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A note to readers of The Institutional Risk Analyst , we have published a new paper entitled " Improving Liquidity for Ginnie Mae Servicing Assets" which is available on SSRN . The paper has been well received in the regulatory community. We hope that it will better inform the debate over "risk" from nonbanks in the mortgage sector. We make the point that the biggest risk to Ginnie Mae and the taxpayer is that unnecessary regulation and bank centric thinking will drive the remaining participants out of the government loan program entirely. We provide an overview of secured finance in the post-WWII era. The paper then asks two basic questions: 1) why do Government National Mortgage Association (GNMA) servicing assets trade at a discount to conventional and even private label mortgage servicing rights (MSRs) and 2) why do lenders offer inferior terms when lending on GNMA MSRs? To answer these questions, we examine the evolution of GNMA as part of the U.S Department of Housing and Urban Development (HUD). Particular emphasis is placed on the relationship between GNMA and private market participants in providing insured credit to support affordable home ownership. We conclude with some suggestions for reform that will improve liquidity in the GNMA market for MSRs. Here's an excerpt: When Ginnie Mae was created in 1968 and the issuance of government-insured mortgage backed securities (MBS) began in 1970, nonbank finance did not exist in the United States. In a 1925 decision, Supreme Court Justice Louis Brandeis applied New York State law to secured finance in a bankruptcy case, Benedict v Ratner 268 U.S. 353 (1925) . The decision brought secured finance to a halt and created the six tests for legal isolation that describe a “true sale.” It took lawyers, bankers, the states and Congress nearly half a century, including several revisions to the Uniform Commercial Code and numerous pieces of federal legislation, before nonbank finance was even possible in the US. Collateralized lending in the US was essentially impossible outside of banks from 1925 through the mid-1970s, and even then, banks felt constrained in terms of obtaining a clear lien on collateral. The market for secured finance that existed in 1970 was a bank market comprised of state-chartered banks and thrifts, a legacy of the Great Depression, WWII and the subsequent years of Cold War. In the post-WWII period, national banks held mostly commercial, government and state obligations and were not even allowed to lend generally on real property until the mid-1950s. When Congress created GNMA, the assumption was that the agency would operate in a securities market dominated by large commercial banks and broker dealers. The rules and regulations adopted by Congress half a century ago were influenced by the experience of the Great Depression and Benedict, and were tailored for a market operated and funded by large depositories. Significantly, GNMA would blaze a path for the GSEs and later private issuers in terms of secured financing via the issuance of MBS. Consumer finance receivables and mortgages on real property were eventually packaged into private securities, all to be financed in the engine of American prosperity known as the bond market.

February 7, 2022 | Last week saw the start of the reporting season for publicly listed mortgage companies, with loanDepot (LDI) and PennyMac Financial Services (PFSI) issuing earnings results for Q4 and the full year. “Economic forecasts for 2022 total originations average $3.1 trillion,” PFSI observed. “While a large market by historical standards, it reflects a substantial decline from a record 2021 ‒ Excess industry capacity established in recent years will need to be right-sized” -- all comments familiar to readers of the Premium Service of The Institutional Risk Analyst . Source: PFSI Among the larger issuers, PFSI, which is the external manager of PennyMac Investment Trust (PMT) REIT, has some of the better reporting. In addition to informing investors about forward volumes, PFSI also illustrates that primary/secondary spreads have fallen back toward 1% after widening last summer. As we never tire of reminding our readers, profits for financial companies are directly tied to spreads. Wider is better. The fact that $2 trillion or so in the estimated 2022 volume is likely to be purchase mortgages provides little reason for great joy. Purchase is the most costly type of mortgage origination. The fact that PFSI is focused on consumer direct, which is a lower cost execution channel, is a positive. Rising servicing income and falling prepayments on mortgage servicing rights is another positive. But production pretax income for PFSI in 2021 was half of 2020 and that downward progression will continue in 2022, led by falling correspondent volumes. Correspondent was down 50% YOY, from almost $60 billion in Q4 2020 to $33 billion in Q4 2021. Source: PFSI As we see the FOMC raising interest rates and ending both new purchases and even reinvestment of principal returns for the system open market account (SOMA), the importance of servicing portfolios grows. Both as a source of new loans and because of monthly cash flows, the yield on the MSR is a big part of future earnings. At a little over $500 billion, PennyMac Loan Services ranks sixth among primary servicers, according to Inside Mortgage Finance . LDI, on the other hand, is not a very large servicer and ranks 16th in terms of owned servicing, again according to IMF. At $162 billion in unpaid principal balance of the loans, the LDI MSR is valued at 122bp. Between the end of 2020 and 2021, the value of the LDI MSR rose to just below $2 billion from $1.1 billion at the end of 2020. Some observers remarked on the fact that LDI wrote down the MSR $118 million in Q4 2021. Our question is why didn’t LDI write down more. Sure, 5x cash flow is where the bulk market is for conventional MSRs. But 122bp does not strike us as a particularly conservative mark given that LDI wrote down $445 million in MSR in 2021. Call it a “rainy day” mark, something that is easier when you do your MSR valuation work in-house. PFSI, by comparison, took down the value of its predominantly GNMA MSR portfolio by just $44.2 million for a period end multiple of just 4.1x the cash flow from the $278 billion in UPB. But more telling is the fact that production expenses, net of LO compensation, went from 24% of net revenues in Q4 2020 to 69% in Q4 2021 (Pg 10 of LDI Presentation), suggesting that cost cutting will be a priority in 2022. PFSI has one of the longest and most stable operating profiles in the industry, even during the roller coaster years of QE and COVID. During 2020, PFSI delivered a return on equity north of 60%. The following year 2021 was half that rate., reflecting the decline in lending volumes and gain-on-sale (GOS) margins. Like the rest of the industry, PFSI believes in the virtuous cycle of lending and servicing, a proven formula unless and until delinquency becomes significant. Notice in the chart below for LDI that operating expenses in 2021 rose above 2020 levels even as revenue fell in 2021 below the previous year. PFSI also saw production expenses rise through 2021 even as revenue and volumes softened. This is the traditional operating profile of the mortgage finance business, rushing to catch an opportunity c/o the FOMC in 2020-21, followed by a painful retrenching in terms of operating expenses in 2022. LDI’s GOS margin was 4.41% in 2020 and 2.9% in 2021, a trend that may continue into 2022. Source: LDI LDI’s total expenses were up $800 million in 2021, a fact that will need to be addressed before the end of Q1 in terms of variable expenses. But then again, the entire industry is going to be dealing with layoffs and other efforts to rein in costs after a record year in 2020 and part of 2021. In that sense, the layoffs announced by Better Mortgage before the end of last year may have been prescient. Cost cutting is the name of the game in residential mortgages in 2022. 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.

November 18, 2021 | In this Premium Service edition of The Institutional Risk Analyst , we look at a small but highly profitable bank holding company (BHC), Raymond James Financial (RJF) , the 47th largest banking group in the US and a comp for larger specialty BHCs such as Charles Schwab (SCHW) . RJF is one of those quiet high-performer banks in the investment world that few understand but many own in LT portfolio, resulting in a 2.6x multiple to book value. The FL-based RJF just announced the purchase of Pittsburgh, Pennsylvania-based TriState Capital Holdings, Inc. (TSC) , a $12 billion asset banking group with an asset management business. Upon the close, the TriState combination will make RJF a $70 billion institution with more than $2 trillion in client assets and 8,500 financial advisors. Of note, TSC will keep its name and continue to operate as an independently chartered bank subsidiary of RJF. Source: Google Finance The fact that RJF has out-performed larger institutions in the equity markets is no surprise. The BHC’s financial performance is quite strong, due largely to the non-interest income generated by the investment business and its large broker-dealer unit, Raymond James Associates. If we compare the performance of RJF with larger institutions and Peer Group 1, the firm’s performance immediately stands out. Of note, RJF saw a significant increase in loan losses at the end of 2020 due to the adoption of CECL and the write-down of criticized loans held inside the bank. The explosion of COVID at the start of 2020 pushed down valuations for RJF and other financials, but the CECL adoption nine months later did not really affect stock prices for RJF or the Peer 1 large bank group. RJF had the capital and income to increase loss provisions as required by CECL, write down more than $100 million of doubtful loans and keep on going, and reported record revenues in that quarter. Source: FFIEC After credit losses, the next question to ask is how does RJF do in terms of pricing on the loans that they originate? Half of RJF’s consolidated balance sheet is actually loans, evenly divided between real estate, C&I and consumer facing exposures. The BHC’s loan pricing is competitive with SCHW and Morgan Stanley (MS) . Source: FFIEC Note that while RJF is not able to compete with the likes of JPMorgan (JPM) in terms of loan pricing, it compares well with the other bank specialty investment shops such as SCHW and MS. And again, while lending is important to RJF based upon assets, the total income of the BHC is weighted 16:1 in favor of non-interest revenue vs net interest income. Even though the RJF business is primarily focused toward investment products, net loans and leases are almost half of total assets of the BHC. RJF's bank unit has $30 billion in core deposits and a cost of funds that compares with the largest banks in Peer Group 1, as shown below. Source: FFIEC As we’ve noted previously, SCHW with nearly $500 billion in core deposits has among the lowest cost of funds in the industry, but dollar for dollar of assets in the bank, RJF has more investment assets than its larger rival. In fact, the investment business at RJF is so large as a percentage of the total that the FFIEC puts the firm in Peer Group 9, which is designated for “atypical” BHCs. This is also why RJF has a fiscal year ending in September, whereas most banks run on the calendar year by regulation. We’ve used Peer Group 1 for financial comparisons. Only when you look at RJF in terms of consolidated income vs average assets do you begin to appreciate the earnings power of the investment business and how this could support the growth of the bank. At present, RJF only retains half of the $66 billion of sweep deposits generated by its investment business and places the other $25 billion with other depositories. There is potential for RJF to grow the asset side of the bank and thereby increase the internal earnings of the group. As RJF grows the bank, it should be able to push its efficiency ratio down from the nosebleed 80% today to something close to the 60% reported by SCHW. Source: FFIEC In the quarter ended September 30, 2021, RJF reported $2.7 billion in net revenues and took $429 million down to the bottom line. This was a 72% growth rate year-over-year in terms of the bottom line, one reason why RJF trades in the same company as SCHW and First Republic Bank (FRC) , which trades over 3x book value. Like most financials, RJF is fully priced but has excellent potential for growth in the future, both on the investment side and the bank. 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.

