NYCB blues… could events at the bank hit smaller institutions?
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NYCB blues… could events at the bank hit smaller institutions?

At a Glance

  • We don’t believe the problems exposed by the 2023 banking crisis have been properly addressed, with the New York Community Bancorp stock rout highlighting this
  • A failure to regulate smaller banks or address liquidity buffers, coupled with continued quantitative tightening, has left the system vulnerable
  • There is a split between larger more cautious institutions and smaller ones which will struggle to cope should conditions deteriorate further

Within our global team of fundamental research analysts, eight are dedicated to covering financial institutions across equities and fixed income. This financials team gets together regularly to debate the big issues, and the events at New York Community Bancorp (NYCB) got us talking about both this specific company and the broader potential implications.

As a group, we feel that problems exposed by the 2023 banking crisis haven’t been properly addressed. The US Federal Reserve (Fed) stepped in with a temporary liquidity program – the Bank Term Funding Program (BTFP) – in March 2023 and told the large and medium-sized
banks to hold more capital. However, nothing was done to regulate smaller banks or to directly address liquidity buffers. As a result, we believe the banking system is vulnerable to aftershocks as central banks continue quantitative tightening (QT) – a monetary policy tool to reduce the amount of money in the economy.1

What’s happening at NYCB?

NYCB is historically a New York City metro commercial real estate (CRE) lender. In late 2015, the OCC, a primary bank regulator, issued a statement telling banks with high concentrations of CRE that they would be subject to higher standards and oversight2. This came after an industrywide period of rapid growth in the asset class, whereby regulators witnessed a loosening of terms and conditions due to heightened competition among lenders. NYCB’s CRE concentration was twice the regulator’s acceptable level. The company attempted to address the problem by diversifying through acquisition. The purchase of Flagstar Bank in 2022 and the Signature Bank assets from the Federal Deposit Insurance Corporation (FDIC) in 2023 increased commercial and industrial (C&I) lending, diluting the CRE concentration. The acquisitions effectively doubled the size of the bank to $116 billion at the end of 20233.

Moving above the $100 billion asset threshold, however, created another problem for management to tackle. NYCB is now a “Category IV” institution in the eyes of the Fed, which brings with it enhanced capital and liquidity requirements4. Conversations between banks and their primary regulators are almost always private, but it is not a leap to assume that the Fed asked NYCB to improve its capital and liquidity position to be more in line with other Category IV banks. Management responded by communicating an increase in NYCB’s cash position and its reserve for future credit losses in the CRE loan book. The costly liquidity increase dragged the net interest margin down, leading to a decline in the future profitability profile of the bank by around 40%, while the increased provisioning resulted in the bank posting a loss for the quarter. In addition, the bank cut its quarterly distribution by 70% to preserve capital, sending shares tumbling5.

What now?

Ironically, NYBC is a much safer bank than it was three months ago. However, management is planning more action to shore up the balance sheet. The loan-to-deposit ratio is too high at more than 100%6. It could look to sell some of the C&I loans it just bought – portfolios of equipment finance and dealer floorplan lending may be options – but it can’t sell CRE loans at this point in the cycle. Why? Mainly because the loans would be sold at lower values than presently carried on the balance sheet, which would have negative implications for capital levels.

What about a buyer?

We think the chance of a buyer is close to zero. Much of NYCB’s loans are backed by rentregulated buildings in New York7. These assets are unattractive. Borrowers are experiencing stress because they can’t raise rents to improve cashflows. In addition, the accounting rules force a purchaser to mark to market the entire acquired loan portfolio, which would force an equity injection. We don’t think that attempting an equity raise is a good option either – it could destabilise rather than improve matters. All of this leaves them in a tricky situation.

How did we get here again?

The responsibility, in our view, lies with management, regulators, and politicians. Let’s take each in turn:

 

Management NYBC was running a huge concentration in CRE with weak liquidity and capital positions, while doubling the size of the bank over a two-year period with back-to-back acquisitions. It is extremely difficult to maintain disciplined risk management when this happens. History provides us with countless examples, but the Irish banks in the early 2000s spring to mind – and that didn’t end well.

 

Regulators We think regulators bear considerable responsibility for creating this situation. The Federal Deposit Insurance Corporation (FDIC) sold the large portfolio of loans from the Signature bank failure to NYCB. This sale moved NYCB into a higher set of rules for which the company was not prepared. The sale forced the bank to take drastic actions to satisfy the new rules, triggering the crisis. Did the FDIC anticipate this chain of events and went ahead with the sale anyway, or were they surprised as well?

