rates are closing in on 2.5%, so figure that rates for most secured advance and warehouse lines for non-banks lenders is around 3.5% to 4%. Meanwhile, the total cost of funds for JPM is still inside 40bp vs average assets as of Q2 2022. Source: FFIEC Back in June we reviewed Upstart Holdings (UPST), the once high flying partner of Cross River Bank (“ Update: Upstart Holdings & Cross River Bank ”) that has lost 80% of its market value since last year. UPST was sued by the class action law firms after revelations about surreptitious warehousing of unsold loans shattered the company’s veneer of invincibility. A large group of hedge funds selling the stock short certainly helped in the devaluation process. When banks and non-bank lenders like mortgage companies and UPST had a cost of funds approaching zero, then it was easy to pretend that non-banks could compete with insured depositories. Likewise, zero returns on risk-free assets made crypto tokens seem reasonable. But non-banks fund off the market, while banks have funding called deposits. Big difference, especially when the FOMC moves federal funds hundreds of basis points in a quarter. Now that market interest rates are starting to become very positive, but bank deposit rates are barely moving, the pretense of fintech as bank killer is over. The rising real costs of funding for non-banks is the chief risk in 2022 and beyond, one reason that the Ginnie Mae proposal to increase the capital charge for government MSRs is so completely ridiculous. As we move through 2022 and prepare for another year of down debt and equity markets, all of the market funded, market facing lenders in fintech, whether operating in mortgages, auto loans or unsecured IOUs, are going to be at the mercy of lender banks and an ABS market that has suddenly grown a good bit more picky. That is one reason why UPST is down 81% YTD, but they have a lot of company. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes. 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August 17, 2022 | One of the more amusing tasks we have at The Institutional Risk Analyst is explaining to readers, old and new, why the government sponsored entities (GSEs), Fannie Mae and Freddie Mac , will likely sit in conservatorship indefinitely unless and until Congress acts first. It has been almost 15 years since the Treasury retook explicit control over the GSEs, yet the $7 trillion in conventional MBS guaranteed by these two “private” issuers is still not included in the national debt of the United States. There are well-intentioned people in Washington who continue to believe that, given the right political alignment, the GSEs will be recapitalized and released from conservatorship and the U.S. Treasury will recoup its full investment. Yet getting from here to there is a lot more complicated than most Washingtonians appreciate, one reason why former Treasury Secretary Stephen Mnuchin ultimately did nothing at the end of the Administration of Donald Trump . The first thing to understand about the GSEs is that, post 2008, post-Dodd-Frank and multiple amendments to the Basel capital guidelines, we can no longer pretend that these federally chartered corporations are sovereign credits once they leave government control. Under conservatorship, Fannie Mae and Freddie Mac are “AAA/AA+” credits, referring to the sovereign rating for the United States from Moody’s & S&P , but once they leave conservatorship, the rating drops. Under Basel capital rules, Ginnie Mae obligations have a zero percent risk weight for banks and the obligations of the GSEs have a 20% risk weight or $2 per $100 of risk exposure. In the world of Basel capital rules, 100% risk weight equals $8 of capital per $100 of exposure. As the GSEs exit conservatorship, the risk weight for GSE risk could rise to 50% or $4 of capital per $100 of risk. Private corporate exposures are 100%. Why would Fannie Mae and Freddie Mac be downgraded? Because the criteria used by Moody’s and S&P for sovereign ratings makes it impossible for a “private” obligor to achieve a “AAA/AA+” rating. No matter how much private capital an issuer possesses, even with a contingent $250 billion credit line from the U.S. Treasury, you are still not a “AAA” issuer. This means that the conventional mortgage backed securities issued by Fannie Mae and Freddie Mac would be downgraded as well. Hold that thought. During her first testimony before Congress, Federal Housing Finance Director Sandra Thompson noted that once the GSE have raised the required $300 billion or so in private capital, they would need to have a conversation with Treasury about the preferred equity position held by the government. If the GSEs exit conservatorship, will the Treasury get par value for its investment? Another good questions you never hear discussed on Capitol Hill. Rep. Blaine Luetkemeyer , R-MO, asked Thompson about the capital requirement under the amended regulatory enterprise capital framework put in place by FHFA. “Do you think $300 billion is the point at which the conservatorship can end?” Thompson did not answer the question directly, but rather listed some of the things that need to be done once the GSEs have retained $300 billion in private capital. She said (h/t to Inside Mortgage Finance ): “When the enterprises meet their capital targets, that’s one component of exiting conservatorship. There are other factors that need to be taken into consideration. Certainly, conversations with Treasury about its senior preferred shares. Conversations with the Federal Reserve about certain policy issues, like single counterparty and what happens if the enterprises exit and what’s other significant institutions’ exposure to Fannie/Freddie stock.” What Thompson did not say, however, because it would be too shocking to members of Congress, is that long before the US government begins to move towards removing the GSEs from government control, the Treasury must agree to continue guaranteeing the existing and future MBS issuance by Fannie Mae and Freddie Mac. Imagine how that change in the business model of the GSEs will impact the value of the private equity. With, say, a “A+” rating from S&P for the two now “private” GSEs, the spreads on conventional MBS will widen, the market prices of the MBS will fall, and the cost of conventional loans to consumers will rise proportionately. Just call our colleague Warren Kornfeld at Moody’s and ask him what happens if the GSEs simply exit conservatorship with $300 billion in private equity capital (and zero corporate debt, BTW). Allowing $7 trillion in conventional MBS to be downgraded by the major rating agencies would be a catastrophic event for the Treasury and the US housing market. As a result, most serious analysts who have looked at the GSEs understand that prior to release, Fannie Mae and Freddie Mac would essentially have to transfer full responsibility for the conventional MBS market to the Treasury. Instead of earning 50bp+ in insurance fees on MBS, the GSEs would need to pay the Treasury around 20bp annually to guarantee the secured mortgage debt. Now, you are probably thinking, charging 50bp or more to consumers and giving Treasury 20bp is not a bad business. But here’s the rub: Who’s going to care about a guarantee from Fannie Mae with a “A+” rating? A: Nobody. Even at “AA,” the GSEs would be marginally competitive with the large banks, private mortgage insurers and also nonbank aggregators like Rocket Mortgage (RKT) and PennyMac Financial (PFSI) . Keep in mind that the GSEs are nowhere near as efficient operationally as these private counterparties. Source: Bloomberg You see, there is this guy named Jamie Dimon . He’s got a bank named JPMorgan Chase (JPM) with a lead depository with a strong “AA” rating. He’s just below sovereign in credit terms. Why? Because rating agencies automatically give large, systemically significant money center banks a full notch of uplift in credit ratings. Why? Because JPM has access to the Fed’s discount window. In addition, Dimon has got over $2 trillion in core deposits. The GSEs have no internal liquidity, and no access to the Fed and by 2030 will have zero term debt in their capital structure. Source: Bloomberg Once the corporate debt is redeemed in 2030, the GSEs will basically be conduits with just enough working capital to buy loans and sell MBS. If you take the GSEs out of conservatorship without federal legislation, then the Treasury must cover all conventional MBS. The original issuers, Fannie Mae and Freddie Mac, become superfluous. More, as and when the Treasury puts a public price on a federal credit wrapper for conventional MBS, why can’t JPM issue its own conventional deal, pay the Treasury 20bp and keep the rest? And that is precisely what will happen. Tell us again how the GSEs will make money post-conservatorship? Going back to the inception, Fannie Mae always depended upon the federal guarantee for its debt to function in the capital markets. When it was created by Congress in the 1930s, Fannie Mae was essentially a federally chartered thrift owned indirectly by banks, a utility. In the 1970s, the Administration of Lyndon Johnson pretended to privatize the GSEs, but only in name. The government retained “dominion” over the assets, to paraphrase the US Supreme Court, voiding true sale and forever tainting the IPO of Fannie Mae and Freddie Mac as a monumental act of fraud by Congress. In a perfect world, Congress would transfer responsibility for guaranteeing the conventional MBS market to Ginnie Mae and extinguish Fannie Mae and Freddie Mac, without any compensation to holders of common or preferred. The Uniform Mortgage Backed Securities (UMBS) platform would be opened to all issuers of conventional mortgages, aligning the conventional market with the market for government loans and Ginnie Mae MBS. Any issuer could sell conventional loans into an MBS without a federal guarantee in good times, but fall back on a Treasury credit wrapper in times of market stress. Many of the operational and human resources at the GSEs could be migrated to the Federal Home Loans Banks , which become the liquidity backstop for the industry in a post-GSE mortgage market. As we noted in our latest column in National Mortgage News (“ Washington is the problem in mortgage finance ”), Director Thompson needs to reopen access to the FHLBs for independent mortgage banks (IMBs) that are helping to achieve the mission of the conventional market before the Fed induced recession overwhelms the secondary mortgage market. Of note, some of our readers may have seen a press release a while back from an organization calling itself the “Capitol Forum” saying that Fannie Mae General Counsel Terry Theologides was leading a crusade against the acquisition of Black Knight (BKFS) by Intercontinental Exchange (ICE) . We wrote about the deal in May in our Premium Service (“ Does ICE + Black Knight = Shareholder Value? ”). We hear from the highest levels that the Capitol Forum statements about Theologides and Fannie Mae “were a complete fabrication.” Such is life in the swamp called Washington. But in June, Scott Olson of the Community Home Lenders (CHLA) did send a letter to the Department of Justice seeking an antitrust review of the proposed purchase of Black Knight by ICE – citing concerns about the impact on consumers and smaller IMB lenders. As we never tire of reminding our readers, whether we speak of GSEs, zombie banks or large private monopolies, the public interest is rarely served but the private interests on and around Capitol Hill always benefit.

August 15, 2022 | Premium Service | In this issue of The Institutional Risk Analyst we focus on the world of universal banks, institutions that have a depository but are primarily involved in the investment business, including advisory, capital markets and investment banking activities. We exclude the top-four money center banks from this group, but include some of the best performing stocks in the industry, both in terms of operations and also market performance. Note to our subscribers: We shall be changing the pricing and terms of our Premium Service after Labor Day. Take advantage of low annual rates today! We published a profile on Raymond James Financial (RJF) last November and the company has outperformed much of the bank group since that time, both up and down. Financials generally have rallied in the past month on hopes that inflation will moderate, but we’d point out to our readers that the FOMC won’t start shrinking the Fed’s balance sheet until next month. The advisory income that RJF and other members of the universal bank group generate will enable them to outperform many money center banks in the uncertain and likely volatile period of adjustment ahead. In this report, we feature: All of the firms above are bank holding companies with large broker dealer subsidiaries, but that is where the similarities end. Goldman Sachs (GS) and Morgan Stanley (MS) are more traditional brokerage and investment management models, married to significant trading and investment banking lines. Charles Schwab (SCHW) and Raymond James (RJF) are far more focused on the advisory business and building both client assets and related bank deposits than trading or investment banking. SCHW is also a sponsor of money market funds and exchange traded funds (ETFs), as well as offering third-party managers to its advisory clients. RJF and SF have significant investment banking arms, but these businesses are smaller than the advisory businesses of these firms. Of the two, Stifel Financial (SF) is a more traditional securities firm with substantial principal and investment banking activities, but also boasts almost $400 billion in wealth management assets. We have written positively about MS in the past because we believe that CEO James Gorman created a goal of building a diversified universal bank and executed on that strategy. Gorman had to pay a significant price to acquire some of the businesses absorbed by MS over the past several years, including E*TRADE (2020), Eaton Vance (2020) and FrontPoint Partners (2006), but there was no real alternative. Likewise, SCHW, RJF and SF have made significant acquisitions and also paid and today pay top dollar to attract advisors onto their platforms. SCHW acquired TD Ameritrade in an all-stock transaction valued at approximately $26 billion that closed in 2020. Both RJF and SF have been gradually rolling up brokerage firms and advisory businesses for much of their existence. The 130-year old SF has a storied history of acquiring other brokerage business from its base in St Louis. It became a bank holding company in 2007 when it acquired First Service Financial and now has two national bank units. Many years ago, SF floated a loan for Bolivia. GS has a large investment management business, and a consumer and wealth arm, and the fees reflect the fierce competition for assets. If we compared $4.4 billion in investment management revenue with $2.495 trillion in assets under supervision, the gross is just 17bp. Throw $7.1 billion in revenue at MS vs $5.6 trillion in assets managed or in wealth advisory accounts, and the result is 12bp. Yet the sheer size of these business allows them to contribute to profits with ~ 10% ROE for MS in recent years from the asset side of the business. The exception to the rule of growth by acquisitions in the group has been GS, which has refused to make a transformative acquisition of a bank for fear of losing control over the overall business. SCHW, for example, paid to grow into the 7th largest bank in the US by spending money to acquire advisors. We have argued that Key Bank (KEY), with over $100 billion in core deposits and a focus on financing and servicing commercial real estate would be a good fit for GS, but prudential regulators would force the resultant bank holding company into a very different business model than the present-day Goldman Sachs. Eschewing acquisitions, GS instead has chosen to grow organically, particularly with respect to the banking side of the business and with decidedly mixed results. Below we go through the key indicators that we use for all banking groups, namely credit loss rates, the gross yield on loans and leases, funding costs and finally profitability vs total assets of the parent company, which is how the Federal Reserve Board looks at these companies. Source: FFIEC As the chart above suggests, GS is a good bit above its peers in terms of loan losses. We can take comfort from the fact that the GS loan portfolio is relatively small, just $250 billion, but it is now big enough to hurt the firm if credit conditions deteriorate to a degree equal to the benefit lenders received from QE during 2020-2022. Note that the other members of the group including MS and Peer Group 1 are well below the outlier GS. The loan book at GS has grown 140% over the past five years, of note, 5x the growth rate of the firm’s capital. Next stop is the pricing on the loan book, an important indicator of operational efficiency and management control. Note in the chart below that the gross spread for Peer Group 1 is near 4% while larger banks have seen spreads compressed to 3% during QE. GS is next above 3% gross yield, but the rest of the group are below 3% yield before SG&A. Note the way that GS was forced to give ground on loan pricing during QE in 2020 and 2021. Source: FFIEC The question of loan yield is crucial to all of these banks, however, because market interest rates are rising faster than loan yields. GS saw interest income rise 35% over the year ended June 2022, but interest expense rose 56% over the same period. The next key factor after loan yields to consider with this group is funding costs, shown in the chart below as interest expense vs average assets. Note that SCHW had the lowest cost of funds in the industry at just 8bp in Q1 2022, a position unchanged in Q2 2022. Source: FFIEC Through the end of Q1 2021, GS had a cost of funds that was 2x the rest of the group and, significantly, above the average for Peer Group 1. MS, on the other hand, has a funding cost that is below the average for the top 134 banks in the US above $10 billion in assets. RJF has a relatively high cost of funds, while SF has a cost of funds below all of the other names in this report other than SCHW. At the end of Q1 2022, MS had $340 billion in core deposits comprised almost entirely of retail funds from its advisory clients. MS has no jumbo deposits in its liability structure, zero. GS, on the other hand, has a significant proportion of deposits in jumbo CDs, foreign deposits and other forms of “hot” money that can depart immediately. GS had $200 billion in federal funds borrowed at the end of Q1 2022 vs just $74 billion for MS. Total noncore funding at GS was over $700 billion at the end of Q1 2022 vs $321 billion for MS. Despite the efforts at diversification, MS and GS remain dependent upon investment banking and principal trading for a large portion of profitability. The table below shows the total derivatives positions of the top banks as a percentage of average assets. Note that MS and GS have the largest notional positions in derivatives, literally thousands of percent of total assets, higher than JPMorganChase (JPM) or Citigroup (C) . These positions are about 80% interest rate contracts, but are many times the total capital of both firms. The other names in this report have little derivatives exposure and are more focused on third-party business for clients. SCHW, for example, has less than 5% of total assets in gross derivatives positions. Total Derivatives/Total Assets (%) Source: FFIEC The last key indicator to inspect is net income, one of the most important performance benchmarks for any financial institution. More than capital, banks survive because they can generate sufficient earnings to offset credit costs and continue to operate profitably. When a bank has to rely upon capital to offset credit losses, then you can be pretty sure that the Federal Deposit Insurance Company is already marketing the bank for sale. Since the enactment of Dodd-Frank, the FDIC now has the legal authority to place the entire organization into conservatorship and to then sell the enterprise intact without resolving the subsidiary bank. Source: FFIEC As the chart above illustrates, the two smallest members of our universal bank group have the best financial returns measured against total assets. RJF and SF, which have both performed well during the recent market downturn and rebound in Q2 2022, also have consistently better financial returns on assets overall. MS did 1.02% ROA in Q1 2022, but RJF and SF were close to 2% or 2x the 1.2 average for Peer Group 1. Q2 2022 Earnings The results for most of the universal bank group were weaker in Q2 2022, if for no other reason than the modest selloff in equities reduced assets under management (AUM) across the industry. GS saw results fall sequentially and YOY, but asset management was up almost 100%, an illustration of the volatility that attaches to this particular line item at Goldman. Total net revenues in the first half of 2022 were down 23% vs the previous year, again illustrating the volatility in the GS income statement. Likewise MS saw weakness in Q2 2022, both sequentially and YOY. Institutional securities took the brunt of the decline, but all three of the main business segments showed weakness due to market conditions. Provisions for credit losses also rose to $101 million in Q2 2022, the highest level seen at MS since 2020. SCHW, by comparison, reported record revenue in Q2 2022, with revenues up 6% for the first half of 2022. SCHW is a far simpler business than either MS or GS and it shows in the fact that the summary of advisor activity takes up the entire financial supplement. SCHW CEO Walter Bettinger makes clear in his Q2 2022 comments that client engagement, not market conditions, is the chief metric that SCHW uses to measure success. Remember, while SCHW has lower nominal income than its peers, the risk-adjusted returns are far higher. SCHW has total nominal assets of $648 billion for the purpose of the basic regulatory leverage ratio, but the risk weighted assets component for Basel capital purposes is only $154 billion. The bank reported ROE of almost 20% in Q2 2022. RJF saw revenues and earnings up in Q2 2022, which is Q3 in the bank’s fiscal year for purposes of GAAP reporting. The bank holding company still files quarterly