Q: Are the annual stress tests good for bank stocks? See discussion on Yahoo Finance by clicking here (Interview starts at 12:30). Early in 2009, when the Federal Reserve Board began the annual exercise of “stress tests” for banks, confidence in the US financial institutions was nonexistent. The year before, Treasury Secretary Hank Paulson almost single handedly cratered the US economy by embracing the creation of a “Super SIV” to buy bad assets from the largest banks. Paulson’s ill-considered comment told investors that US banks like Citigroup (NYSE:C) were insolvent. At the time, JPMorgan (NYSE:JPM) was trading below $30 per share and other large banks were similarly discounted. As part of a broader effort to restore confidence in banks, the Supervisory Capital Assessment Program or SCAP was designed to measure whether the 19 largest banks with more than $100 billion in assets had sufficient capital. The key objective of the SCAP was not to actually measure capital per se, but instead to restore investor confidence in holding bank debt. In that sense, at least, the SCAP was successful. Kudos to Messrs Bernanke & Geithner. Yet the necessary decision to report the results of the SCAP publicly had significant future implications for banks and also for investors. In 2009, investors were concerned about a growing federal role in the banking system. And that is precisely what has occurred. The SCAP evolved into the Comprehensive Capital Analysis and Review (CCAR), which is the key part of the stress test duet that determines if banks can increase cash returns to investors. The Fed noted in May 2009: “The unprecedented nature of the SCAP, together with the extraordinary economic and financial conditions that precipitated it, has led supervisors to take the unusual step of publicly reporting the findings of this supervisory exercise. The decision to depart from the standard practice of keeping examination information confidential stemmed from the belief that greater clarity around the SCAP process and findings will make the exercise more effective at reducing uncertainty and restoring confidence in our financial institutions.” When the Dodd-Frank law was passed a year later in 2010, Congress included an expanded legal mandate to conduct annual stress tests and for hundreds of banks. In October 2012, the various federal regulatory agencies issued final rules implementing stress testing requirements for hundreds of public and private companies with over $10 billion in total assets. Most of these smaller institutions outside of the original 19 banks had no part in the 2008 financial crisis and were in fact victims. The bank stress tests continue the fine American tradition of punishing the victims. Since 2012, the stress tests have devolved, from a modestly useful annual process focused on the top institutions to a monumental waste of time and money. This effort is focused on most of the US banking industry as measured by assets. The chief architect of this regulatory effort was former Fed Governor Daniel Tarullo, who was responsible for bank supervision and resigned earlier this year. Governor Tarullo turned the stress test process into a nearly continuous form of supervisory torment involving bank management, directors and legions of consultants and lawyers. JPM CEO Jamie Dimon remarked frequently about the cost of stress tests, living wills and the various other requirements of Dodd-Frank. On top of required levels of capital, the Fed under Tarullo’s leadership proposed capital buffers and capital surcharges partly based upon the subjective stress test performance of each bank. The stated point of this exercise is supposedly ensuring the safety and soundness of US banks, but the reality is far different because the process has shifted from a short-term focus on restoring confidence in bank debt to an annual media event that impacts bank equity. So intense is Wall Street's interest in how stress tests could affect bank earnings that even Fed Chair Janet Yellen has become involved in the media frenzy. And the stress tests contain no information that would be material to investors. Violating the traditional confidence of the supervisory process to release stress test results serves no useful purpose, especially given that the tests are different for each bank. There is no comparability one bank to the next. How are analysts much less investors supposed to use this chopped salad? First and foremost, the bank stress tests do not measure the ability of a bank to weather the types of market stress seen in 2008. As regulators have known for decades, income is the key determinant of a bank’s ability to offset credit losses. Income, net of provisions for future losses, is also a key factor when it comes to predicting a bank’s probability of failure and thus maintaining investor confidence. When a bank starts to show (or event hint at) red ink due to climbing credit costs, investors start to flee and liquidity evaporates. The amount of capital the bank may or may not possess is immaterial, as illustrated by the events of 2007 and 2008. The added uncertainty caused by off-balance sheet finance (using the very same SIVs made famous by Secretary Paulson) led to the failure of many large firms from 2008 onward. Yet the only time that a bank actually consumes capital is when the institution fails and its net assets are being sold. As shown by the situation facing Citi in 2008, the GSEs, and in Italy last week, by the time that we actually start talking about a bank’s capital, that institution is already dead. Second, because of the public nature of the stress tests, the Fed and other regulators have become the very public arbiters of bank dividends and stock repurchases. The annual process of conducting the Dodd Frank Act Stress Test (DFAST) and CCAR has become a dual yardstick for whether a given banking organization can increase dividends and/or share repurchases to meet Wall Street’s expectations. The fact of the Fed conducting the stress test initial process publicly in 2009 made this evolution to the public stress test process inevitable. But any benefit in terms of bank safety and soundness has been lost as the stress test exercise mutated into a media circus that each year precedes second quarter earnings by a week or so. From an equity market perspective, the Fed’s timing could not possibly be worse. Ryan Tracy at The Wall Street Journal notes: “The tests will continue to matter to investors. The Fed will still use them to audit banks’ plans to boost dividends and buybacks for shareholders, and the numerical part of the exams will still be crucial to determining those payouts.” So are stress tests good for bank stocks? No. The stress test process is part of the expanded regulation of the US economy by the Fed since the 2008 financial crisis. Dodd Frank has reduced the opportunities for banks to earn profits, while limiting their ability to provide new credit to support economic activity. Payouts to investors are now held hostage to the opaque annual stress test process conducted by the Fed and other regulators. American banks have been neutered as sources of alpha for investors. Through the prohibition of principal trading activities and any type of risk lending, banks have become low risk, no alpha platforms. The stress test process has transformed the capital finance dimension of banks into a regime similar to the rate setting process applicable to heavily regulated electric utilities. This is not a problem of bank management, but of our public officials in Washington. While the evidence continues to mount that over-regulation of banks is constraining economic growth and job creation, there are still voices in Washington that seek additional regulatory constraints on banking. Elizabeth Warren (D-MA) told The Wall Street Journal last week that President Donald Trump does not have a mandate to lessen regulation of banks. She said: “You do polls across this country, and I’m talking about polls of everybody—Democrats, Republicans, Independents, Libertarians, vegetarians, everybody. Somewhere in the neighborhood of 80% and upward believe that the largest financial institutions in this country need more regulation, not less regulation.” Senator Warren’s comment is right but only mimics what Teddy Roosevelt proved a century ago, that most people hate big banks. But is her prescription for more regulation a good idea in terms of public policy? Absolutely not. Warren’s comment suggests that politics, not substance, is her true motivation when it comes to yowling about bank regulation. But at least she is asking questions. Looking at the patchwork of regulations, punitive capital rules and meaningless stress tests that have been embraced by Congress since 2008, there is little that either protects the taxpayer or promotes a healthy banking system. The only thing that the current regime for U.S. banks ensures is that financials will have little upside in terms of equity valuations unless and until the regulatory situation changes. That was the whole point of the rally in banks stocks following the November 2016 election. At about 1x book value, today most bank stocks are fairly valued given the current regulatory regime and their business opportunities. Some of the better performers among larger cap names such as US Bancorp (NYSE:USB), Bank of the Ozarks (NASDAQ:OZRK) and Wells Fargo (NYSE:WFC) command higher valuations due to strong financial performance, but most banks simply do not deserve higher book value or earnings multiples in the current regulatory regime. The financial crisis is over. The DFAST/CCAR process needs to be ended as a public exercise. Future capital adequacy analysis by regulators should be performed privately as it was prior to 2009. The regulatory burden on banks needs to be reviewed with an eye to removing regulations that fail either to make banks safer or support economic growth. And remember that bad banks never die from lack of capital, they just run out of cash.

