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June 15, 2022 | Premium Service | As markets wait to find out how high the FOMC will jump in fighting inflation and pursuing credibility, we are going to focus on some obvious opportunities in the markets presented by rising interest rates. Big picture, a lot of assets that traded at a premium a year ago are now at a discount. “Negative-incentive Ginnie paper prepays faster than does negative-incentive conventional paper,” First Horizon Financial (FHN) SVP Walter Schmidt wrote in a June 14, 2022 report. “And since the market is now clearly in a negative incentive position with almost every asset priced at a discount to par, faster-prepay assets should perform better.” In other words, you can buy GNMA MBS at a discount and profit from prepayments at par. Schmidt notes that the largest non-banks service roughly three quarters of the unpaid principal balance of the Ginnie Mae sector while only 14% is serviced by the five largest commercial banks. “This leads to more aggressive servicing tactics, particularly along the lines of cash-out refinancings,” he concludes. Approximately 44% of the conventional market is serviced by “aggressive non-bank servicers,” FHN adds. Yeah, and those aggressive nonbank servicers will keep prepayment rates elevated as a matter of survival. Meanwhile, Signature Bank (SBNY) got a 2x4 in the mouth earlier when concerns about the demise of the crypto market caused the equity market value of this $120 billion asset unitary bank to crater. The SBNY common is down more than 40% YTD. SBNY just came off of a strong Q1 2022 earnings report, thus the down move caught many investors by surprise. Net income in Q1 2022 increased $148.0 million to a record $338.5 million vs $190.5 million in Q1 2021. What's not to like? Crypto. "The stock was suffering from the selloff in bitcoin as many on Wall Street see it as a cryptocurrency play , as the bank has a digital payments platform, named Signet, and because it offers a loan product collateralized by cryptocurrencies," Marketwatch reports. SBNY management needs to explain to investors just why they decided to risk the bank’s excellent reputation on something as absurd as lending on crypto tokens. Taxi medallions, an asset class where the bank was once active, would be a superior speculation. When you recall that SBNY traces its lineage back to Republic National Bank , the obvious question is this: What would Edmond Safra say? Large bank leader American Express (AXP) has given back just 10% YTD in terms of its equity value, one of the best performances among financials. Next on the list is the low-beta Toronto Dominion Banks (TD) , which is down 11% so far in 2022. The leader in our large bank group is HSBC (HSBA) , which is up almost 20% YTD in a larger flight to perceived quality. Our bank surveillance group is shown below c/o Bloomberg. June 15, 2022 What is remarkable but not surprising is looking at where the market’s volume is concentrated. Aside from HSBA, other volume leaders include Bank of America (BAC) , Wells Fargo (WFC) and Citigroup (C) , which is now trading less than half of book value. How does anyone explain this seemingly irrational behavior by investors? Big is better than quality in times of market uncertainty. Other names that are out performing the group that we have highlighted in the past include Raymond James Financial (RJF) and U.S. Bancorp (USB). As the market deflates a lot of aspirational stocks in coming weeks, we are looking to add to our holdings of preferred and possibly even some common. That said, we are in no hurry and are more inclined to add to positions in energy and technology. Truth to tell, even with the selloff to date, the financials are not particularly cheap. AXP at 5x book value is cheaper than it was in January, but not yet compelling for our money. USB and JPMorganChase (JPM) are still trading well above book value. Our basic view is that the whole banking complex will trade lower on credit fears arising from a recession, but lackluster financial performance will add to worries. Meanwhile over at Citi, the noise regarding the Ukraine war and sanctions have pushed the stock down to what seem silly levels. We are less worried about the possible credit risks to the bank and more concerned by the army of consultants from McKinsey that are swarming the Citi operations. Even by past standards, the consulting expenditure at Citi on various risk remediation projects has become massive and will likely show up in operating expenses as the year progresses. As the bubble created by the Fed’s QE exercise collapses, we expect more substantial names in the financial sector to come back into vogue. We do not anticipate a bounce in pre-tax income for banks, adding to downward pressure after 18 months of artificially enhanced results. The fact of more aggressive action by the FOMC may push funding costs up faster, making our earlier prediction of a narrowing of net interest margin come to pass. A lot of Street peeps have been caught off guard in financials, in particular our Twitter buddy Jim Cramer , who has made us a lot of moolah over the years. On banks, however, the Street has largely refused to accept the magnitude of Jay Powell’s impact on NIM and pre-tax earnings, which remain down $40 billion per quarter vs the end of 2019. Even as the FOMC raises interest rates, we are dubious that asset returns will keep pace in the near term. Thus we caution our readers to be prepared for disappointment from banks in the near term. 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.

June 13, 2022 | First a big thank you to readers of The Institutional Risk Analyst who liked our post regarding non-controlling interests in the disclosure of public companies (“ Memo to Gary Gensler: Beware the “Non-Controlling Interest ”). None of the media companies that are in the business of aggregating and re-selling financial data have yet been willing to report on the issue. We remain hopeful. Perhaps the Securities and Exchange Commission and FINRA eventually will look into the obvious disclosure and GAAP presentation issues this anomaly raises. One wonderful technical supporter at Bloomberg commented that he couldn't change the calculation of equity to include non-controlling interests since it would "affect too many people." Well, you are affecting them right now. Tens of thousands of shareholders of hundreds of public issuers are impacted by this false presentation of equity. We are hoping for a new series including the non-controlling interest. Not only does the characterization of equity as a “non-controlling interest” strike us as inaccurate in many (but not all) cases, but the question of inaccurate data and derivative metrics raises a lot of nasty questions for the world of “artificial intelligence” or AI and credit. If the inputs into an automated system are wrong, then the output is garbage. Garbage in, garbage out as they say in Silicon Valley. But then, technology companies would never accept the error rates that are considered normal on Wall Street. Q: Can a new era broker dealer like Robinhood Markets (HOOD) use AI to power retail investment recommendations without checking the accuracy of the data? There are hundreds of issuers that utilize “non-controlling interests” in their public company financial disclosure, for example, yet the data vendors do not inspect the presentation of the data. In the world of investment banking, you cannot use vendor data for fairness opinions or other materials, for example, because of such anomalies. So, is a typical 2-3% error rate for financial data and metrics OK for retail investors? The issue of data quality and fidelity is crucial not just for consumers, but because it goes to the very heart of risk in the fast approaching credit cycle. All of the "new" loan approval systems that were developed after 2008 and during the period of quantitative easing (QE) are biased down in terms of the cost of credit. These are systems primarily designed to originate an asset to a minimum level of confidence and sell it to an investor while minimizing the legal liability of the issuer. Loans held in portfolio by a bank, for example, are subject to far more scrutiny and thus incur more cost of origination. As we’ve documented in The IRA Bank Book Q2 2022 , the cost of credit in bank owned 1-4 family mortgages has been negative for five years. As default rates normalize in this pool of large, mostly prime mortgage loans, what do you suppose will happen to the less prime mortgage exposures that were sold into an ABS? FHA exposures, for example, could reach the high teens in terms of delinquency in this cycle -- before home prices actually crack a couple of years from now. Source: FDIC/WGA LLC Of interest, last week the Consumer Financial Protection Bureau (CFPB) issued an order to terminate Upstart Network (UPST) from its list of approved “no-action letters.” The CFPB granted special regulatory treatment to Upstart by immunizing the lender from being charged with fair lending law violations with respect to its AI-based underwriting algorithm, while the “no-action letter” remained in force. Upstart requested an amendment to the “no-action letter” that effectively seeks immediate termination. “Loans originated by Upstart are either held, sold to institutional investors, or retained by bank partners,” notes the CFPB. “In 2021, Upstart’s bank partners originated 1.3 million loans, totaling $11.8 billion.” It will be interesting to see how the various vintages of UPST production perform in a rising interest rate environment. The CFPB, of note, is taking increased interest in technology that supports lenders and the vendors that provide these systems of record. The CFPB granted UPST a first “no-action letter” in September 2017 and a second letter in November 2020, just when the utopian frenzy of nonbank fintech AI-enabled lending caused by QE maxed out. “No-action letters” typically grant individual companies special regulatory treatment, on certain specified matters, where an agency agrees to not take action for violations of law. Remember, making good loans is about making good underwriting decisions, not machine learning. As the head of non-QM lending at a top-four bank said of using AI for automated post-close due diligence prior to sale: “No, I know what we are dealing with. Open the door and loan quality will degrade.” The idea of modifying an automated credit model at the end of a decade of QE may strike some of our readers as significant. We agree. Our skepticism toward the world of automated credit originations is similar to our view of automated appraisals for residential mortgages. They work until they don’t, especially at major economic and market inflection points. The reason why lenders continue to spend big dollars on data consumption and validation is the need to limit the process errors to a certain level so as to avoid spikes in credit costs. But it is axiomatic that the production that is sold to investors is always inferior to the production retained. Thus the big risk to originate-to-sell lenders is repurchase claims. As we noted last week, it was the retention on balance sheet of UPST production that spooked investors (“ Update: Upstart Holdings & Cross River Bank ”). When investors see a nonbank issuer like UPST and its partner banks retaining exposures that were meant for sale to investors (aka, the “victims”), then you can understand the natural feeling of consternation. In the world of retail, this is what is known as "expired stock" -- especially when interest rates are rising. Falling market liquidity in the private markets for asset backed securities (ABS) adds a certain urgency to news that UPST has decided to make significant modifications to its credit model. Given the way UPST handled its involuntary foray into warehousing unsecured consumer loans, we look for more revelations in the future. But the big picture facing the ABS markets is of greater concern. New issue volumes for ABS actually rose sharply in May 2022, but the absolute value of $35 billion in new issuance remains well-below 2019 levels. Since January of 2020, ABS issuance has been throttled, a decidedly negative indicator for liquidity risk and the U.S. economy. Likewise the bid for non-QM mortgage loans is also moderating after a torrid 2021, raising more operational issues for residential lenders. Notice that total mortgage issuance of all asset types is now below $200 billion per month, as shown in the SIFMA data below, half of levels a year ago. The May data for Treasury issuance, added to the record tax receipts, pushed the government’s cash balances over $1 trillion in May, but is now trending lower. Meanwhile, the crowd looking for risk-free returns at the Fed’s reverse repurchase window (RRPs) is growing toward $2.5 trillion. Notably the crowd does not include the dealers and banks that were the intended participants. The negative stigma of borrowing from the Fed remains too powerful as disincentive. The RRP facility is now a policy challenge for the FOMC. We suspect that the usage of the RRP facility is going to become a problem because the crowd of money market funds looking for risk-free returns is only going to grow as rates rise. The only way to reduce the level of utilization in RRPs, it seems, is to push down the awarded rate and literally force participants back into Treasury bills. The chart below shows 30-day T-Bills vs the award rate for overnight RRPs. This desire for higher risk-free returns may only be a transient problem, however, since we fully expect the 10-year Treasury note to start falling back towards two percent yield in short-order. Even as the FOMC forces up the front of the Treasury yield curve, the back end is more likely to rally. Could we see a rally in bonds and some down marks on servicing assets in future even as mortgage rates rise? The 4x growth in the duration of the Fed’s MBS portfolio since last June describes the magnitude of the credit risk which resides inside all fixed income assets. The FOMC moved loss rates on 1-4 family loans down by an order or magnitude over the past four years. Given the huge amount of credit exposure embedded in private financial assets over a decade of QE, and the closely related demand for safe assets, the true risk free rate is probably less than zero. Ponder that as Chairman Powell tries to wind-down QE. 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.