 

Politics Small banks (those below $100 billion of assets) are held to a very weak regulatory standard compared to their bigger peers. These banks tend to operate more locally and their communities rely on them as an alternative to the larger national operators. This geographic concentration denies the small bank economic diversity. However, with the risk of operating locally comes an important ally – the local politician. Seemingly every new, more strenuous set of regulations comes with a carve out for these small banks. Their representative points out the community needs them to make loans when the big banks turn them down. And, the argument goes, the cost of compliance will burden the small bank as they will need complex risk management systems. All of which is perhaps true, but this means the riskiest, most concentrated banks are being run to a low standard with poor risk management systems. The politicians want their local bank to play by an easier rule set, and when that local bank gets too big – like NYCB did – their weaknesses are exposed, with dire consequences.

Let’s put some numbers around that …

The big four US banks have a buffer to minimum “gold plated” capital requirements of more than 200bps on average. For Europe’s big banks it’s 400bps over somewhat less onerous requirements. If we apply the same rules to the small and mid-sized US banks we cover, the number is less than 50bps, with several falling below the required minimum. Similarly, the big four US banks are running cash balances equivalent to 20% of deposits on average; most smaller US banks are around 10% with some holding 5% or less! 

What about the read across to Europe?

Credit Suisse was the domino knocked over by problems at Silicon Valley Bank. Could NYCB’s issues spread to Europe? Quite possibly. The large European banks, like their big US peers, are well capitalised with low exposure to CRE. However, a handful of regional German lenders are more exposed to US office lending than many US banks. If we take provisioning to large US bank levels overnight – as NYCB did – it would leave these banks close to minimum capital levels. We expect some uncomfortable months ahead.

Can’t we just let capitalism do its thing and let the small banks fail?

One argument against regulating smaller banks is that they are small enough to fail without causing problems at the system level. The trouble with this is that if several small banks get into liquidity problems at the same time, credit starts to tighten and it all begins to get a bit systemic. (Small bank lending is important to the US economy: around two thirds of all bank CRE loans sit with small banks8).

What’s more, we are headed into an uncertain time for bank liquidity as QT continues. Quantitative easing (QE) pumped around $10 trillion into the US, UK and eurozone systems over a decade, an amount equivalent to 25% of banking sector deposits9. Central banks are now a year or so into withdrawing that liquidity. The process has gone smoothly to date and the US is furthest ahead, but we are watching what will happen this year.

A word on QT

This is fiddly, but bear with us. It’s all down to two items on the liability side of the Fed’s balance sheet: reserves from banks (the banking sector’s cash balances), and reverse repo (from money market funds). The Fed’s balance sheet has declined by about $1.5 trillion since it started QT10. Reverse repo has fallen materially – money market funds have shifted into treasury bills to pick up yield – but bank reserves have gone up as the big banks hoard cash. We could soon reach a point where reverse repo reaches a floor and bank reserves (cash) start falling.

There is a level of reserves required for the financial system to operate smoothly. In 2019, when money market rates spiked to around 9%, reserves in the system were around $1.6 trillion. Now, the banking sector and economy are bigger and liquidity rules tougher so the current system requires more cash. The level at which the system starts to run short is probably well over $2 trillion. At the current rate of QT we could get there this year and the banks with lower cash levels will be most vulnerable11.

To conclude

The speed limit might be 60, but in potentially icy conditions society expects drivers to slow down and proceed with caution to prevent accidents, regardless of the size of vehicle! We are seeing that at large banks with great capital and high cash balances. Many smaller banks, however, still have the foot to the floor in top gear. We think the market will reward careful drivers this year.

23 February 2024
Peter Tiletnick
Senior Equity Analyst
Dick Manuel
Senior Equity Analyst
Paul Smillie
Paul Smillie
Senior Credit Analyst, Investment Grade
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NYCB blues… could events at the bank hit smaller institutions?

1 Japan Exchange Group, Tokyo Stock Exchange, Enhancing Corporate Governance, June 2023
2Columbia Threadneedle Investments, Japanese Inflation: signs of meaningful change, 26 July 2023
3 Bloomberg, as at December 2023
4Nikkei Asia, Japan domestic M&A spending at 18-year high as buyout deals surge, 21 December 2023
5Columbia Threadneedle Investments’ analysis, December 2023
6Jefferies Microstrategy, December 2023
7Bloomberg, Retail Traders May Boost Japan’s Stock Market More Than Expected, 7 December 2023
8SNL, Fed Flow of Funds, Autonomous. April 2023
9National central banks
10Federal Reserve, February 2024
11Federal Reserve, Fed Balance Sheet Normalization and the Minimum Level of Ample Reserves, February 2023

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In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

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In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

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Risk Disclaimer

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). This is a marketing communication. The mention of stocks is not a recommendation to deal.

 

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.
columbiathreadneedle.com

 

 

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