November 3, 2021 | New Residential Investment (NRZ) reported Q3 2021 earnings yesterday , providing an important window into developments in the mortgage industry. Unlike Mr. Cooper (COOP) , NRZ reported higher gain on sale margins in Q3 2021. Revenue almost doubled from Q2 2021, but expenses also increased and, of note, servicing revenue was flat sequentially despite the close of the acquisition of Caliber Home Loans in August. Source: NRZ Q3 2021 When NRZ closed the acquisition of Caliber, this added significantly to the firm’s top line as well as increased its mortgage servicing rights (MSR) portfolio. That said, the brisk rate of loan prepayments still visible in the industry took $421 million off the value of the NRZ MSR portfolio in the first nine months of 2021. These servicing assets as well as loans and MBS simply vanished in a cloud of prepayments, like magic. And no surprise, NRZ is still trading at book value. Source: NRZ Q3 2021 A big question facing NRZ and other mortgage lenders and investors is the rate of prepayments going forward. Since 2020, prepayments on NRZ assets soared to over 30% annual rates on average spread across the firm’s portfolio. NRZ claims that originations exceeded MSR run off in Q3 2021, something the firm shares with COOP and other market leaders, but only due to great efforts in terms of recapturing refinance opportunities. Source: NRZ Q3 2021 “During Q3’21, average portfolio speeds slowed for the third consecutive quarter but remain well above historical averages and have room for continued improvement as refinance burn-out continues,” NRZ states. “Newly created MSRs that are being added to our portfolio have a lower WAC and higher lifetime value than those paying off.” Well, maybe. If the Fed lowers rates again, those loans will prepay too. We have observed previously that NRZ and other hybrid REITs do not have the luxury of being picky when it comes to asset purchases. When your book is running off at 25% per annum, buying or creating new assets is your one and only task. And you must replace assets that prepay before you can log any incremental growth, one of the unfortunate effects of the radical asset purchase policies of the US central bank. Thanks to Jerome Powell and the rest of the FOMC, we have asset price inflation, but zero or even negative duration in markets, sending asset returns falling towards the zero bound. “Of course, it was not so long ago that lenders had primary-secondary spreads around 50 bps and lenders made more from the MSR’s monthly cash flows than they did on originating and selling a loan,” says Mike Carnes , Managing Director, Capital Markets MSR Valuation Group, at Mortgage Industry Advisory Corporation (MIAC) . “Now we are making more from origination than from the MSR. This has created incentives for buyers to pay premiums for MSRs in the hope of recapturing some of the refinancing from a pool of loans.” The folks at NRZ claim to have recapture rates in the ~ 70 percent range, but they are doing the calculation incorrectly – a common enough problem in the mortgage industry. For the record, the mortgage industry standard for calculating a recapture rate for an MSR portfolio is defined as: Recapture rate = recapture fundings / all payoffs Nothing is excluded. A good recapture rate across the industry is 20-25%. Some of the larger nonbank shops in the government sector get into the high 30s or better. Thus the restrictions on streamline refis of VA loans, for example, imposed by Ginnie Mae in a desperate but ultimately futile effort to slow prepayments on MBS. Folks like NRZ, however, apparently look at payoffs where they can match a new loan to the same borrower on the same property, i.e, a refinance. In the adjusted recapture rate, the denominator is ONLY REFI’s vs all payoffs. IOHO, that’s cheating. But we digress. While some observers believe that prepayment rates are likely to fall back down to 2020 levels, we remain skeptical of such statements. The simple reason is that the FOMC is unlikely to change the target rate for Fed funds until at least 2023, if ever. NRZ points to estimates of the 10-year Treasury reaching 2.5% yield by 2023. We politely disagree and note that dollar swap spreads are inside Treasury yields from five years on out. Do you think there is brisk demand for dollar assets? Hmm? Source: Bloomberg We’d be very surprised to see the 10-year Treasury breaking 2% or even maintaining current levels given the strong bid for risk-free dollar collateral. Also, any slowdown in the US economy will force a choice between supporting employment or fighting inflation. The former, politically speaking, is the only part of the Humphrey-Hawkins mandate that matters at the end of the day. Of course, if President Joe Biden continues to stumble politically and fails to reappoint Fed Chairman Jerome Powell for an additional term, then the interest rate calculous changes dramatically. With MD socialist and former bank regulator Lael Brainard as Chair designate, the 10-year Treasury yield would be at 3% before you can say “Goodnight Irene.” The NRZ earning release has some points of interest. For example: “U.S. house prices have been growing at a 21% annualized growth rate over the last three months as a result of competition among buyers for a dwindling national housing supply.” Does this fact and the purchases of a non-QM originator by NRZ suggest a peak in asset prices? To that point, the acquisition of Genesis Capital LLC from Goldman Sachs (GS) is another point of interest for investors. The market for non-QM loans, business purposes loans and fix and flip financing is a fringe market that exists in times of low interest rates and rising asset prices. As and when asset prices start to soften, however, the market for these loans likewise will start to evaporate as it did in April of 2020. In our view, if Genesis was such a great business, GS would not be a seller. We think that the GS folks are too smart for that and realize that the fringe market in mortgage assets is a transient phenomenon. Once again, NRZ is buying at the top of the market in order to increase assets and drive nominal earnings. They have no choice. Stay big or go home. In addition, while Caliber and Newrez Mortgage are being combined, there is still no hint of a spinoff of the lender from NRZ to finally separate the businesses from Fortress Investment Group and its parent company, Softbank . As we’ve noted before, the creation of an independent seller/servicer called Newrez a la PennyMac Financial Services (PFSI) to pair with the NRZ REIT a la PennyMac Mortgage Trust (PMT) , would greatly enhance NRZ CEO Mike Nierenberg’s efforts. A spinoff could unlock shareholder value and hasten the rebuild of NRZ after the 2020 meltdown and subsequent prepayment blizzard c/o the Federal Open Market Committee. Creating a good comp for the NRZ empire created by Michael Nierenberg and his team is just one reason for doing a Newrez spinoff, and sooner rather than later. The notorious Japanese investment firm that owns Fortress (and indirectly controls NRZ as the external manager of the REIT) has been involved in a number of dubious investment schemes , including Wirecard and WeWork , to name the short list. Softbank is now reported to be considering the sale of Fortress, which it acquired in 2017. That is great news for NRZ shareholders. The Softbank purchase of Fortress never made sense to us. Of note, Bloomberg News reports that the Committee for Foreign Investment in the US (CFIUS) placed limits on Softbank’s corporate control of Fortress . Bloomberg reported: “To win approval from the Committee on Foreign Investment in the U.S., SoftBank agreed to cede any control of day-to-day operations of Fortress. Since the transaction closed in December 2017, Fortress has been run independently.” We think it speaks volumes as to the perception of Softbank by the US government that CFIUS would put such extraordinary limits on CEO Masayoshi Son’s control of a financial firm. CFIUS limits on direct foreign investments in the US usually are driven by national security concerns. Fortress founder Wes Eden is a leader in the world of finance, of course, but the CFIUS restriction on Softbank’s investment in Fortress is remarkable nonetheless. SoftBank shares have tumbled about 21% this year in Tokyo trading, compared with the 8% gain by the Nikkei 225 Index, Bloomberg reports. The good news is that NRZ is growing and making strides in terms of asset creation and, especially, asset retention. The days when lenders could retain servicing for years and years are gone thanks to the FOMC. Duration is now zero. A blizzard of prepayments in both residential and small business loans has driven most of the hybrid REITS into the fringe markets of non-QM loans and fix & flip financing. NRZ today is the fourth largest originator in the US, but the asset mix is changing rapidly for all originators as they chase both yield and hopefully duration outside the world of agency loans. Disclosures: NLY, CVX, NVDA, WMB, BACPRA, USBPRM, WFCPRZ, WFCPRQ, CPRN, WPLCF, UWMC (s), RKT (s) 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.

