Latest thoughts on the banking sector (part 3) – an update on yesterday's events; The latest from my friend Enrique Abeyta; Greetings from VALUEx in Switzerland

1) Wow, I rarely get the timing so right...

In Tuesday's and yesterday's e-mails, I shared my expert friend's thoughts and presentation on the banking sector – which I'll continue today...

After nailing the bottom of the regional banking crisis last May – which I covered in my May 3 e-mail – and seeing the three stocks he recommended nearly doubling on average, he sold all of his regional banking stocks for reasons he outlined in my past two e-mails.

I summarized these in Tuesday's e-mail:

• There are many headwinds for the banking sector: continued high interest rates, credit risk, deposits declining and becoming more expensive, etc.
• As he puts it: "A pretty positive scenario has to play out for valuations to be warranted – bank stocks are priced for perfection."
• As such, he has sold all of his regional-bank stocks, including [Metropolitan Bank (MCB), Western Alliance Bancorp (WAL), and Zions Bancorp (ZION)].

Well, wouldn't you know it...

Only a day after this warning, New York Community Bancorp (NYCB) – a large regional banks that operates as the bank holding company for Flagstar Bank – reported disastrous fourth-quarter earnings yesterday and the stock plunged 38%. (The collapse has also continued today).

Investors, fearing this is a canary-in-a-coal-mine sign of trouble for other banks, sold the stocks of similar companies. That dragged down the SPDR S&P Regional Banking Fund (KRE) 6% yesterday – and it's also falling today.

For further insight on what's going on, last night I e-mailed my expert friend to ask for his thoughts and he was kind enough to share them – which he also gave permission to share with my readers today.

Below is what he sent to me (mainly some more complex brokerage perspective first – so for an easier-to-digest summary from him, that's farther below)...

Below are summaries from four brokerage firms that cover NYCB, all of which are fairly accurate.

I'd say many banks face the same issues, but NYCB has extra regulatory scrutiny given its size ($116 billion in assets) so they are likely just one of the first to deal with being under-reserved and don't have a ton of capital when loans are marked to their fair value.

Here's an excerpt from the KBW report (note the last line that dividend funds were likely sellers; there is a ton of passive money in this stock, with dividend-focused funds being especially large holders):

NYCB – Devastating qtr w/ huge credit issues, a slashed dividend and significant downside in the guide.

• CREDIT: They took the ACL to 1.17% from 0.74%. NCOs were 86bps (2 loans: 1 co-op & 1 new office loan), w/ criticized +$1.9B QoQ (MF & CRE).
• DIVIDEND: Slashed to 5c from 17c due to lower earnings power and Cat IV requirements.
• '24 GUIDE: Pencils out to ~50% downside to EPS. Combo of much lower NIM (2.40-2.50% vs KBWe 3.11%) and focus on liquidity build, as well as higher opex.
• CAP RAISE??? – Has been asked a bit, we don't think anything is coming. Also for the industry this feels more idiosyncratic to NYCB and the industry is well capitalized. CET1 is 9.1% now, down 50bps and 10% will be the goal.

BOTTOM LINE: This is a very tough qtr and the Regs are likely coming down on them hard to raise liquidity and shrink ASAP to get to 10% CET1. It's a mess that doesn't look be getting resolved anytime soon. TBV is $10.06 but that doesn't carry much weight in the face of this credit deterioration & a 6-8^ ROTCE. I'd expect investors that dipped their toe into NYCB as an anointed regulatory winner in an uncertain environment to now jump feet first into FCNCA. First question is contagion risk but this feels idiosyncratic for the time being. It also seems like the key here moving forward is lower rates to help on the credit/multi family side for NYCB. On the technical side, there will be a lot of discussion of if Divy funds are forced to sell...

Here's Piper Sandler:

NYCB – Reported: (36c) Core: (27c) Cons & PSC: $0.29 – The company is taking a $552MM provision (vs our estimate ~$50MM), this brings reserve ratio from 0.74% to 1.17%. They took a fairly large $185MM charge-off in the quarter. Bolstered liquidity- added $1.5B of cash to b/s -> NIM down 45 bps in the LQ and 20 bps below us. Cut the dividend from 17c to 5c. In the press release the company cited being a $100B+ Category IV bank as a driver for necessary enhancements

Here's the Janney Montgomery Scott report:

NYCB: Preemptive Actions on Credit, Liquidity, and Dividends Reduce EPS Estimates and Fair Value Outlook. Payout Ratio With 50% in '24 and 35% in '25.

