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May 15, 2024  | Premium Service  | There has been a lot of worrying about smaller banks with outsized exposure to commercial real estate, yet the larger performers in the bank group are marching higher and have been for the past year and more. Big banks have big CRE exposures, too. So what drives this marvelous progression up the wall of worry? Revenue growth? Equity manager angst? No, big is better. But big and superlative is even better.

July 11, 2024 |   Premium Service  | In this edition of The Institutional Risk Analyst , we take a look at the consumer lenders as Q2 2024 earnings begin to see what these institutions are telling us about the likelihood of a recession in 2025. But earnings are a secondary concern as President Joe Biden  nears a decision to step aside in favor of Vice President Kamala Harris .

May 28, 2024 | Premium Service | Mortgage Bankers Association Chief Economist Michael Fratantoni  has one of the hardest jobs in finance. Mike and his colleagues at the MBA manage to accurately forecast purchase and refinance loan volumes in residential mortgage finance . And each quarter, he gets the numbers right without playing favorites or politics with a key sector of the US economy. Mike asked an important question after our last comment: “ So is it going to be debt deflation or deficit driven excess demand leading to higher inflation?  Both arguments make sense, but I think you have to choose one.  Unless you’re thinking about different timelines?” We’d have to say “both” in response. There is a general problem with inflation due to chronic deficit spending, causing the US economy to run “hot.” In fiscal year 2023, the US government spent $6.13 trillion, which was more than it collected in revenue, resulting in a deficit of about $1.7 trillion or $320 billion more than the year before. Deficit for this year will be higher. Progressives, of course, believe that the economy should always be running at 105% on the reactor. We argued this point with our friend Bill Grieder for many years. But conservatives might be shocked at how the US economy looks and feels with zero federal deficit. Like a heroin junkie stone cold turkey. A quarter of total federal spending is financed with debt instead of taxes, as shown in the chart below from FRED. Obviously, the budget deficit is a problem. In the world of commercial real estate, however, something also measured in trillions of dollars and altogether ghastly is appearing in the haze, the result of aspirational finance post-2008 and even more since Covid. Imagine the loans made on commercial properties between 2020-2022 at inflated prices and cap rates of between 2-4 that are now being repriced at cap rates of 6-8. Remember the calculus of CRE deflation: Cap Rate = Net Operating Income / Property Value There is a large pile of flotsam accumulating in the CRE market, busted bridge loans and other financial detritus created between 2020 and 2022 at absurd loan-to-value ratios that are, to borrow from the Eagles song, already gone. Just imagine the discount rate that should be applied to CRE loans made between Q1 2020 and the end of 2022. Start at 25% and do the diligence. When we talk of distress in CRE, we are not talking about some "C" property near the interstate between Denver and someplace else. Buyers of the "AAA" portion of a $308 million note backed by the mortgage on the 1740 Broadway building in midtown Manhattan, for example, got less than three-quarters of the original face amount back after the loan was sold at a steep discount. Think about the $2-3 trillion in "value" that appeared in CRE after Q1 2020 that has now disappeared and more. The troubles in CRE are also reflected in the capital markets. The changes in the world of equity markets issuance certainly tells a tale of woe. We usually focus on the debt securities issuance data from SIFMA, but first let’s first consider the world of initial public offerings and secondaries. When ST interest rates were at zero in 2021, crypto tokens, shares in loss-leading tech firms and freeze-dried soretes – anything really – could be offered to the public in the form of securities. Today, not so much, as shown in the chart below. Source: SIFMA/WGA LLC It’s interesting to see that the decrease in new equity offering volumes is roughly proportional to the falloff in new residential mortgage lending. Notice that new IPOs and the issuance of preferred equity is basically nil since 2022. In the world of debt issuance, however, the data shows surging issuance in Treasury debt, agencies and corporates, but flat volumes in ABS, mortgages and municipals. We annualized the first four months of 2024 to estimate the full year. That green hockey stick is the US Treasury.    Source: SIFMA With a budget deficit projected to be $1.8 trillion in 2024, the odds of the FOMC actually controlling inflation are pretty low.  