Options Traders Target New York Community Bank as the Regionals Bank in Flux

Amid the approaching one-year anniversary of Silicon Valley Bank's collapse, the American financial sector is once again cloaked in trepidation. New York Community Bank has been thrust back into turmoil following a shakeup in its leadership announced on February 29th and the revelation of deep-seated issues with its internal controls.

NYCB disclosed in a regulatory filing last Thursday a hefty $2.4 billion goodwill impairment, owing to the discovery of deficiencies in its loan review process. Significant internal control flaws encompassing lax regulation, risk assessment, and monitoring were identified by the management. Amidst this upheaval, NYCB announced a change at the helm, with Alessandro DiNello set to replace Thomas Cangemi as CEO. The bank also signaled that it would need more time to submit its annual report to regulators due to the strengthening of its internal controls.

NYCB's stock has experienced a tumultuous period recently, with its shares plummeting 32.8% across the last few sessions and enduring an additional slide of 4.66% on Wednesday morning.

Option trading volumes for New York Community Bank (NYCB) have skyrocketed, with figures of 154,715, 443,419, and 285,953 over the past three sessions—a stark contrast to the 30-day average volume of 147,341. The Put/Call open interest (OI) ratio has escalated to 1.40, pointing towards a bearish market perspective. Dominating the options chain are $2 puts set to expire on April 19th and $2.5 puts due March 15th, while the $7 calls expiring January 17th, 2025, rank as the third most substantial in open interest, suggesting some investors are hedging for recovery in the longer term.

"We are seeing lots of defensive positions being opened," said Steve Sosnick, chief strategist at Interactive Brokers. "Those buyers are betting that the situation will continue to worsen in the short term."

Underpinning these concerns is the risk associated with commercial real estate loans. A study by real estate firm Highwoods Properties found that as of the end of last year, about one-fifth of office space across the United States stood vacant, with figures in major cities like Los Angeles and Houston reaching 25%. The International Monetary Fund (IMF) noted in a blog post that U.S. commercial property prices have dropped 11% since the Federal Reserve started hiking rates in March 2022, marking the most severe decline in half a century. Moreover, CBRE Group Inc., the world's largest commercial real estate services firm, reported a 30% plunge in net profits for 2023 due to slowing demand in the industry.

Data from Trepp, a provider of commercial real estate data, indicates that by the end of 2025, banks will face the maturity of about $560 billion in commercial real estate debt, accounting for more than half of all real estate debt coming due at that time. Regional banks are especially vulnerable to shifts in the commercial real estate sector and may be hit harder than their larger counterparts, which can counterbalance risks with extensive credit card portfolios or investment banking operations.

"I think it (CRE exposure) is going to affect a lot more banks, whether or not they have underwritten properly," said Robert Riva, member of real estate department at corporate law firm Cole Schotz, "This is not something that's localized to someone who's maybe repeating the mistakes of Lehman Brothers, just 15 years later. It's an industry-wide problem."

Federal Reserve data shows that as of January 2024, the U.S. banking industry held $2.9 trillion in commercial real estate loans, with small to mid-sized banks accounting for 69% of these loans. These loans represent approximately 13% of all banking assets, with the proportion for small to mid-sized banks at about 30%, marking them as a fragile link in the financial system amidst commercial real estate risks.

The lender may be compelled to offer higher rates to retain deposits following a series of downgrades, the most recent being a four-notch downgrade by Moody's Investors Service late Friday, lowering the bank's main subsidiary's deposit rating to Ba3 from Baa2. This follows an earlier two-notch cut by Moody's in early February.

Analysts and investors are keenly observing the status of NYCB's deposits. The bank reported $83 billion in deposits as of February 5th, with 72% of those insured or collateralized. However, these figures are from before Moody's initiated the rating cuts, prompting speculation about potential deposit outflows.

"There is potential risk to servicing deposits in the event of a downgrade," Citigroup analyst Keith Horowitz said in a Feb. 4 research note.

As NYCB navigates these choppy waters, the broader regional banking industry remains on high alert. The pressures of short selling, a troubled commercial real estate market, and the risk of a bank run looming, making the stability and adaptability of regional banks like NYCB a focal point for the financial markets in 2024.