Key points
- Shares of New York Community Bank fell 37% after a fourth-quarter loss blamed on bad loans in commercial real estate.
- The S&P Regional Banking Index ETF is down 5.73% over the past week.
- Regional banks rely heavily on commercial mortgages, including office buildings, which are risky as remote work trends pose a growing risk to lenders.
- 5 stocks we prefer to New York Community Bancorp
Is the regional banking crisis, which first emerged almost a year ago, about to return?
Community of New York Bancorp Inc. NYSE: New York City shares plunged more than 37% on Jan. 31, after the regional lender reported an unexpected $260 million loss in the fourth quarter.
The bank cited bad loans for commercial properties, particularly condominiums and offices.
This resulted in a loss of 27 cents per share for the quarter. New York Community Bancorp’s earnings data illustrates how severe that loss was: Analysts had expected earnings of 29 cents a share, never in the universe of a loss of 27 cents a share.
Drastic dividend cut
The bank also cut its dividend by 70% and appointed a new executive chairman.
New York Community Bancorp’s dividend yield is currently 16.23%, but that’s a yield increase while shares of a struggling company are plummeting.
THE SPDR S&P Regional Banking ETF NYSEARCA: KRE, which tracks the index of the same name, also lost ground following the New York Community Bancorp news as pessimism spread across the sector. The ETF is down 5.73% over the past week.
The most important components of this index and their one-week returns are:
New York Community Bancorp quickly scheduled an investor call in an attempt to stem the bleeding, but as can be seen from New York Community Bancorp’s chart, it appears to have been unsuccessful.
Debt downgraded to junk status
Adding to the pain, bond rating Moody’s downgraded the bank’s long-term debt rating to junk status.
Downgrading a bank’s debt to junk status signals an increased risk of default, which in turn erodes investor confidence in the bank’s financial stability. This increased perception of risk often leads to higher financing costs for the bank, which reduce profitability, causing the stock to fall further.
New York Community Bancorp shares are down 30.76% over the past week.
This time the problem is real estate, not long-term bonds
This downturn in the regional banking sector differs from last year in that it is driven by defaults in the commercial real estate sector.
The events that destroyed regional banks in 2023 were due to Silicon Valley Bank and some others buying long-term bonds without any protection against the Federal Reserve’s rapid pace of interest rate increases.
Long-dated bonds are at risk when interest rates rise because their fixed interest payments become less attractive to new investors than newly issued bonds that offer higher rates.
This reduces demand for existing bonds, causing their prices to fall. When investors try to sell off long-dated bonds, it leads to losses.
Regional banks at risk of bad mortgage loans
However, regional banks are the lenders of commercial mortgages in their areas. Some of these banks may have overestimated their borrowers’ ability to service their debt or perhaps did not charge interest rates high enough to make it worth taking on additional risk.
The federal government is taking notice.
Treasury Secretary Janet Yellen, speaking recently to a congressional committee, said she was concerned about regional banks, adding that regulators were working with banks to make sure “loan loss reserves are built to cover losses” and that “dividend policies are appropriate.”
He added: “I think it’s manageable, although there may be some institutions that are quite stressed by this issue.”
Working from home endangers office loans
Meanwhile, regional banks continue to rely heavily on commercial mortgages, with substantial portions of their loan portfolios tied up in properties such as office buildings, condominiums, shopping centers and hotels.
These loans could become increasingly risky as more employees work from home, rather than commuting to an office building, which could lead to more defaults, with regional banks holding the bag.
At the moment, it does not look promising for large investors to step in and do business in the regional banking sector. Analyst ratings at New York Community Bancorp show a “reduction” consensus, something you don’t see very often.
As investors, regulators and bond raters watch the sector very closely, it is wise to be wary of this part of the banking industry. Large-cap banking stocks, however, have very different business models and multiple income streams, making them immune to this particular problem of real estate portfolio defaults.
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