January 31, 2022 | In this issue of The Institutional Risk Analyst, Chris Abate , CEO of Redwood Trust (RWT) , discusses the world of non-agency mortgages after two years of COVID pandemic and related responses from the Federal Open Market Committee, Federal Housing Finance Agency and other state and federal organizations. Prior to 2008, half of all mortgages written in the US were private. Now almost 15 years on, some lenders are addicted to government subsidies for borrowers who don't need them, Abate writes, but regulators are rediscovering a trusted partner in the private mortgage sector. In January of this year, the FHFA revised the GSE Enterprise Pricing Framework by increasing upfront fees (also known as loan-level pricing adjustments, or LLPAs) for certain high balance loans and loans on second homes. These changes are in keeping with the GSEs’ core mission of supporting sustainable homeownership and affordable rental housing. The changes will concentrate support to borrowers most in need of the valuable, and subsidized, liquidity that the GSE loan programs provide. As a partner to the GSEs and a leading voice for quality and innovation in the housing finance sector, Redwood Trust applauds this move by the FHFA. Not surprisingly, however, not everyone is supportive. There remain a number of lenders and their K Street lobbyists who prefer cheap credit regardless of the cost to taxpayers. They promote nonfactual scare tactics or alarmist arguments in hopes of maintaining status-quo subsidies – and easy profits – for loans to higher income borrowers. The recent LLPA increases put forth by FHFA Acting Director Sandra Thompson were a bold move. They are the clearest acknowledgment yet that government subsidization of certain parts of the mortgage market is unnecessary when the private market continues to serve them efficiently. By focusing GSE capital and resources where they are needed most, the FHFA is achieving a few very important objectives: greater support for the GSEs’ mission-driven activities, increased safety and soundness, and the continued “crowding in” of private capital in areas where specialized underwriting and loan administration expertise can more effectively serve homebuyers. We all know the dynamics in today’s housing market are unprecedented. Record high home prices and an elevated demand for homes, with extremely low levels of inventory, characterize markets in many parts of the country. Without a rationalization of mortgage subsidies, the GSEs could assume unnecessary risk on mortgages to homebuyers with incomes well in excess of the median in their own neighborhoods. In fact, household income of two times the area median is often required to support debt payments on higher balance loans, assuming a reasonable debt-to-income ratio of 40%. These can hardly be described as “mission serving” borrowers, and the considerations in extending them credit are anything but homogenous. The upward trend of GSE purchases toward larger loans is already well established. High balance loans represented approximately 11% of GSE purchases in 2021, up from 8.2% in 2018. In addition, since 2018, the average size of a high balance loan purchased by the GSEs has increased 21%. (1) Source: 1010 Data, Falcon Capital Advisors Importantly, the GSE regulator also seems to recognize this trend and is taking action. Along with the LLPA increases on high balance loans, the FHFA recently rejected as insufficient the GSEs’ “Duty to Serve” plans, which among other things, outline efforts to provide liquidity for affordable housing in underserved markets. Today’s Private Mortgage Sector The role of the private mortgage sector, in a competitive sense, has always been to serve markets that federally subsidized loan programs don’t reach. And the fact is, Redwood and others have already demonstrated the ability to seamlessly fill gaps whenever the GSE footprint has been reduced, and to do so with no discernible impact on borrower’s interest rates or process efficiency. Just last year, the private sector collectively executed a 400% increase in securitization volume of Agency-eligible loans – responding immediately and effectively to regulatory shifts impacting the GSE financing of mortgages on non-owner occupied homes. And as the private sector expanded, it continued to offer rates to homebuyers that were near or better than those offered through the GSEs, underscoring the maturity of the private market. The chart below illustrates the relationship between conforming (GSE) and private sector consumer mortgage rates over the past several years, along with annual volumes. Borrowers continue to benefit from the strong presence of the private mortgage sector. It is now estimated that a typical borrower could see a marginal rate benefit of between 0.125% to 0.25% for high balance loans and 0.25% to 1% for second homes. Along with added purchasing power, consumers benefit from private sector sponsors with deep experience in the risk-based underwriting and pricing of their home loans. At Redwood, we help make quality housing accessible to all American households. We work in support of the safety and soundness principles emphasized by the FHFA to help ensure a strong and stable housing finance market. Since 2010, Redwood alone has purchased over $50 billion of loans from our origination partners and distributed them through a combination of private-label securitizations that we sponsor, and whole loan portfolio sales to leading depositories, insurance companies, and other quality institutional investors. Our emphasis on speed to closing and reliable execution has helped to institutionalize private sector workflows in tandem with traditional GSE workstreams. We’re also leading the charge to innovate in an industry that has long been characterized by archaic systems and processes. Some recent examples include our Rapid Funding program and our use of Blockchain technology in securitization, reflecting our commitment to ensuring a powerful liquidity alternative for home owners as regulators determine the future priorities of the GSEs. We see a bright future ahead for the private label loan market and, again, applaud the FHFA for having the courage to let the markets work best for those borrowers who clearly need no assistance from the taxpayer.

January 27, 2022 | In this Premium Service issue of The Institutional Risk Analyst , we return to Citigroup (C) , one of the top three banks in the US and among the highest risk franchises in the US financial services industry. Founded in 1811, Citigroup was a banking pioneer in the early 20th Century, establishing outposts in retail banking markets from Europe to Africa and the Middle East, to China and Japan, and later Mexico and the Americas. Now the offshore empire of Citi is being dismantled under CEO Jane Fraser , including the retail banking business in Mexico just south of the US border. The model going forward apparently is international capital markets, private banking and subprime consumer lending in the US. When the rationalization of Citigroup is complete, will the Citi that Never Sleeps still have a reason to exist? Source: Google In Q4 2021, Citi reported down revenue in single digits, but a 33% drop in earnings due to rising operating expenses and the cost of disposals. Even a significant release of loan loss reserves could not put a good face on a messy quarter that included a $1.2 billion charge for winding down the Korean retail business. Citi has announced agreement with UOB Group (UOB) on the sale of Citi’s consumer banking franchises in Indonesia, Malaysia, Thailand and Vietnam. E ven if we are mindful of the costs involved in the disposal of these businesses, and the fact that Citi and other banks are often light in Q4, the performance at Citi was especially disappointing but not surprising. Over the past five years, Citi has underperformed the top-five banks in terms of both operational factors and equity market valuations. With the exception of Wells Fargo (WFC) , which continues to suffer from the dysfunction within the CSUITE, Citi has trailed the group. JPMorgan (JPM) and Bank of America (BAC) have been the best performers in terms of stock price, but we’d argue that the value destruction at BAC under CEO Brian Moynihan has been far worse than the studied mediocrity of Citi. For reasons apparent only to behavioral psychologists, Buy Side managers cannot help but buy BAC for their clients’ portfolios, one reason this name is consistently among the most actively traded large bank stocks. Citi's business mix is high-risk and highly variable, as illustrated by the fact that Q4 2021 earnings were less than half of Q1 2021. Even with the higher spread on its consumer loan book, Citi's costly funding mix and operating expenses leave shareholders short compared with JPM or USB. Over the past month, of interest, the performance of the top-five banks has inverted, with WFC outperforming the group, followed by U.S. Bancorp (USB) . Notice that JPM, which missed badly in Q4 2021 earnings, is now the laggard with BAC #4 in the group. As banks retreat from some of the lofty equity valuations seen in 2021, the group is going to start to more heavily reflect fundament performance and less the hopes and dreams of Buy Side Managers, who mostly have no idea about bank operations. The degree to which quantitative easing or “QE” by the Federal Open Market Committee has boosted bank valuations – this even as fundamentals have declined rather precipitously – will no doubt be a subject of interest for researchers in years hence. Source: FDIC/WGA LLC One CIO asked us this week about why Citi has been engaged in a “fire sale” of assets. The simple answer is that many of these business have such poor operating performance and therefore elevated efficiency ratios that Fraser had no choice but to cut and run. The chart below shows efficiency ratios for the top-five BHCs plus Goldman Sachs (GS) and Peer Group 1. Notice that C, BAC and WFC all have efficiency ratios above the Peer average, while JPM and USB are below. Source: FFIEC For large banks today, an efficiency ratio starting with a “5” is the goal, but Citi and other large banks have been losing ground in terms of profitability since 2019 under