We also think that FOMC Chairman Jerome Powell should be prepared to cut the fed funds rate a quarter point in December, but then lay down a new marker for the next President on his way out the door. No more rate cuts without deficit reduction. This may sound like fanciful speculation, but the deficit numbers are large enough and serious enough that a future Fed chair picked by either party will eventually be forced to say those precise words.   UMB Financial + Heartland Financial As of the close on Friday,  the WGA Bank Top 50 Index  (WBXXVW) was up 13.6% vs 9.48% for the Invesco KBW Bank ETF (KBWB) . UMB Financial Corporation (UMBF)  ranked 34th in the WG. A Bank Top 50 Index in Q2 2024, a mediocre score driven largely by the bank’s 68% efficiency ratio. The average for Peer Group 1 is 62% Source: Google Finance UMBF is a middle of the road performer. Since announcing the acquisition of Heartland Financial USA (HTLF)  UMBF has traded sideways and HTLF has declined. The purchase of HTLF would increase the size of UMBF 40%, but it is unclear to us whether this transaction will be accretive to UMBF shareholders.  Obviously the leadership of UMBF is quite positive. “This is a historic and exciting milestone for our company,” said UMB Financial Corporation Chairman and CEO Mariner Kemper . “While we have maintained an outstanding pace of organic growth during the past decade, this compelling combination with HTLF marks a truly momentous expansion of all our core services in both existing and new markets. This synergy, along with a like-minded culture and customer approach, is an ideal fit for our business model, our credit and risk profiles, and our associates, customers and communities.” HTLF is a mostly peer performer in terms of asset returns and other metrics, but had a particularly bad Q4 2023 due to losses on available-for-sale securities equal to 0.7% of assets. That event drove income down to 0.4% of assets vs 0.9% for Peer Group 1. The bank recorded a negative equity return in Q4 of -24%. HTLF is a good bit more efficient than UMBF, which does not exactly fill us with optimism. HTLF likes to talk about “tangible” equity returns because the bank carries half a billion dollars in goodwill out of almost $2 billion in total equity. This large intangible asset is the legacy of numerous acquisitions done over the past several decades  as shown on the FFIEC profile for HTLF.  HTLF also has negative $446 million in accumulated other comprehensive income (AOCI), meaning that the bank really has about $1 billion in tangible capital – this after  the Q4 write down of AFS exposures. Fortunately the bank has a low loss rate historically, but HTLF does have $2 billion in non-owner occupied commercial real estate loans on the books. The bank has been aggressively selling real estate owned (REO) and reported lower provisions in Q1 2024, but NPLs have been increasing, as shown in the chart below. Heartland Financial Q1 2024 Source: FDIC/BankRegData Looking at the transaction with UMBF, we can't help but think that the officers and directors of HTLF are feeling a good bit of relief at the prospect of the acquisition. The value destruction illustrated by the large goodwill at HTLF as well as the negative AOCI position does not suggest good things ahead for UMBF if the purchase of HTLF proceeds. Under the terms of the offer, UMBF will acquire Heartland Financial in an all-stock transaction valued at approximately $2.0 billion. UMBF is ignoring the unrealized losses and giving full value to the purchased goodwill. We think that the fair value of the equity of HTLF is about $1 billion today, depending how you feel about the bank's CRE exposures. HTLF's CRE delinquency is still 20% below peer, but the party in CRE is just starting. We believe that the HTLF purchase will be a value destroyer for UMBF. Heartland Financial Q1 2024 Source: FDIC/BankRegData As HTLF shows very clearly, paying above book value for community banks in the Midwest is not a path to fame and fortune. The stock trades at 1x book, but was at 0.7x a year ago. We have a transaction that looks and feels more like an arranged rescue than a value creator. But the question we put to our readers is this: How many more small regional banks with large non-owner occupied CRE exposure will need to be married to stronger partners? The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

June 3, 2024 | Premium Service | Whalen Global Advisors has published the latest edition of  The IRA Bank Book for Q2 2024 . The quarterly outlook for the US banking industry is available to subscribers to The Premium Service and features more than thirty pages of charts and commentary about the financial condition of the sector.  Below is the latest chart for the $1.1 trillion non-owner occupied commercial real estate (CRE) portfolio.

