Last week, following the first of what would ultimately be several very bad days for shares of New York Community Bancorp, I described the potential for a spiral dynamic to take hold in commercial real estate.
Rather than paraphrase myself, I’ll quote from the linked article. “As we get visibility into what these properties are actually worth, more banks will ‘unexpectedly’ increase provisions, and it’ll be impossible for market participants to determine with anything approaching certainty the size of those provisions ahead of time,” I said. “That suggests additional instances of seemingly anomalous one-day selloffs in shares of lenders with outsized exposure to US CRE [and] the more of those days there are, the more pressure on other banks to raise their own provisions against prospective losses, lest they should have to explain why their portfolio is somehow immune.”
I went on to say that ratings agencies would surely be compelled to institute reviews, and that downgrades were possible. Implicit (it was actually explicit) was the notion that this could become a self-fulfilling prophecy. Fast forward a few days and we may be seeing the beginnings of that with Moody’s and NYCB.
Although the bank told an industry analyst that its day-to-day operations are “business as usual,” the shares were decimated in the days following the dividend cut and outsized increase in loss provisions which, you’re reminded, were eleven times higher than analysts expected.
Subsequent reporting suggested NYCB was under pressure from the Office of the Comptroller of the Currency. The same reporting said a pair of top managers — the chief risk officer and an audit executive — exited their posts in the lead up to last week’s drama.
Moody’s wasn’t amused. “NYCB faces high governance risks from its transition with regards to the leadership of its second and third lines of defense,” the ratings agency said late Tuesday, referencing the risk and audit functions while cutting NYCB to junk.
The language Moody’s employed wasn’t especially auspicious. Ratings rationales are just lists of facts and statistics, but by their very nature, they can be foreboding. NYCB’s multifamily risk is an issue, or at least the market thinks it is, and Moody’s didn’t exactly go out of its way to paint a rosy picture.
The rationale warned that although vacancy rates in multifamily are low, the combination of higher interest expense and larger repair bills (tied to inflation) could “prove challenging for owners of rent regulated properties,” who are obviously constrained in their capacity to pass along costs to renters.
In addition, Moody’s said NYCB “has a significant concentration of low fixed-rate multifamily loans [which] face refinancing risk.” That’s all on top of the office exposure. Indeed, it seems as though some investors are more concerned about potential problems with the multifamily portfolio than they are with office.
But it was Moody’s assessment of the bank’s funding and liquidity profile that felt particularly ominous, or at least to me. For example, Moody’s noted that NYCB leans “heavily” on FHLB funding. Note that the FHLBs’ role as “lender of second-to-last resort” is under scrutiny — it’s possible the government will seek to rein in decades of mission creep at the Depression-era institutions, cutting off a key source of wholesale funding for banks.
Moody’s went on to point out that NYCB’s share of uninsured deposits was 33% as of December 31 and cautioned that “the bank could face significant funding and liquidity pressure if there is a loss of depositor confidence.”
Of course, a downgrade to junk doesn’t do anything to restore any confidence already lost, and could, under the wrong circumstances, spark a confidence crisis. Hence my warning last week about the potential for a self-fulfilling prophecy vis-à-vis the regional bank-CRE-ratings nexus.
Maybe the Moody’s downgrade doesn’t affect NYCB ‘s near-term prospects, but if the bank has to eventually sell more debt, it (the downgrade) could be an albatross.
So, why hasn’t this bled into equities more generally? Well, as BMO’s Ian Lyngen and Vail Hartman wrote Wednesday, “it’s precisely due to the nature of the CRE market that there hasn’t been a wholesale repricing of risk thus far.”
The market, they said, is “fragment[ed],” has a “bulky maturity schedule” and sports an “array of idiosyncratic risks.” It’s hard to get a handle on that until deals start getting done and the attendant price discovery forces more painful mark-to-market exercises with, potentially, more big reserve builds.
As to the role of ratings agencies and the potential for a domino effect, it’s worth quoting Lyngen’s morning note at greater length. To wit:
This is an interesting episode during which the rating agencies could come into focus once again; although the prevailing sense is that the credit analysts are simply playing catch-up to market pricing and recent financial reporting. Nonetheless, downgrades remain relevant, if for no other reason than the cross into below-investment grade status often negatively impacts a firm’s financing opportunities or at least costs. Historically, there have been plenty of examples of expanded contagion based on credit rating changes, so we find ourselves sympathetic to the prevailing apprehension. While we’d like to assume that the NYCB issue is isolated and idiosyncratic, we suspect that there will be more scrutiny and focus on the stresses in the sector as the Fed remains content to signal no near-term cuts on the horizon.
That’s a good summation, and it underscores the overarching point from my quick assessment published here last week: This isn’t going away.
We’ve moved from a kind of stasis (where the realization of the underlying risk was forestalled by a frozen market) to a slow-burning mini-crisis. The question is whether it morphs into a fast-moving train wreck with systemic implications. My answer would be “probably not” because, as noted a few days ago, everyone’s apprised of this risk and it’s hard to get a crisis from a well-socialized problem.
