Let's Talk Loans - Vol 82.

Welcome back to a very interesting week. If you're looking to dive deeper into the world of lending, you've come to the right place. What's trading and trending on the minds of community and regional bankers. I hope you enjoy the content and please share / subscribe with a peer. Let's get right too it.

Not to diminish the multitude of other news but you had the Fed and you had the specter of a banking crisis rear its head again in NYCB. I'm going to start with the Fed but I'm going to spend more time on the CRE story as well.

WIRP (implied forward curve) had us this morning at 38% chance of a hike in March. I find that rich, in no uncertain terms, that Powell said March is off the table. I suppose the mob wants what the mob wants. Then the jobs number came out and further put the suplex on the early pivot hopeful. The two year immediately shot up 15bps (yield) and the ten year was up 10bps (yield) after the news.

Looking at how far we've come in just a month. The narrative at the start of the year, after the market got a bit ahead of itself back in December, was that we were in store for 6-7 cuts in 2024. Below WIRP (forward expectations), as of Jan 1 - the cut for March was all but assured. I wrote this back in Vol. 77.

"I believe the market is a bit still over its skis in its exuberance for those cuts. As I read the words above, I continue to see Chair Powell insert a measure caution, slowness and a call for patience. Throughout this cycle, the market largely ignored his caution to its ire. "We will be data driven." "We still have a ways to go." "We are moving carefully." The Fed has stated 2-3 cuts in 2024 and the market wants 5-6 cuts in 2024 (WIRP graph below). I think it will be fascinating to watch if we are equally caught off guard by the pace at which we raised rates versus the pace at which we cut rates."

Mid-January, just after MLK day, the market was absorbing the possibility that a March cut may not be in the cards. The market had priced in a cut probability of around 66% but pushed those cuts back into one for May and another for June.

This brings us full circle to this morning. Per my typing above, we had a 38% chance of a cut prior to the jobs number. Post that blockbuster jobs figure, nearly doubling estimates, reduces the chances now of a May cut from 101% to only 66%. June has fallen from 115% to 86%, further pushing down market expectations as to timing. The market has gone from nearly 7 cuts in January to right at 4-5 cuts for 2024 today. I fear they have a ways to go in further tightening in the expectations.

Despite this news in rates, let's put these moves all in perspective. The 10-year peaked around 4.98% and the two-year peaked around 5.22% back in mid October. The two year is 85bps and the ten year is 68bps off their highs - even despite the recent run up.

Shifting over to the NYCB news. Making heads or tails of their call report data isn't easy. They've experienced the NYCB / Flagstar merger and the more recent Signature bank portfolio. I would call the NYCB / Flagstar your more "standard" M&A - Signature was more "opportunistic" and had some hair on it. Hat tip to Bill Moreland and BankRegData.com for the graphics. Quickly, this is a loan shop. Roughly $8.7bn in bonds (7.8% of assets), $85.3bn in loans (73% of assets). Drilling down further, this is a commercial loan shop, not so much in consumer lending. 44% in multifamily, 14% C&I, 9% "CRE: Non-Owner Occ" and 3.5% "CRE: Owner Occ". They have a bit of 1-4 family resi (8%) but they are more slanted to commercial than consumer lending.

With multiple mergers, it remains difficult to determine did they acquire the problem assets, or did they originate the problem assets? The challenge with those institutions that are more heavy in CRE are some of the tricks you can play with restructuring loans. Should they go into nonaccrual? Should they not? That can mask some of the true performance in the book. Non-performing assets have been rising.

Restructured loans are on the rise these last few quarters. Again, I don't find that too surprising (though the numbers are significant) and if I looked at most CRE balance sheets I suspect I'd see more of this. "Extend and pretend". "Stay and pray". "Survive until '25". Before anyone passes judgement, people who live in glass houses shouldn't throw stones.

Remember the goal here is to keep as much out of charged off as possible. Past due loans are on the rise. Non accrual loans are on the rise. TDR loans are on the rise. All of these are precursors to? Charge offs. If you're in commercial lending right now you're pulling every trick out of the bag you can. The challenges will get more difficult as rates remain higher, loans continue to adjust and struggle to meet debt service coverage ratios and current cap rates. This is why so many are praying for cuts sooner, not later. I suspect those restructurings will continue to expand inside the total book as more and more of the portfolio reaches either maturity or an adjustment period. As to that repricing risk, they have comments from their earnings transcript.

John J. Pinto - CFO

"So -- yes when you look at the migration, a lot of it will do partially to interest rates. So depending on what happens to the 5-year part of the curve, that can change dramatically the trajectory of, especially the multifamily book. We're seeing the loans that hit their option date take that floating rate option. That is not the typical spot that these borrowers want to be."

"So depending on what happens with rates, we can see some movement pretty quickly in that portfolio from a paying off perspective or just the rerating of that portfolio. As rates start to drop and the payment shock gets less and less, and we start to see more and more information on '23 financials and how the cash flows and the net operating income is coming on, that will start the trend of getting these closer and closer due out of the criticized buckets."

The challenge a shop like NYCB has, compared to most community banks, is they carry a lot of chunky loans. When one goes bad, it likely isn't small. 185mm in charge offs...2 loans. They discuss that in their earnings transcript. As to their charge offs, straight from their earnings transcript they state:

"Thomas Robert Cangemi - President"

"Net charge-offs for the quarter were $185 million or 22 basis points of average loans, driven by 2 loans. First, we had 1 co-op loan with a unique feature for pre-funded capital expenditures. Although the borrower is not in default, we transferred the loan to held for sale in the fourth quarter and expected to be sold during the first quarter."

"Importantly, this loan is a one-off, and our review did not uncover any other co-op loans similar to this one. Second, we had an additional charge-off of an office loan that became nonaccrual in the third quarter based on an updated valuation. This one was more than we originally expected, and we responded by recalibrating our qualitative factors in the office portfolio to address the issue and increase the ACL coverage on the office portfolio."

"Collectively, these 2 loans accounted for the bulk of the charges we took during the fourth quarter."

Chucky post this week. Needless to say there will be more of this as we work through 2024. Hope you enjoyed the post and have a great weekend!

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