• NYCB's weak 4Q23 earnings included significant actions on credit risk recognition, new liquidity focus, and a reduced cash dividend (read Janney's initial 4Q23 review).
• We think this was preemptive by management to get ahead of pending regulatory changes on capital rules (AOCI deduced in CET-1 ratio calculation) and liquidity (hold more cash and unencumbered/unpledged securities). A chain-reaction occurs on dividends and forward EPS as NYCB seeks to grow capital ratios and tangible book value to boost its status with both regulators and investors.
• New EPS estimates are significantly lower, and still support a combined dividend payout ratio of 50% in 2024 and 35% in 2025 (includes preferred and common). Residual PPNR is $540M in '24 and $640M in '25, combine for 1.45% of Loans for future credit loss recognition.
• Our EPS [forecast] is the more conservative range on NYCB's 2024 guide (higher expenses, lower fees, low NIM). Also, Mortgage activity may improve if interest rates drop. See Page 4 details.
• Criticized Loans are 6.2% of NYCB's portfolio, up from 3.9% at 9-30-23. Further deterioration is possible as Pass-rated CRE, Multifamily, and other Commercial Loans migrate for credit risk. This triggers Reserve building, most of which already occurred in 4Q23. It does not necessarily signal significant loan losses. We have net charge-offs near 0.20% for 2024 and 2025 ($270M combined), considerably higher than the long-term experience near 0.05% 1995 to 2023.
• Our new Fair Value estimate is $9.25, which is nearly 90% of 2025 tangible book value ($10.77) discounted for present value. The stock could trade at a larger discount in the short-term, then narrow as quarterly EPS and credit quality progress.
• It is important for investors to recognize that NYCB elected not to delay credit and capital actions ahead of new regulatory rules on CET-1 calculations and liquidity standards. Taking early and preemptive action is painful in the short-term, while leading to greater credibility in the long-run.

Lastly, here are key lines from Compass Point's report:

The actions taken by mgmt. to get the bank ready for $100B ultimately drove (1) a reported loss in 4Q23, including a massive provision and reserve build that injected greater uncertainty into the credit picture (although we are convinced this build was a one-off driven by the regulators)...

If we are correct in our expectation that the regulators indeed drove these accelerated actions at NYCB (reserve build, liquidity test in April 2024 instead of April 2025 – definitely a regulator decision, strategy to accrete capital faster for NYCB to hit 10% CET1 by year-end), we view this acceleration by the regulators as exhibiting a lack of foresight and running counter to the ultimate goal of the regulation itself, which is meant to boost the safety and stability of banks and the banking industry...

Credit: Trends look better after digging into the details. Although mgmt. noted it conducted a deep dive in office and multifamily, which drove the material reserve build (office to 8% from 2%, and multifamily to 0.82% from 0.42%) we gained the sense that mgmt.'s expectations for loss context in the multifamily book had not changed, in that there is an expectation that losses will be low...

NII: Mgmt. provides new NII guidance after the close, pointing to better NII trends vs. our avg. balance sheet analysis. While mgmt. originally held-off on providing any outlook on NII trends for the year, NYCB offered such guidance alongside its NIM guide post the close, guiding to $2.8B-$2.9B and NIM of 2.40%-2.50% for FY24, reflecting a sharp decline from FY23, with 1H24 NIM closer to the lower-end of the range.

To wrap it up, my friend concluded with the following comments:

I would say this is the first large bank to show pretty significant credit deterioration. As the KRE fell 6% yesterday, the super-regional banks like KEY, CMA, ZION, etc. were hit the hardest while the big-four banks (JPM, BAC, C, and WFC) held up a smidge better. Today was the last meaningful day of bank earnings and I would say that credit issues have been more one-off issues here and there with no banks of size reporting major problems.

This table shows how material the credit deterioration was at NYCB: 6.2% of total loans are now criticized [ones that show preliminary signs of higher risk], 16.7% of CRE loans, and 8.2% of multi-family loans.

For a bank this size to have such a high level of criticized assets in addition to a big loss on an office loan and a co-op loan in New York City has really caused a scare that credit losses could be coming. In addition, as highlighted in all the analyst summaries above, NYCB has liquidity problems, thin capital, and a ton of low-yielding long-term loans on the books.

In addition to NYCB, Japan's Aozora Bank Ltd. dropped more than 20% after warning of a loss tied to investments in U.S. commercial real estate, and Deutsche Bank AG more than quadrupled its U.S. real estate loss provisions in the fourth quarter when compared to the year earlier.

I'm not sure this is necessarily symbolic of an immediate meltdown for all banks, but it certainly highlights all the risk that is in the banking system right now from both a credit and liquidity perspective.

I owe my expert friend a huge "thank you" for being so generous and open in sharing these insights!

2) Today is a big day for my longtime friend and former colleague at Empire Financial Research, Enrique Abeyta...

He and his team are launching a new firm called HX Research, which went live for the first time a little after midnight last night.

I'll be speaking with Enrique next week about his outlook for the markets this year, so stay tuned.

In the meantime, he's launching a new free daily e-letter this afternoon. (If you're interested, you can sign up for it here.)

3) Greetings from Klosters, Switzerland, where I'm once again attending my friend Guy Spier's annual VALUEx conference!

As always, I'm catching up with old friends, making new ones, and hearing a range of investment ideas. I'll share the highlights next week. In the meantime, here's a picture of me and Guy:

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.