financials on a December year-end for regulatory purposes. Revenues were down slightly on a sequential basis, but up 16% for the past nine-months. Provisions for credit losses were up 66% YOY, reflecting the normalization of credit across the markets. RJF had 8,600 advisors at the end of June 2022 and is aggressively recruiting in the channel. SF saw revenue and earnings down in Q2 2022, with both commissions and principal transactions under pressure due to market conditions. SF in many ways has more in common with GS than with RJF. We think of RJF as a smaller version of the giant SCHW, which is now the largest platform for RIAs and also a dominant provider of tools and solutions for independent advisors. SF is a classic investment bank with deep roots in the Midwest community and a fierce devotion to client service. They have literally rolled up dozens of other firms over the past century and, more recently, several banks. The $35 billion bank holding company reported solid results with net revenues of $1.1 billion, the second highest second quarter in its history, driven by higher net interest income and asset management revenues. Bottom line: We like the universal banks as a group because of the stability of earnings and low risk, but MS and GS are obviously outliers due to the trading and market risk taken by both firms. SCHW is the low-risk player in the universe of US universal banks, serving as the enabler and finance provider for independent advisors. But for us, RJF and SF may offer the most interesting opportunities in the universal space as each firm continues to grow its advisory business and related bank deposit base, but without the outsized market risk taken by GS, MS and the top-four money center banks led by JPM. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

August 10, 2022 | One of the goals of The Institutional Risk Analyst is to help our readers see the rocks in the water ahead before we hit the prop on the brand new Yamaha outboard motor. We try to do this by highlighting the exemplars among banks, finance companies and aspiring fintech issuers in our Premium Service . Last year, we helped several readers avoid the downturn in financials, positioning them to go shopping today. We recently featured Block Inc. (SQ) and Guild Mortgage (GHLD) , in our last issue (“ Update: Guild Mortgage & Block Inc. ”). West Grand Lake August 2022 We also focus on the those increasing instances where the speed of change in the macro markets is adding more noise than signal to the common narrative of investors and risk managers. In that regard, we were more than a little amused when the notorious SoftBank of Japan announced that it was dumping shares of SoFi Technology (SOFI) after reporting a more than $20 billion loss on its portfolio. Bloomberg News reports: “SoftBank Chairman and Chief Executive Officer Masayoshi Son earlier Monday said he plans widespread cost cutting at his Tokyo-based company and the Vision Fund, following a record 3.16 trillion yen ($23.4 billion) loss. The Vision Fund has been hammered by a selloff in global technology stocks this year, and SoftBank also reported a $6.1 billion foreign exchange loss because of the weaker yen.” As we predicted last year, SoftBank has been forced to put Fortress Investment Group up for sale. “SoftBank announced its acquisition of Fortress, one of New York real estate’s more active lenders, in February 2017. The deal came out to $8.08 per share, or $3.3 billion overall,” reports The Real Deal . Price talk for FIG is now said to be around $1 billion. Remember, the end of QE means asset price deflation . Q: If SoftBank needs to take a 70% discount on the sale of FIG and other assets, what does this say about the sustainability of Masayoshi Son ? More than any other global hedge fund, SoftBank represented the one-way trade created by the Federal Open Market Committee during the past decade. Its most radical adventure in quantitative easing or QE was merely the finale of a decade of inflationism. The most recent round of “large scale asset purchases,” as QE is known internally at the Fed, caused stocks and bonds to move higher in a nearly 100% correlation, a fundamental change in how private markets operate. By nationalizing the short-term money markets, the FOMC created the appearance of control. Just as SoftBank seemed to be minting money with every investment it made over the past decade, the Fed suspended the laws of economic gravity. QE was essentially a free long call option on the equities markets for global investors, especially those fueled by leverage. Now, however, that long-call position has suddenly migrated into a short-put position , with equity managers desperately trying to avoid another down quarter as clients take losses. As short-term rates rise but medium-duration exposures fall in yield, the FOMC is confronted with one of the more profound aspects of QE: namely that having inflated asset values to a grotesque extent, the central bank is now compelled to embrace and even encourage debt deflation. Not only does this suggests a prolonged period of economic contraction equal to the expansion under QE (read: a recession), but it also suggests that we’ll experience above-average credit defaults after a period of artificially benign credit. Source: FFIEC The reality of the construct above is revealed by the decidedly bearish views spilling out of the bank regulatory community. When the Fed directed JPMorgan (JPM) and other banks to raise capital buffers in preparation for the “hard landing” dreaded by economists, what they are really saying is that the conclusion of extraordinary policy may be a significant uptick in bank credit losses. If deflation takes hold and asset prices for stocks and homes weaken, then banks will take a significant hit after two years of negative credit costs. If you believe that the FOMC is going to stick to its guns and force down prices for residential homes, then you must also believe that all manner of credit investor will also take significant losses in the process. This is not a reference to losses on crypto tokens or other pieces of the financial fringe, but rather a mark-down in the value of real assets with real cash flows. Whereas the 2008 financial crisis was about the excesses of Wall Street in selling private-label residential mortgages, the deflation of 2023 is about marking down all types of real assets to the price level that equates with a non-QE world. As the FOMC now attempts to reduce the size of its portfolio, it will be a net-seller of Treasury debt and mortgage-backed securities (MBS), putting pressure on the dealer community even as issuance volumes fall. As bank reserves fall, banks and other investors will be forced back into the market for Treasury debt and MBS, pushing interest rates lower in the process. Lower reserves means lower deposits held at banks, eventually pushing down assets for the entire industry. Bank funding costs will remain suppressed for the next 12-18 months, however, giving banks a significant advantage in the money markets. Source: FFIEC And as the FOMC raises short-term interest rates and, with it, the cost of borrowing Treasury and MBS from the Fed’s reverse repurchase (RRP) facility, money market funds will be forced to buy Treasury debt and MBS in the open market, again putting downward pressure on medium and long-term interest rates. Banks, meanwhile, will be net sellers of assets as they comply with regulatory edicts to raise