Troubled NYCB is not another Silicon Valley Bank. It's worse.

By Peter Morici

Expect more bank failures and bailouts as a result of Federal Reserve decisions

It's almost impossible to protect banks from the arbitrary, unintended consequences of abrupt changes in government policies.

The commercial real estate industry in the U.S. is in for a tough ride, along with the regional banks that hold many of their mortgages.

The current situation is different from what undid Silicon Valley Bank (SVB) a year ago. Yet, as with SVB and other banks that failed last year, tougher bank regulations and liquidity requirements can't completely avoid crises. It's almost impossible to protect banks from the arbitrary, unintended consequences of abrupt changes in government policies.

SVB had heavily invested in U.S. Treasurys when the Federal Reserve pushed up interest rates in 2022. This torpedoed the immediate market value of the bank's Treasury bond investments, but those would have recovered if the bonds were held to maturity.

Regulators don't require that Treasurys be marked to market on balance sheets, but SVB depositors panicked when the bank tried to raise new capital. SVB lacked quick enough access to credit at the Federal Home Loan Bank when depositors withdrew $42 billion in a single day.

Banks shun the Fed's discount window, because borrowing through it is viewed as a sign of weakness. Many small banks don't have systems in place to use the window, and in fact this facility might have saved SVB.

NYCB blues

New York Community Bancorp (NYCB) (NYCB) is causing similar tremors, but unlike SVB, NYCB is sitting on too many poorly performing commercial real estate loans whose value will never recover.

On Jan. 31, NYCB announced it was setting aside $552 million for bad loans - much more than analysts expected. Over two days its stock dropped 45% and the KBW Regional Bank Index XX:KRX of 50 companies fell substantially too.

Interest payments are a significant landlord expense, and the economics of a building can be substantially impacted by a two- or three percentage-point higher rate. If landlords must refinance at higher rates, they may have to fund a larger down payment. If they don't have the funds, they must sell.

Work-from-home has lowered tenant occupancy rates and the underlying value of many office buildings - outstanding loans on office buildings are currently more than $900 billion. The loss of value varies greatly - the San Francisco market has lost about 40%, while New York about 15%. Banks vary considerably in their exposure, but regional banks tend to be most vulnerable.

Rent control is a culprit

New York State ratcheted up rent controls just before the COVID-19 pandemic. These regulations limit the rent increases that enable landlords to pass along costs for repairs and improvements. The sale value of rent-controlled buildings are down 34% since 2019. Buildings vary considerably in their potential losses, and NYCB reported material weakness in its risk monitoring.

Many states have some kind of rent control. While these may have been manageable when inflation was low, the risk that inflation could continue above 2% drags on the market value of multifamily properties.

In the wake of SVB, Fed bank examiners have become more diligent, placing more pressure on banks with vulnerable commercial real estate (CRE) loans.

The risk of more U.S. bank failures is high, especially among smaller banks which serve their local markets by having a high concentration of CRE loans. Fortress Investment Group, for example, is purchasing bank loans at discounts of up to 50%, and with about $580 billion in bank loans coming up for refinancing over the next two years, lenders' potential losses are huge.

The regulatory industrial complex is gearing up, proposing that banks be required to annually use the discount window and post large amounts of collateral in advance at the Fed - regardless of the composition of their loan books.

Boosting bank capital by holding more assets idle or in short-term Treasurys to backup prospective discount window borrowing would require banks to charge more for loans and drive more landlords to private creditors. That will ultimately make new buildings more expensive, limit supply and raise rents. Burdening all banks with these costs won't help small- and regional banks when local market conditions turn against landlords.

The discount window requires good collateral. But the banks in question are troubled because they hold bad loans. This is not like SVB, where its Treasury holdings would have eventually regained their value.

Bail or fail

Much of this woe is due to circumstances beyond these banks' control: the COVID-19 pandemic; the Fed printing excessive amounts of money during COVID; central bankers deciding that inflation was transitory, and then finally being forced to raise interest rates and keep them higher for longer to cover those mistakes.

In early March, an investment group led by former U.S. Treasury Secretary Steven Mnuchin rescued NYCB with $1 billion in new capital. Not all troubled banks will be so fortunate. In the end, the Fed and Treasury will have to bail out some banks or let them fail.

Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.

More: NYCB raises more than $1 billion in equity investment led by former Treasury Secretary Steven Mnuchin's firm

Also read: NYCB's stock downgraded to underperform at Raymond James on expectation of rising credit costs

-Peter Morici

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03-19-24 0705ET

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