June 8, 2022 | Premium Service | A number of subscribers to The Institutional Risk Analyst have been asking about different regions of the mortgage and asset management complex. Creators and servicers of loans are currently in disfavor, but some investors are beginning to nibble on the real estate investment trusts (REITs). We’ll be looking at a number of asset gatherers and managers in upcoming issues of the Premium Service . Here’s the key questions: First, do you expect the yield on financial assets and particularly mortgage-backed securities (MBS) to rise faster than funding costs? And second, how do you feel about mortgage servicing rights (MSRs), which seem to be the plat du jour among the REIT community in this cycle? As the housing market rolls over and asset prices begin to fall for the first time in a decade, credit costs will reappear in at least equal measure. Interest Rate Volatility The big worry we see ahead is the fumbling approach of the Federal Open Market Committee to normalizing monetary policy combined with the rapid pace of change in the markets. Bill Nelson , Chief Economist of The Bank Policy Institute , illustrates the problem faced by the FOMC compared to the Bank of England: “The BoE plans to set the interest rate on its collateralized loans equal to Bank Rate, the rate it pays on deposits (reserve balances). It then plans on shrinking its securities holdings at least until borrowing picks up, which should happen at roughly the unknown structural short-run level of reserve demand,” Nelson noted in a missive earlier this week. He continues: “By contrast, the Fed’s plan is to stop QT ‘when reserve balances are somewhat above the level it judges to be consistent with ample reserves.’ At that point, the Committee will let currency growth reduce reserve balances until the balances are ‘at an ample level.’ The New York Fed is basing its balance sheet projections (available here ) on an assumption that that minimum ample level is 8 percent of nominal GDP (the level in December 2019) and will be reached in 2026 when reserve balances are $2.3 trillion.” In other words, the FOMC staff in Washington is modeling the demand for total reserves based upon GDP and the BoE is going to let the markets decide. Obviously we give the latter policy course a higher chance of success. Speaking of bad models, the FOMC continues to buy mortgage-backed securities even as new issuance of agency MBS is plummeting. The chart below shows dollar swaps vs the Treasury yield curve, which is essentially flat now from 2 years out to 30 years. Source: Bloomberg Given that new issuance is falling across the board in the fixed income markets, buyers of assets such as New Residential (NRZ) and Annaly (NLY) are going to be part of a much larger crowd that is chasing a shrinking pool of opportunities. The change in new issuance in areas such as high-yield and MBS is large in relative terms, thus we will be watching for signs of expansion in bank yields when the Q1 2022 bank peer data is released by federal regulators next week. Mortgage Issuers & Servicers The elevated velocity of change we alluded to with respect to interest rates is evidenced in the housing sector, with new mortgage applications at a 22-year low and aspirational prices for high-end dwellings softening. The fact that sales volumes are falling on the high-end properties is partly driven by lean inventories and provides little relief to low-income households, who face continued shortages of homes in many markets. “There is a massive shortage of housing in Arizona and California,” notes Alan Boyce in an email earlier this week. “Imperial County has 40 homes for sale with a population over 200,000 people.” With the shortage of housing assets for sale and falling lending volumes, it is difficult to paint a rosy picture of rising yields for investors in loans, servicing and MBS. This is not to suggest that astute managers cannot make money in this market, but the fact remains that bellwethers such as NLY and NRZ have been going sideways in the equity markets since the COVID selloff in March of 2020. NRZ has suffered the most severe decline, but since 2020 has clawed back about half the ground lost due to COVID and the FOMC’s response. Source: Bloomberg We sold our position in NLY earlier this year. While we continue to like the diversification of the NLY balance sheet into servicing assets, the outlook for the agency REIT market overall in terms of the FOMC is so unclear that we are just not comfortable holding the stock. We see an at least equal chance that margins will get squeezed for agency and MSR investors before they expand in response to higher benchmark interest rates. The flat yield curve and tight swaps curve both speak to a general scarcity of assets, yet the bid for non-agency loans and even MSRs has fallen away in recent weeks. Investors are running away from risk and back into Treasury and agency assets. The velocity noted above also applies to credit exposures, meaning that returns on GNMA mortgage servicing rights may start to be impacted as short-term interest rates rise. When we talk of interest rate spreads and credit, this all gets boiled down to net-interest income. As with banks, REITs such as NLY and NRZ have seen an erosion of net interest income since 2020. Now, as credit costs rise and lending volumes fall, some investors are starting to look at nonbank mortgage lenders as a distressed asset class. Given the clumsy behavior of the FOMC, we honestly do know when credit investors will once again see NII expansion. This is another reason why we and also the market remain circumspect on the bank, nonbank mortgage and agency REIT sector. The components of NII for NLY are shown below. Note the volatility of the results as market swings have hurt returns, in part by driving up the cost of hedging MBS 3x compared to pre-COVID. NRZ has actually out performed NLY since 2020, particularly over the past year, and added significant operating assets and MSRs with the acquisition of Caliber. Now the largest non-bank owner of MSRs, NRZ took a $575 million positive mark on its servicing asset, accounting for most of the increase in servicing income for Q1 2022. With lending volumes falling like a rock, NRZ will be under a lot of pressure to replace revenue and is reported to be employing unconventional valuation methods to boost the fair value of MSRs. Meanwhile, NRZ's once successful trade in Ginnie Mae early buyouts (EBOs) has reportedly turned sour and could be the source of losses later in the year. Overall, the EBO trade could cost the mortgage sector billions in losses in Q2 2022 with Ginnie Mae 2.5s trading at 90 and change in the TBA market. Along with JPMorganChase (JPM) , NRZ is reportedly using assumed revenue from cross selling opportunities to customers acquired via MSR purchases. A number of other banks have been purchasing conventional MSRs at multiples approaching 6x and, again, are referring to cross selling opportunities to justify MSR valuations. We find these reports troubling but not surprising since the flow of credit into MSRs is only increasing marginal demand. Of note, Bank of Montreal (BMO) and BNP Paribas (BNP) have jumped into the market for lending on MSRs. A breathtaking number of conventional issuers are plunging into the opportunity for non-QM loans, a shift that is unlikely to bring relief to lenders fleeing the carnage in the conventional loan market. Many issuers are losing money on secondary market execution, a situation which is a function of overcapacity. Our mortgage equity surveillance group is shown below and is sorted by dividend yield. The big concern in the near term is that market volatility and rising demand for risk-free assets will pressure residential and agency REIT returns even as new lending volumes fall. More important, we see growing pressure in the seller/servicer channel as debt prices fall to multi-year lows. RKT 2 7/8s of 2026, for example, traded above par as recently as December 2021 but are now trading in the mid-80s. If there is a credit event in the world of nonbank issuers, bank lenders will step back from this sector. PennyMac Financial (PFSI) 4 1/4s of 2029 are trading at 79 and a spread of 500bp over the Treasury curve. A winning strategy for survival is said to be one leg down in Ginnie Mae and the other in non-QM, leaving the conventional market out of the calculous. But we worry that the large and growing crowd in non-QM is going to drive the execution in that market into loss as well. Meanwhile, some of the bigger non-bank issuers have been leaning into large loan and MSR trades to capture assets, this in response to the reappearance of banks in the market for Ginnie Mae MSRs. Outlook In the background of the discussion of US interest rate policy and housing markets, there is a continued debate as to whether the FOMC will actually try to sell MBS from the system open market account or SOMA. It is important for investors and risk managers to understand that the flat yield curve imposed on markets by the FOMC, together with the threat of outright sales, is having pernicious effects. So long as the FOMC needs to absorb $2 trillion in cash via reverse repurchase agreements (RRPs) and the Treasury is awash in cash, managing the process of reducing the size of the SOMA is going to be problematic – especially if the Fed is using a GDP-based model to guide its actions. The chart below shows some of the major factors impacting the supply and demand for risk-free assets in the near term, including SOMA holdings of Treasury paper and the Treasury's General Account. If the FOMC wants to end all purchases of Treasury securities and MBS for the SOMA, then the Committee must also manage the availability of RRPs and slowly allow market rates to force investors out of RRPs. At the same time that the Fed is forcing money market funds out of RRPs, banks will be migrating out of reserves and back into coupons and T-bills. Funds and offshore buyers have been outpacing last year’s pace of purchases of Treasury notes and bills even as new issuance has fallen. Dealers have been taking down significantly less paper at 10-year Treasury auctions than a year ago. Any way you cut it, demand for risk free assets and MBS is likely to keep the yield curve flat to inverted for 2022 and beyond. The FOMC may indeed get the fed funds rate to 3% or higher, but the yield on the 10-year Treasury note may be considerably lower. The financial implications of such an environment for leveraged lenders and investors is not very pleasant to consider. 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.

