Why Wall Street Continues to Worry About Regional Banks

Why Wall Street Continues to Worry About Regional Banks

The Wall Street – Following a $228 million capital infusion, the stock of Dallas regional bank First Foundation (FFWM) fell precipitously, serving as yet another reminder that some regional lenders are still facing significant issues in the commercial real estate space.

First Foundation indicated that its concentration of loans for multifamily apartments would be lessened with the support of investments from other companies including the massive private equity firm Fortress. These properties, which are located in states like Texas, Florida, and California, account for about 52% of its portfolio.

The Wall Street Report

In early trade on Wednesday, its stock fell 25%. First Foundation CEO Scott Kavanaugh told analysts on Tuesday, “We’ve been honest about the fact that some of these multifamily loans are on the lower-yielding side, which has led to a decline in our earnings.” Reassuring analysts, the CEO said, “there has been no degradation in our credit whatsoever.”

The latest illustration of investors underlying concerns regarding certain regional banks’ capacity to weather this difficult time comes from the market’s response to the events at a bank valued at $13 billion.

Many mid-sized financial institutions are still battling high interest rates, expensive funding, and their exposure to flaws in the commercial real estate sector, even a year after regulators seized several large regional banks.

As issues or worries arise, investors have driven down the stocks of other regional banks this year.

It happened in May when Bank OZK (OZK) debt was brought to light in an analyst’s report on two projects a multi-use project in Atlanta and a life sciences building project in San Diego. Axos Financial (AX) was the target of a short sale in June due to its portfolio of real estate loans.

Additionally, earlier in the year, New York Community Bancorp’s (NYCB) stock fell precipitously when the bank increased its reserves for real estate loan losses, some of which were connected to rent-regulated apartment buildings in the New York City region.

With an emergency infusion of stock from a consortium that includes former Treasury Secretary Steven Mnuchin NYCB was able to calm the market.

Investors in bank stocks will be keeping an eye out for additional weaknesses in the coming weeks when some regional banks release their first-quarter earnings reports and talk about difficulties with lending as well as profit margins.

“We anticipate that this year’s loan loss provisions will exceed street expectations, especially as banks increase their reserves for community real estate” Manan Gosalia a regional bank analyst at Morgan Stanley wrote in a note on Tuesday.

Last month, Apollo Chief Economist Torsten Slok stated that there is “increased pressure on some banks’ balance sheets especially smaller banks.” (Disclosure: Yahoo Finance’s parent company is Apollo Global Management.)

According to Slok, mid-sized to smaller regional banks are over four times more exposed to commercial real estate than larger domestic commercial banks.

Banks have received warnings from regulators to lessen their exposure to commercial real estate. Overseers are also giving bankers the latitude to negotiate difficult loans with borrowers and, in certain situations, prolong maturities prior to refinancing.

Nevertheless, banks will make less money if they continue to honor maturing fixed loans that were taken out before to the Federal Reserve’s dramatic rate hikes two years ago.

In the first quarter, First Foundation set aside $577,000 for credit losses, while net income was $38 million.

“We believe our reserves are adequate, bottom line,” Kavanaugh, the bank’s CEO, said on Tuesday. “But in this cycle that the banking sector seems to be in right now, I think most people would say that our reserves appear low.”

Outside investors include Fortress Investment Group ($115 million), Canyon Partners ($46 million), and Strategic Value Bank Partners and North Reef Capital ($22 million apiece).

In addition, First Foundation will grant Fortress the option to add a fifth seat in the future and add four new seats to its board of directors.

First Foundation intends to use the capital infusion to potentially sell some of its multifamily loans when the transaction closes, which is anticipated to happen early next week.

Matthew Clark, managing director of Piper Sandler expressed his amazement at the highly dilutive capital raise in a note on Tuesday night.

The sale, according to the bank analyst, would result in a 50% reduction in the shares value of First Foundation.

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