June 7, 2024 | Premium Service  | In this issue of The Institutional Risk Analyst , we take stock of the banking sector as Q2 2024 grinds to a conclusion in three weeks time. Bank OZK (OZK)  fell off the table at the end of May, reflecting market worries about commercial real estate. Several Sell Side equity analysts downgraded OZK and the financial media are working the recession narrative into a frenzy. But we are more concerned about the equity in commercial real estate than the secured lenders. “When a Citi analyst downgraded Bank OZK from a buy to a sell, sending the stock price tumbling 17 percent, the news shook the industry,” reports The Real Deal . “Normally, an analyst’s downgrade is not the center of real estate water cooler conversations. But OZK is arguably the most important bank in commercial real estate.” Really? The chart below from BankRegData shows the loan categories for OZK. Bank OZK | Q1 2024 Source: FDIC Reports from the world of commercial property are a mixed bag to put it optimistically. The financial media decided some time ago that OZK is involved in commercial real estate. A more accurate statement is that the bank is involved in new construction lending on CRE and multifamily. But given the tentative tenor of commercial real estate markets, facts may not matter as much as fear and media hype, especially when that media hype has a hedge fund behind it. Yet we remind readers that unrealized losses on securities are still a bigger problem for banks than CRE . OZK ranked 25th in the WGA Bank Top 100 Index in Q2 2024 . Another name that lost more than 10% at the end of May was Axos Financial (AX) , which ranked 16th in the WGA Bank Top 100 Index in Q2 2024. AX is one of the better performing regional banks in the US, but a number of hedge funds have shorted the stock on the premise that the bank’s commercial real estate exposures are problematic and that disclosure regarding the same is lacking. Swarms of trial lawyers follow in their wake like flies. We are a seller of Hindenburg. The public attack and short-selling strategy against AX launched by Hindenburg Research is well-prepared and compares with the class action lawsuit filed against   United Wholesale Mortgage (UWMC)  earlier this year. The hostile investment thesis advanced by Hindenburg Research  regarding AX essentially accuses the bank of a massive fraud with respect to disclosure on its portfolio of commercial and multifamily loans, many located in New York. The colorful details of some of the loans are pretty typical of the uneven quality of New York City real estate. The voluminous qualitative analysis in the Hindenburg report is fascinating but unconvincing. Most New York City lenders have similar tales of duplicity and fraud on their books. Every loan has a story. Even the folks at Hindenburg might be surprised how many CRE assets in New York are owned by one flavor of international organized crime gang or another. There is a reason that New York, the Internal Revenue Service and FinCEN have focused on commercial and multifamily real estate in recent years. That's where the money is. The cute innuendo in the Hindenburg report detracts from the real argument, namely that the equity in these deals is gone. Does that mean that the bank will take a loss? Maybe. Hindenburg does not seem to have the data to make that case. Ultimately, the accusations made by Hindenburg cannot be proven or disproven except by the actual financial results of the bank and its borrowers. AX has called the report misleading, but banks don't generally disclose loan level detail about borrowers. But more significant than the AX accusations is the fact that the bank has a senior secured position in these credits. Update: AX & OZK As disclosed in the May 7, 2024 investor presentation, Axos’ largest commercial real estate portfolio, CRE Specialty Lending, had $5.22 billion in outstanding balances as of March 31, 2024. AX states that when collaborating with fund partners, it structures its credits to occupy the most senior secured position in these loans. This explains why the historical realized loss rates for AX are so low compared with the level of CRE delinquency. "For Axos to incur any principal loss," AX states, "the fund partners would first need to lose the entire principal value of their position.... The fund partners assume a significant risk of loss before it does and this