Trouble for regional banks and their balance sheets are bubbling up once again, but with a different flavor than last year’s episode that brought down several mid-size lenders. Investors and analysts on Wall Street are scrambling to find out just how big the new issues are. The latest concern threatening regional banks started on Jan. 31, when New York Community Bancorp. reported unexpected fourth quarter loss and a large loan loss reserve against futures losses, due in part to the bank’s commercial real estate (CRE) exposure. NYCB also slashed its dividend. The stock fell sharply after the report and has struggled to find a bottom. Moody’s Investors Services downgraded NYCB’s credit rating to junk on Tuesday. So far, most Wall Street analysts and investors are treating NYCB as an isolated issue, given the specifics of its loan book and additional regulatory requirements created by recent acquisitions. But the trading action around last year’s collapse of Silicon Valley Bank showed that investors and bank clients alike can be spooked quickly. “The regional banking angst will likely linger for the foreseeable future based on the fragmentation of the market, bulky maturity schedule, and array of idiosyncratic risks,” BMO strategist Ian Lyngen said in a note. “It’s precisely due to the nature of the CRE market that there hasn’t been a wholesale repricing of risk thus far, rather a growing concern that as the passage of time offers greater clarity on the damage done, valuations will be revised even lower,” he added. Last year’s regional bank sell-off was caused in part by lower market prices for Treasury bonds held on bank balance sheets relative to where banks had valued them, which helped spur clients to pull their deposits. One worry is that the NYCB credit downgrade could spur ratings agencies to take a closer look at other banks, or cause clients to again pull deposits out of regional banks. “Historically, there have been plenty of examples of expanded contagion based on credit rating changes, so we find ourselves sympathetic to the prevailing apprehension,” Lyngen said. “While we’d like to assume that the NYCB issue is isolated and idiosyncratic, we suspect that there will be more scrutiny and focus on the stresses in the sector as the Fed remains content to signal no near-term [interest rate] cuts on the horizon.” For its part, NYCB quickly followed the Moody’s credit downgrade with an updated liquidity disclosure that showed deposits have risen since the end of December — a key difference compared to last year’s regional bank flare up — and announcing a new executive chairman. Those moves appeared to help the stock steady Wednesday, before it resumed its slide on Thursday. For the week, NYCB is off 31%. NYCB 1M mountain Shares of NYCB managed to close higher on Wednesday but are still down sharply from late January. But those moves failed to ease the jitters among investors and analysts. D.A. Davidson analyst Peter Winter, for example, called the liquidity update “positive” but still downgraded NYCB to neutral from buy. “Nevertheless, we are concerned that deposits and bankers could start fleeing the bank, with the headline risk of the Moody’s downgrade to junk, the barrage of negative news reports, plus heavy exposure to CRE, as the Fed is likely to cut rates less than the 6 rate cuts the forward curve was forecasting at 12/31/23,” Winter said in a note to clients on Thursday. Will it spread? Determining exactly how unique NYCB’s exposure to commercial real estate is will be a key focus for investors and analysts in coming weeks. A note on Wednesday from Wolfe Research analysts focused on banks and commercial real estate showed that regional banks have in general reduced their commercial real estate exposure over the past 15 years. By contrast, NYCB had relatively high exposure to offices and apartments while being under-reserved compared to peers. Analysts from other firms have also highlighted that NYCB may have a unique combination of issues that could keep this incident from becoming a wave across the industry. “Idiosyncratic risks aside, we do not expect any meaningful bank capital deterioration, systemic crisis, or contagion to other sectors of commercial lending,” Solita Marcelli, UBS global wealth management CIO for the Americas, wrote in a Feb. 7 note to clients. “In our view, the main concerns in urban and suburban office properties and U.S. bank office exposure appear manageable,” she said. But banks are complicated, and history is full of examples of credit downturns that revealed unexpected issues on balance sheets. Macrae Sykes, a former financial industry analyst turned portfolio manager at Gabelli Funds, said that investing in banks ultimately requires trusting management teams to handle tangled situations. “Banks in general are levered institutions. They’re made up of loans that can be fairly sophisticated, diversified and have lots of detail. To me, you always want management of those types of institutions to be experienced, have a history of understanding credit cycles, and just be very good and entrepreneurial in their approach,” Sykes told CNBC. “It’s very difficult to look at a $100 billion bank with a 10-Q at 80 pages and really have a terrific insight into it. But to the extent that you do get management feedback like we did the other night, you can draw greater conclusions of whether you want to be invested in that bank or not,” Sykes added. Sykes says he prefers to lean on bigger bank stocks right now, with Wells Fargo as one of the top 10 position in his Gabelli Financial Services Opportunities ETF (GABF) as of Dec. 31. The question of rates The idea that NYCB’s issues are unique to the Long Island-based lender could be tested further if interest rates don’t fall much this year. Real estate projects, and the loans tied to them, are highly sensitive to interest rates. Lower rates can both improve the implied value of the loans on banks’ balance sheets and make it easier for loans to be renegotiated or replaced. That could push concerns about a so-called “maturity wall” further into the future when, potentially, office usage has rebounded. But rates have been going the wrong way in recent weeks, with 10-year Treasury yields bouncing back over 4% after several strong economic reports and Federal Reserve Chair Jerome Powell saying that a rate cut was not likely at the central bank’s March meeting. Bond yields move in the opposite direction of price, meaning that bonds on bank balance sheets have recently declined in value. US10Y YTD mountain The benchmark 10-year Treasury yield has risen back above 4%. Tom Fitzpatrick, a managing director at RJ O’Brien, warned in a note on Thursday that higher rates could put pressure on regional banks to an extent that it could also cause a sell-off in the stocks of their larger peers as well. “The longer we have higher for longer, the more likely we have higher for ‘wronger,'” Fitzpatrick said. — CNBC’s Michael Bloom contributed reporting.