capital, putting upward pressure on interest rates as they sell loans and MBS. For all of you members of the Buy Side community who have been talking about rising bank lending volumes as interest rates rise, forget it. As the FOMC normalizes policy after several years of radical QE, banks will be forced to shrink risk assets and build liquidity, a counter-cyclical aspect to the scenario that is not addressed in most economic models. Banks will be net sellers of risk, putting downward pressure on loan prices and bank earnings for 2022-2023. Bottom line is that the Fed has created a scenario whereby the central bank and commercial banks are net sellers of risk. The structural aspects of this decidedly Fed market may force rates lower in the near term. As reserves disappear and the bid for Treasury paper and MBS rises in a market with dwindling supply of collateral, medium-term and long-term rates may fall significantly. Chairman Jerome Powell and his colleagues on the FOMC want you to believe that they can manage this complex process without market disruption and without taking the Fed’s balance sheet down below ~ $6 trillion. Sure. Have a great summer.

August 8, 2022 | Premium Service | Earnings season continues to roll along, with some notable surprises and also disappointments. This week, The Institutional Risk Analyst looks at Block (SQ) and Guild Mortgage (GHLD) , two story situations that have important messages for investors in financials. Both were punished in the first half of 2022 but both names have significant value outside of the current noise in the financial markets. With SQ, we see the negative impact of the deflation of crypto as the FOMC raises real interest rates, but the core business continues to grow. We think the Street is dead wrong about an impending pivot by Fed Chairman Jerome Powell and remind one and all that a sea change has occurred at the central bank. While the threats and bullying from the progressives in Congress is tough to take, restoring credibility in terms of inflation is now the Fed’s focus. Investors in the credit markets ought to consider how some of these platforms and strategies will look when the Fed goes into 2024 and into the general election with short-term interest rates still elevated. Housing costs, for example, are going to continue rising into 2023, thwarting hopes for an early pivot by the Fed. And across the universe of financial assets, the upward demand pull on valuations by investors is striking. The evidence of systemic inflation abounds. While it is “different this time,” the basic cycle of employment and inflation that has governed US financial markets remains intact, albeit with much higher volatility. We expect the FOMC to maintain elevated interest rates through to 2024, a dire message for equity managers that are betting the house on a pivot by the Fed before year-end. We look for many credit metrics to normalize over the next year as volumes remain low and default rates are rising. Guild Mortgage The volatility caused by the FOMC's shift to fighting inflation was very much in evidence in financials and particularly mortgages in Q2 2022, thus we were pleased to see GHLD deliver a strong quarter in terms of managing loan production expenses and other costs. The fact that rates rallied into the end of the quarter provided a bit of lift for GHLD and many other mortgage lenders and issuers. The first thing to notice about GHLD is that while the industry is down 60-70% on volumes, the purchase mortgage lender is only down less than 40%. GHLD has smartly reduced expenses 30% YOY, keeping this traditional retail lender solidly in the black while continuing to grow its servicing book, now $76 billion in unpaid principal balance (UPB) or about 315,000 loans. Source: EDGAR Likewise gain-on-sale volumes fell very modestly, again attesting to the strength of the GHLD model and their focus on retail purchase mortgage volumes. Total in-house originations of $11.8 billion compared to $17.9 billion in the first six months of the prior year. In addition, net revenue of $769.3 million compared to $820.3 million in the first six months of 2021. Net income of $266.3 million compared to $169.5 million in the first six months of 2021. “We delivered solid financial results for the second quarter of 2022 despite higher interest rates, excess capacity and limited inventories,” said CEO Mary Ann McGarry. “Despite shifting market conditions, our tenured management team has a proven track record across cycles and our differentiated purchase-focused business model positions us well, as refinancing volumes continue to weaken. In fact, purchase loans accounted for 84% of our total origination volumes in the second quarter.” GHLD has obviously given up a lot of ground since the end of 2021, but it has outperformed all of its mortgage peers save Mr. Cooper (COOP), as shown in the chart below: GHLD is down 17% YTD, a better performance than many other stocks in the mortgage group with the exception of COOP. The next year is going to be challenging for mortgage issuers, but we look for GHLD to continue to out-perform the group and perhaps even be a buyer of struggling mortgage firms. If you want upside exposure for the next Fed rate easing, names like GHLD and COOP ought to be part of your basket. Block Inc. (f/k/a Square) The results for Block were actually good in Q2 2022, but for the distraction of the crypto market. With the Fed raising interest rates, MMT and its techno hell spawn bitcoin are being deflated by rising real returns. Crypto tokens, NFTs and other collectibles only made sense in a zero rate environment. So long as central banks were removing trillions of dollars in duration from the markets, humans created new games from which to profit. The same crypto cachet that made SQ soar during the past two years has now become a bit of a headwind in the near term. As SQ stated in its shareholder letter: “Total net revenue was $4.40 billion in the second quarter of 2022, down 6% year over year, driven by a decrease in bitcoin revenue. Excluding bitcoin, total net revenue in the second quarter was $2.62 billion, up 34% year over year. Gross profit was $1.47 billion, up 29% year over year and up 47% on a three-year CAGR basis, and included $18 million in amortization of acquired technology assets.” We were involved in SQ early, but exited at the end of 2018 after returns went into double digits. The stock then proceeded to double and more during COVID. Since January of 2022, however, SQ has been cut it half, making us wonder if now is not an opportune time for re-entry based upon the core payments business as opposed to crypto fluff. Names such as Visa (V) , Mastercard (MA) and Fiserve (FISV) are better comps in our view. We were more than a little disappointed when SQ co-founder Jack Dorsey got involved with crypto and even changed the name of the company to give the firm a blockchain flavor. We think such short-term behavior detracts from the excellent results that Dorsey and his team have delivered on the core business. As we’ve noted in previous missives, we got into SQ half a dozen years ago because we knew that the roving hoard of equity managers seeking fintech would eventually find the stock. And they did. We loved the new approach to vendor transaction clearing for small business and that aspect of SQ remains the most attractive part of the business. Now, however, we think that a more constructive way to think about SQ is in comparison to the other