structure ensures robust collateral protection for Axos, even in adverse market conditions." More than telling us anything new or remarkable about AX, the Hindenburg report confirms our view that there is a lot of trouble coming for the US economy in commercial real estate. New York City is easily the most problematic market in the country, but it is also a magnet for new greater fools with new capital who somehow keep the assets trading. For this reason, attentive lenders have a least 50% equity ahead of them in the credit stack when lending on NYC commercial property. Both OZK and AX are relatively small banks with above peer revenue and income and below peer loss rates. It is easy for hedge funds and other predators to push these stocks lower because they are relatively small in terms of market cap, especially when the sellers employ derivatives to amplify the weight of short-selling pressure. But the bigger issue raised by Hindenburg is the accusation of false disclosure around troubled CRE loans, an accusation with wider implications for other banks with similar exposures.  Looking at AX, for example, while non-performing loans are elevated, the very profitable bank’s reported loan loss reserves are more than 100% of NPLs. In effect, AX could charge off their entire NPL portfolio tomorrow, illustrating yet again that income is more relevant to loss mitigation than capital. More important, the rate of charge-offs on the AX portfolio is just a fraction of the charge-off rate for AX peers. Going back five years, AX has experienced actual loan losses that are in the bottom decile of Peer Group 1. Has the bank been manipulating its results and fooling regulators and audit firm BDO for the past five years? Now we can attribute this excellent performance to the FOMC from 2019 through 2021, but AX has continued to perform above peer in most financial metrics since that time.  Axos Financial | Q1 2024 Source: FDIC Note in the chart above that AX has loan loss reserves that exceed total NPLs, perhaps a conservative move by a bank that is 85% loans to assets and has 10% tangible common equity. Even if we were concerned about AX loan losses, the bank is twice as profitable as its peers and is easily able to use that cash flow to remediate a higher loss rate on its portfolio. Like OZK, AX has a gross spread on its loan book that is more than two points above the average for Peer Group 1.  Likewise at OZK, short-sellers and media are waiving the bloody shirt of commercial real estate exposure, but the reality seems otherwise. In fact, the reported loss numbers for OZK in Q1 2024 were greatly improved. Charge-offs and provisions were down and assets and revenue were up. We last profiled OZK in April of this year (“ A Rising Floor on Interest Rates? | Update: Bank OZK ”). Below we look at some of the asset quality metrics from Bank OZK to see if the negative narrative regarding the stock matches the disclosure. While AX has above peer levels of NPLs, OZK continues to show below peer levels of delinquency even while growing top and bottom line results. The chart below from BankRegData tells the story. Bank OZK | Q1 2024 Source: FDIC OZK has 4x the level of NPLs put aside in loss reserves and, as the chart shows, the level of delinquency has been falling. Will the level of delinquency on the C&D exposures at OZK rise in 2024? Probably, but the real question is whether the impairment of the equity in these commercial property deals, often more than 50% of the original loan amount, will lead to a loss for the bank. That is a question that only time and future earnings can answer. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

June 18, 2024 | A couple of readers have asked us to look at  Bank of Montreal (BMO)  since they closed the acquisition of Bank of the West from BNP Paribas (BNP) in Q1 2023. BMO ranked 52nd in the WGA Bank Top 100 in Q2 2024.  As the financials slowly give up ground from the May 2024 highs, the WGA Bank Top 25 is still up 8.5% YTD through yesterday's close vs 5% for Invesco KBW Bank ETF (KBWB) . Before we delve into the mess at BMO, however, we wanted to highlight two discussions of note from last week. The first was a conversation with Bill Bymel of First Lien Capital . We were joined by Ocwen Financial founder Bill Erbey  and Bill Moreland  from BankRegData to talk about the outlook for credit in the mortgage industry.  