Fynsa
After steady improvements in aggregate deposit outflows and bank stock prices in recent months, a weak fourth quarter earnings announcement by New York Community Bancorp NYCB (a New York-based regional bank) has prompted renewed concern about small/regional bank balance sheets. Given the important role that the banking sector plays in commercial real estate (CRE) financing, this announcement (as well as the similarly negative earnings of a Japanese bank with a large U.S. loan portfolio) has naturally raised concerns among investors about potential contagion effects.
Beyond the direct impact on regional banks, which fell more than 10% in 2 days, while the NYCB plunged 45%, we have not seen a contagion effect on the rest of the market, except in the rates market, where Treasury bond rates fell by an average of 20 percent in two days.where Treasury bond rates fell by an average of 20bp, with a greater impact on the long end of the curve. This despite the fact that the US economic data dynamics remain positive and that the Federal Reserve, despite withdrawing the "tightening bias" in its statement this week, continues to deliver a diagnosis that is not consistent with imminent rate cuts (with an economy that continues to expand at a solid pace, a strong labor market, and inflation that, while declining through 2023, remains elevated), let alone the market's aggressive built-in expectations for rate cuts this year.
This leads us to believe that either the market judges that a Fed "less sensitive" to rate cuts puts "soft-landing" at risk, or, as happened in March 2023, regional banks will "force" more restraint from the Fed and an earlier rate cut.
But the reason why the situation for regional banks appears to be different than in March 2023 is that it is not a duration issue but rather a credit risk issue, as banks are finally being forced to recognize losses on their CRE books. This is not a duration mismatch of portfolio holdings, but rather a credit quality issue. So this really isn't something that the Fed can or will quickly bail out like they did last time if things get more convoluted, as they have been talking about commercial real estate risks for the last 18 months in their releases and that is not solved by simply injecting liquidity.
That said, a recent report by GS finds that the information announced in NYCB's earnings is largely idiosyncratic. NYCB has unusual vulnerabilities relative to the broader regional banking sector: excessive exposure to commercial real estate (especially NYC multifamily), weaker liquidity, and lighter regulatory capital.
Putting the banks' CRE holdings in context, the accompanying table shows the breakdown of delinquent loans for multifamily, CRE and residential loans (in total more than 30 days past due and non-accrual). Focusing on the median group of US$101-us$500 billion asset banks, multifamily and owner-occupied CRE delinquency rates are the highest, while other commercial loans, while high, are still lower than those of the largest US$500+ billion asset banks. In addition, banks between US$100 and US$500 billion have the highest percentage of loss reserves relative to loans/leases held for investment. So then, the overall delinquency rate of CRE debt on bank balance sheets does not indicate a systemic risk to the banking system, although there is a possibility that banks could build up reserves as a result of the stress on these two troubled banks this week. It should also be noted that multifamily loans, a key driver of NYCB's higher loss provisions, account for only 5% of total bank loan books. In addition, the challenges for the multifamily segment are largely cyclical in nature, as opposed to the secular challenges faced by branches.
