NYCB's office loans come due

New York Community Bancorp’s earnings went badly wrong. The lender made a sudden $552 million provision and cut its dividend by seventy per cent, a sign that losses on commercial property are now reaching bank balance sheets. Size was the trigger. Buying Signature Bank assets pushed NYCB past $100 billion in assets and into stricter capital rules.

The market's verdict was swift. The shares lost more than a third of their value on the day of the results at the end of January, and Moody's cut the bank's credit rating to junk within a week. The board then made Alessandro DiNello, a former head of Flagstar, executive chairman. For a bank that had long advertised its low loan losses, the shift in tone was abrupt.

How NYCB got so big

The growth came quickly. NYCB bought Flagstar Bancorp, a Michigan mortgage lender, at the end of 2022, and a few months later its Flagstar unit took over much of Signature Bank from the FDIC after Signature failed in last March's regional banking panic. The deal looked cheap at the time. It also carried NYCB across the $100 billion line that separates mid-sized lenders from the Category IV banks the Fed watches more closely.

Category IV status brings tougher liquidity requirements, regular supervisory stress tests and closer scrutiny of capital planning. The Fed's proposal last July to rewrite capital rules along the lines of the Basel III endgame would push further demands onto banks above the same threshold. Supervisors also expect a bigger bank to hold reserves more like those of its new peers, and NYCB's provision and dividend cut look like a hurried attempt to meet that standard.

Bigger bank, tougher rules

NYCB lent heavily against rent-regulated flats and city office towers. Regional lenders struggle when appraisals fall at the same moment as Category IV capital rules start to bite. As office debt matures into base rates of five per cent, provisions will keep rising and eat into capital that would otherwise back new loans.

Two problem loan books

The rent-regulated flats were once regarded as the safest loans in the city. That changed with New York's 2019 tenant-protection law, which sharply limited landlords' scope to raise rents after renovations or when tenants left. Landlords' income now grows slowly while their repair bills, insurance and interest costs climb, so buildings bought or refinanced at low rates may not cover new debt at current ones. Offices face a simpler problem: remote working has left floors empty and cut the value of many towers.

The process is slow and grinding. A loan written at a low fixed rate years ago matures, the building is reappraised at a lower value, and the borrower must put in fresh equity or hand back the keys. Each shortfall becomes a provision, each provision reduces earnings, and lower earnings leave less capital to support lending. The dividend cut keeps money inside the bank, at shareholders' expense.

Not only a New York problem

NYCB was not alone in flagging trouble in the same week. Japan's Aozora Bank warned of losses on its American office loans, and its shares fell sharply, while Germany's Deutsche Pfandbriefbank came under pressure over its exposure to American commercial property. Foreign lenders that bought into American offices during the years of cheap money are discovering the same arithmetic as domestic ones. The losses are spread thinly across many balance sheets, which limits the risk of a single catastrophic failure but makes the drag on lending broad.

The timing of a support scheme adds pressure. The Fed's Bank Term Funding Programme, created last March to lend to banks against their underwater bond holdings at face value, will stop making new loans on 11 March. Banks that relied on it will need to find other funding, most likely at higher cost, just as their property books demand more capital.

Winners, losers and the counterargument

Shareholders and holders of the bank's riskier debt bear the first losses. Landlords in rent-stabilised buildings face tougher refinancing terms from every lender that has watched NYCB. Buyers of distressed loans, including private-credit funds, could pick up property debt at discounts if regional banks decide to shrink their books. The largest banks, whose loan books are more diversified, may attract deposits from customers who prefer not to test a smaller lender's resilience.

The fair counterargument is that NYCB's troubles are partly its own. Few other lenders are so concentrated in New York rent-regulated housing, and office loans are a modest share of most banks' portfolios. Markets also expect the Fed to start cutting rates this year, which would ease refinancing. Lower rates would help at the margin, but they would not restore office occupancy or undo the rent law, and appraisals tend to lag the market on the way down.

History suggests the process takes years. In the early 1990s a collapse in commercial property values across New England brought down the Bank of New England in January 1991 and hundreds of smaller lenders across the country over several years. That crisis unfolded slowly, loan by loan, as buildings were reappraised and borrowers defaulted, and it weighed on credit and growth well after the property market had bottomed.

The indicators to watch are the reserve builds disclosed in regional banks' quarterly results, deposit flows at mid-sized lenders, and the Fed's annual stress tests, whose scenarios assume a steep fall in commercial property prices. Any sign that deposits are leaving lenders with heavy property exposure would echo last spring, when Silicon Valley Bank, Signature and First Republic failed within weeks of one another.

NYCB has learned that a bank above the threshold gets much less patience over old property loans. Other regional lenders near $100 billion will probably think twice before buying their way past it, and more provisions on office and rent-regulated loans are likely to surface in the next two quarters' results.