credit card and payments players, which is hardly a bad thing but not quite so hyperbolic as the fintech sector has been in the past several years. The chart below shows SQ's results through Q2 2022. Source: EDGAR We like the positioning of the company and the fact that they are growing their business on larger accounts. CFO Amrita Ahuja addressed this issue: “We have obviously a diverse base of sellers, millions of sellers. From a vertical perspective, we span a range of verticals. So, 40% of Square GPV comes from a range of services verticals in 2021. The remaining 60% is across some of those discretionary areas like food and beverage, retail and other smaller, but growing verticals where we've continued to see stability from a three-year CAGR perspective. From a seller size perspective, as I said, continue to grow upmarket. In the second quarter, two-thirds of our volume in the Square business is from larger sellers, $125,000 in annual GPV or more. And historically, those larger sellers have been more resilient through downturns. And as we've said, larger seller, broader retention within the Square business, even including our smaller sellers, has been positive across GPV and gross profit in the second quarter and into July.” The major negative with SQ is the childish dalliance with crypto and the equally ill-considered name change. There does not seem to be any appreciable contribution to Block's business from blockchain technology. More, Square is how the firm is known inside the company and in the consumer payments community. Since Block has not yet changed its ticker symbol, perhaps Mr. Dorsey will eventually change the company's name back to Square and slowly distance himself from the crypto world and the equally unimpressive blockchain morass. While SQ is down 45% YTD, it rallied over 30% in the past month, along with names such as PayPal (PYPL) , SoFi Technologies (SOFI) . We suspect that concerns about the economy and the intentions of the FOMC with respect to interest rates are going to remain a drag on many consumer finance stocks. But we are impressed by SQ's progress in building its core business and think a long-term perspective that de-emphasizes the crypto component may be appropriate. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

August 1, 2022 | This week The Institutional Risk Analyst is headed for Leen’s Lodge in Grand Lake Stream, Maine , for a week of fishing, discussion and perhaps a poker game. Topic A on the agenda items for debate will be the state of monetary policy in the United States. Big Lake (August 2020) First and foremost, let's review last week's FOMC presser. Powell declared victory and proceeded to state that the neutral rate of interest or ”r*” is somewhere close to the current nominal level of Federal Funds (FF). The incredulity in the room was palpable, yet nobody in the media dared to challenged Powell’s statement. He said: “I'd start by saying we've been saying we would move expeditiously to get to the range of neutral. And I think we've done that now. We're at 2.25 to 2.5 and that's right in the range of what we think is neutral.” The chart below shows effective FF vs the rate on reverse repurchase agreements (RRPs). In these latter transactions, the Fed lends securities and takes cash out of the market. But hold that thought. The lack of specificity in the Fed’s statement about r* provides a hint about just how little precision there is in the way the FOMC looks at variables like inflation and interest rates. This lack of clarity, in turn, trickles down into all of the policy decisions made by the Committee. Thus if Powell actually believes that FF is now at r*, then no further rate hikes are required in 2022? Bill Nelson at Bank Policy Institute rejected Powell’s statement about FF neutrality: “That is incorrect – the current level of the federal funds rate is not neutral. The neutral federal funds rate is the rate above which monetary policy is restraining the economy and below which monetary policy is stimulating the economy. The neutral rate is usually defined in term of the real federal funds rate – the nominal federal funds rate minus a measure of inflation or inflation expectations. The neutral real federal funds rate is often called r*. The median FOMC participant indicated in the June SEP (Summary of Economic Projections) that he or she judges that the nominal federal funds rate will be 2.5 percent in the long run at which point inflation will be 2 percent. That reading indicates the neutral real federal funds rate is 0.5 percent.” Fed Chairman Jerome Powell mentioned the phrase “balance sheet” twice during his remarks. None of the senior reporters and columnists in the room asked about the portfolio, which is the single most important factor in monetary policy. Putting Powell on the spot about the vagueness of the Fed's intentions on the portfolio would be seen as unconstructive. Thankfully Jean Yung of Muck Rack asked about the pace of balance sheet reduction. Powell replied: “So we think it's working fine. As you know, we tapered up into it. And in September, we'll go to full strength. And the markets seem to have accepted it. By all assessments, the markets should be able to absorb this. And we expect that will be the case. So, I would say the plan is broadly on track. It's a little bit slow to get going because some of these trades don't settle for a bit of time. But it will be picking up steam.” What Powell was saying is that reinvestment of redemptions and prepayments on mortgage securities will end in September and forward trades in the mortgage market will likewise settle by that time. Translated into plain language, the Fed will start shrinking reserves and in theory force investors out of reverse repurchase agreements in September. Dealers will also be expected to shoulder 100% of the duration of Treasury and agency MBS issuance. Powell then defined the timeframe: “So I guess your second question was getting-- the process of getting back down to the new equilibrium will take a while. And that time, it's hard to be precise, but the model would suggest that it could be between two, two and a half years, that kind of thing. And this is a much faster pace than the last time. Balance sheet's much bigger than it was. But we look at this carefully and we thought that this was the sensible pace. And we have no reason to think that it's not.” Greg Robb of MarketWatch then asked Powell a good follow-up question about the potential for a repeat of the December 2018 taper tantrum, when markets seized up after several money center banks back away from overnight funds markets. Powell’s answer was quite revealing and detracts from the idea that reserve targeting as a percentage of GDP is a good way to avoid similar market hiccups: “So I think we learned, there have been multiple taper tantrums, right? So there was the famous one in 2013. There's what happened at the December '18 meeting where markets can ignore developments around the balance sheet for years on end, and then suddenly react very sharply. So we just had developed a practice of moving predictably and doing it in steps and things like that. It was just like that's how we did it. And so we did it that way this time. We were careful to take steps and communicate and all that kind of thing. Yeah, we were trying to avoid a tantrum. Because they can be quite destructive. They can tighten financial conditions and knock the economy off kilter. And when it happens, you