Mid March: The Rarity of the "Isolated Credit Issue"
What Now for NYCB? Credit at TBBK, MYFW and SSBI; Dogwood State Bank, FCNCB
Hello again.
It’s nice to enter mid-March without the bank sector plunging as has happened twice in the past 4 years.
A brief note on the evolution of 5 Points. Please pardon that this edition is the size of a Dickens novel but still isn’t able to properly dive into several issues. Future editions will be more concise.
Inside:
Credit migration: We are all on the alert. Look for cues on credit culture to decipher if a bad loan is a “one off”. We look at examples at First Western (MYFW), Summit State (SSBI) and Bancorp (TBBK).
What now for NYCB?
Dogwood State Bank’s (DSBX) tricky situation.
Vote! The angle at First Citizens (FCNCA, FCNCA).
An update on First Sunflower (FSUN)
Brief note: Bank investing in a time of debt spiral If you are like me, you watch in concern and frustration as politicians buy votes at the expense of US treasury solvency.
To navigate resulting USD weakness the market turns to gold and crypto because they rise in value around a narrative.
However gold and crypto can act like liabilities; neither generates any cash unless you use them as collateral or various questionable defi arrangements, and both tend to charge rent, depending on whatever custodian you choose.
One alternative for bank sector investors is to own well-run institutions outside the US. Granted, most banks around the world have terrible net interest margins, and are influenced by their state, which may also be wrecking its own currency (see the EU).
However, sustained winners exist. HDFC (HDB) and NU are foreign banks that have created value over time for ADR holders regardless of exchange rate. Butterfield (NTB) operates mostly in Cayman and Bermuda and is consistently highly profitable. As always these are not recommendations but starting points for investigation.
On to the notes:
1) “Our credit issues are isolated.” Credit culture tells and a look at SSBI, MYFW and TBBK.
Bad loans today are the result of lenders and policies in place from 2020 - 2022. The cake is baked; either they created a process with credit backstops or they took shortcuts.
Everyone is talking about New York Community and their foolish loans. Management on the other hand tells us “We have no multi-family delinquencies”.
This he-said she-said is a common intersection in bank investing; the way to the truth is by understanding culture. You can screen for office or whatever type of credit seems bad but underwriting discipline is the ultimate determinant.
For example in 2007, some banks like Ozarks ran 30% construction and made it through profitably while Corus failed twice over. Today, we are seeing a few tells on culture in a similar vein.
A loan ideally has 3 “legs” - cash flow, collateral, and some kind of recourse. A good credit culture mixes all three of these.
Cash flow and collateral are shown in the blue oval below and recourse in green.
For example, any construction loan should carry recourse and be priced with fat fees because the cash flow leg is kicked out from the start. Any non-recourse loan should also have an offset, and so on.
Banks that only have to worry about purple are in the best shape because issues in that overlap are relatively uncommon.
Let’s look at the example of Summit State Bank:
Summit State is a lender north of San Francisco. The bank is $1bn and has a reasonable track record of profits over the last five years.
Today however the bank’s level of bad loans is among the worst in the country, yet the bank is not recording charge-offs. This is unusual. The reason management is not recording charge-offs is due to appraisals - comfort in the blue oval:
SSBI sees NPA recapture as a bullish setup, but we have to respect the tells. What are some credit culture questions at SSBI?
The lack of reserve build. Some banks aggressively reserve for bad loans up front. Other banks, including in this instance Summit State, expect the appraiser is correct, the borrower is making an uneconomic decision, there is room left over for transaction and legal expenses and there won’t be losses. These are big assumptions.
Loan type. One of the bad loans mentioned above is non-recourse against a bank branch with a terminated lease. The recourse leg of the stool never existed, the cash flow leg got kicked out, and the loan is balancing precariously on one leg.
I wish banks told us in their earnings release the techniques and underwriting they used to grow loans, but we tend to learn about them on the back end unless we ask direct questions.
For another example let’s switch to First Western (MYFW), subject of recent analyst upgrade on valuation and expectation of credit resolution. The recent earnings release profiles a $42mln bad loan:
The loan is part of a relationship to a person named Dan Burrell profiled here.
Investors will want to get comfortable that the bank is not making other loans to borrowers who might take the money and give it to their ex wife. Again, this due diligence requires significant work.
Finally, Bancorp (TBBK) is a money-printing payments bank that got into bridge multifamily on a non-recourse basis. This loan category is essentially construction lending, so why banks do it without liquid recourse is unclear but they now have at least one troublesome asset:
Some market observers pointed out in 2022 the risks to non-recourse construction:
It took a minute for that post to prove out, but the market has come around:
The silver lining is that TBBK gets to repurchase shares more cheaply.
More recently, and for anyone wondering if 5 Points has any real world value, we highlighted the stressed loan before anyone cared, in bullet three the December edition of 5 Points.
There is another bank with similar characteristics to TBBK but which the market is oblivious to and which may be profiled here in a future edition.
The moral of the story:
Try your best to understand a bank’s underwriting process. A stool with less than three legs balances poorly.
If a bank is taking shortcuts on repayment redundancy, they should be compensated, like credit card lenders getting 21%, vs 4% fixed for 5 years like NYCB. This is a good segue to:
2. What now for NYCB?
NYCB Chairman Dinello, March 7 “As Joseph said, we don’t know.”
This note is on why NYCB was fortunate to get this capital infusion, despite the dilution.
Part of the reason 5 Points exists is that if I force myself to write about a topic with several angles, clarity shines through by the end of the process.
To that end in January I was intrigued by a Raymond James note defending the economics of rent-stabilized loans, but in the process of writing about it I determined that NYCB was a muddle-through if they were given time.
Obviously they were not given time.
Then, after shares fell 40%, this note further clarified that $6 was potentially generous and analyst estimates seemed optimistic.
Today, for our final act we will applaud the Raymond James analyst who has evolved his approach and taken a hard look at the underlying loan structures.
Analyst Moss has uncovered that NYCB is toting a massive interest-only multi-family loan book. Moss asked management for color on this on their March 7 call, the same call where new ownership shared the “we don’t know” quote above on credit.
On the IO too, Chairman Dinello did not know, and CFO Pinto, instead of giving color, mentioned that it would be in the 10K that should be filed shortly.
I wrote about credit culture at the top of this note. To write non-recourse loans on a stabilized-asset IO is particularly aggressive, a race to the bottom with now dead SBNY and walking dead Fannie Mae.
The answer is that this book is riddled with suspect underwriting and write-downs and management was fortunate to find a billion dollars in willing capital.
In a prior note I presumed 3%+ embedded charge-off content among the $10bn fully rent stabilized. As details emerge, that number may be well higher. Management has 12-24 months of difficult cleanup ahead.