That’s right, three guys named Bill and Chris. ***   To Our Readers *** We have discontinued the monthly Premium Plan  to The Institutional Risk Analyst. Subscribers who wish to migrate to a new annual plan at the equivalent subscription rate, please contact us: info@rcwhalen.com Note that during the discussion, Moreland talks about the burgeoning commercial real estate (CRE) exposure at Bank of America (BAC) and Wells Fargo (WFC) , CRE is not a small bank problem. Neither one of these banks is adequately reserved compared with their peers, meaning that more of future income will be put aside to cover losses. The black line in the chart below is the Peer Group 1 average of loss provisions vs loans. BAC is in red. BAC vs Peers | Q1 2024 Source: FDIC/BankRegData Second, we joined Yahoo Finance later in the week to talk about the banking sector and where to deploy capital. Of note, we sold our common equity stakes in Wells Fargo (WFC) and U.S. Bancorp (USB) on the premise that we’ll be able to re-enter these names after the storm blows over in commercial real estate. Below we spoke with Zacks Investment Management Client Portfolio Manager Brian Mulberry  and Josh Lypton  on Market Domination. Of note, Bank OZK (OZK)  and Related Fund Management just inked $668 million in construction financing for the planned Waldorf Astoria Hotel & Residences in downtown Miami, reports The Real Deal , marking the largest ever condo construction loan in Florida .   Note please media peeps that this is construction finance, not a commercial mortgage. No matter what the fundamentals may say about a given bank, the financial media are going to paint this sector with a very broad brush. Control your natural disappointment. A considerable dichotomy persists between the 100% loss severity rates in the commercial sector and the very low loss rates in residential mortgages, basically zero for bank-owned loans due to high home prices. Will this continue in Q2 2024? Yes and this situation will persist until home prices begin to weaken. Just because home price inflation due to the Fed is keeping visible credit costs low for 1-4s, consumers are being kicked around pretty badly today. More than 80% of residential mortgage payoffs are sales today vs 80% refinance in 2021. A tough economy is forcing Americans to sell their homes. Bank of Montreal + Bank of the West = ? BMO is a $1.3 trillion total asset Canadian bank that has expanded in the US over the past three decades. Acquisitions include the wreckage of Suburban Bancorp in 1994, Marshall & Ilsley in 2011, and Bank of the West in 2023. BMO purchased Bank of the West from BNP Paribas (BNP) and thereby increased US assets to over $290 billion. Bank of the West performed at or below peer over the past five years, with net income vs average assets in the bottom decile of Peer Group 2.  By acquiring Bank of the West, BMO has essentially bought a mistake from another foreign bank that unsuccessfully attempted to expand in the US. Foreign banks have attempted to gain a foothold in the regional banking market for much of the past half century and with decidedly mixed results. Bank of the West had high personnel costs and modest equity returns. In Q1 2023, BMO paid $16 billion for a bank with about $10 billion in book equity and just $5 billion in tangible capital. You can view the Q1 2024 Bank Holding Company Performance Report for the US business of BMO below: https://www.ffiec.gov/npw/FinancialReport/ReturnFinancialReportPDF?rpt=BHCPR&id=1245415&dt=20240331 The most successful foreign bank business models have been focused on institutional markets and securities, such as BNP’s NY operations or Barclays Capital. Most recently, Banco Santander (STD) , the largest retail bank in the Eurozone, has focused on auto loans and other securitization markets. The truth of the matter is that none of the foreign banks operating in the US over the past fifty years have particularly profitable operations. The competition from incumbent US regionals and money center banks is simply too intense to surmount.  How does BMO Financial look on the hot-off-the server report from the FFIEC? Net income just below 1% ROA was in the middle of the pack, operating expenses are in the bottom third of Peer Group 1 and net credit losses are elevated. The bank’s efficiency ratio is well-below peer, a good sign, and the gross spread on the loan book is in the middle of the pack.  