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March 18, 2024 | Last week, several readers of The Institutional Risk Analyst asked whether the arrival of former Treasury Secretary Steve Mnuchin, former OCC chief Joseph Otting, various other former regulators, and $1 billion in new equity does not indicate a bottom in New York Community Bank (NYCB). Short answer: Maybe. And maybe not.
Given that investors took significant losses in NYCB thanks to the bank’s failure to disclose material information, we ought to proceed with caution. Forgiveness is easy for members of the faith, but trust must be earned. Ask George Gleason at Bank OZK (OZK) about what it takes to earn and keep investor trust.
With NYCB, the first obvious issue for investors is that a change in control is in process. The new investors, who will control 40% of the bank upon regulatory approvals and conversion of preferred equity into common, seem intent upon returning the bank to the glory days of community banking in New York. The Empire State is the last venue in the US where we’d operate a bank. If Mr. Otting et al do try to execute a community bank redux in the New York market, then we'd be inclined to exit the stock.
Milton Berlinski, a newly appointed member of the NYCB Board and Managing Partner of Reverence Capital, said: “We are happy to be investing alongside these strong investors. We believe NYCB has a tremendous opportunity to reposition itself as a regional bank and return to growth and profitability and we look forward to working with incoming CEO Joseph Otting and the management team."
To us, with all due respect to the new owners of NYCB, the community bank model is the problem. The only reason to own NYCB was the purchase of Flagstar Bank two years ago. NYCB was a sleepy, under-managed asset with branches that looked like old OTB parlors, a concentration in multifamily and lots of core deposits. Multifamily assets in progressive states like New York carry MORE political risk than do residential assets.
Banking multifamily mortgages had worked for a century for NY lenders. Low defaults and full rent rolls allowed banks like NYCB to carry way too much exposure in rent-stabilized apartment buildings than prudence would normally dictate. But in 2019, the Democrats in Albany turned these once sought after commercial properties into toxic waste. A mark of 50% of the original loan amount is about right.
The acquisition of the assets and deposits of the failed Signature Bank was the cream on the cake and more for NYCB, but this assumed that the Flagstar and NYCB teams had come together and were running the bank as a large complex institution under OCC guidelines. Even though NYCB was a bit over $100 billion in visible balance sheet assets, it was the $350 billion in servicing assets, the number 2 spot behind JPMorgan (JPM) in warehouse lending, and its role in the market for Ginnie Mae MBS that makes NYCB a systemically significant institution.
NYCB is now the largest bank servicer in the Ginnie Mae market. Yet now those interesting and valuable Flagstar assets may likely be sold at a loss so that the new investors can turn NYCB back into a typical community bank – in New York? Keep in mind that delinquency on FHA, VA and USDA assets are all rising, making any business with exposure to the operating expenses of government servicing suspect vs say two years ago.
Source: MBA, FDIC
Selling Flagstar now will be difficult, especially if the pool of potential acquirers is limited to only banks. As we’ve noted in an earlier comment, there are a number of possible bank acquirers. But either way, the team that built Flagstar into a national residential mortgage business is not likely to survive the change in control. And once Flagstar is gone, why exactly do we care about NYCB?
After the fact of a change in control, the second major issue for us and other investors in NYCB is the question of future losses. The year-end disclosure featured a surprise revelation of asset quality problems and a dividend cut attributed to the need to raise capital because of the costs of being a large bank. The bank has since sold some problem assets. The bank states in its 10-K filed last week the good news and bad news of NYC multifamily:
"[I]n New York City, where the majority of the buildings securing our multi-family loans are located, the rents that tenants may be charged on certain apartments are typically restricted under certain rent-control or rent-stabilization laws. As a result, the rents that tenants pay for such apartments are generally lower than current market rents. Buildings with a preponderance of such rent-regulated apartments are less likely to experience vacancies in times of economic adversity. At origination, we typically lend up to 75 percent of the appraised value on multi-family buildings and up to 65 percent on commercial properties."
Going into year end, the message from NYCB was that portfolio quality was superior to lenders like Signature Bank and other NYC banks. Our concern now is that the bank has indicated no further change in its year-end 2023 financials: “As previously disclosed, the material weaknesses identified by the Company did not impact the financial results included in the Form 10-K.” Really.
Given the bank’s recent track record on disclosure, we think it is reasonable to ask whether the quarter-end that is two weeks hence represents a risk or an opportunity. For those who might view the $2 low for NYCB as a potential entry point, we’d not be inclined to join in the fun. Let's see what NYCB has to say for Q1 2024.
Now it is true that the arrival of Secretary Mnuchin helped the stock. Mnuchin et al also got the folks at Moody’s to dance around like trained circus dogs. We cannot recall another time when within weeks of taking a major ratings action to downgrade an issuer, Moody’s Investors Service turned on a dime and upgraded an issuer without even taking a few days to review NYCB’s restated financials. So much for smooth ratings transitions.
Given the proportion of the NYCB balance sheet in tainted NYC multifamily assets, we’d like to see the Q1 disclosure before we make any judgments, much less investment decisions. As readers of the commercial press know, a property in NYC does not need to be rent-stabilized to be financially troubled. As NYCB notes in the 10-K:
"At December 31, 2023, $21.1 billion or 57 percent of the Company’s total multi-family loan portfolio is secured by properties in New York State, of which $18.3 billion are subject to rent regulation laws. Of the $18.3 billion properties subject to rent regulation, approximately 38 percent are currently in an interest only period. The weighted average LTV of the New York State rent regulated multi-family portfolio was 58 percent as of December 31, 2023 as compared to 57 percent at December 31, 2022."
Given that loss given default on bank owned multifamily loans is just below 100% of the loan amount, what does this say about the future of NYCB ex-Flagstar?
Source: FDIC/WGA LLC
We’d like to hear more from Mr. Otting about the future direction of the bank and whether he intends to attempt the sale of the Flagstar mortgage business. Our fear is that in order to create a big enough pile of cash to clean up the legacy NYCB mess, Mr. Otting may accept a steep discount for Flagstar. In the event, we'd be out of the stock that day.
The MBA just reported record losses for lenders in 2023, including record costs for new, mostly purchase residential loan originations. Servicing costs are rising just as fast. Trying to get a decent price for the Flagstar lending and servicing business in this market will be a challenge, but the alternative is another highly dilutive capital raise.
The wild card in the equation is the prospect that Donald Trump returns to the White House and forces New York to take ownership of the rent-stabilized assets that Albany deliberately impaired. As we noted earlier, FDIC Chairman Martin Gruenberg fully intends to stick the FDIC and the banking industry with the cost of retaining the rent-stabilized assets from Signature Bank, assets that NYCB and others refused to buy.
A future FDIC Chairman appointed by President Trump, however, could force the sale of the majority stakes in JVs that control these impaired multifamily assets, creating an immediate financial crisis for New York State. Hopefully Secretary Mnuchin will have a private conversation with Governor Kathy Hochul to avoid that unfortunate eventuality. But FDIC Chairman Gruenberg seems to have a plan to bury the problem inside the FDIC's bank insurance fund.
Is it not remarkable that despite the recent FDIC assessment to pay for the three bank failures a year ago, and the prospect of future expenses on the Signature Bank assets, the banking industry says not a word about Chairman Gruenberg's progressive gift to the State of New York? Private landlords may not be able to recover maintenance costs on multifamily buildings, but perhaps the FDIC will pay for the renovation of rent-stabilized apartments in NYC?
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