DPST: Regional Banks Teeter As NYCB Gets Junk Rating

seekingalpha02-08

New York Community Bancorp sent tremors across the regional banking sector.Does Moody's downgrade mark the bottom or just the bottom of an innings?We look at DPST, a 3X levered banking play, and tell ...

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href=https://seekingalpha.com/article/4668526-dpst-regional-banks-teeter-as-nycb-gets-junk-rating><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>New York Community Bancorp sent tremors across the regional banking sector.Does Moody's downgrade mark the bottom or just the bottom of an innings?We look at DPST, a 3X levered banking play, and tell ...</p>\n\n<a href=\"https://seekingalpha.com/article/4668526-dpst-regional-banks-teeter-as-nycb-gets-junk-rating\">Source 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However, there is a reason these stocks get traded around at low single digit P/E multiples. That reason is that there are blow-ups and those tend to destroy years of value creation. It is the nature of the business that runs 10X leverage on equity and requires some level of faith from the community. Today, we examine a popular fund to play the regional banks, Direxion Daily Regional Banks Bull 3X Shares ETF (NYSEARCA:DPST) and what you should consider in light of recent events at New York Community Bancorp, Inc. (NYCB). The Fund According to the fund website,  DPST seeks daily investment results, before fees and expenses, of 300% of the performance of the S&P Regional Banks Select Industry Index. There is no guarantee the fund will meet its stated investment objective. This leveraged ETF seeks a return that is 300% of the return of its benchmark index for a single day. The fund should not be expected to provide three times the return of the benchmark’s cumulative return for periods greater than a day. Source: DPST  That seems obvious for any 3X fund as there are limits in how you can set these up. So leverage levels only work on a day to day basis. This is the reason these funds longer term charts tend to puzzle those expecting a direct 3X multiplier on the underlying index's return. The fund does have exposure to the regional banking sector from top to bottom. Amongst them are M&T Bank (MTB), Zions Bancorporation, National Association (ZION) and of course NYCB.   DPSTWhile the expenses may seem high relative to the standard ETFs, they are rather standard for funds delivering this kind of leverage. One point to note is that those holdings above are not the fund's holdings. Those are the holdings in the index. The fund gets the bulk of its exposure via swaps. As you can see below, these add up well over 100% and that is how the fund does its 3 step dance for every regional banking move. DPSTThe Macro Commercial real estate stress is still in the third or fourth innings in our view. There has been an extremely rapid rate hike cycle and that is still flowing through the system As we saw in the bear case made for Blackstone Mortgage Trust Inc. (BXMT) (see, 11% Yield Inside Muddy Waters), the borrowers have generally used swaps and caps to protect them and that protection dwindles over time. The second dynamic is similar in its timeline. Investment grade companies are not going to break existing leases, but they will downsize and negotiate aggressively as leases mature. So whatever occupancy levels you see today and whatever debt service coverage you can calculate, it gets worse 1 year from now. Of course the bull case is the rate cut cycle and that looks more and more like it is missing in action. With the January data, suggesting a rather strange anomaly in the job market, the Fed was forced to walk-back its own exuberance in declaring a soft landing. For CRE, we really need the most perfect of all soft landings. Reacceleration means that rate cuts are delayed and the losses will be huge. Hard landing means that bank lending which is already tight, gets tighter. That creates a vicious cycle for the banks themselves. NYCB Moody's downgraded NYCB last evening.  Feb 6 (Reuters) - Rating agency Moody's downgraded New York Community Bancorp's all long-term and some short-term issuer ratings to junk on Tuesday and warned of further downgrades. The agency also downgraded all long-term and some short-term ratings and assessments of its lead bank, Flagstar Bank. Moody's downgraded NYCB's ratings from Baa3 to Ba2, which is considered a junk rating. The downgrade reflects Moody's views that NYCB faces high governance risks from its transition with regards to the leadership of its second and third lines of defense - the risk and audit functions of the bank - at a pivotal time, the agency said. Moody's said that NYCB's core historical commercial real estate lending, significant and unanticipated loss on its New York office and multifamily property could create potential confidence sensitivity. Source: Reuters  Timely, considering the stock was down more than 60% from January 29. While we were not too pleased with the way the whole situation was handled by NYCB, their exposure is hardly the worst in the sector. If you look at,  CRE as a percentage of assets and Allowances of losses as a percentage of CRE loans,  NYCB came off as modestly under-reserved prior to charge offs. But banks like ConnectOne Bancorp, Inc. (CNOB) and Lakeland Bancorp, Inc. (LBAI), to name just two, would fare worse. None of that means that any bank is going under because of CRE. Tangible equity cushion is adequate to take these losses and since these losses come up for renewal over the next 3 -5 years, there is a lot of time to earn interest and absorb losses. Each bank also has to be evaluated separately based on their office exposure and relative loan to value ratios. But if NYCB is forced to go under because the accurately raised their ACL ratio, then all hell will break loose. You are essentially punishing a bank for cleaning up. NYCB also holds very little of those low-yielding long dated securities that got Silicon Valley and Signature into trouble. Their FDIC insured deposit levels are also very high.   NYCB Q4-2023So we are rooting for the bank and hope some sanity prevails at the end of the day. Verdict This is not an existential threat to the system, but, at the end of the day, there is significant risk. This level of inverted curve should make you cautious on the banks.   Y-Charts, Edited By AuthorIt can resolve with the most aggressive rate cut cycle or it can resolve with the back end blowing up 6%. Which would you prefer? Remember all the banks like Bank of America (BAC) that hold those long-dated mark to fantasy (oops, that is hold to maturity actually) securities. There is pain on either side and DPST is a 3X levered tool on that ride. We are 100% sure it won't work out. Funnily, that 100%, is the percentage by which DPST has underperformed the SPDR S&P Regional Banking ETF (KRE). Data by YCharts Sure you can have a few nice up days, but the 3X leverage means that your longer-term path is likely way lower.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2409737797"}