The bank’s cost per employee is one-third that of SoFi Technology (SOFI) and the $15m in assets per employee also earns a thumbs up.   Delinquency on the loan book is high and rising relative to peers, which is really the big concern. The BMO franchise in the US has never been particularly good at credit, at least looking at the metrics from the FFIEC, but the bank is clearly a large institution for US regulatory purposes. But here’s the real problem, if you subtract the $45 billion in other assets and goodwill from the $34 billion in book equity, then BMO Financial Corp in Chicago, IL, is insolvent. BMO reports $19 billion in intangibles for BMO Financial but "other assets" is 16% of total assets and 2x the average for Peer Group 1. Restructured and Nonaccrual Loans and Leases + OREO in Q1 2024 was more than 100% of loss reserves, meaning that BMO faces some rough sailing ahead. BMO Financial Corp | Q1 2024 Source: FDIC/BankRegData Given that BMO has eliminated the Bank of the West brand, why hasn’t the bank written off the related goodwill? Good question. But the real question we have is why the Federal Reserve Board allows banks to purchase layer upon layer of old, intangible equity without any adjustment to reflect the clear diminution of value. The tangible book value of parent BMO is just over $50 billion vs $1.2 trillion in assets, illustrating the extreme leverage of the group. Why does the Fed even allow BMO to buy US banks with such weak capital? "Bank of Montreal missed analysts’ estimates after setting aside more money than expected for potential credit losses as consumers and businesses struggle with higher interest rates," Bloomberg reported. "The Toronto-based lender earned C$2.59 a share on an adjusted basis in the fiscal second quarter... falling short of the C$2.77 average estimate of analysts in a Bloomberg survey." Bottom line: Look for more disappointments from BMO through 2024 as credit losses climb faster than earnings. BMO arguably has the weakest reserve position among the large Canadian banks, writes Paul Gulberg of Bloomberg . "Credit is weakest in commercial real estate and larger idiosyncratic US credits, and more provisioning or charge-offs may be needed." Ditto. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

June 24, 2024 | Premium Service  | In this special June Fishing Trip edition of The Institutional Risk Analyst , we set up the top seven US depositories for Q2 2024 earnings. On Wall Street, we are taught from an early age that past performance does not guarantee future results, but in banking an astute review of current performance does  inform your view of the future in terms of earnings and credit losses. How do the actuals align with Street estimates?

July 5, 2024 | Premium Service | Happy July fourth! In this edition of The Institutional Risk Analyst , we return to look at Charles Schwab (SCHW)  and the other asset gatherers, including Morgan Stanley (MS) , Goldman Sachs (GS) , Ameriprise Financial (AMP) , Raymond James (RJF)  and Stifel Financial (SF) . We generally use several groupings to describe commercial banks: Lender Banks, Universal Banks, Consumer Lenders and Asset Gatherers.  We used to think about fintech banks or even crypto banks. With the fall of Silvergate Signature Bank, FTX and others, and now the Fed settlement , maybe we will forget that one for now (" Silvergate, Reverse RPs and the Theology of Prosperity "). Despite the resurgence of bitcoin prices earlier this year, the willingness of institutional investors to risk capital on coin-related ventures remains weak and highly variable one day to the next. The aftermath of the various ETFs and other fund vehicles seems to be first and foremost a liquidity event for incumbents, but now with far less robust volumes than many hoped. There are a number of crypto ventures we've seen in the past year, including one with a full-blown banking license in Bermuda, yet capital seems to be strangely reluctant to commit. Perhaps investors fear that any prophylaxis devised by counsel will prove inadequate to prevent contagion a la FTX. None of the companies profiled in this note are taking positions in foreign banks acting for global counterparties as a payments platform focused on coins. Ever resourceful, GS did start a crypto trading effort in 2021. The table below shows the rank of these stocks in the WGA Bank Top 50 Index for Q1 2024.  