the constant pressure of the Fed’s QE. In addition, much like the General Electric (GE) of old, Citi in many ways is a legacy conglomerate. It is comprised of business lines that did not necessarily make sense, either as standalone units or as part of a larger whole. Many of the offshore retail businesses that have been sold were simply too small. The poor operating performance historically also is attributable to another aspect of Citi, namely a small core deposit base in the US. Only half of Citi’s business is supported with deposits and only half of that is in the US. The chart below shows the top five BHCs and Peer Group 1. Notice that Citi is the weakest performer in the group besides WFC, which has suffered badly due to regulatory sanctions. Source: FFIEC Notice that the unweighted average of net income to average assets for the 132 large banks in Peer Group 1 is less volatile than the results for the largest banks. Where Citi has an advantage over other banks is the gross spread on its consumer loan book, a portfolio that is relatively sub-prime compared with the other top-five banks and Peer Group 1. Notice that Citi’s gross spread on loans and leases is hundreds of basis points higher than the rest of the group. Source: FFIEC The strong cash flow from the consumer lending business has been an important part of the Citi revenue model for many years, to some degree offsetting the poor operating metrics of the offshore retail banking businesses. The loss rate on Citi’s portfolio, however, is also elevated compared with the other four banks in the top five. In many respects, monoline credit card lender CapitalOneFinancial (COF) is a better comparable for Citi’s consumer business than is JPM or BAC. Source: FFIEC The final piece of the puzzle that helps us to understand the mediocre operating performance of Citi is the cost of funds for the group. As the chart below illustrates, the cost of funds for C is considerably elevated compared to its asset peers and the unweighted average of the 132 banks in Peer Group 1. This relatively expensive funding is a major structural disadvantage for Citi, especially in a period of high credit losses. Source: FFIEC The current strategy of Fraser to finally, after years of delay and obfuscation, sell the underperforming offshore retail business leaves Citi with a two-legged strategy in a four legged banking market. The bank has no retail banking business outside of a few MSAs in the US and no asset management strategy, with the sale of Smith Barney to Morgan Stanley (MS) . Citi’s capital markets unit is limited, although as we noted in our last comment, C has the second largest derivatives exposure after JP Morgan and Goldman Sachs. In past years, we have joked about merging Citi with Deutsche Bank (DB) , another global banking institution with a limited core deposit base and a weak middle market banking presence in any market. A combination would at least consolidate two second-tier investment banks, but leaves unanswered the basic question we ask again and again: Why does this bank exist? What market does it serve and how will it grow in the future? The exchange between analyst Mike Mayo and Jane Fraser during the Q4 2021 earnings call illustrates the point . During the Cold War, Citi was an outpost serving American interests in all the right places around the developing world. The irony of Citi selling the retail business in Mexico while keeping the problematic private banking business will amuse long-time students of the bank's operational troubles when it comes to money laundering. Today, like DB, this $2.3 asset bank has lost its reason to exist. Ultimately, the history of Wall Street’s institutional money center banks has been one of atrophy and eventual consolidation. The weak have bought the strong. The only problem is that today, in 2022, there is no obvious suitor for Citi. The IRA Bank Profile is published by Whalen Global Advisors LLC and is provided for general informational purposes. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The IRA Bank Profile. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The IRA Bank Profile are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The IRA Bank Profile represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The IRA Bank Profile is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The IRA Bank Profile is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The IRA Bank Profile. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

January 25, 2022 | This week The Institutional Risk Analyst is in Nashville for the MBA’s Independent Mortgage Banker (IMB) conference. The good news is that the latest wave of COVID seems to be receding even as home prices continue to climb. The bad news is that this week the FOMC is “continuing discussions” about reducing the size of the Fed’s $8 trillion securities portfolio. But recall, the Fed is still buying bonds and has yet to hike short-term rates. How will this uncertain environment impact banks and nonbank lenders? Investors are struggling with price inflation in many goods markets even as the financial sector deflates. Telltale indicators of asset price inflation, Bitcoin tokens and Tesla (TSLA) chief among them, are both sagging as the week begins, but let’s not lose perspective – yet. Spreads have a long way to go before we return to the crisis levels of Q1 2020. And we are not nearly ready to go shopping. Just as equity investors are having a tough time making decisions about risk, on or off, the bond market is relatively tranquil, in large part because the FOMC has done an above-average job of telegraphing change. Think of it as a social learning process. As in 2018 and 2019, the FOMC is going to raise interest rates and deflate its portfolio at the same time . You'd think that Powell & Co have learned by now that tightening target rates while draining liquidity is a bad strategy, but apparently not. In 2020-2021, the Treasury was the big market mover and the FOMC was forced to accommodate massive spending plans and the aftereffect of those fiscal actions. In 2022, however, the FOMC is the big mover, even as the predicted fiscal wave from Washington is subsiding into the more familiar pattern of inaction. James Lucier of CapitalAlpha Partners wrote last week: “It’s now officially Build Back Smaller,” this after the Biden Administration abandoned most of its legislative agenda. The FOMC continues to buy MBS. The buy on Friday was $3.7b, compared to $3.3b in the previous session. As the FOMC struggles with the monstrous pile of assets that has been accumulated over the past 18 months, investors will come to understand how the shrinkage of bank reserves and the coincident decline in Treasury and MBS issuance is going to impact US interest rates. That is, collateral is becoming scarce. Assuming that the Fed does stop new purchases in March, net supply of MBS this year could reach $600 billion, but there is no shortage of buyers. Robert W. Baird writes: "GSEs purchased $595.1 billion of newly originated loans in 3Q, a 16.1% decline from the previous period. That represented 71.8% of conventional-conforming origination during the period, the lowest securitization rate since 2019.” Source: FDIC This is not about the yield on the 10-year Treasury note understand, but instead about a tectonic shift in the distribution of risk-free assets and how this change impacts spreads for MBS and other debt instruments. Changes in credit spreads, though uninteresting to equity markets, ultimately drive stocks, especially when the Fed has been manipulating the markets for years. Increased credit spreads mean lower economic growth. “We saw a 20 bp rise of HY-Ts on Friday and 1 bp rise of BBB-AA,” notes Fred Feldkamp . “By my index, that's a 61 bp decrease in US marginal efficiency of capital. At roughly $5 billion per bp per year, Friday alone ate up capital growth at the rate of $305 B per annum ($3 T over 10 years). If it was not clear that over leveraged firms will soon be forced to report reductions of earnings due to expectations of higher rates, it certainly is clear now.” Despite all of the bloodshed in MEME stocks and crypto, the damage to more pedestrian sectors of the stock market is limited. As the screenshot below illustrates, the banking world is relatively unaffected albeit somewhat cheaper than at year-end. To Feldkamp’s point, notice that JPMorgan (JPM) and Goldman Sachs (GS) , two firms with outsized global market exposures, are underperforming the group. Source: Bloomberg Both JPM and GS, of note, have derivatives exposures that could wipe out the capital of both banks several times over, but most other US banks avoid such risks. At the end of September 2021, total derivatives exposure at JPM and GS were 1,345% and 2,800% of total assets, respectively. Citigroup, by comparison, was only 1,818% of total assets at the same date. The average for all large US banks in Peer Group 1 is 28%. With American Express (AXP) trading north of 5x book and U.S. Bancorp (USB) near 1.8x or now a premium above JPM, the world is not yet ready to end. But the fun in the world of MEME stocks and pretend assets is clearly at an end. JPM strategist Peng Cheng noted yesterday that small investors are heading for the door, selling $1.4 billion in stock before noon Monday. The key question for risk managers is to differentiate between stocks that have been grossly inflated by the FOMC’s action and general market exuberance, and to what degree. If you look at valuations for banks back in Q1 2020, for example, the whole industry has essentially gone sideways for two years. If we look at names such as TSLA, NVIDIA (NVDA) and Rocket Companies (RKT) , on the other hand, the story is very different. The moral of the story is that volatility is now a permanent fixture in many markets, especially those assets where FOMC policy has inflated prices excessively. Securities markets can reprice in minutes or hours. Less efficient markets like residential real estate could overshoot for the next several years. But there are large sectors of the US equity markets that are relatively unaffected by the gyrations so far. The world is not ending just yet. In the meantime, do watch those credit spreads in coming weeks.

