Wall Street worries banks aren’t worried enough about commercial real estate as NYCB turmoil mounts

Regional banks have been setting aside more money to deal with future losses on commercial real estate. Some analysts now fear it hasn’t been enough.

The stock of commercial real estate lender New York Community Bancorp (NYCB) continued to slide Tuesday, putting it on pace to drop by more than half since it surprised Wall Street last week by slashing its dividend and reporting a net quarterly loss of $252 million. It was down by as much as 18% Tuesday afternoon.

The turmoil surrounding this $116 billion bank is stoking new concerns about the industry’s vulnerability to office buildings and apartment complexes that are suddenly worth a lot less due to high interest rates and shifting work patterns.

“I’m concerned” about commercial real estate exposures, US Treasury Secretary Janet Yellen said during a US House Financial Services Committee hearing Wednesday.

Yellen said regulators are working closely with banks to ensure “loan loss reserves are built up to cover losses” and “that dividend policies are appropriate.”

“I believe it’s manageable, although there may be some institutions that are quite stressed by this problem,” Yellen added, echoing comments made by Fed Chair Jerome Powell on Sunday.

Treasury Secretary Janet Yellen testifies before a House Financial Services Committee hearing on 'the annual report of the Financial Stability Oversight Council' on Capitol Hill, Tuesday, Feb. 6, 2024, in Washington. (AP Photo/Manuel Balce Ceneta)

Treasury Secretary Janet Yellen testifies Tuesday in Washington. (AP Photo/Manuel Balce Ceneta) (ASSOCIATED PRESS)

Analysts are arguing that many other regional banks will likely have to set aside more money this year to absorb future losses from commercial real estate via a balance sheet addition known as “provisions.”

Banks typically add more provisions when they anticipate credit will deteriorate, marking them as an expense. The more provisions banks add, the lower their profits will likely be.

New York Community Bancorp‘s provisions were $552 million in the fourth quarter, up from $62 million in the same year-ago period. That led to its quarterly loss.

“We believe consensus is too low on provision expense for 2024 for nearly every bank we cover,” Manan Gosalia, a regional bank analyst for Morgan Stanley said in a research note Friday.

“I do think that we’re going to see provisions going up across the industry,” added David Chiaverini, a regional bank analyst with Wedbush Securities, in an interview with Yahoo Finance.

A sign is pictured above a branch of the New York Community Bank in Yonkers, New York, U.S., January 31, 2024. REUTERS/Mike Segar/File Photo

A New York Community Bank branch in Yonkers, N.Y. REUTERS/Mike Segar/File Photo (Reuters / Reuters)

What also has investors and analysts concerned is whether regulators could force banks to stockpile more of these reserves.

Bloomberg reported Monday that officials from the Office of the Comptroller of the Currency applied pressure on New York Community Bancorp to set aside more money and slash its dividend in case commercial real estate loans end up souring.

The Hicksville, N.Y.-based bank has a high level of exposure to rent-controlled apartment complexes in New York City. Those buildings account for 22% of its loans.

New York Community Bancorp said last week that its efforts to build up reserves was an adaptation to stricter capital rules that apply to institutions with more than $100 billion in assets — a threshold it passed last year when it absorbed part of the failed Signature Bank.

Regulators are now “pumping the phones basically asking, ‘What does your commercial book look like?’” Chris Whalen of Whalen Global Advisors told Yahoo Finance.

The concern regulators have, Whalen added, is that higher commercial real estate exposure could get banks “tarred and feathered” by investors.

FILE PHOTO: Acting Comptroller of the Currency, Michael Hsu, testifies before a Senate Banking, Housing, and Urban Affairs Committee hearing in the wake of recent bank failures, on Capitol Hill in Washington, U.S., May 18, 2023. REUTERS/Evelyn Hockstein/File Photo

Acting Comptroller of the Currency, Michael Hsu, testifies on Capitol Hill last May. REUTERS/Evelyn Hockstein/File Photo (Reuters / Reuters)

The stocks of many other regional banks with high exposures to commercial properties are also down over the last week, including New Jersey lender Valley National (VLY). It was down more than 7% Tuesday afternoon.

“What really annoys us about NYCB and other banks with commercial exposures is that they knew months ago that the OCC was demanding pre-emptive increases in capital and loan loss reserves,” Whalen said in a separate research note.

“Why? On the assumption that some commercial property valuations in the $20 trillion market are in a free fall and that, accordingly, defaults will spike in 2024.”

Chiaverini said “the severity of the issue is, I would say, mostly idiosyncratic to New York Community Bank because they were so under-reserved relative to the risk in their portfolio.”

But there is a “perfect storm” that could still create problems for the rest of the industry, according to Chiaverini. If inflation goes back up, forcing the Fed to keep rates higher for longer, and the US economy enters a recession. Borrowers would then have problems keeping up with their loans.

If those things don’t happen, the commercial real estate pain should be “manageable” for the banks, he added.

David Hollerith is a senior reporter for Yahoo Finance covering banking, crypto, and other areas in finance.

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