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A Bank Crisis Is Percolating

Published 02/06/2024, 12:47 AM

I didn’t watch Jay Powell on “60 Minutes” because I knew it would be mainstream media sugar-coated drivel wrapped around propaganda as the obsequious 60 Minutes anchor tossed J-Pow meatball questions. But I did learn that Powell asserted that it is unlikely that there will be another real estate-led bank crisis, particularly with the TBTF banks. I course, there’s no way he can honestly say that he has a clue as to the potential magnitude of CRE exposure via OTC derivatives at the TBTFs – no one does. And Powell’s statement is certainly reminiscent of when Ben Bernanke asserted that the subprime debt problem was “contained” in 2007…

Note: The FOMC removed the sentence “The U.S. banking system is sound and resilient” from the FOMC Policy Statement released Wednesday. Read into that what you want but if the Fed was unwilling to make that assertion, it’s likely that the bank crisis from early 2023 is rearing its ugly head again. Note that the Fed “stabilized” the banking system back then by promptly printing money to inject $400 billion in reserves in the banking system. It also set-up the Bank Term Funding Program without a ceiling, which had $167.7 billion drawn from it as of January 25th.

The Fed also announced that it was cutting off the funding from BTFP in March and it is drawing up a plan to encourage banks to use the Fed Discount Window for liquidity needs. The Discount Window is perceived as a “last resort” lending facility and a signal that the borrower is in financial trouble. Banks borrow overnight and pledge high-quality fixed-income collateral like Treasuries, agency securities, etc.

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Possible trigger for a big stock market sell-off? Ironically, a week after the Fed announced that it would stop making new BTFP loans on March 11th as scheduled, $168 billion in deposits flowed out of the banks. It’s the biggest weekly drop since the SVB crisis. There’s thus a good possibility that the continuation of the 2023 regional bank crisis may be percolating. KRE, the regional bank ETF was down 7.2% for the week.

The stock price of New York Community Bancorp (NYSE:NYCB) plunged 37.6% on Wednesday (January 31st) after it reported a surprise loss for Q4 and cut its dividend. The stock was down another 13.8% the next day. It’s down 56% since the end of July.

NYCB closed the acquisition of Flagstar Bank in Q1, which “diversified” the bank’s loan business into residential mortgages and the servicing of residential mortgages. It also acquired Signature Bank’s commercial and industrial loan portfolio deposits. Prior to these acquisitions, NYCB was primarily a multi-family CRE lender.

Multi-family housing mortgages represent 44.5% of NYCB’s loan portfolio. Commercial real estate and commercial property acquisition, development, and construction represent 15.9% of NYCB’s loan portfolio. CRE loans in total represent 60% of the bank’s loans. Total interest income declined 4.3% from Q3. The YoY comparison is not relevant because of the two acquisitions mentioned above. The source of the loss in Q4 was a $552 million provision for loan losses. The reason for the provision is the expectation of write-downs in its CRE portfolio, particularly the office sector. In addition, a portion of the credit loss provision is to reflect, as the banks states it, “potential repricing risk in the multi-family portfolio.” That’s a polished way to warn that it expects write-downs in its multi-family loan holdings.

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For the full year, NYCB reported $2.341 billion in GAAP net income – but there’s a catch. In Q1 the bank recognized a “bargain purchase gain” (non-cash) of $2.150 billion, representing the difference between what it paid for Signature Bank’s assets and the guesstimated “fair market value” of the assets. Part of the loan loss provision is a partial reversal of that “gain.” Removing that non-cash bump in income, NYCB’s net income for the full year was just $191 million, down from $650 million (70%) in 2022. So far the acquisitions have been failures.

The bank charged off (net of recoveries) $223 million in loans in 2023. Of that, $119 million was multi-family and $117 million of that was in Q4. The bank also reported $442 billion in non-performing loans at the end of 2023, $266 million of which were multi-family/CRE and another $95 million were residential mortgages. The magnitude of the provision tells us that the bank expects to write-off quite a bit more multi-family and office debt as well as residential mortgages. In addition, the bank classified another $250 million in loans as 30 to 89 days past due.

In my opinion, this downward spiral in NYCB’s loan portfolio is just getting started. The quality of NYCB’s total loan portfolio will continue to decline. The $83.6 billion in loan assets is financed with $81.3 billion in checking/money market deposits, savings deposits, and CD’s. It also has $20.2 billion in wholesale borrowings, which are loans from the Federal Home Loan Bank. This source jumped from $13 billion at the end of Q3 to $20.2 billion at the end of Q4. Recall that bank loans from the FHLB spiked higher just prior to the regional bank crisis in March 2023. I can’t say for certain, but it’s possible the jump in FHLB loans from Q3 is an indicator of financial stress.

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A good, cheap way to bet on the demise of NYCB is with January 2025 or 2026 $3 puts. But it may take a while for NYCB to grind lower, particularly if the Fed aggressively cuts rates later this year. But I wanted to discuss what happened to NYCB because Japan’s Aozora Bank ADRs plunged 26.1% Thursday after slashing the value of some of its U.S. office tower loans by more than 50%.

Aozora is Japan’s 16th largest bank by market value and said it would post a $191 million loss for the fiscal year vs previous guidance of $164 million in profits. The bank’s biggest US office loan exposure is Chicago and Los Angeles and it disclosed that it has $719 million in non-performing loans in the U.S. It increased its loan-loss reserve ratio on U.S. offices to 18.8% from 9.1%.

While everyone was discussing the potential for a CRE debt crisis to foment this year, the NYCB and Aozora earnings reports confirm that it has already begun. $117 billion in CRE office debt needs to be refinanced this year, led by buildings in NYC ($10 billion), SF (nearly $4 billion), Chicago (over $2 billion) and LA ($2 billion).

The problem is that many buildings in these cities are worth, based on recent market transactions, 50% or less of their book values. Blackstone (NYSE:BX) is marketing a Manhattan tower with a $308 million mortgage for $150 million. That’s the offer price. The building, if it sells, will sell for a lower valuation. The loan-to-value on many buildings is 100% to 200%. The vacancy rate of offices in NY, SF, Chicago and LA is near 20%. An article in the Denver Post last week reported that the vacancy rate in downtown Denver is 37%. If these loans can not be refinanced, they will need to be severely restructured or put in bankruptcy for liquidation. This will blow holes in regional bank balance sheets and REIT NAVs. It could well also blow big holes in the TBTF bank balance sheets via OTC derivatives exposure.

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Latest comments

very interesting analysis. Possibly a good early warning we should put on our radar.
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