June 6, 2022 | Updated | One of the downsides of the era of technology is that people tend to lose the ability to discern when a data point displayed on a screen is clearly wrong. We don’t code or compute by hand any longer, instead we have automated tools that display metrics. The world of finance, with all manner of derived metrics, derivatives and outright frauds, is a forest of opaque indicators and misleading signs. As a result of the adoption of "artificial intelligence," the 21st Century investor is mostly a victim in waiting. We bide our time before the next convulsive shift in politics or monetary policy turns the idealistic speculation of today into tomorrow morning’s road kill. No amount of warning or protestation prevented millions of people around the globe from losing big in crypto or aspirational stocks. And there were no metrics visible to retail investors to warn of the reversal. The risk is lost in the fog of complexity. Leaving aside the surreal but rapidly fading world of pretend currencies, the supposedly “real” work of investing in stocks and bonds also is rife with problems of definition and transparency. Vendors such as Bloomberg LP and S&P's Capital IQ provide investors with lots of data and metrics, but they rarely display how the metric was calculated from, say, a public company’s financial statement. Most vended financial data, let’s keep in mind, is hearsay evidence that has been consumed and “adjusted” so that the vendor may claim ownership, breaking the fidelity with the public record. The result of errors in calculation and/or presentation, however, can also allow issuers of securities to mislead investors. Just because the presentation of the data is allowed under GAAP or industry convention does not mean that it is not misleading. Whenever you simplify a piece of data by aggregating it into a derived metric like a P/E ratio or price multiple, fidelity and context is lost. And all too often the presentation of value is incorrect because the global providers of financial data are ignorant of context and the always moving target of GAAP accounting as interpreted by accountants and lawyers. Let’s take the question of calculating a very basic metric, namely the book value of equity. This is one of the most important measures in the global equity market but also one where changes in convention and presentation can mislead investors. One of the more significant issues we’ve noticed in our work of late at The Institutional Risk Analyst is the “non-controlling interest,” a once de minimis line item that has become more and more relevant in recent years as private equity investors defend their entitlement to double-digit equity returns. If you search on the SEC’s EDGAR portal , the term “non-controlling interest” appears in quarterly (10-Q) and annual (10-K) reports more than 10,000 times over the past five years, in most cases appropriately so. The convention in the world of data and analytics is to exclude this item from the definition of equity and that is mostly the correct approach. The result in some cases, however, is understating the actual capital of the enterprise and overstating all of the metrics derived from capital. Take, for example, Rocket Companies (RKT) , the owner of Quicken Mortgage. If you look at Yahoo! Finance , the market capitalization is shown as $1.1 billion and the price to book value multiple is shown as 1.85x. But this is clearly wrong. Not only is RKT trading at a discount to recent values like the rest of the mortgage industry, but it is trading at a steep discount to the 30x book value shown on Bloomberg . Let's see, $16.8 billion MVE / $8.7 billion BVE = 1.93x book. We asked one of the leading Sell Side research analysts in the sector to explain why the metrics shown on Yahoo! Finance and Bloomberg are wrong: ”The issue is that Bloomberg doesn’t include the “non-controlling interest” line item in total equity which distorts the price to book value multiples. For example, RKT has $8.7B of total equity but $8.2B of it is ‘non-controlling interest’ so Bloomberg uses $0.5B of equity as the denominator which increases the price-book value multiple.” Likewise in the case of United Wholesale Mortgage Corp (UWMC) , the 46x price-to-book value multiple shown on Bloomberg is clearly wrong. Let's see, $6.4 billion / $3.1 billion = 2x book. But the real issue is the distortion caused by the GAAP accounting. The relevant section of UWMC’s most recent 10-Q is shown below. Notice that of $3.2 billion in total equity underneath the company, 99% of UWMC’s capital is somehow considered a “non-controlling interest.” And do notice all of the different classes of preferred and common stock in the UWMC capital structure. UWMC Obviously the derived calculation on Yahoo! Finance of 2.6x book value is in error. The same number on Bloomberg , BTW, is 45x book for UWMC, again very obviously wrong. But how could these two big time data shops fail to get this right? Easy. It is not just the calculation but the business context that matters. The challenge for Bloomberg , Capital IQ and other data providers and also the SEC, is more subtle in this case than simply accounting. In the age of QE, the accountants, lawyers and bankers have contrived a structure for public offerings whereby you hide the majority of the equity of an issuer behind a legal façade of “non-control.” This legal fiction obscures the true economic capital of the enterprise. The presentation of non-controlling interests found in many SEC filings today is the functional equivalent of Jim Fisk and Jay Gould manipulating a stock with a hidden investment pool 150 years ago, but it is permissible under GAAP. If you are the head of analytics at Bloomberg , for example, how do you decide when a company’s use of a “non-controlling interest” classification in its equity account that is allowable under GAAP is nonetheless misleading to retail investors? Let’s look at another example, namely Switch Inc (SWCH) . As of Q1 2022, the company reported $338 million in total Switch, Inc. stockholder equity , a $287 million non-controlling interest, and total stockholders equity of $625 million. Bloomberg shows SWCH at 14x book value vs an $8.3 billion market cap. Is this right? If Bloomberg was true to form and used the $338 million for the book value calculation, then the answer is no. Half of SWCH's equity is hidden from view. In fact, the “non-controlling interest” is created from the inception of the corporate structure, and is true equity in the business and should be included in total equity for calculating all metrics for investors, particularly retail investors. But the needs of the private equity community have distorted the world of capital finance to the detriment of retail investors in public equities. A retail investor looking at the metrics for RKT, UWMC or SWCH might conclude that these stocks were outperforming other companies in the sector, when it fact the opposite is the case. The fact that Bloomberg, Capital IQ and other data vendors post these erroneous metrics and the derivatives therefrom should draw the attention of regulators and members of the trial bar. Part of the reason that many public companies have chosen to misstate their financials via “non-controlling interests” is the use of the umbrella partnership - C corporation structure (“Up-C”). This is an indirect way for an operating partnership to conduct an initial public offering (“IPO”), notes a 2019 Mayer Brown comment . Essentially fund investors use the non-controlling interest strategy to boost short-term share valuations by concealing the true float of the issuer. “Private equity-backed and venture capital-backed companies generally favor the Up-C structure because these financial investors often use flow-through entities to hold their interests in portfolio companies. The Up-C structure is a convenient tool to offer the portfolio companies’ shares to the public through an IPO,” notes Mayer Brown. Up-C derives its name from the Up-REIT structure, widely used by real estate investment trusts since the 1990s. An Up-C is composed of two entities: the parent company, which is organized as a C Corporation), and a subsidiary usually structured as a limited liability company or a limited partnership. By manipulating the presentation of the equity interest in the public company, the private partnership can make the public entity look more attractive to investors than its true fundamental performance dictates. That seems to be the explicit intention of the owners of RKT, UWMC, and SWCH; to conceal the true equity capitalization of the enterprises to make metrics such as price-to-book and return on equity appear superior until the private investors cash out. Naturally the Up-C structure has been particularly popular among private equity investors in recent years, who seek to maximize short-term equity returns over long-term performance. By allocating capital to early investors and advisers higher up in the capital structure via different classes of common or preferred stock, the partnership can manipulate the timing and size of equity returns taken by insiders in the public markets. And all of this is permitted under GAAP and SEC regulation. Remember, there are literally dozens of other examples of public companies that have used the rules of GAAP and the SEC’s Reg SX to distort their financial statements under the canard of non-controlling interests. Since the SEC long ago mandated XBRL data tagging for Form 10 filers, all that SEC Chairman Gary Gensler needs to do is ask the question. How many filers of Form 10’s have reported a “non-controlling interest” that is > 10% of the total stockholder equity of the enterprise?

