NYCB Is the First Domino
I’m not the kind of guy to say “I told you so”… but if I were, I’d sure be saying it now.
Banks are in trouble. They’re holding way too many underwater assets… especially when it comes to commercial real estate (CRE).
New York Community Bancorp is a prime example. But there are also two other critical events coming down the pike that are sure to hurt the sector.
We’ll start with how New York Community Bancorp (NYCB) got into its mess.
The bank merged with Michigan-based Flagstar Bank, a top-25 U.S. mortgage lender, in December 2022.
Then in March 2023, “Flagstar surprised the market amid the banking crisis by acquiring some assets, liabilities and deposits of Signature Bank from the Federal Deposit Insurance Corporation (FDIC),” according Lee Smith, senior executive vice president and president of mortgage at NYCB.
Smith said the Flagstar-NYCB transaction created a “bigger bank with scale, very little business overlap, and a more diversified business model.”
He also noted the Signature deal strengthened the bank’s balance sheet.
And in a perfect example of regulatory mismanagement…
Regulators took more than a year to approve the NYCB-Flagstar merger… the FDIC sold Signature assets and deposits to Flagstar… and the Federal Reserve, which not only provided financing for the Signature purchases by Flagstar, would be the bigger bank’s primary regulator as its combined assets were bound to exceed $100 billion.
All these watchdogs failed to what was happening right under their noses. That’s worse than frightening.
NYCB’s assets were $116.3 billion in December 2023. That meant the bank would face tougher reserve requirements… would have to submit to stress testing… and was subject to an all-around tougher regulatory regime.
When NYCB reported earnings last week, it announced it had to set aside $552 million for loan losses, 10 times what analysts expected. The bank lost $185 million in the fourth quarter, while analysts expected a $50 million profit.
The stock dropped 46% in intraday trading and closed the day down 38%. The bank’s credit rating was cut to junk by Moody’s. It would have to raise more Tier-1 capital with its stock down 60% at $4.25.
What was the cause of that huge loss? You probably already guessed… its commercial real estate loans.
And we’re going to see more losses like that in the near future…
Bills Past Due
The Fed’s Bank Term Funding Program was born on March 12, 2023… thanks to a Federal Reserve Act provision that lets the private central bank do whatever it feels it has to under “unusual and exigent circumstances.”
The program has a 12-month sunset provision. It lets cash-strapped banks borrow from the Fed on a one-year term basis by putting up grossly underwater collateral the Fed would lend against at par value.
Flagstar’s assets were underwater, especially its mortgage portfolio and CRE portfolio. But the Fed lent against those assets, valuing them at par. That’s how Flagstar was able to buy Signature assets and deposits.
How insane is that?
The program expires on March 11, 2024. And it’s unlikely to be revived, especially in an election year.
Why? Because besides providing liquidity to banks teetering on insolvency, especially if they had to sell any underwater assets to raise money, the program is a very profitable arbitrage opportunity for all who employ it.
Borrowers put up underwater collateral and get full-value cheap term loans from the Fed at low interest rates, which they turn around and deposit back at the Fed and reap the Fed’s hefty interest of reserves, which was 5.4% in January.
That’s free money for banks, baby! It’s not going to be extended in an election year.
And banks that need cash will be hit hard.
Why would banks need cash? Because the clock is ticking on CRE refinancing.
As $1.5 trillion in loans come due on empty commercial office buildings in the next four years, it’s going to be hard to re-fi that debt at anything but exorbitant interest rates.
A lot of those properties won’t get refinanced and will have to be sold… to anyone brave enough to buy them, at pennies on the dollar.
And when they’re sold, banks will “realize” the losses they’ve been carrying in hidden “hold to maturity” buckets.
Those losses will kill their earnings and capital.
Clearly… banks are in trouble. Buy put options on regional banks when they bounce… but be very careful trying to buy falling knives.
After all, you’re likely to get cut.