Federal Reserve officials on Wednesday removed language from a key policy statement qualifying the US banking system as "sound and resilient," a phrase it had used since March 2023 to reassure the public that regional lending problems were contained.
That same day, fresh turmoil at a New York regional bank offered a reminder that those problems are far from over.
New York Community Bancorp (NYCB) shocked Wall Street when it slashed its dividend, reported a surprise quarterly loss, and stockpiled millions for future loan losses. The stock of the Hicksville, N.Y.-based lender fell 37% on Wednesday and another 11% on Thursday, dragging the rest of the sector down with it.
Stocks of many other mid-sized lenders, such as Valley National Bancorp (VLY), BankUnited (BKU), and Western Alliance (WAL), also took big hits Wednesday and Thursday as investors punished many of the sector's names. An index that tracks mid-sized banks also plummeted by 9% in two days.
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"It's definitely sell now, ask questions later," Alexander Yokum, a regional bank analyst with CFRA, told Yahoo Finance.
Some experts urged caution, noting that the challenges at New York Community Bancorp do not apply to the entire sector. And many regional bank stocks recovered some losses during Friday's trading as New York Community Bancorp rose 5%.
"We see the issues impacting NYCB as being specific to the company with little read-through to the broader regional banks," Steven Alexopoulos, a JPMorgan Chase (JPM) regional bank analyst, said in a Thursday note.
The chaos on Wednesday and Thursday offered a mini-flashback to 11 months ago, when fears about the safety regional banks spread across the country. Eventually, those fears brought down three sizable institutions — Silicon Valley Bank, Signature Bank, and First Republic — that were seized by regulators.
There are a number of factors that help explain the market's new worries, from concerns about commercial real estate weaknesses to stricter regulatory rules placed on regional lenders of a certain size.
But the core questions about this section of the banking industry are the same as they were last March: How weak are the balance sheets at regional lenders? Can they withstand the pain of the Fed's aggressive interest rate hikes?
And can they ultimately be profitable and survive in the pocket that exists between a coast-to-coast colossus like JPMorgan and thousands of tiny community banks in small towns across America?
A crisis that created another crisis
The irony of New York Community Bancorp’s current predicament is that it can be partly traced back to the company's attempts to play the role of rescuer during the 2023 crisis when it stepped in to purchase assets of the fallen Signature Bank from regulators just months after acquiring another rival.
The rapid consolidation doubled the size of the institution and pushed the bank above an important asset threshold of $100 billion that brought stricter regulatory requirements applied to lenders of that size.
Those requirements, the company said, help explain why it had to bolster its balance sheet by cutting its dividend and boosting the money it set aside for future loan losses.
"They picked up the Signature assets at a discount, which seemed quite good, but my concern now is that it’s just been too much to handle, unfortunately," Yokum said. "If you're larger and more diversified, you're less likely to have one of these shocks hit you directly."
This new challenge for one of the country's top 30 banks may help stoke a larger debate in the regional banking world about whether it's better to pursue consolidation and get bigger, or get smaller as a way of avoiding new regulatory demands that could crimp profits.
PNC Financial Services Group CEO Bill Demchak took the former view last month when he told analysts that corporate customers will eventually migrate to national giants with implied government backing.
So it's "critical," he said, that his Pittsburgh-based bank "move into that next level" and be known "coast to coast as a ubiquitous standard brand."
"Scale matters," he added. "We’re going to have to play that game."
But getting bigger, as New York Community Bancorp found out, also brings new hurdles that can quickly turn into profitability problems. Regulators are also currently considering new rules that would make capital demands on regional banks even stricter.
Some regional banks, as a result, are trying to get smaller by shedding loans, investments, and business lines.
When regional lender US Bancorp (USB) announced last October that it had agreed to a cap on its assets and a shrinking of its balance sheet as a way of avoiding tougher regulations from the Fed, its stock moved higher by 7% in one day.
"You need to shrink if you’re not healthy," Yokum said.
Commercial real estate worries
The new turmoil for New York Community Bancorp is raising another specific concern for the sector: commercial real estate.
NYCB is largely a commercial real estate lender, and there have been concerns about the pain for such banks as office and multifamily apartment properties fall in value due to elevated interest rates and the effect of a pandemic that emptied out many city-center buildings.
Regional banks are particularly vulnerable because they hold a lot more exposure to those properties than larger rivals. Trillions of these loans are expected to come due in the next several years.
The issue is under scrutiny by regulators. "All of the bank regulators are working with banks that have, you know, concentrations of troubled real estate to work it out," Federal Reserve Chairman Jerome Powell said late last year at the New York Economics Club.
In the case of New York Community Bancorp, it was largely one office loan and one co-op loan that were responsible for a steep rise in net charge-offs to $185 million from $1 million in the year-earlier period.
It also set aside $552 million for future loan losses, a sign it expects credit to deteriorate further.
"They have to build reserves," said Christopher Marinac, an analyst with Janney Montgomery Scott, who has covered banks for more than three decades. "They're catching up. And I don't think the company truly has losses that they're going to incur, but they have to build their protection around the unknowns of credit risk."
There were other reminders Thursday outside the US of the potential for more problems to come. Germany's Deutsche Bank and Japan's Aozora Bank disclosed new commercial real estate weaknesses Thursday that stoked investor concerns.
But the boss of another US regional lender, Citizens (CFG), downplayed larger worries about the industry in an interview with Bloomberg TV.
"For the most part, everything’s in the rear-view mirror now," CEO Bruce Van Saun said during a day when his bank's stock fell by more than 4%.
Most regional banks, he said, have been able to manage their interest rate risk while the deposit pressures of 2023 have eased.
"So things are starting to feel a lot more normal," he said. The NYCB announcement "was a bit of a surprise. I think that’s an outlier."
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