June 2, 2022 | Back in June of 2021 , we noted that the nonbank lending platform Upstart Holdings (UPST) was not so new after all. The originate to sell model crafted by this band of former Google employees had the same risk characteristics as the non-banks that caused the 2008 crisis, namely exposure to market risk. The fact of UPST using “AI” to make lending decisions only made us more skeptical given our experience in the world of decision engineering for loan underwriting. "AI" is simulated cognition, not intelligence. Wind the clock forward 12 months and our worst fears have been realized. UPST is in the tank in terms of the equity market value, down 65% in the past year due to the changes in the credit markets. More, a growing crowd of trial lawyers are suing the company for securities fraud. Yet the company's earnings are up compared to Q1 2021. What's the problem? The table below comes from the most recent UPST earnings report. After restating financials and moving loans from “held for investment” to “available for sale,” UPST recorded a negative $19 million fair value mark and essentially had to come clean about warehousing loans on balance sheet. Has the originate-to-sell model that seemed to allow UPST print money and pass the risk on to "partner" banks become extinct? And, please tell us, why are the CSUITE at UPST providing forward guidance to the Street? Total losses due to adjustments to fair value and other factors was $38 million, this on top of a $24 million fair value adjustment in Q4 2021. More, UPST has $675 million in variable interest entities (VIEs) that it claims are unconsolidated and for which UPST has disclosed a net exposure of just $15 million. If the nonbank lender was quietly hiding unsalable loans on balance sheet, what does this say about the investors? As we all recall from the collapse of Citigroup (C) in 2009, off-balance sheet can become on-balance sheet risk in a few hours once investors start demanding their money back. As delinquency rises, UPST will be in danger of triggering ABS thresholds that will require accelerated payoffs for senior tranches of deals. In that scenario, the juniors simply have to wait until the senior investors are paid, all this while the FOMC is raising interest rates. “The average loan pricing on our platform has increased more than 300 basis points since October,” UPST CEO Dave Girouard told investors on May 9th. “In addition to increasing rates for approved borrowers, this also has the effect of lowering approval rates for applicants on the margin.” The other big issue facing UPST is the credit performance of its loans. As we have written previously in The Institutional Risk Analyst , the positive impact of COVID loan forbearance on visible default rates is ended. We now expect to see loan delinquency rates for UPST and other lenders rise above pre-COVID levels, reflecting the lending volumes possible due to the gold-rush mentality that prevailed in the capital markets between Q1 2020 and today. “The unprecedented level of government stimulus caused the majority of these post-COVID vintages to overperform significantly,” says Girouard. “The abrupt termination of these stimulus programs has caused some of the more recent vintages to underperform. And finally, we're confident that our models are currently well calibrated to the latest consumer credit conditions, performing in line with expectations and are more accurate than at any time in our history.” UPST CFO Sanjay Datta summarized the market risks that have sent UPST into a tailspin in the equity markets: “Net interest income was a negative component of net revenue this quarter as the loan assets on our balance sheet which we mark-to-market each quarter sustained declines in valuation due to the rising interest rate environment.” One of the big problems we see for UPST is their seemingly obsessive habit of providing forward guidance to investors, a decision which is only creating risk for the company. Obviously the dozen or more analysts that follow this volatile stock want and certainly need guidance, but given the volatility of the UPST business model, perhaps another strategy would be advisable? We see the big risk facing UPST and similar originate-to-sell shops is the loss of investor appetite for unsecured consumer loans. UPST notes that loans in the company’s ecosystem have risen 300bp in recent months, reducing pull-through for new loans. More, the company’s statement during the Q1 2022 earning call that rising delinquency levels has “stabilized” in recent months seems fanciful. As we note in The IRA Bank Book for Q2 2022 , the positive impact on credit caused by QE has only begun to reverse. ABS investors are extremely sensitive to changes in interest rates and delinquency. Our fear is that UPST is going to eventually lose access to the ABS investors that have powered the company’s growth, an extreme eventuality that could badly hurt the prospects for UPST. “I think that with respect to our large ABS deals, I don't think there's much concern of breaching triggers,” Datta told investors. “We do some smaller monthly sort of pass-through issuance. And there is a possibility that those triggers will be breached.” Simon Clinch at Atlantic Equities asked a key question during the earnings call: “I'm kind of surprised to hear that you're using your balance sheet to put some loans on there, which aren't just for R&D purposes. And it strikes me as it's just not a normal course of business for you given you're a platform business for. So I was just wondering what kind of message that might send to your bank partners or to others in the system. Just curious about that.” If UPST is being forced to use its limited balance sheet to warehouse loans, then this may be the beginning of the end of the story. If investors and partner banks don’t want to buy UPST loans at current market rates, then the game is over in an originate to sell model. Thus we move to the other half of the originate-to-sell binary with UPST, namely Cross River Bank in Fort Lee, NJ. Cross River Bank Back in January of 2022, we tempted readers to ponder the fact that Cross River Bank (CRB) was one of the best performing banks in the US. Exploding from $1 billion in total assets to over $12 billion a year ago, CRB was one of the largest PPP lenders during the COVID lockdown. And these pioneering souls are also the largest bank partner for UPST, documenting, funding and closing many of the loans that are originated by this AI-based loan acquisition funnel. Since Q1 2021, CRB has shrunk by a third as its portfolio of government-guaranteed assets has run off. With $9 billion in total assets as of Q1 2022, CRB has risk weighted assets one quarter of this amount, allowing the bank to function with $800 million or so in capital. The bank has a concentration in commercial exposures and non-core funding that is breathtaking for a bank of this diminutive size. But, again, most of the assets are guaranteed by Uncle Sam. CRB is a subprime lender, with an average gross yield on its loan book of 7.41% as of Q1 2022 vs 4.14% for Peer Group 3. The bank’s income to average assets is 2x the Peer average, an indicator that suggests that CRB is an outlier in terms of risk. For example, CRB reported a yield of 17% on its MBS book, 10x the average return for Peer Group 3. All of the bank’s treasury investments for liquidity are in private commercial and residential MBS, of note, with no Treasury or agency MBS securities reported. Treasurer Dushyant Abhyankar just departed CRB to join Spencer Savings Bank . The above-peer yield on the CRB loan book is needed because the loss rate on the bank’s loans, which are 84% of total assets, is 0.18% or 5x the average of Peer Group 3 calculated by the FFIEC. The bank’s past due loans of 6.55% is astronomical and puts CRB in the 99th percentile of Peer Group 3. These PPP loans have US guarantees, but the high level of delinquency may still raise concerns. The bank has already been the focus of congressional attention because of the size of its PPP business. While the bank’s current income is strong and in the top decile of the group, the unusual business mix and funding profile are concerns. For example, CRB has 51% net non-core funding dependence. The good news is that the bank is shrinking at mid-double digit rates, including a 42% drop in new loans and leases since Q4 2021. CRB looks to be exiting the market and shrinking the balance sheet as quickly as possible. Reading between the lines of the UPST disclosure, one wonders if CRB is still closing and selling loans. CRB took $61 million to the net income line in Q1 2022, a far cry from the $372 million reported in Q4 2021. Loans held for sale almost doubled in Q1 2022 to $1.3 billion. The bank has cut back on its brokered funding in the latest quarter, but borrowed funds still account for half of liabilities. CRB reports no hedging or derivatives positions, making us wonder how or if the bank hedges its available for sale book. We expect to see CRB continue shrinking its business back down to the base of $2-3 billion in risk assets. The C&I exposures that currently comprise 70% of total assets will run off over the next year. The big question for the bank and also for UPST is how the loans originated, closed and sold to investors perform in what looks to be the worst credit environment in a decade. 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.

Each summer a number of our friends go fishing in Downeast Maine at Leen's Lodge . Leen's is a half century old fishing camp located on West Grand Lake , which is one of the most beautiful natural lakes in the United States. Our friends in the Grand Lake Stream community raised millions of dollars to protect the area around the lake and created the Downeast Lakes Land Trust to manage this responsibility for the benefit of the community. West Grand Lake from Leen's (2018) The "Camp Kotok" fishing trip in August was created by David Kotok , Chairman & Chief Investment Officer of Cumberland Advisors in Sarasota, FL. More recently, two fully social but distanced trips in August have been sponsored by the Global Interdependence Center in Philadelphia. The Labor Day trip is somewhat less structured and harkens back to the early days of Camp Kotok, held at a small hotel in downtown Grand Lake Stream. The June trip is transitory and depends upon the elasticity of demand for pre-Father's Day fishing, which usually is quite spectacular. David Kotok arrives on Katahdin Air As befits the generous character of trip founder Kotok, these excursions are about enjoying the natural beauty of Maine, catching fish and good conversation. The water in West Grand Lake is never more perfect than on Labor Day Weekend and the fishing in the many lakes and streams in the area is always excellent. By the end of August, the bugs are gone but the fish are still biting, making for a perfect way to end the summer. Lunch at Ray's Camp (2018) Most important, the hospitality of the people of Maine, from Portland in the south to the northeastern region known as Acadia that lies between Bangor and the St. Croix River, is always welcoming. Henry David Thoreau wrote in "Walden, or Life in the Woods" about this scenic area of rivers and small hills: “We need the tonic of wildness...At the same time that we are earnest to explore and learn all things, we require that all things be mysterious and unexplorable, that land and sea be indefinitely wild, unsurveyed and unfathomed by us because unfathomable. We can never have enough of nature.” The inhabitants of the rural region that includes Washington County primarily make their livelihoods outdoors via forestry, tourism and sporting activities such as camping, fishing, hiking and hunting. The season from May through October provides much of the economic activity for the community during the entire year in Downeast Maine. The trips we take each year to Leen's helps to support the community and a traditional way of life unknown to many Americans. The Maine Guides focus first and foremost in our safety, but also give us a priceless gift by making this stunning part of the American wilderness accessible to all. Guides transport the "sports" to and from the fishing ground, handle lunch and get you home safe and sound. Veteran Maine Guides such as Ray Sockabasin , Steve Schaefer , Dale Toby , Randy Spencer and many others have taken care of us for three decades of fishing and enjoyment. Steve Schaefer & Nicole Boutmy Ray and the other members of the The Passamaquoddy Tribe live in a nation that extends on both sides of the border between Maine and New Brunswick, Canada. The native word for this area is "Dawnland" since it is the easternmost point in the region. One of our favorite trips is to float down Toma Stream in the nation and lunch at Ray's camp looking west over the water towards Princeton. The Passamaquoddy have welcomed us into their homes and their lives for many years. Click on the photo below if you want to contribute to rebuilding Ray's Camp on Toma Stream along the border with Canada. Better yet, come fishing. Ray Sockabasin This year the two August trips sponsored by the GIC are sold out, but we have a few spots left on the Labor Day trip. This time of year, the gating issue on the size of the group is guides. By September many of our friends have already switched to hunting birds, moose and bear. The dates are September 1-6, 2022. If you'd like more details, please contact us or Scott Weeks at Leen's scott@leenslodge.com Some photos follow below. Kotok at Breakfast (2018) Guide Potato Chips Megan Greene, David Kotok & Michael McKee (2018) Toma Stream John Silvia & Dale Tobey (June 2015) Randy Spencer, Mitchell and Aisha Kotok (2018) Nolan Turner (June 2015) Three Generations of Flansbaums Kotok & Whalen (June 2019) Maine Guides from left: Les Williams, Bob Gagner, Dave Irving, Mike Hegarty, Jerry Richardson, Gary Santerre Long Lake (2021) Michael Lau & Steve Schaefer (June 2018) Kotok with Pickerel (June 2018) Big Lake