have to, really in both 13 and 18, really had consequences for the real economy, two, three, four months later. So we were trying to avoid that.” We noted earlier that the Fed is modeling future market liquidity requirements vs GDP. Economists love to argue about mysterious quantities like liquidity or unmeasurable notions such as r*, yet the fact is that the FOMC ultimately relates everything to interest rates or gross domestic product. More complex notions are completely beyond the comprehension of members of Congress and the investment advisory profession. The purely domestic focus of the Humphrey-Hawkins law encourages this childishly simplistic view of the dollar political economy, a view significantly that excludes the rest of the world. For example, when Chairman Powell stood up last week and spoke about the neutral rate of FF, he never once acknowledged that the 10-year Treasury note had rallied almost 50bp in yield since the last FOMC meeting. Why is this key benchmark falling in yield? Because of the global shortage of risk-free collateral created by QE. Few people among the Big Media that “cover” the Fed have any idea about the bond market, risk-free collateral or the dollar. Notice in the chart below that sellers of fixed dollar cash flows are paying up handsomely in swaps, but outside of 30 years dollar cash flows trade at far lower yields than Treasury collateral. Source: Bloomberg Jeffrey Snider , Head of Global Research at Alhambra Investments, did an important piece recently where he discussed the shortage of collateral in the context of the dollar and interest rates (“ Collateral Shortage…From *A* Fed Perspective ”). Snider noted that since 2017, Treasury bills have been trading at a premium to risk-free reserves at the Fed, a strange situation that suggests a systemic shortage of this crucial collateral. At the same time, the short-term market for dollar swaps has been trading well-outside of the Treasury yield curve, but beyond 30 years is very tight and well-through Treasury yields. Since only banks may hold reserves at the Fed, the shortage of collateral has fallen most heavily on private market participants. Snider concludes: “It’s all about the puppet show. Top-level policymakers still, to this very day, believe that they can convince the world to dance to their tune; playing the federal funds “market” as the sole instrument in the accompanying FOMC Orchestra. The intended audience for this pitiful display includes, ridiculously, collateral suppliers and multipliers. That very fact alone gives it away. No one uses nor really cares about fed funds except those in the media who then give the public a distinct monetary impression that is plainly false.” “Even now, you’ll hear it said that the dollar goes up because of rate hikes to either the FOMC’s fed funds target (pre-2009) or its range plus instruments (like RRP and IOER),” Snider relates. “The Fed does not matter. Only Euro$.” We agree. For some time now, we have tried to focus the attention of our readers on the growing influence of foreign investors when it comes to the dollar and also the rate of interest in the dollar system. The growing number of disturbances to the offshore dollar system, including the financial implosion of China’s “Belt & Road” effort, the default of HNA and other corporate failures, and the related carnage in the Chinese property market, were early signs of stress. The war in Ukraine, inflation and the rising rates have thrown the non-dollar world into another debt crisis. And yet, strangely, the FOMC managed to conduct a press conference last week where the word “debt” was never mentioned. Foreign nations and markets were barely acknowledged. All of this is part of the exceptional American perspective that our domestic debt does not matter and the impact of the dollar on other nations, most of whom are short dollars, is of no consequence. As we noted in our comment to subscribers of the Premium Service last week (" Questions for Chairman Powell "), one reason that the Fed is not willing to allow its balance sheet to fall below about $6 trillion by the end of the decade is uncertainty about how the different pieces of the puzzle – the $9 trillion portfolio, $2 trillion in reverse repurchase agreements, and the Treasury market and cash balances -- will interact. But politics also plays a role. The FOMC figures that they can manage the politics of losing money on an interest rate mismatch more easily than taking hundreds of billions in realized losses on securities held in the system open market account (SOMA). Thus the FRBNY research team last month assumed no realized losses from the SOMA at all, zero, and thus no sales. Somehow nobody in the Big Media thought this was important? The $9 trillion in paper held by the SOMA (~ $6.2 trillion in Treasury debt and $2.7 trillion in mortgage backed securities) constitutes a threat to the global economy outside the US. Why? Because when countries and private companies and banks engage in offshore dollar transactions, they need risk-free collateral to back the trade. The low coupon Treasury paper and MBS created in 2020 and 2021, however, is now a ghetto, unsalable paper that is trapped on the Fed’s balance sheet, creating a serious problem in the global market for dollars. “Given the Fed primarily holds 2.0% to 2.5% coupons on its balance sheet, the ‘Sword of Damocles’ that is active sales hangs over these lower coupons as the Fed postures to embark on this unprecedented route,” writes Gordon Li of TCW, referring to the considerable underperformance of the lower coupon MBS since last year. He elucidates: “In stark contrast to these developments in lower coupon sectors, current coupon agency MBS have seen nominal spreads widen to levels roughly 35 bps in excess of previous Fed 'Reinvestment-QT' ranges, perhaps suggesting that the ‘pricing in’ of hawkish Fed actions has been overdone this hiking cycle. Valuations in current coupons have been made even more compelling by a sharp decline in dollar prices.” Given the dichotomy between the Sell Side tendency, which has already begun to chatter about Fed rate cuts before the end of next year, and the rest of the world, which is suffering from a strong dollar, the lack of clarity with respect to the optimal level of Fed involvement in the market is striking. Specifically, should the Fed assume that it needs to aggressively lend out its SOMA portfolio as the process of shrinkage actual begins in September? Here’s a question we’ll leave with our readers until later this week, when we report on the discussions at Leen’s Lodge: Will the Fed actually be able to “force” investors out of the more than $2 trillion in reverse RPs? “Force” is one of those unfortunate terms in monetary economics. We cannot force people to lend or invest unless we turn America into a copy of Xi Jinping's Chinese prison. Some believe that the Fed lost control over its own balance sheet at the start of QE. More, how much of a discount to FF will investors tolerate in return for borrowing risk free securities from the Fed? The answer to those questions will better inform the FOMC’s consideration of optimal reserve levels than a modeled output based upon GDP. After all, the relative demand for risk-free collateral and thus liquidity is largely a function of how JPMorgan (JPM) CEO Jamie Dimon feels about risk on any given day. As we noted recently, Dimon is a seller of risk. Stick that in your model and stir briskly Chairman Powell.