As of the end of June 2024, the WGA Bank Top 50 Index was up more than 14.5% vs 9.5% for the Invesco KBW Bank ETF (KBWB) .  The WGA Bank Top 10 Index was up more than 15% during this same period. If you want more information about licensing the WGA Bank Top Indices, please email info@rcwhalen.com   Like the rest of the industry, SCHW reached a peak just short of $80 per share in mid-May and has given ground ever since.  This large cap bank stock is still up 30% over the past year, but this is less than half of the gains seen by recent sector leaders such as Western Alliance (WAL) , which is up 75% over the last 12 months but is still trading at just 1.25x book value. Many of the names in the top 25 banks measured by 1 year total returns are trading at or about 1x book value.  Call this normal. The larger banks led the way in January and February, but today the top 25 names in terms of total return include many smaller stocks. WAL is up due to, among other reasons, the prospect of lower interest rates. Attentive readers of The IRA know that mortgage rates need to fall about 200 bp before we start to see significant purchase and refinance volumes. WAL's big connection with residential mortgage is a function of the purchase of AmeriHome mortgage from Apollo Global (APO) portfolio company and balance sheet Athene in 2021. The other big question mark on WAL and other banks with mortgage exposure, is whether the historically wide spreads of mortgage-backed securities over US Treasury debt are likely to narrow anytime soon. Or to put it another way on MBS spreads, will mortgage spreads come back in without more QE from the Fed? Are spreads today around +140-150 bp or more to the Treasury yield curve now the new normal ex-QE? Nobody really wants to talk about this.  We added Ameriprise Financial (AMP)  to the group this quarter and that change has certainly added a new benchmark in terms of equity returns. Over the past five years, AMP has outperformed the group by a considerable margin, delivering a total return to shareholders approaching 200%.  Source: Google Finance AMP is a $45 billion market cap bank holding company from Minneapolis with over $1 trillion in assets under management and another $400 billion in assets under administration. It  offers financial planning products and services, chum for the fish if you will. The core products include wealth management, asset management, insurance, annuities, and estate planning. As of year-end 2023, more than 80% of the company's revenue came from wealth management. Many of the firm’s comps are non-bank giants such as Black Rock (BLK)  and Apollo Global Management (APO) .  As you might imagine, the credit profile of AMP is good, below Raymond James and the perennial leader in terms of credit losses at Goldman Sachs. Now more than a year since disposing of the loss-leading retail assets of Marcus, GS continues to report very high levels of credit loss compared to other asset gatherers and even compared with some of the largest universal banks.  Source: FFIEC A net loss rate of 62 bp vs average assets  for Goldman Sachs is 2x Peer Group 1 and higher than the same metrics for JPMorgan (JPM)  and Bank of America (BAC) .  As discussed below, the gross spread on loans for GS is over 11% as of Q1 2024. Recalling the old credit rating breakpoints from S&P, this suggests that the clients of the House of Goldman are decidely subprime and are about a “B” universe. AAA:  1 bp AA:  4 bp A:  12 bp BBB:  50 bp BB:  300 bp B:  1,100 bp CCC:  2,800 bp Default:  10,000 bp A net loss rate of 62 bp at Goldman Sachs is closer to a “BB” bond equivalent. More importantly, these credit losses are coming not from the retail value trap known as Marcus, but the institutional side of the house, one reason why the gross spread is 2x JPM and WFC.  The type of secured lending that Goldman Sachs puts on the books is a good bit more risky than the same type of prime and warehouse lending business at JPMorgan. This is mostly a function of the clientele, who tend to be more volatile than the customers of Jamie Dimon. Think about GS pricing loans against mortgage servicing assets vs JPM, which has a cost of funds half that of Goldman. Same with MS, Nomura (NMR) and other large dealers. With the debacle at New York Community Bank (NYCB) in Q1 2024, JPM pretty much owns the high end of secured finance, while GS, MS et al fight over the scraps. After credit losses, we move next to the gross spread on loans and leases. These banks don’t tend to make a lot of loans, but the pricing of their loans says a lot about the business model. Notice in the chart below that AMP is right behind GS in terms of gross spread at 8% and well-above the other banks in the group.  