May 30, 2022 | Over Memorial Day weekend, we released the latest edition of The IRA Bank Book with our review and outlook of the banking sector for Q2 2022. As we analyze the ebb and flow of earnings in the financials, in many respects the patterns visible in bank results are also visible elsewhere. We all have the same problem: rapidly repricing asset values under the weight of threatened Fed tightening. Market risk realized today becomes credit risk tomorrow. Look at ad revenue for Twitter (TWTR) , Snap (SNAP) and the company formally known as Facebook, Meta (FB) (h/t to Variety ), and you see the same manic pattern as is visible in financials. Sadly we cannot share the really cool chart in VIP+ earlier this month. Suffice to say that Q2 of 2021 was a good time to sell online ads. But the more important point is that the asset value of all of these companies has been cut in half or more. A sharp spike in online advertising activity was caused by COVID and followed by the latest episode of social engineering from the Federal Reserve Board. Now that the COVID contagion has seemingly (but not in fact) moderated, we see an equally rapid collapse in demand in many sectors. The JPM index of global developing debt is down 15% so far this year. Will the FOMC come back to the rescue if the patient begins to flatline? Like most potions conveying unnatural life, the side effects of ending the Fed’s purchases of securities via QE is an equally powerful snap in the other direction. People are no longer cloistered at home staring at their cell phones, thus no surprise that ad revenues have fallen back to pre-COVID levels at TWTR and FB. When you pull tomorrow’s sale into today, tomorrow ends up being light. The power of the Dark Side of inflation wielded by the Fed is most felt in the leveraged world of finance. The 120% increase in the ad revenue for SNAP, for example, is as nothing compared to the three-fold rise in operating income orchestrated by the Fed for banks, this as net interest revenue was falling rapidly. The FOMC ultimately sliced $40 billion per quarter out of bank interest earnings, a loss that may never be restored. Source: Quarterly Banking Profile If you examine the price movements of TWTR, SNAP and FB, all began to crater as ad revenues fell at the end of Q3 2021. Likewise, banks started to roll over as investors started to understand that the 340% spike in operating income seen in 2021 was an anomaly. Market risk realized today becomes credit risk tomorrow. Let’s consider another example c/o Joe Garrett at Garrett McAuley & Co in San Francisco and the Mortgage Bankers Association. When lending profits were 1.5%, mortgage companies actually seemed investable. What a difference a few months makes. Suffice to say that we’ll test the lows of 2018 in terms of lending profits during this up cycle in interest rates. No matter how many times we explain to investors that the earnings surfeit at banks was a mirage caused by GAAP, many refused to accept the data. More did not sell bank stocks at record levels and rode them down. And many today are sitting with low coupon loan exposures that are likely to move lower in the near term as the downward sloping trend in bank earnings unfolds. Likewise mortgage lenders dependent upon fat gain-on-sale margins are now fighting the Fed. But perhaps the largest banks face the most risk in the near term. Consider, as we noted in The IRA Bank Book , that the gross yield on the loan portfolios of the large banks in Peer Group 1 averages 4% as of Q1 2022. Some of the larger, more profoundly mediocre names such as Bank of America (BAC) are closer to 3% gross yield, according to the FFIEC. Figure BAC's gross yield at year-end was 3.25%, minus overhead of 2% of total assets and funding cost of 0.16%. What remains is net operating income. Notice that we did not include credit provisions in the analysis in the previously paragraph, not meaning to upset the more impressionable members of the reading audience. Provisions for loan losses were still negative in Q4 2021. Add 15-20bp vs average assets for normalized loan loss provisions in 2022. So the hypothetical reckoning for BAC's loan book looks like this: Gross yield: 3.4% SG&A 2.0% Funding costs: 20bp Provisions expense: 15bp Net income ~ 1% It does not take an astrophysicist to see that a small increase in funding costs and/or credit expenses will be enough to drive many banks into loss. If our fishing pal Danielle DiMartino-Booth is correct about a Paul Volcker style rate increase regime this year, say 50bp per meeting, then many banks could find themselves underwater a la the 1980s and the S&L crisis. But of course, Chairman Volcker moved faster and bigger than this crowd on the FOMC today. He not only attacked inflation, but also called out fiscal dishonesty in Washington . Volcker destroyed a lot of banks, home builders and investors by fighting inflation in those politically difficult years. As all manner of companies struggle with the increase in interest rates this year, many investors find themselves holding paper that was created during 2020-2021 that is now profoundly under water. The secret of QE is that the Fed’s machinations embedded big losses on the balance sheets of banks, pensions and other savers, the latest and largest manifestation of Financial Repression in this cycle. “The Fed’s May meeting minutes contained few revelations, leaving our Fed Minutes Sentiment Indicator little changed and remaining relatively hawkish,” Bloomberg Intelligence strategists Ira Jersey and Angelo Manolatos wrote in a note. They continued that a “number” of FOMC members thought sales of agency MBS could be necessary after runoff was “well underway,” according to the minutes “We wouldn’t be surprised if the Fed were to embark on sales in 1H23 after getting some feedback from market participants and allowing about six months of full runoff to occur before making a final decision,” the analysts wrote. We certainly hope so because any attempt to sell large portions of the Fed portfolio will badly distort interest rates and especially mortgage rates. As we’ve noted, the mark-to-market on the Fed’s $2.7 trillion portfolio of mortgage backed securities is easily minus $500 billion, a sum that is actually a loss to the taxpayer. When we said a while back that the Fed’s actions with QE are illegal, we refer directly to the fact that the Federal Reserve Board is spending money in a market speculation without authority from Congress. Robert Eisenbeis of Cumberland Advisors told The IRA back in December of 2017 (“ The Interview: Bob Eisenbeis on Seeking Normal at the Fed .” “The Fed almost by definition cannot make a profit. It baffles me how people inside the system can fail to see the accounting reality here. The Fed issues short term liabilities to buy Treasuries taking duration out of the market. The Treasury makes interest payments to the Fed who takes out its operating costs, including interest payments on reserves and returns the remainder to the Treasury. If this intra governmental transfer were settled on a net basis like interest rate swaps, there would always be a net payment from the Treasury to the Fed.” And the Fed now also stands to lose money for the Treasury on QE, a fact we think is rather remarkable. Since the national Congress has chosen to treat the remittances from the Fed as a “profit” for the purposes on the federal budget, perhaps it does not matter in Washington. It certainly matters for lenders, investors and risk managers around the world. As our friend Alan Boyce opined previously, the MBS that the Fed purchased for 102 with a duration of 4 now trade in the low 80s with a duration of at least 12. As interest rates rise, the duration of the Fed’s MBS portfolio will extend further, increasing taxpayer losses and creating a vast obstacle to normalizing policy because these low-coupon mortgage bonds are essentially unsalable. To understand the scope of the problem, instead of $2.7 trillion in MBS, imagine that the Fed actually owns $10-12 trillion in MBS that is lengthening in duration and falling in price as interest rates rise. Welcome to the risk of negative mortgage convexity , BTW. But as private investors see large portions of the gains they thought were real over the past several years eviscerated, they can take some comfort in the fact that Fed Chairman Jerome Powell feels their pain, sort of. And again, market risk realized today becomes credit risk tomorrow.

May 29, 2022 | Premium Service | With this issue of The Institutional Risk Analyst , we introduce a new format for our quarterly review of the US banking industry. By popular demand, we are now publishing The IRA Bank Book in PowerPoint, making the charts easier to read and forcing your dutiful publisher to be very concise. Subscribers may share the IRA Bank Book within your organization. In this issue, we describe the migration of the banking industry back to 2019 levels of operating income. Why did bank stocks out-perform perform in 2021? Because the banking industry spent much of the year repatriating $60 billion in loan loss reserves taken in 2020 back into income. Why did financial stocks soar in 2021? Due to GAPP adjustments to income because of COVID and the FOMC's radical asset purchases which suppressed credit costs. Now we go the other way on the financial roller coaster. The special adjustments to GAAP income are behind us and many asset classes remain rather considerably over-valued, like loans and mortgage servicing assets. This prepares the world of financials for a year of rising funding costs and credit expenses, falling asset prices and eventually, hopefully, higher asset and equity returns after the nuclear winter of quantitative easing or QE. Source: FDIC Subscribers please log-in to download your copy of The IRA Bank Book for Q2 2022 The IRA Bank Book (ISBN 978-0-692-09756-4) is published by Whalen Global Advisors LLC and is provided for general informational purposes. By accepting this document, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The IRA Bank Book. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The IRA Bank Book are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The IRA Bank Book represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The IRA Bank Book is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The IRA Bank Book is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The IRA Bank Book. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

May 25, 2022 | Premium Service | In this issue of The Institutional Risk Analyst , we start with a general market comment and, from that vantage point, then slide into the earnings reports from PennyMac Financial Services (PFSI) and United Wholesale Mortgage (UWMC) . The general comment is fairly simple to summarize: a massive surfeit of cash sloshing around the financial system and growing as stocks sell off, threatening to inundate the Fed with cash seeking a risk-free home. In theory interest rates are rising c/o the FOMC, but in fact risk-free collateral remains scare and rates seem more inclined to fall than to move higher. At the end of last week, reverse repurchase agreements (RRPs) with the Fed of New York grew to over $2 trillion while the Treasury’s General Account (TGA) has soared to almost $1 trillion due to strong tax payments. As the TGA rises, bank reserves at the Fed fall 1:1. This illustrates why the Powell FOMC is going to find it very difficult to manage a reduction in the system open market account or SOMA. This fact will directly impact the financial performance of mortgage banks and all financials, especially issuers of securities. “Treasury is still decreasing bill supply and that seems to be driving the market firmly into the arms of the RRP facility as the only place of refuge,” said Gennadiy Goldberg, a senior US interest rates strategist at TD Securities, Alexandra Harris of Bloomberg News reports. “The big implication is that with RRP usage remaining high, QT will drain reserves from the system rather quickly at the start of runoff.” It is managing the “runnoft,” to paraphrase the film " O Brother Where Art Thou ," which is the task facing Jerome Powell . Last week, as the TGA was rising on the back of stronger than expected tax payments, total reserves at the Fed fell by almost half a trillion dollars. “As a result, outstanding bank reserve balances dropped by $466 billion in the week ended April 20,” reports Harris, “the largest weekly decline on record.” This outflow of bank reserves has the impact of forcing investors and banks back into the market for T-bills, which is already under downward rate pressure due to the Treasury’s large cash position and lack of new issuance. Observe that the 10-30 year complex in Treasury securities seems to want to rally in the worst way. Net, net, the dynamics in the market are actually forcing interest rates down even