July 27, 2022 | Premium Service | In this issue of The Institutional Risk Analyst , we look at the Q2 2022 results for Mr. Cooper (COOP) released today. COOP is one of the larger owners of servicing among independent mortgage banks (IMBs) and one of the first members of the group to report. Generally speaking, IMBs, fintech platforms and other members of the finance market fringe tend to hide in the weeds until the last week or two of the 45-day reporting season mandated by the SEC. United Wholesale Mortgage Corp (UWMC), for example , reports on August 9th, but COOP is always one of first out of the gate and always has some of the best disclosure in the industry. Most of the rest of the industry won't report till next week at the earliest. As Sydney Poitier said so well in The Jackal , the good guys don’t hide. COOP is the sixth largest owner of mortgage servicing and one of the largest servicers for third-parties, with over $800 billion in primary servicing. The chart below is from COOP’s Q2 2022 earnings presentation. COOP is well on its way to reach its goal of $1 trillion in mortgage servicing. The Q2 results included a $195 million, non-cash amortization on the owned-MSR, which reduces reported income 1:1. Going forward, COOP expects that lower amortization and higher interest income will benefit earnings. Indeed, COOP told investors on the call that Q2 2022 may be the worst quarter of the cycle . Significantly, the compounded prepayment rate (CPR) of COOP’s servicing book is now down to 11% and the firms projects that rate falling to high-single digits by year-end. One of the big advantages that COOP has vs. its peers is a relentless focus on operational efficiency and cost savings, illustrated by the 40% decline in operating expenses since 2018. At the same time, COOP has increased the number of loans per employee from just shy of 700 in 2018 to 850 in Q2 2022. New loan volumes in Q2 2022 were running at a quarter of last year’s levels, but the servicing book generated substantial income. Unlike most of the mortgage sector, COOP's stock is up year-to-date, reflecting the balanced business model that includes one of the largest servicing books in the industry and a state-of-the-art lending operation that is more efficient than most other issuers. COOP claims that they have a 30% cost advantage vs other lenders and servicers. Like New Residential Investment (NRZ) , COOP has slowed purchases of MSRs and, indeed, recently sold owned-MSRs to a client in order to raise cash. COOP clearly believes that there will be opportunities to acquire MSRs in the future as other IMBs encounter operational difficulties as the economy slows. As we've noted in past notes, pricing in the MSR market has been week since the start of 2022 as previously active banks have backed away and have even sold assets. The fact that COOP is telling investors that they expect operating income and cash flow to grow for the rest of the year reflects a very bullish view on the part of management. It is interesting to note that COOP continues to be a buyer of its stock. More, COOP has no significant debt liabilities maturing for the next five years, providing a clear runway for the firm to build cash and acquire MSR portfolios opportunistically. “We are in a period of very unique opportunities,” Vice Chairman Chris Marshall told investors. “We want to position to take advantage of opportunities in the markets.” CEO Jay Bray noted that there are more and more MSRs coming to market, mostly from IMBs, thus supporting the narrative that says that assets are going to be getting cheaper. The twin prospect of disruption and opportunities in the mortgage market may provide COOP with an opportunity to continue to expand the MSR portfolio. We view COOP as one of the more prudently managed IMBs in the industry. The focus on the use of technology to reduce costs, plus the capital light strategy and the move to sell assets opportunistically makes COOP one of the more nimble and more survivable firms. The move last year to sell Title365 and spin the servicing technology platform to Sagent Lending Technologies illustrate the superior strategy and implementation of COOP. Leon Cooperman , a large shareholder, asked during the call what COOP sees as the long-term capital needed to run the business, Bray indicated that the current 30% capital to assets is probably too high and the minimum target is half that amount. Cooperman then went on to suggest that Bray ought to do a more substantial share repurchase or tender offer, a luxury most IMBs cannot even consider. We agree with the assessment of COOP management by Mr. Cooperman that this firm is one of the best positioned IMBs in the industry and has the liquidity necessary to continue to build value for shareholders. The fact that Leon Cooperman is one of the largest shareholders of COOP, even after the mortgage market selloff, speaks volumes for the way that this company has performed in good markets and in bad. If the recession now before us is extended, then COOP will be well positioned to navigate through it and acquire new assets as MSRs valuations come under pressure. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. 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