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It’s been clear for nearly a year that regional banks’ fates could turn on their exposure to commercial real estate markets, and New York Community Bancorp just gave investors a very jarring reminder.
In a fact, in recent note, Barclays was able to quantify the importance of CRE to regional banks pretty easily. Not with something so crude as equity prices (why invest in bank stocks anyway?) but with bond spreads.
The bank found that they can explain 85 per cent of a regional bank’s bond spreads with just two factors: weighted average rating factor, or WARF, and their exposure to CRE as a percentage of total capital.
The analysts explain:
A multifactor regression based on ticker rating (using WARF) and CRE as a percentage of total capital explains most of the credit spread for each regional bank in our cohort. While there is a relationship with CRE coverage, as noted above, once ratings were added to the regression, the significance dropped, implying that CRE concentration is the main fundamental driver of spreads. Note that for the regression, we include only tickers with index-eligible debt (rated by S&P, Moody’s, or Fitch).1
Although it could be argued that aggregate size is also a factor in the issuers’ current spreads, we found that adding total assets to the model didn’t improve the results and CRE as a percent of total capital was still the driving fundamental factor.
In their view, New York Community Bancorp was an “outlier” because it had become a large bank through acquisitions, but still had a regional-bank-scale CRE business: Its CRE loans were about “four times higher than similar-sized peers”, Barclays wrote.
So what can this tell us about other banks? The analysts find that bonds of Comerica, Zions Bancorporation and Huntington Bancshares trade cheap, with Huntington posing the “lowest CRE risk”. Valley National Bancorp is also trading at wide spreads, but for a reason, as it’s “very heavily concentrated in CRE”.
On the other side of the trade, investors could be a little too sanguine about BankUnited and FNB Corp, “which have above-average exposures to CRE office lending yet relatively low CRE reserve coverage”, says Barclays. And Webster Financial is highly concentrated in CRE, at 265 per cent of capital.
And sector-wide, Barclays says regional-bank credit spreads are pretty tight relative to the SPDR S&P Regional Banking ETF. So bond investors might be too upbeat about regional banks as a whole, especially compared to equity investors.