as the FOMC pretends to raise the cost of credit. The impact of the conflicting flows between the Federal Reserve and Treasury is visible in terms of the uncertainty in the markets. Bond spreads and primary lending rates are soaring, but benchmarks such as the 10-year Treasury note are displaying a reluctance to move higher. The result is a flattening yield curve and a primary market for residential mortgages that is going to be more challenging as the year progresses. The difference between 30-year mortgage rates and the 10-year Treasury is widening, yet industry profits are falling fast due to chronic overcapacity. PennyMac Financial Services The story with PFSI is similar to that facing the entire industry, namely falling production volumes and not as rapidly falling production expenses. Some firms are actively reducing headcount, others are trying to redeploy valuable people to servicing and loss mitigation. In either case, cutting volumes in half has focused the entire industry on cost. The bottom line is a draconian cut in operating profits as the industry slowly manages down operating costs to fit ~ 50% of the $4.4 trillion in new origination volume seen in 2021 in 2022. The table below from the PFSI supplement shows earnings before interest, depreciation and amortization (EBITDA). Note that the upward adjustment to the MSR in Q1 2022 was 2x PFSI’s reported income. The decline in operating income is relatively easy to see, but what is more troubling and less easy to see is the sharp deterioration of the net production revenue less loan officer (LO) compensation. In Q1 2021, PFSI reported $585 million in production income with production expenses of $222.6 million or 38% of production revenue. In Q1 2022, in sharp contrast, PFSI reported $235.6 million in revenue and production expenses of $226.3 million or 96% of production revenue. This shocking collapse in profitability is visible across the industry and shows how difficult it is for the mortgage industry to manage operating expenses. Of note, net production income for the industry has fallen from 124bp in Q1 2021 to 5bps in Q1 2022, according to the most recent survey from the Mortgage Bankers Association. The table below from the PFSI Q1 2022 earnings supplement shows the production results for the firm. The increase in interest rates has also taken much of the profitability out of purchasing delinquent government loans out of Ginnie Mae pools (aka “EBOs”), a big part of PFSI earnings in 2021. In Q1 2021, EBO revenue added $283 million to the bottom line, more that total servicing revenue for PFSI in that period and roughly 25bp per loan. The same line item in 2022 saw revenue of $95 million or just 7.4bps earned on each resolved delinquent loan. Provisions for loan losses rose 50% to $30 million in Q1 2022. The sharp upward mark in the value of the PFSI MSR helped reported earnings significantly, as shown in the chart from the PFSI Q1 2022 earnings presentation. Notice the interaction between the changes in valuation for the MSR, production income and the results from the PFSI hedging operations. In 2020 when the firm reported 60% equity returns, it was net of a $1.1 billion negative markdown of the MSR due to mid-double digit mortgage loan prepayments. Half of the $12 trillion mortgage market was refinanced in 2020 and 2021. PFSI's common equity is down 30% YTD, reflecting investor concerns with the plummeting equity returns for this leading mortgage issuer. In 2020, PFSI generated 60% equity returns, but in 2021 just half that amount and only 21% in Q1 2022. Through the balance of 2022 and beyond, PFSI will be forced to tighten operating expenses to keep pace with declining revenue and industry volumes. Upward valuations may continue to be a positive for the rest of 2022, but servicing assets are overvalued today vs the likely NPV of the asset. United Wholesale Mortgage If PFSI is a good example of the broader mortgage industry, UWMC is an outlier and one that displays a good deal more volatility than do other issuers. The common equity of UWMC is off 60% in the past year, even though the SPAC transaction is still showing a premium multiple to book value. But with firms like UWMC, what is book value? Piper Sandler wrote on May 19th: “We are downgrading UWMC to Underweight from Neutral and adjusting our price target to $3.00 from $5.00. In our view, UWMC will struggle to generate earnings that exceed the current dividend run rate of $0.10/share as production revenue declines at a rapid pace due to lower demand. UWMC should experience an incremental decline in expenses, but we think the pace of expense reductions would be slower and therefore, UWMC would experience operating margin compression.” Like PFSI, volumes fell and expense less so at UWMC, generating a squeeze in operating results. The table below from the UWMC earnings report illustrates key operating metrics. Note that GAAP income was “only” cut in half because of a $390 million increase in the value of the MSR vs Q1 2021 and $170 million sequentially, an adjustment that is non-cash. When asked during the earnings call about his rosy view of the outlook, Ishibia said: "Right. That's why you sit there and I sit here. So, that's the reality is $170 million of our $450 million was fair value markup, not $450 million of it. So, understand our business is extremely profitable as I told you guys last quarter. It's going to be extremely profitable in the second quarter. So, you just have to be confident that I sit over here and I run the show and we're doing a great job. And once again, 2018, I referenced it earlier in the call, was the last time this happened. Most companies didn't make money. We did. I've seen this before. This isn't like my first day on the job. I've been here 19 years. I built the company. We're doing pretty well. I think you'd understand that and agree with that." As a result of falling lending volumes, adjusted EBITDA was just $128 million in Q1 2022 vs $711 million in Q1 2021, including a negative mark on the MSR. UWMC, of note, derives its own valuation for the MSR – a Level 3 asset under GAAP -- using internal models and assumptions. It is fair to say that UWMC could not sell its MSR in today's market for anything like the reported value. UWMC has stated that it will not be laying off employees, thus it remains to be seen how CEO Matt Ishibia will manage expenses going forward. Ponder the logic of Mr. Ishibia in his Q1 2022 earnings conference call: “Well, we're still hiring people. So, we're different than these other guys and gals, companies, however you want to say it. So, we're hiring and we look for great people to join our company all the time. And so, will attrition affect you? Of course. When you have so many team members, there always some people leave, some people move out of town, things happen.” Expenses at UWMC were basically unchanged in Q1 2022 vs the previous quarter. Rhetoric aside, we expect to see some rather aggressive cost cutting from UWMC in Q2 2022 and beyond. The big concern with UWMC is the rate of growth in the company from 2020 to today. The firm now has $2 billion in “non-funding debt,” meaning corporate borrowing that is not directly contributing to revenue and profits, but likely underpins the MSRs. One interesting comment from Ishibia on the Q1 2022 earning call concerned his focus on the wholesale channel, arguably UWMC’s strongest suit and a consistent #1 ranking for the firm. He describes why top performing LOs would rather be independent brokers in a tough loan market: “You know, we saw a huge pick up in the first quarter from the fourth quarter, and I see the momentum continuing. It's like a snowball going downhill. It's always better for a loan officer to be at a mortgage broker shop. They can offer better rates and have better technology and better processes than they have at retail. That's just fact. And so, for consumers to go there and the realtors to follow those loan officers, that's happening. And so, it's just a matter of how fast it happens. And I think a lot of data out there is showing that the speed is picking up because, as I think I said last year, a bunch of times, when the market is so busy, you know, a loan officer closing 25 loans a month, it's hard to pick up and leave a retail shop.” Will the snowball of LOs migrating to the higher ground of the broker channel come to the rescue for UWMC? We hope so, but like the folks at Piper we remain skeptical. Winter has come in mortgages and its likely to be the longest, nastiest winter in residential assets since 2008. The issue this time is not credit at first, but market risk and the bizarre reality of trillions in conventional and mortgage paper that is 200bp or more out of the money in terms of refinance. In this vast pool of new mortgages with LTVs averaging close to 50% lies a good deal of hidden credit risk that will emerge during the approaching recession. With a recession and higher loan defaults will come repurchase claims from the GSEs. 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.

May 23, 2022 | Last week, JPMorganChase (JPM) CEO Jamie Dimon was rebuked by shareholders unhappy with the bank’s recent performance. JPM is down 25% YTD and was trading at 1.3x book value at the close on Friday, hardly a disaster. But Americans as a group are unwilling to accept such a poor short-term showing, this even though much of the apparent wealth creation of the past two years was entirely surreal. In 2020 and 2021, the FOMC removed $8 trillion in duration from the markets, forcing up asset prices for all manner of equity in the process. Now that very act of asset price inflation is being reversed and threatens to destroy a large chuck of virtual wealth accumulated in the equity markets. Chinese tyrant Xi Jinping has already destroyed several trillion in equity value via the communist crackdown on Chinese tech firms, but the US is preparing to add a zero to that total of value obliteration in coming months. American’s accumulated an addition $35 trillion in paper wealth between Q1 2020 and the end of 2021, writes Ben Steverman of Bloomberg News . But Americans have lost $5 trillion in the selloff so far, JPM estimates in a research note, and may lose as much as $10 trillion by the end of 2022, the bank reports. This downward adjustment in paper wealth tracks the estimate we published earlier, that Americans would have to give back at least 25% of the paper gains created by quantitative easing (QE). Watching the unhappy reaction of Americans to slumping prices for stocks and crypto assets, it is almost as though they feel entitled to continuous share price appreciation. The FOMC, of course, tells us that inflation expectations have not yet become hardened among the broad public. Yet when people complain about the impact of rising interest rates on public company valuations it seems like they don’t understand why stock prices were rising in the first place. Truth to tell, Jamie Dimon is not responsible for seeing JPM reach $172 per share last October and he is not responsible for the fact that the bank’s equity is nearing $100 as of Friday’s close. Financials are simply tracking the ebb and flow of liquidity into the financial markets. Share prices are falling as expectations for short-term appreciation fall and concerns about credit costs are rising in the minds of the more astute members of the audience. Our bank surveillance matrix is shown below: Source: Bloomberg Notice that crypto bank Silvergate Capital (SI) is the worst performer in the group, now below 2x book vs 12x book last March. Western Alliance Bancorp (WAL) is likewise under pressure due to plummeting residential lending volumes. More important, sector leaders such as American Express (AXP) and Raymond James Financial (RJ) are outperforming the rest of the group when it comes to downside risk. Perennial underperformer HSBC (HBA) is the only name that is still up for the year. The market gods do have a sense of humor. Is this the re-entry point for US banks? Not for our money. We are pondering several fintech names as we noted in our comments last week, but we’ll let the banks ride for a while in terms of common equity exposure until the magnitude and timing of the swing in credit costs becomes more clear. Just as US equity valuations will now give back ground, other asset prices including real estate are likely to follow as the great reset gathers pace One reader of the Premium Service of The Institutional Risk Analyst said last week: "I am a very satisfied subscriber and appreciate and value your reports. Quite frankly, it has been your writing that has kept me from investing any of my clients wealth into bank stocks." Now to be clear, it is not that we dislike bank stocks per se , but we are very cautious about investing in financials when the open market intervention of the FOMC, or lack thereof, is the key determinant in bank results. The Fed boosted short-term earnings with QE and suppressed credit expenses for lenders by boosting asset prices – all asset prices. Now we are reversing this process, but bank interest earnings remain 30% below 2019 levels. It is an open question when or even whether banks will be able to rebuild these revenues. Source: FFIEC As we assess whether or not to re-enter certain names in financials, the key calculous involves first determining how run-rate revenues and earnings are likely to look as the FOMC raises interest rates and allows the