Indeed, this particular risk is so well-known that even Janet Yellen’s aware of it. Some CRE loans will have to be “refinanced in a context where vacancy rates in some cities are quite high,” she told the House Financial Services Committee this week, adding that although the situation’s “manageable,” it’s possible that “some institutions” will be “quite stressed by this problem.”
Some individual or group of regulators approved the purchase of Signature Bank by an organization not prepared to handle the issues such an acquisition would create. That’s on the regulators as much as the acquiring entity. Act in haste, repent in leisure. We’ve now taken one bad bank and used it to infect another. What’s next, sell the whole mess to JPM for pennies? Regulation in this country is a necessary set of guardrails, whether it’s on the financial markets, healthcare, or the air frame companies. However, all our regulatory agencies could use some serious oversight. It’s a shame those responsible for such oversight are messing about with politics and ignoring real work.
Hoping the regulators are keeping an eye on Citibank, 85% of 1.3 Trillion in deposits are uninsured.
Is this a serious comment? I really wish you’d stop with this kind of thing, Stevevan. You say stuff like this fairly often in our comments section, and it’s almost always nonsense. Nothing’s going to happen to Citi. You come here about once every two months and basically repeat doomsayer talking points you read on conspiracy blogs and related portals, which you apparently believe to be reliable sources. I’ve asked you (repeatedly) not to do that, but you do it anyway, and the only reason I countenance it is because I’m convinced by now that you’re convinced that these bombastic storylines and implicit warnings (e.g., Citi might collapse) are based in reality, bless your heart. But let me reiterate to you, Stevevan, that it’s very unlikely, to the point of being not worth discussing, that Citi or JPMorgan or BofA are going to run into trouble. And if they did, their troubles would quickly be the least of anyone’s worries, because the conditions under which that would happen would surely entail some exogenous calamity on an existential scale. So, rest easy, my friend. It’s gonna be ok. There are no black helicopters and there’s not going to be a run on Citi.
No, your right, there’s no way another GFC can happen again.
An asteroid could hit the Earth too. Or a super-hurricane could wipe out Florida. But more to the point, if you’re so convinced of this risk (as you seem to be), then why not put some money on it, big man? Downside’s never been cheaper. Literally. Between historically cheap protection and what you implicitly claim are very high (relative to consensus) odds of a cataclysm, seems like you’d be piling into lottery ticket downside. No? If not, why not?
(Also: “You’re,” and you don’t need “again” when you already have “another.”)
Must say, my spelling and grammar have improved immensely since reading you and I’ve never used the “look up” feature on my iphone as much as when I started reading you. (Can you correct that last sentence please, something doesn’t sound quite right)
I went back and looked at NYCB’s 4Q22 report. “Majority of [loan] portfolio focused on low-risk multi-family loans on non-luxury, rent-regulated buildings. Market leader in this asset class having developed strong expertise and industry relationships over the last five decades.” and “Majority of [multi-family] loans are in New York City” The current problem for NYCB (NYC rent-controlled multifamily exposure) predated NYCB’s acquisition of SBNY’s assets. In 4Q22 the MFD LTV was 60%, in 2Q23 61%, in 4Q23 61%, implying they haven’t done any significant mark-to-market of values. If NYC rent-controlled apartments really have fallen steeply in value then real LTV cushion may be thin to nil.
From what I’m seeing, pricing on multifamily properties has generally declined around -10% in the past year and -20% or more since the peak in 2021/22. Highly dependent on local conditions – new supply, population growth, rent control, taxes, etc.
Rent growth is now slightly negative. As an example, CPT just reported new lease rent growth -4%, renewal rent gro +4%, blended gro -1%. A year ago, blended rent growth was +HSD. Its 2024 outlook is for same store rent revenue +LSD, same store expense +MSD (including insurance +18%!). Varies by market, with expected rent growth +LSD in some markets vs flat in others.
The public MFD REITs are profitable, can continue investing, and can issue debt at 5% (vs at 3-4% a year ago). Unfortunately for banks, they loan to smaller privates, who may be more stressed than the big public REITs. While 50-60% LTVs provide some protection against ultimate loss, they don’t protect against provisions and NPLs.
I will be tuned into the EQR earnings release for some “color” on the state of affairs in apartments in the average to luxury end of the market.
Plus, my tribute to Sam Zell by staying tuned in.
EQR reported, nothing dramatic. I just read through the calls for EQR ESS AVB CPT and MAA is tmrw am. All are seeing lenders extend, capital flowing in, no distress sales. Maybe add a “yet” to that, but anyway not bullish for the multifamily doomers. The group is so interesting (my opinion, not investment advice, etc). P/AFFO for practically every multifamily REIT is at/near early 2020 lows.
I’m reading about $240BN of institutional dry powder waiting patiently to buy multifamily buildings when they get to high-5s%/low-6s% yields. Not sure how far apart buyers/sellers are, but some comments about 50bp-ish gap on the 4Q REIT calls.
Makes sense.
NCBs mistake is that when the bought the portfolio they should have put in some provision for losses that were very conservative- maybe that would have lowered their bid, who knows? I recall their stock popped after buying the loans. If they had been smart they would have raised capital at the time of buying the portfolio to give them some headroom in the event of writedowns. I recall that UBS did that when they bought credit suisse…..
meaning in ubs case, they took conservative provisions for write offs