KBRA Financial Intelligence

3 Things in Credit: New York Community Bank, Nonbanks and IMF’s Forecast

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about. I just saw a report that institutional investors pulled out of U.S. stocks in late January at a pace we haven’t seen since 2015. Where did it all go? Well, a bunch went into money markets, which topped $6 trillion for the first time ever. Then came the news that Fed Chair Powell will be on 60 Minutes Sunday. Rumor has it that he is taking his dovish message for rate cuts directly to the people. It’s starting to get interesting.

This week, our 3 Things are:

1. New York Community Bank. An evolving story; here’s what it means to the broader macro story.

2. Nonbanks. They continue to take share from banks. That’s a good thing.

3. IMF’s latest global economic outlook. It’s actually tilting toward bullish.

Alright, let’s dig a bit deeper.

New York Community Bank.

I’ll bet you never spent much time thinking about New York Community Bank. But when you see an outsized move in the 2-Year being attributed to developments at NYCB, it’s time to understand what’s happening at NYCB.

The bank stunned markets this week when it announced “actions to strengthen risk management” that caused it to do what banks never want to do—cut its dividend. In this case, by 65%. The stock has fallen by as much as 47%.

So, who is NYCB?

NYCB is a larger U.S. bank, with $116 billion in assets, and $11 billion of equity. Its roots are that of a thrift, and it is in the process of evolving into a more diversified commercial bank. Its asset mix is unusual relative to more traditional commercial banks, most notably in its multifamily concentration, which makes up 44% of its total loans. The majority of its multifamily portfolio is in New York City, non-luxury, rent-regulated buildings. Commercial mortgages make up another 12%, and construction another 3.4%. It is also a large residential mortgage originator and servicer. It is predominantly a New York City metro area bank that expanded into the Upper Midwest via acquisition. It is noteworthy in that it won the auction to acquire certain deposits, cash, and loans from the failed Signature Bank from the FDIC in 2023. Safe to say, no other large bank looks like this.

“Strengthening risk management” is a qualitative statement that will be judged over time. What management did do was undergo, by its own description, two things: (i) a “deep dive” into the risk in its multifamily and office loan portfolios; and (ii) boosted liquidity. On point (i), it added $552 million in Q4 to the loan loss reserve (compared to $62 million in the previous quarter), partly to cover two big loan losses (one office and one multifamily) that accounted for the bulk of $185 million in loan losses in the quarter.

Here are the important takeaways from a macro standpoint:

• NYCB is an unusual bank, with a comparatively narrow focus (by product and geography), and a need to square up its balance sheet (which has doubled since 2021) with larger banks. Read-across to other institutions is highly limited.

• We are relatively early on in the timeline for recognizing commercial real estate loan losses. This is likely to drag out over years.

• Banks have overearned over the past couple of years because of unusually low loan losses. Normal means profitability will be modestly lower (10%-20%) as a result, although that headwind can be offset to some degree by margin expansion that figures to present in the back half of the year.

Alright, on to our second Thing—Growth in nonbanks.

I’m just back from community banking’s biggest conference, run by Bank Director Magazine, where I had the pleasure of sitting in a banking industry overview given by the CEO of Keefe, Bruyette & Woods, Tom Michaud.

One of the challenges facing the banking industry is the competitive threat from nonbanks, which, of course, have grown rapidly ever since the banking regulators set about de-risking the banks post the GFC, driving much of riskier lending into the nonbanks. Today, no fewer than seven nonbank lenders have loan portfolios that would put them among the top 40 banks. Apollo would be the 10th-largest bank today, Blackstone 15th, KKR 23rd, Ares 24th, Brookfield 25th, Carlyle 28th, and Blue Owl 39th.

Today, according to KBW, nonbanks account for 50% of commercial real estate lending, 58% of consumer credit, 62% of commercial and industrial lending, and 79% of residential real estate. We bring this up to make a point that, in times of stress and/or uncertainty, the U.S. financial system is far more diversified in terms of credit providers than it ever has been (and far better than just about all other developed countries). And this doesn’t include credit markets. That means banks (always subject to the whims of their regulators) are far less important than markets and nonbanks (that are merely subject largely to the whims of markets) in terms of providing credit to the economy. As we have pointed out many times on this podcast, having a vibrant, multisource credit function is superior to lending concentrated in heavily regulated banks in one very important way—markets and nonbanks provide a better shock absorber than banks, who cede control to regulators in times of stress, which often results in a more severe credit crunch.

Alright, on to our third Thing—The IMF’s latest forecast.

The International Monetary Fund came out with its latest World Economic Outlook and it’s fairly bullish, all things considered. All things, of course, includes inflation, two hot wars, and the geopolitical tension that goes with that territory, and China’s ongoing issues, including its property sector distress. For 2024, the Fund is forecasting global growth of 3.1%—that’s 0.2% higher than last October’s forecast. For context, recall that the 20-year annual average prior to the pandemic was 3.8%, so let’s curb our enthusiasm at least somewhat, but given where we were a year ago—where calls for a global recession were not all that uncommon—this should come as a relief.

The improvement in the outlook is attributable to widespread disinflation, in part driven by the benefit of falling energy prices. Over 80% of the world’s economies are expected to see lower headline and core inflation in 2024, according to the Fund. The improvement is driven by favorable supply- side developments and, somewhat paradoxically at least to us, tightening by central banks, which has kept inflation expectations anchored. The IMF does recognize, however, that the relatively high level of rates and the withdrawal of fiscal support will weigh on growth in 2024.

Regionally, the U.S. is expected to grow 2.1%, which is 0.6% higher than the October 2023 forecast, and well above the 1.5% Bloomberg consensus, and even the Fed’s 1.8% longer-run estimate. The Fund believes that resilient consumer spend, aided by confidence that comes from tight labor markets, is driving the growth.

The eurozone is forecast to be a bit weaker than was the case in October, with growth estimated to come in at 0.9%, down from the previous estimate of 1.2%. Weak consumer sentiment, still lingering effects of higher energy prices, and weakness in interest rate-sensitive manufacturing results in what the Fund calls “notably subdued growth.” Similar themes underpin the UK’s 0.6% 2024 estimate, unchanged from October. In Asia, China’s forecast improved 0.4% to 4.6% on greater stimulus, while Japan is forecast to grow just 0.9%.

Downside risks to the forecast include commodity price spikes due to geopolitical and/or weather shocks, and faltering growth in China.

All of this is consistent with our expectation that a soft landing is likely across the globe, something that will likely put the scourge of inflation in the rearview mirror for much of the developed world. The effects of the pandemic may finally be behind us in the fifth year since the outbreak.

So, there you have it, 3 Things in Credit:

1. New York Community Bank. It’s another idiosyncratic story.

2. Nonbanks. They continue to take share from banks. That’s a good thing.

3. IMF’s latest global economic outlook. It’s actually tilting toward bullish.

As always, thanks for joining. See you next week.