I used ta do a little but a little wouldn't do So the little got more and more I just keep tryin' ta get a little better Said a little better than before I used ta do a little but a little wouldn't do So the little got more and more I just keep tryin' ta get a little better Said a little better than before " Mr. Brownstone " Guns & Roses (1987) January 21, 2022 | As we enter the last week in January, it is becoming pretty clear that the FOMC has lost all credibility when it comes to financial markets or managing inflation. Market stability, lest we forget, has been a managed concept since 2009, thus when the FOMC decided to explicitly lean in the direction of "liquidity" (aka inflation) and forget the rest of the Humphrey Hawkins mandate regarding price stability, the cost was paid in credibility. Of course there is a 1:1 correlation between the Fed's credibility and its loss of independence from the US Treasury, the primary beneficiary of QE. Bill Nelson at Bank Policy Institute published an important article on January 11, 2022: “ The Fed is Stuck on the Floor: Here’s How It Can Get Up .” Nelson describes how the FOMC under Jerome Powell deliberately chose inflation of the Fed’s balance sheet as a means of managing the liquidity stress that almost cratered the US money markets that year and in December 2018. He wrote: “The Fed announced that it would conduct monetary policy by over-supplying liquidity to the financial system, driving short-term interest rates down to the rate that the Fed pays to sop the liquidity back up. Previously, the Fed had kept reserve balances (bank deposits at the Fed) just scarce enough that the overnight interest rate was determined by transactions between financial institutions; those transactions consisted of banks with extra liquidity lending to those that needed it. Now the rate is determined by transactions between banks and the Fed. Moreover, the Fed has committed to providing so much extra liquidity that it would not need to adjust the quantity of reserve balances it is supplying in response to transitory shocks to liquidity supply and demand.” Now it goes without saying that the Humphrey-Hawkins mandate is impossibly conflicted, as we wrote in American Conservative . You cannot have price stability and full employment at the same time. But when people like Chairman Powell and his predecessors, including Treasury Secretary Janet Yellen and former Fed Chairman Ben Bernanke , decide to play g-o-d with the global financial markets, bad things happen. The inflationist chorus of economists who decided that deflation was a “problem” essentially convinced the FOMC that a little inflation was a good thing. Our friend Fred Hickey , publisher of The High Tech Strategist , reminds us of the words of Ludwig von Mises , who predicted the age of inflation in the US fifty years after the passage of Humphrey Hawkins: “The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptizing it re-deflation…. What generates the evil is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the ultimate boom has caused.” Hickey adds that the fact that global central bankers, led by celebrity politicians like ECB chief Christine Lagarde , figured out that if they all printed money at the same time, they could inflate their slumping economies without the nasty penalty of currency devaluation. “The end result of their collusion was that the boom lasted much longer than it would have normally,” Hickey wrote, “and now we’ll have to deal with more severe consequences.” The great inflation of 2020-21 will be reckoned as one of the blackest periods in the history of the Federal Reserve System, but the intellectual and institutional rot goes back more than a decade to 2008, when many senior officials of the US central bank lost their nerve after watching the US financial system nearly melt down. The central banker rule book written by the likes of Martin, McCabe and Volcker was tossed out the window of 33 Liberty Street, leaving only a culture of accommodation and endless liquidity that was cheered by liberal politicians. The start of QE in 2009 under then- Fed Chairman Bernanke was the beginning of the end of the Fed’s credibility. Bernanke laid out the rationale for providing endless liquidity support in a 2009 speech at the Bank of England : “The abrupt end of the credit boom has had widespread financial and economic ramifications. Financial institutions have seen their capital depleted by losses and writedowns and their balance sheets clogged by complex credit products and other illiquid assets of uncertain value. Rising credit risks and intense risk aversion have pushed credit spreads to unprecedented levels, and markets for securitized assets, except for mortgage securities with government guarantees, have shut down. Heightened systemic risks, falling asset values, and tightening credit have in turn taken a heavy toll on business and consumer confidence and precipitated a sharp slowing in global economic activity. The damage, in terms of lost output, lost jobs, and lost wealth, is already substantial.” Rather than allow the private markets to reset after the mortgage bubble of the 2000s, Bernanke and his colleagues on the FOMC embraced inflation. Readers of The Institutional Risk Analyst know that the problem with QE and the other liquidity measures put in place by the FOMC is that they cannot be stopped without severe deflationary consequences. If the Fed stops buying securities for the system open market account (SOMA), then reserves start to fall and with it the aggregate level of bank deposits. As reserves fall and banks are forced to buy Treasury debt and GNMA MBS for their reserves, interest rates fall and collateral becomes scarce. Imagine what happens to short-term interest rates, for example, if the $1.6 trillion in reverse repurchase transactions moves back into Treasury and agency securities. The chart below shows the S&P 500 and the Fed's portfolio. Nelson notes that any program by the FOMC to now shrink its balance sheet must be accompanied by more robust open-market operations to deal with any “transitory” liquidity pressures. But now that the global equity markets have grown accustomed to trillions of dollars in excess liquidity, going back to the pre-2019 system of fine tuning is likely to be a rough ride. Nelson concludes: “The Fed is on track to stop expanding its holdings of securities by March 2022, and it is currently making plans for whether and how to reinvest payments of principal. If the Fed allows principal to be repaid without reinvestment, its securities portfolio will decline, reducing reserve balances and the ON RRP. Most likely, the Fed will reinvest payments of principal for a while before beginning to shrink. If it were to reinvest in Treasury bills rather than longer-term securities, it would be able to shrink more quickly once it decides to do so. Consequently, now is a critical time for the Fed to receive input from policymakers outside the Fed and from the public about how it should conduct monetary policy and its role in society.” Chairman Powell is already receiving a lot of “input” about the future course of US monetary policy. As the FOMC desperately attempts to regain lost credibility, the US financial markets could be in for an extended period of volatility and confusion. As the central bank redefines what is meant by price stability, asset classes from MEME stocks to crypto tokens to Treasury securities will all come under selling pressure. And appointed officials like Yellen, Bernanke and Powell may not survive the adjustment process, at least in political terms. There is, after all, nothing new in this world when it comes to inflation.

January 19, 2022 | What is the best performing bank in the US between $10 billion and $100 billion in total assets? Answer: Cross River Bank in Teaneck, NJ. Readers of the Premium Service of The Institutional Risk Analyst know Cross River for its role as the lender behind Upstart Holdings (UPST) , which we profiled last month (“ Update: Block Inc. & Upstart Holdings ”). But we also are reminded of another small, volatile bank, Lehman Brothers FSB , which we described to readers of The IRA nearly 20 years ago. That outlier bank once featured 50% equity returns as the conduit for a subprime mortgage issuer, Lehman Brothers , but is no more. If we told you that Cross River Bank has grown 400% in the past three years, mostly on PPP loans and mostly funded with non-core deposits, would that dampen your enthusiasm? Just for giggles, below are the top-ten performing bank units in the $10 billion to $100 billion group: Source: FDIC Not only does Cross River Bank currently have the best nominal equity returns in Peer Group 1 or 2, but it outperforms leaders like American Express (AXP) and Discover Financial (DFS) . More, when you examine the bank’s credit performance, the balance sheet seems pristine. The bank rates an “A+” from T otal Bank Solutions Bank Monitor and has a return on economic capital of over 80%, but Cross River Bank was not always so righteous. Indeed, as recently as March 2020 the bank was reporting almost 200bp of defaults vs just 25bp in March 2021. Source: FDIC Cross River Bank was founded in 2008 and until 2015, had no credit losses. From June of 2016 onward, however, Cross River Bank went on a wild roller coaster of rising credit losses, peaking at 187bp in December 2017 and remaining elevated through 2020, when defaults abruptly declined to just above the Peer Average. In the world of financial analytics, that’s what we call “movement.” Cross River Bank sells unsecured consumer loans to UPST, for which it receives an upfront fee of as much as 8%, according to a presale report from Kroll Bond Rating Agency . KBRA reports in a presale for Upstart Pass-Through Trust, Series 2022-ST1 (“UPSPT 2022-ST1”), a consumer loan ABS transaction: "Upstart's relationships with CRB and FinWise date back to 2014 and October 2019, respectively. CRB and FinWise each receive an origination fee of up to 8% on each loan originated on the Upstart Program which is deducted from the loan proceeds before being distributed to the borrower . CRB and FinWise pay to Upstart a fee for services provided by Upstart." Just imagine what sort of borrower would agree to take an unsecured consumer loan with an eight-point discount to par. If you have seen the 2013 movie " American Hussle ," then you get the idea. Somehow KBRA managed to assign a "BBB-" rating to this transaction, just on the bleeding edge of investment grade. CRB Group Inc. (CRB) , the parent of Cross River Bank, reported an ROE of 32% and ROA of 3.2% in Q3 2021, and an efficiency ratio of just 32.2% vs a Peer Group 2 average closer to 55%. CRB generated a gross