system open market account (SOMA) to run off. Given that the Fed still has yet to start that latter process, we think that JPM’s estimate that we give back $10 trillion in paper wealth this year may be a tad low. Why? Because magnitude of the Fed’s folly is large enough to force a general price reset for many assets, this as living expenses are rising. A number of readers were appreciative of the post we published about the mechanics of QE and, the opposite, quantitative tightening or QT (“ Chairman Powell's Duration Problem ”). Yet we still don’t think most analysts understand what the end of this “extraordinary” policy implies for equity market valuations. This confluence of open-market manipulation by the FOMC and falling asset prices suggests that deflation, not rising prices, is now the chief concern. “Duration of UMB 2.5s was 4 when they were originated at 102,” notes mortgage veteran Alan Boyce . “Now they trade at 90 and the duration is 12.” Extend that comment from Boyce to the entire housing complex of some $15 trillion in residential and commercial assets, and you begin to understand the scope of the adjustment problem created by QE. The extension of the duration of the Fed’s $2.7 trillion in mortgage-backed securities illustrates the dilemma facing the FOMC. As interest rates have increased, the “weight” of the duration on the markets has grown three-fold in just the past year. This change is forcing down securities prices and creating huge losses on the books of the central bank as well as investors in loans and MBS. The Treasury yield curve and swaps are shown below. Source: Bloomberg Note that dollar swaps are still trading inside of Treasury yields, a slight improvement over the past six months. Demand for dollar assets remains brisk, but notice that short-term swaps are at a premium, suggesting an excess of demand for risk-free collateral. This has implications for the economy and credit conditions. Analysts have taken to comparing the present period to the 1980s, when former Fed Chairman Paul Volcker took up interest rates dramatically. The Federal Reserve board led by Volcker raised the federal funds rate, which had averaged 11.2% in 1979, to a peak of 20% in June 1981. But this time is very different because of the grotesque size of the Fed's balance sheet. Zoltan Pozsar is reported to have said : “Fed won’t be intimidated by asset price corrections, but rather emboldened by them to do more.” If that is the case, then we look to see a far deeper correction in asset prices as the Fed's pushes $30 trillion worth of mortgage risk exposure, measured by duration , down the throats of depositories and non-bank lenders. The lenders that created residential loans in 2020 and 2021, for example, are short a put option to the owner of the home. The holder of the mortgage may pay off the loan at any time and without penalty. During the past two years, just about every mortgage loan in the US was in the money for refinance. The big question is whether the rush for safety will accelerate the timing of the reset in residential housing, which we still see as being at least 24 months off. Since interest rates are rising, the mortgage loan made in 2020 is no longer in the money for refinance, so no problem. Right? But the lender is also long credit exposure to the borrower. As interest rates rise and asset prices eventually fall, these QE-era loans will trade at a sharp discount and the true credit profile of the borrower will come back into view. All of those FHA borrowers that migrated into conventional loans, for example, will show their true credit characteristics in a recession in 2023 and beyond. Many loans made during 2020 and 2021 on the strength of rising asset value will now be re-priced to adjust for falling asset prices, whether we are talking about a home or crypto or margin loans on shares in Softbank (SFTBY) or Tesla Motors (TSLA) . The reduction in the Fed's balance sheet is the largest ever margin call on equity exposures of all descriptions. And the FOMC has not even begun to shrink the SOMA, suggesting that calls last week about the end of the bear market may be a bit premature. The mere suggestion of an end of growth in FOMC securities purchases has caused equity markets to crash. The FOMC “intends to reduce the Federal Reserve's securities holdings over time in a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held in the System Open Market Account (SOMA). Beginning on June 1, principal payments from securities held in the SOMA will be reinvested to the extent that they exceed monthly caps.” As the QT process begins in a week’s time, we expect to see the global money markets slowly tighten, especially when the Treasury returns to the markets for the next refunding operation. Production of mortgage-backed securities is likely to continue to fall as mortgage interest rates rise, thus the end of Fed purchases is likely to be a non-event in a dwindling market for risk-free collateral. The return of duration to the money markets, as represented by the opportunity to earn a return via rising interest rates, has provided an alternative to stocks, real estate and other speculative assets. The opportunity to take returns off the table and exit into risk free assets at positive yields is likely to continue to attract additional flows out of equities in the near term. Medium to longer-term, look for signs of a correction in high-end home prices as a signal that a housing price correction has begun. More reading: Fear and Loathing in Mortgage Land National Mortgage News https://www.nationalmortgagenews.com/opinion/fear-and-loathing-in-mortgage-land Regulators Add to Rising Market Risk Zero Hedge https://www.zerohedge.com/news/2022-05-11/regulators-add-rising-market-risk

May 18, 2022 | Premium Service | As the Federal Open Market Committee raises interest rates and ends the massive purchases of securities under quantitative easing or QE, the liquidity is running out of the global capital markets. Readers of The Institutional Risk Analyst know how this movie ends. Bond spreads are widening and new issue volumes are falling like a rock. The vast output gap in global GDP caused by the Ukraine War is being exacerbated by the FOMC’s actions, only confirming our view that deflation remains the key risk to the US economy as 2022 progresses. Even as new bond issuance volumes are falling, spreads on high-yield securities are rising, a danger sign for the US economy and also the equity markets. Once HY credit spreads rise above 500bp over the Treasury curve, this indicates that the capital markets are not functioning properly. The sharp increase in credit spreads since January 2022 has resulted in a decline in equity valuations, wiping out trillions of dollars in aggregate paper wealth. The 3.5 trillion yen (about $27 billion) loss by the Softbank (SFTBY) Vision Fund illustrates the losses being taken by many investors that foolishly deployed cash into various crypto frauds and aspirational stocks, both public and private. Below we discuss how these negative trends are likely to affect specific sectors as the year progresses. Crypto Assets We will dispense with any analysis of specific crypto assets. The key thing for investors to appreciate is that crypto made sense as a tactical speculation only so long as interest rates were at or near zero. Due to the actions of the FOMC and global central banks, rising interest rates are again creating competition for short-term assets. Both crypto and speculative stocks will now suffer. “Crypto’s an innovation that seems likely to be dead before FASB can determine their proper accounting procedure,” notes Fred Feldkamp . “As mortgage derivatives were the mass destruction devices of 1985-2008, crypto looks like the candidate for that distinction in the decades of a 0-bound Fed.” Once interest rates began to rise, the zero carry crypto schemes began to collapse like any Ponzi-type speculation. The illusion that bitcoin and/or the various other coins could serve as a payments medium has also evaporated once Ether's stable coin fraud broke down. Incredibly, some members of the crypto crowd are now looking for a federal bailout. The post below from Twitter pretty much summarizes the situation. Fintech Our general thesis about the process of QT and reducing liquidity in the financial system is that the stocks and assets that benefitted the most from QE and the investor mania it caused will now see similar price reductions. The mark-to-market on the Softbank (SFTBY) portfolio, to take an example, begins to approximate the mark-down required in similar pools of assets. Q: What do Elon Musk and Masayoshi Son have in common? Gigantic margin loans tied the the equity of their respective firms. SFTBY bottomed at a 52-week low, but bounced to finish the week just below $20. Given that the FOMC has only just started the tightening process, we’d be reluctant to add this name to our portfolio at this stage. The same dynamic that made SFTBY soar in past years is now dragging the heavily leveraged firm down as the value of it’s portfolio falls. “The risk was magnified in mid-March when shares in Jack Ma’s company dropped to $73, the lowest level since 2016. On that day, SoftBank came ‘insanely close’ to a $6bn margin call on the loan borrowed against Alibaba’s shares, according to one person familiar with the situation,” reported the FT last week. It is interesting to note that the Chinese authorities rescued Son and SFTBY, illustrating the close ties between Son and Beijing. This illustrates one big reason why the US government does not trust this organization. In that regard, we continue to wonder whether Masayoshi Son will be forced to sell Fortress Investment Group , which is the manager of mortgage giant New Residential Investment (NRZ) . As we noted earlier, the Committee for Foreign Investment in the US (CFIUS) blocked SFTBY from integrating FIG when it was acquired in 2017. Founder Wes Edens has effectively retired from FIG, making any sale a difficult proposition given the slowdown in the mortgage sector. We just spent the past four days at the Mortgage Bankers Association Secondary Market Conference in New York City. Suffice to say that much of the industry is for sale, but there is no obvious candidate to roll up the sector. Aspirational mortgage tech names such as Blend (BLND) and Better.com are literally dead in the water with no practical acquiror in evidence. Market leaders like Rocket Companies (RKT) have lost any pretense of a tech valuation and the entire sector is under intense operating pressure. There is a growing problem in the mortgage industry with depositories, mortgage banks and funds choking on loans and servicing assets that are mispriced. Loans produced in Q4 2021 and Q1 2022 are now trading at steep discount. We continue to hear troubling reports of buyers and third-party valuations shops using "cross-sell" opportunities to justify sky-high valuations for mortgage servicing rights (MSRs). Servicing assets likewise are trading at a discount to the official valuations seen in Q1, with several bulk deals now languishing in the secondary market. Names such as PennFed credit union are frequently named as among the more aggressive buyers of 1-4 family loans, including high-risk loans for solar conversions in residential properties. JPMorgan (JPM) has been among the most aggressive buyers of MSRs, but from a very selective perspective in terms of price and composition. Most of the assets are either jumbos or large balance conventionals. TIAA has been among the most aggressive sellers. A host of foreign and regional banks have recently entered the sector to finance MSRs, never an encouraging sign. We sold our position in REIT Annaly (NLY) last week and have been adding to our position in Nvidia (NVDA) as well as some of our bank preferred positions, since many of these names are now trading below par. Our view of the tech world is that companies with real profits and revenues are going to weather this storm far better than the aspirational names. The situation with Twitter (TWTR) is a case in point since the stock peaked three times in the past six weeks, apparently as discussions with Tesla Motors (TSLA) founder Elon Musk began to leak out, as suggested by the movement of the stock. We continue to wonder as to Musk’s true motivation in launching a bid for TWTR, which like most acquisitions announced in the past several weeks is mispriced. Could be simply be attacking TWTR and the large population of bots in the user base? And we agree with Jim Cramer on CNBC that Musk may be compelled to follow through on his agreement with TWTR unless he can demonstrate fraud regarding the number of bots in the social media’s firm’s user base. Our surveillance group for the fintech financials is shown below. We are pondering re-entering names like payments providers like Block (SQ) and Fiserve (FISV) , but we believe that the macro downdraft in terms of the reality of and fears regarding the Fed’s future actions is likely to make all of these names cheaper in the near term. We are going to be patient as the crowd comes back to earth in terms of valuations and earnings expectations. Fintech Group Question? Comment? Do you have a name you'd like to see profiled in a future comment? info@theinstitutionalriskanalyst.com Disclosure: L: EFC, CVX, NVDA, WMB, BACPRA, USBPRM, WFCPRZ, WFCPRQ, CPRN, WPLCF, NOVC 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.