SCHW and RJF are tied for number 3 and just above the average for Peer Group 1.  A bit over 25% of total assets at SCHW is held in loans, but the loss rates are near zero.  Notice that the gross spread on loans at MS fell in Q1 2024. Source: FFIEC After credit and the yield on loans, another part of the analysis is the return on securities. In Q1 2024, SCHW has a very low yield on its investment securities at 2%. This implies a discount from par in excess of 20 points.  However, SCHW has among the lowest interest expense in the industry at 1.5% of total assets at Q1 2024. Thus while the yield on the book is low, so is the funding cost.  The yield on securities for SCHW is ugly disclosure, but not fatal by any means. Yet SCHW no longer has the lowest cost of funds in our Asset Gatherers group. AMP has a cost of funds that is just one third that of SCHW at 51 bp.  And AMP has a yield on its securities book of almost 5% or 200 bp above the average for Peer Group 1. Obviously we do not need to teach the folks at AMP about duration. Note that GS and then MS have the highest funding costs in the group and also have average yields on their securities books well-below their funding costs . Fortunately, fee income is most of revenue for both firms. Source: FFIEC Finally we look at net income and, again, the results hold some surprises. Earning assets at SCHW equal almost 90% of total assets, but at AMP only 37% of total assets generate interest income.  There is a 4:1 ratio between AMP’s non-interest fee income and interest earnings. Only RJF has a similar operating profile. Indeed, if we look at the group, AMP, RJF and SF perform far better than do the larger firms such as GS, SCHW and Morgan Stanley. Source: FFIEC Although GS and MS are part of our asset gatherers group, both of these banks also share many attributes of the universal banks. The major difference is funding costs, because neither GS nor MS have a substantial retail deposit base. Thus while AMP, SCHW, RJF and SF focus mostly on advisory business for their revenue, MS and GS also focus on trading, investment banking and also lending to institutional customers. MS, for example, has the largest derivative position on Wall Street and GS is a close second. Indeed, the pattern of the derivatives positions of the two firms suggests a high degree of correlation. Most of these exposures are related to interest rates, but the sheer size of the derivatives books of the two largest dealers is reason for concern. The point is that MS and GS have one foot in the world of asset management, but the bigger foot in trading and capital markets. But it seems pretty clear from the LT stock performance that AMP is stock to beat among the Asset Gatherers. Source: FFIEC The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. 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July 18, 2024 | Premium Service  | Bank earnings for Q2 2024 remind us a lot of Groundhog Day , the 1993 film directed by Harold Ramis and starring Bill Murray and Andie MacDowell . Each quarter, we have basically the same bank earnings, but each time the reaction from investors is different. And meanwhile, behind the scenes, institutional investors are churning positions in bank stocks, pushing down larger cap names from May highs and forcing smaller, less liquid stocks up. How will all this end?

July 18, 2024 | Premium Service  | Last month, we published a comment asking whether credit-risk transfer (CRT) transactions would help depositories manage various types of risk (“ Will Credit Risk Transfer Save the Banks? Are MSRs Overvalued? ”).

July 25, 2024 | Premium Service | As we slowly make our way through Q2 2024 earnings, the big question in the minds of investors and political candidates is the economy. The Federal Open Market Committee is happy to see the economy slow ever so slowly, one major reason why the Committee is unlikely to cut rates in 2024. Nearly half of CFO's in survey done by PNC's Gus Faucher see NO cuts this year , reports Kathleen Hays .

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