loan yield over 500 bp in Q3 2021 and a return on investment close to 2.4%. And of note, CRB has 21% risk weighted capital and a 14% Tier 1 leverage ratio as of Q3 2021. The fact that this relatively new $11 billion asset bank does not yet need to file a Y-9C speaks to the velocity of change since the end of 2018, when Cross River Bank had just $1.3 billion in average assets. Source: FDIC So, what’s not to like? Well, for one thing, Cross River Bank had $1 billion in assets four years ago. The originate-to-sell business model was clearly not working given the elevated credit losses, then suddenly the bank shifted focus to underwriting PPP loans. Today, Cross River Bank is the largest PPP lender in the US. This hyper-aggressive strategy is funded via hot money rather than core deposits. The bank manages this outlier business model by keeping risk weighted assets (RWA) at just $2.6 billion or less than 25% of the nominal balance sheet. Even with the change in strategy, the bank's losses are still above Peer Group 2 and with half the earnings coverage of similar banks. The rest of the bank’s assets include $8 billion in C&I (aka PPP) loans, which are government guaranteed via the SBA and thus carry a zero Basel risk weight. And given the volume of PPP loans processed by Cross River Bank , no surprise that the bank has been caught up in congressional investigations into the program . At the end of Q3 2021, the bank had $9.1 billion in loans held in portfolio and not available for sale. The bank funds these assets with $1.4 billion in brokered deposits and other borrowed money. Core deposits equaled just 19% of total deposits at the end of Q3 2021 vs almost 80% on average for banks in Peer Group 2. Total other borrowings were 62% of assets compared with 0.45% average for Peer Group 2. The interest expense of Cross River Bank is 4x the Peer Group 2 average but so are the asset returns. Is this bank idiosyncratic? Yes, very and now faces a new challenge, namely what to do after PPP. One big driver of returns for Cross River Bank is a large investment in mortgage-backed securities of $1.8 billion, an apparently highly leveraged position that generated a yield of 17.8% in Q3 2021 vs 1.57% for similar assets held by members of Peer Group 2. In terms of return on earning assets, Cross River Bank reported total interest income of 7.8% vs the Peer Group 2 average of 3.1%. Again, the bank is an outlier vs banks of similar size. Bottom line, when a bank seems to be doing much better than other banks, there is usually a reason and that reason is almost always bad. The Lehman Brothers FSB example should be recalled . In Q3 2021, Cross River Bank reported net income to average total assets of 3.9% vs 1.28% for Peer Group 2. Today everything looks great, indeed, too good. We wonder how this bank will look this time next year when both interest rates and loss given default (LGD) are rising. The chart below shows LGD for all US banks. The fact that Cross River Bank has seen no improvement in LGD at a time when other banks are experiencing sharp downward skews in post-default loss due to FOMC policy is remarkable. Now that Fed policy is changing, we expect LGD to rise accordingly. In Q3 2021, of note, loss given default for Cross River Bank's loan portfolio was 86% of the original principal amount vs only 54% for all FDIC-insured banks. Source: WGA LLC The originate-to-sell model built around the relationship with UPST during the period of ultra-low interest rates maintained by the FOMC is an obvious point of focus in the future for risk managers, ratings analysts and counterparties. If the bank has an 85% LGD on non-PPP loans today, how will those credit exposures look in a year or two? At a minimum, as interest rates rise, we look for the credit performance of both retained loans and loans sold to investors via UPST to deteriorate. Both direct credit loss from portfolio loans and potential repurchase claims are areas of concern for the future. The IRA Bank Profile is published by Whalen Global Advisors LLC and is provided for general informational purposes. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The IRA Bank Profile. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The IRA Bank Profile are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The IRA Bank Profile represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The IRA Bank Profile is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The IRA Bank Profile is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The IRA Bank Profile. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

January 12, 2022 | Readers of The Institutional Risk Analyst know that US banks have been trapped in a world of shrinking NIM and asset spreads, and flat volumes, through the years of quantitative easing or QE. Over the same period, investment managers bid up banks stocks to silly levels, both in historical terms and also vs asset and equity returns. The Sell Side host has encouraged this evolution of bank valuations. Source: Yahoo Finance Now equity market valuations for financials are churning, just as bank fundamentals threaten to improve from the depths of the hunger-winter of 2020 . What will professional investment managers do? Real returns on bank stocks, more than non-financials, are impacted by inflation. The latest iteration of central bank market operations took almost 25bp off the return on earning assets for all US banks. Between Q4 2017 and Q4 2020, ROEA fell from 85bp to just 57p in Q2 2021. Source: FDIC/WGA LLC For the year to date 2022, at least, the major financial indices are up after hitting a near-term trough on December 17, 2021. JPMorgan Chase (JPM) , Citigroup Inc. (C) and Wells Fargo & Co. (WFC) will deliver fourth-quarter earnings this Friday. Bank of America Corp. (BAC) and Goldman Sachs (GS) report earnings on January 18 and Morgan Stanley (MS) provides its fourth-quarter update on January 19th. We'll be profiling several of these names in our Premium Service in coming weeks. The financial media will describe the Q4 2021 results in glowing terms and, of course, always avoid historical comparisons. Just remember that US banks are still running below levels of equity and asset returns of more than two decades ago. Your investment in bank common in 2022 buys less for more moolah than in 2002, thus we accumulate bank preferred when they are cheap – likely real soon. The chart below shows ROA and ROE for all federally insured depositories as of the end of Q3 2022. Source: FDIC/WGA LLC The failure of the Federal Open Market Committee to manage inflation is as nothing compared to the silence regarding the cost/benefit of QE. The utter incapacity of monetary policy to grow demand for credit on $22 trillion in bank assets has inspired zero commentary from the Sanhedrin of American economic policy. Meanwhile, the cost of QE continues to mount. Senator Pat Toomey (R-PA) summarized the situation in the confirmation hearing for Federal Reserve Board Chairman Jerome Powell: “None of the Fed’s pandemic actions came without a cost. This negative-real interest rate environment continues to distort markets, risk asset bubbles, and punish savers. And the Fed has dramatically expanded its balance sheet with trillions in government bonds, effectively monetizing a lot of debt, facilitating profligate government spending.” The losers with QE are all savers, from banks to retirees. In the past five years of extraordinary policy, including during the aggressive period of policy response to COVID, bank lending has been flat and, indeed, significant portfolios across the industry like credit cards and C&I loans are shrinking. Lending from the nonbank sector, much of it processed and closed by partners such as Cross River Bank , has exploded, driven by more efficient point of sale tools. As we discuss below, the legacy of QE may well be an equally large bubble in credit losses generated by nonbanks and sold to banks and end investors. The chart below shows bank lending vs deposits through Q3 2021, a key relationship for investors to understand now that QE is ending, perhaps suddenly. As deposits start to fall, will bank lending increase? The lending performance of US banks going back to 2008 suggests the answer is no. Source: FDIC With talk now shifting to ending QE and raising interest rates, the prospect of another liquidity crisis looms. Like taking heroin or opium, the immediate effect of QE is pleasant enough, but the monetary sippy cup requires a constant refill to maintain that particular sense of market euphoria. The narcotic effect of QE is clearly visible in unproductive areas such as crypto and meme stocks. Brendan Greeley notes with his usual insight in the FT that bitcoin is "an asset that has value, but no purpose." With the end of QE, however, the agreeable feeling leaves and is replaced instead by dread, namely a tightening or constriction of liquidity. For every bond that matures or prepayment that is received in the system open market account (SOMA), the Treasury must immediately refund that bond. When the Treasury repays the Fed and issues a new piece of debt, a bank deposit disappears. If the Fed reduces or eliminates QE, then bank deposits start to shrink -- fast. But we've seen this movie before. Former Fed Chairman Ben Bernanke is said to have observed at the start of massive asset purchases a decade ago, once you start QE you cannot stop. In December 2018 and September 2019, the Fed’s attempts to raise rates and end QE simultaneously ended in disaster. Part of the problem was that liquidity was ebbing, but the other side of the trade involved an increase in net supply of Treasury paper and MBS on a dealer community unable to shoulder the load. With the rapid, almost daily evolution of FOMC policy, we may well enter February with the Fed intent upon ending net purchases of securities and even starting to taper. Sometime after June 2022, we may arrive at a replay of September 2019. Earnings Setup | JPM, USB, BAC, C, WFC As we go into earnings on Friday, the outlook is for strong results on the transactional side of the house at JPM and signs of lift in terms of the banking business, which is now less than half of the bank’s total assets. CEO Jaime Dimon has guided the Street to net interest income of $51 billion for Q4 2021, but this is still below the bank’s reported performance going back five years. Source: FFIEC, JPM In order to understand the deleterious impact of QE on banks generally, let’s now compare JPM to the other banks in the top five depositories based on asset returns. Again, the negative impact of QE on bank asset and equity returns is apparent, in part due to the fact that QE has swollen bank balance sheets with a