May 16, 2022 | In this issue of The Institutional Risk Analyst , we feature a discussion with Dan Sogorka , CEO and President of Sagent Lending Technologies . Payments provider Fiserv (FISV) in 2018 sold a majority stake in Sagent, which includes the Fiserv mortgage servicing business, to Warburg Pincus . We spoke to Dan last week just as New York Stock Exchange-parent Intercontinental Exchange (ICE) announced that they will acquire mortgage software and data monopoly Black Knight (BKI) for $13.1 billion . But the big news at the Mortgage Bankers Association Secondary Conference this year is how lenders will navigate an environment with rising interest rates and also rising levels of loan delinquency. Dan Sogorka The IRA: Dan, thanks for taking the time to speak to us in a very busy week. Let’s start with the obvious and talk about the announcement of the acquisition of Black Knight by ICE. A lot of people were surprised by the deal due to anti-trust questions and the ambitious price as well. But several observers also suggest that the Sagent deal with Mr. Cooper (COOP) played a part in making this marriage come to pass. Do you take this deal as a compliment to Sagent? Sogorka: The COOP transaction did generate a lot of inquiry from Buy Side investors about Sagent and the servicing sector more broadly. The ICE transaction with Black Knight also helps to raise the profile of the sector. I must say, after two years it feels good to be able to report that we have won some big pieces of business. We have state-of-the art technology, a fantastic team and a process to actually meet customer asks. We also have important partners like Warburg Pincus, COOP and other large issuers that want a better solution. The IRA: COOP has a reputation for being savvy investors in technology, but having Warburg Pincus and FISV behind you is also a great endorsement. Of just about any PE firm in the business, Warburg Pincus is known for its success when investing in banks and other financial companies. Most recently they partnered with Varo Bank . We featured a discussion with former Warburg Pincus Vice Chairman Bill Janeway in 2018 (“ William Janeway on Capitalism and the Innovation Economy ”). In terms of highlighting the sector and the need for new solutions for manufacturing and servicing loans, in a way the ICE deal seems fortuitous for Sagent. Sogorka: Our customers as well as both partners and competitors in the fintech space are asking how the ICE deal may play out and whether Washington will delay, kill, or require divestitures. The deal announcement said this will play out into 2023, so time will tell in the coming quarters. Regardless of what happens, Sagent remains committed to the industry and our customers. We are focused on two things (1) executing alongside our customers in the trenches every day to build stable, future-proof platforms for them, (2) staying in the lead on homeowner-first innovation for our industry. Our vision for data-first, cloud-native platforms that connect consumers and servicers in real time across the performing and non-performing loan lifecycles is accelerating each week. As we integrate 200 new Mr. Cooper mortgage fintech specialists into Sagent’s 600-strong team of mortgage innovation experts, we have the best team in the industry. The IRA: We thought the $400 million breakup fee that BKI has to pay ICE in the event was of particular interest. Both ICE and BKI are hyper-acquisitive, heavily levered credits that grew more valuable during the upswing in mortgages, say 2016 on through 2022. Call it half a decade of rebound and then overperformance. Since we are on the backside of the interest rate cycle, don’t these names and the whole mortgage sector come under pressure? The public names in the industry are getting pounded in the options markets. How do you talk to clients and investors about the operating environment and also the financial markets going forward? Sogorka: As I noted, we’re all about being in the trenches with our customers to do the precise work of innovating in this complex sector – which is as much about smart technology as it is about intimately knowing the needs and challenges of servicing operators and their customers. Marrying modern fintech with in-the-weeds operational expertise is Sagent’s special sauce, and it’s our unwavering commitment to servicers. This is how banks and lenders thrive even in acute market cycle adjustments like this. And the more we help them thrive – and operate in a way they see fit rather than forcing them into black-box solutions – the more they can seize on market consolidation opportunities as this cycle plays out. The IRA: Sadly the changes at Ellie Mae since being acquired by ICE have not brought happy news for issuers used to a degree of customization. Can you deliver a hosted, cloud-based service for issuers that is robust and enables them to customize their version of the tool? Much like COOP contributing technology to Sagent? Giving lenders control and accountability over these key tools is crucial. We can see that many large issuers still maintain their own proprietary POS, LOS, etc. How do you deliver this level of custom service and at reasonable cost? Sogorka: Sagent is all about the cloud-native, open-API model giving servicers optionality and cost control. That fintech development mindset is still new for our industry, but it’s the future. It’s how we deliver ongoing, fast innovation at a lower cost without surprises, and without charging customers for tools they do not use. Also, It’s worth noting here that the new technology that powers the Sagent-Cooper vision for servicing is already proven in the market. Mr. Cooper generates customer retention that’s two times the industry average. This clear performance doesn’t just lead to better experience, it also has significant implications for cost savings by not having to re-acquire lost customers. The IRA: As we go through 2022 and the next several years, it seems pretty clear that interest rates are going to be higher for longer than in the post 2008 period. This suggests some pretty big operational and financial challenges in servicing. How does Sagent take advantage of this coming test for distressed servicing across the industry? Does the focus on expense management and loss mitigation help you further grow your share in the industry? Sogorka: The simple answer is yes. We will continue to talk about the need to change the paradigm from merely servicing a loan as a debt collector into something that is more sympathetic and responsive to the consumer – again, it’s all about a customer retention mindset. We think that the need to manage expenses and better interact with consumers will make the industry ask whether they have the right technology for that job and the right technology partners. It is not just about efficiently dealing with troubled mortgages and offering the best options for consumers, but how do we get ahead of the process to give servicers and consumers more time to consider options. The IRA: We learned years ago that keeping the family in the house and helping them to get back on track is always the best course for the consumer, the note holder and ultimately for the US taxpayer, who backs the credit risk on most residential mortgages. While investors are protected, servicers often lose money on foreclosures, even with record high home prices. How does Sagent address this pain point for servicers? Boathouse Row Want to join The Institutional Risk Analyst this Labor Day for fishing and fun at Leen's Lodge in Grand Lake Stream, Maine? Email: info@rcwhalen.com Sogorka: No one wants extended foreclosures. Giving consumers options earlier in the process and making sure these are the right options is, to us, the key to effective loss mitigation. If you don’t have electronic tools that can effectively engage with consumers, then you lose precious time. These are human beings that are going through difficult circumstances. Being able to engage with them, understand their situation and intent, is the key. Doing this via the web or a smartphone is mandatory. Sagent was first to enable digital hardship care as the CARES Act rolled out, and it's because of our digital-native, cloud-native platform. This lets our servicers maintain real-time compliance and customer care during rapidly evolving market and policy changes – this is the world we live in, and Sagent is meeting the moment. The IRA: Tell us a little bit about why Warburg Pincus got interested in mortgage servicing. How did you convince one of the premier private equity firms and investors in financials to dive into residential mortgages? And does FISV stay a minority but still significant investor? Sogorka: Fiserv is still a partner but Warburg Pincus is the primary capital partner. As you know, they’re one of the world’s elite investment organizations, and an ideal partner because they understand the scale and speed required to power America’s $12 trillion housing market. They enable us to think big and execute on our visions to lead innovation in this space. We often say modernizing servicing is the last frontier of the fintech era because it’s the biggest, most complex operationally, and the most regulated. Having a lead partner like Warburg Pincus who truly understands this means we can keep going fast on making innovation a reality. The IRA: For FISV, it obviously is a huge plus to have a credible partner like Warburg Pincus and now COOP in the mix and helping support the investment required, especially as the industry goes through a down period. As we go through this year and 2023, what is the message to the mortgage industry from Sagent as we approach the MBA Secondary? Sogorka: With the recent transaction with COOP, we have a lot more tools to talk about with clients, tools that are highly relevant to an environment where credit and compliance only grow in importance. We’ve also brought on a lot of deep industry talent in the servicing space to support client implementation and execution. We are not going to hand you a proprietary tool and tell you to figure it out yourself. As I’ve said, we’re in the trenches with you to help you redefine how you perform servicing and actually make it a profitable business for your organization. We have found that consultative approach is what the industry wants and it is central to how we approach the market. The IRA: And you are fully committed to an open source architecture? This is an industry that builds its own tools. Sogorka: Yes, completely. We’ll show you what is possible today, what new products we’re delivering shortly and how you, the customer, can decide how to create your servicing and loss mitigation process to your specifications. The industry hasn’t had this before, and with Sagent, now they do. We start with a very different perspective, which is to listen to the client and tell them how we can build and maintain the platform that they want today and tomorrow to be cost effective and compliant. If they want a certain set of third-party tools added to the mix that they believe are best-in-class, we make it happen in a cost effective way. The IRA: As Henry Ford said about the Model T, you can have any color you want as long as it is black. Thank you for your time Dan. Enjoy the MBA.