lot of sterile deposits that have no utility in terms of encouraging credit expansion or supporting bank income. All of these names should see improvement in asset and equity returns in Q4 2021. Notice in the chart below that USB has been the most stable performer of the top-five bank group, followed by JPM and Peer Group 1. Citi, BAC and WFC are all performing below the average for Peer Group 1. Notice that the Bank of Brian and Wells are competing for last place. Source: FFIEC The good news is that we expect the change in Fed monetary policy to be a net positive for bank results, but this does not mean that investors will react rationally. Just as the fact of QE compelled a lot of investment managers to buy bank stocks as the earnings fundamentals for financials deteriorated, today we may see just the opposite behavior with managers selling bank stocks out of fear of an eventual recession. At the moment, however, bank stocks are on the rebound YTD. As we never tire of reminding our readers, bank earnings are driven by spreads rather than market rates. When you hear a talking head on TV saying that the increased yield on the 10-year Treasury note will help bank earnings, that is your signal to change the channel to ESPN . The chart below shows gross loan yields for the top-five banks and Peer Group 1. Source: FFIEC Readers will notice that the average spread for the 140+ banks in Peer Group 1 beats out all of the top-five banks other than subprime lender Citi, an illustration of the fact that smaller banks have better pricing power for loans. Large banks suffer a disproportionate negative impact from QE. Perhaps Senator Elizabeth Warren (D-MA) can sponsor a new agency in Washington to defend money center banks from the ill-considered policy gyrations of the FOMC. One area that needs watching during Q4 earnings is stock repurchases, a popular way for under-leveraged banks to return capital to shareholders. Angry Jacobins such as Senator Warren have attacked the largest banks for employing share repurchases. Indeed, JPM’s Dimon has already indicated that he intends to slow or end share repurchases so as to avoid skewing the bank’s capital structure. Source: FFIEC Bottom line is that we expect Q4 2021 bank earnings to show the slow emergence of US banks from the winter of QE, which should see run rate revenue and net income revert back to year-end 2019 levels in short order. Over the balance of 2022, however, as state and federal loan forbearance moratoria due to COVID end, look for the cost of credit to also return to pre-COVID, pre-QE levels and higher. After a period of credit expansion, mostly outside of the banking sector, credit inevitably becomes an issue. As the weaker corporate and consumer borrowers are no longer supported by artificially low interest rates c/o QE, credit expenses will rise and loss given default, currently negative for many loan types, will swing back into positive territory. The chart below shows the sharp drop in post-default loss on all $11 trillion in US bank loans through Q3 2021. Source: FDIC/WGA LLC In the short-run rising interest rates and spreads will help bank earnings, but rising credit costs in areas such as consumer exposures in mortgages and credit cards, and multifamily real estate in commercial loans, may start to require a larger share of NII, depressing bank earnings. In October 2017 ( “Bank Earnings: QE Means "Lower for Longer’”) we wrote: “An end to QE also implies a significant increase in credit losses for US banks, an eventuality that will not be a problem given robust reserve and capital levels. But the wild card for global financials is whether the suppression of credit spreads by the Fed and other central banks has caused the formation of another hot spot of risk that is currently hidden from investor scrutiny.” Where is the next credit hot spot created by QE? That is the question for 2022. Disclosures: L: NLY, 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.

January 6, 2022 | In this Premium Edition of The Institutional Risk Analyst , we ponder the world of interest rates, stocks and mortgage servicing rights (MSRs) in the wake of the latest pivot in US monetary policy. In past comments, we have referred to the policy shift of FOMC Chairman Jerome Powell as pirouettes , but the most recent change in FOMC policy seems to be more of a fouetté . If you are Misty Copeland , Gillian Murphy or any of our other friends at American Ballet Theater in New York , you got to be able to do a couple dozen fouettés in a row to be in the big leagues of dance. News that the FOMC is pondering the schedule for rate hikes and other changes took stock markets unawares this week, creating a level of discomfort with more speculative stocks. As we wrote a while back (“ As the Fed Ends QE, Stocks and Crypto Will Retreat ”), the degree to which stocks have been pushed higher by QE is not fully appreciated by global investors. There are a long list of MEME stocks, for example, that are at valuations that do not make sense in the absence of QE. We think the chart below from FRED is worth any amount of words on the impact of QE on equity market valuations. As we noted in our last comment, the published plan from the FOMC is to end additions to the system open market account (SOMA) by March 2022. This means that the Fed’s bond portfolio will continue to grow for three more months . Yet even the prospect of a change has sent waves of selling through the stock market. Imagine what happens if the FOMC decides to curtail reinvestment of redemptions and prepayments and shrink the Fed’s balance sheet a la 2019. Thus the good news is that the markets ought to be stable through the end of Q1, cushioned by more than ample liquidity, on the one hand, and a robust reverse repurchase (RRP) facility ($1.6 trillion at 12/31/21) to absorb any wayward cash. Lee Adler in Liquidity Trader writes: “The debt limit has been raised. The Treasury has flooded the market with supply, and will continue to do so for another month or two. But there’s been no disaster in the market. The Fed’s RRP slush fund, designed to absorb the flood of supply, has even grown, thanks to year end window dressing. Even after that window is undressed this week, there will still be around $1.6 trillion in that fund to start. That is overnight liquid money that holders will use to buy new Treasury issuance. The RRPs will gradually be drawn down. But there’s enough there to absorb the ongoing supply bulge that the government needs to issue to rebuild its cash and repay the internal accounts it raided while the debt limit was in place.” Meanwhile in the MBS markets, falling production and slightly wider spreads are setting the tone for 2022, but as yet market participants are not focusing on the implications for net demand for mortgage paper over the full year, after the FOMC ends additions to the SOMA. Robert W. Baird’s Kirill Krylov and Steven Scheerer see net supply growing to $650 billion as the Fed and banks pull back, suggesting that MBS spreads will widen to clear the markets. They write: “Add to this another $30 billion of supply produced by GSEs (via portfolio reductions) and the market will have to absorb close to $715 billion in net supply in 2022. On the net basis, the Fed’s contribution in 2022 will decline to only $43 billion compared to the $480 billion purchased in 2021; banks will also lose steam with expected appetite of $315 billion or a $100 billion decrease from last year.” While stocks and bonds may not benefit from the planned and prospective changes in Fed monetary policy, the negative duration world of MSRs is looking increasingly attractive. In reaction of the latest Fed moves, Alan Boyce told The IRA that the Fed may not appreciate how the change in policy will impact the mortgage market. “Here comes the extension risk embedded in $12 trillion of 30 year 3% mortgages,” he opined earlier this week. “Nobody is going to prepay. MSRs are going to be worth a bunch. If nobody prepays those cashflows are worth a 6 multiple.” January data indicates that December fixed-rate 30yr and 15yr prepayments decreased 7-9% for Freddie Mac and Fannie Mae, and decreased 3-7% for Ginnie Mae, the 7th decrease in the past 9 months though not as pronounced as November. eMBS reports. "ARM prepayments increased for Fannie SOFR-indexed ARM pools, decreased for Freddie SOFR-indexed ARM pools, and were otherwise mixed." Source: MIAC In the same conversation, Boyce notes that real interest rates in the US are now profoundly negative, a big argument of the FOMC doing more sooner. “Real interest rates are negative 9%. The Fed should cease buying bonds and reinvestment right away and raise the federal funds rate by a bunch. The last cut to the funds rate of 0.25% came in March 2020." One reason that agency and government MSRs are likely to climb in value is the fact that issuance is falling overall. Even though the Federal Housing Finance Authority increased the conforming limit at the end of 2021, the window for buying loans on second homes and high balance loans in the conventional market has been severely reduced The FHFA announced targeted increases to the loan-level price adjustments the government-sponsored enterprises charge for second-home mortgages and certain high-balance loans. The LLPA increases will not go into effect until April 1, 2022, to “minimize market and pipeline disruption,” the agency said. The change by the FHFA is clearly meant to position Acting Director Sandra Thompson for a successful Senate confirmation. But the change is also consistent with her previous comments, namely that the announced changes in the PSPA were not the end of the story in terms of changes to the GSE windows made under former Director Mark Calabria . FHFA raised the conforming limit because they had to, but have now walked back a significant part of the increase. By adding the LLPAs, FHFA is essentially telling the market that they do not want the high-balance and second home business at all. High-balance loans in CA go above $1.5 million, for example, not a loan that needs government subsidy. Also, because of the existing limits on such paper, the change should not negatively impact the too-be-announced (TBA) market. Net, net however, the changed by the FHFA will effectively reduce the supply of GSE MBS in 2022, perhaps offsetting the planned sale of portfolio loans. The real question for Thompson and President Joe Biden , however, is when are you going to remove the LLPAs for low-income borrowers who do need help? We applaud Sandra Thompson for raising LLPAs on loans for the wealthy and investors, but it is high time that the FHFA did the right thing and reduced or eliminated the 2008 LLPAs on low-income borrowers.