New York Community Bancorp (NYCB) continues to feel the pressure a year after the collapse of Silicon Valley Bank. That stress may be alleviated as Former Treasury Secretary Steve Mnuchin leads a team of investors poised to inject the regional bank with a $1 billion bailout.

KBW Head of US Bank Research Chris McGratty joins Yahoo Finance to discuss NYCB's commercial real estate concentration issue and broader challenges for the regional banking sector.

To address the bank's significant share of commercial real estate, McGratty outlines several paths forward for New York Community Bancorp's management:
"The concentration issue is something that they're trying to address. Now if they were to sell this portfolio, the mark they would have to take given where interest rates are would be capital destructive. So it would reverse tangible book value. It would pressure earnings even further. You have to take a step back and say what could they sell, what could they reduce or take off their balance sheet. We estimate there's roughly $24 to $25 billion of loans on the balance sheet that could either be sold or securitized. And really the mark would be less punitive. Now it does increase the CRE concentration proportion on their balance sheet, but it's one step I think they need to take."

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Nicholas Jacobino

Video Transcript

- A year on from the surprise collapse of Silicon Valley Bank. Despite the initial shock being over for the markets, the ripple effects are still being felt for regional banks. No more so than at stricken regional NYCB. Bank security significant funding raise of $1 billion last week led by former Treasury Secretary Steven Mnuchin temporarily alleviated near-term worries for investors about the entire banking space. Repros we talked to say the sector isn't out of the woods.

Chris McGratty is KBW's head of US Bank Research. And he's been looking into this. Chris, great to get some time with you.

So you've been following this NYCB situation. Are there other banks out there from a regional perspective that investors need to worry about?

CHRIS MCGRATTY: Sure. Thanks for having me back. New York Community is very unique. I hate the word idiosyncratic.

But this business model is very different from the average regional bank. A couple of data points here. They're entirely New York metro market focused. 60% to 70% of their book is multifamily commercial real estate in New York. And this has been an issue, and a concentration issue for as long as we follow the company.

If you take a step back, the regional banks are real estate is an important asset class. But the level of concentration that New York Community has is different than every other bank.

JULIE HYMAN: I want to linger on NYC for just a minute here, Chris. This is Julie. You talk in your note today. You keep a market perform. You talk about the shares being range bound.

With that multifamily concentration, what is the new management need to do, right? Because I believe they've indicated they're going to keep at least some of that multifamily portfolio. But since a lot of it is rent stabilized, how much flexibility do they have, and how can they optimize that portfolio?

CHRIS MCGRATTY: Right. It's a fair question. The concentration issue is something that they're trying to address. Now, if they were to sell this portfolio, the mark they would have to take given where interest rates would be capital Destructive.

So it would reverse tangible book value. It would pressure earnings even further. So you have to take a step back and say, what could they sell, what could they reduce, what could they take off their balance sheet.

We estimate there's roughly 24 to $25 billion of loans that are on the balance sheet that could either be sold or securitized. And really the mark would be less punitive. Now, it does increase the CRE concentration proportion on their balance sheet.

But it's one step I think they need to take. And I think they're going to tell us more on that in April next month.

- Chris, what's the case for an investor to even own shares in a regional bank? Because when you look at a Bank of America, JP Morgan, these are fortress balance sheet type companies. Why not just own them?

CHRIS MCGRATTY: I think you've seen that trade, right? If you think about the last three to four months, the regional banks, the small banks, the RECs they've underperformed the BKX, which is the KBW top '24 by about 11 to 1,200 basis points. So investors are clearly making a bet that the larger banks are the safer play.

Now at some point, there will be a mean reversion trade. The valuations will be a little bit more offsides. But right now, investors are making that trade.

And I think there's credibility with that. The largest banks have more diversification. And they've got higher reserves.

And so if you look at what's in earnings estimates, the largest banks have higher credit assumptions already factored in. So if the economy worsened, they'd have less earnings pressure than the small banks.

JULIE HYMAN: so how are you thinking about where investors should look right now, especially given that surprising commentary from Jay Powell last week that the Fed might be a little bit more flexible on capital requirements or on new capital requirements for the big banks?

Right. Basel III the end game there. That's a big one certainly the largest

CHRIS MCGRATTY: Banks would benefit if we got a watering down of Basel III. Regulation is something that's really important for the banks for good reason. Most of the regulation is good. But I would say some of the proposals that are in place are really punitive.

So those are the things. In terms of interest rates higher for longer, that's our base case. We think rates will stay higher for longer.

We think you want to own banks that are going to poise to do well in that a scenario. Companies like East West Bank, Wintrust, Webster financial, these are banks that trade at very low multiples eight, nine times earnings. And the arrows are in the upper teens. And so those multiples and the valuations should converge over time.

Chris, on the flip side, and to go back to something that you mentioned, if NYCB is idiosyncratic, and those other banks you think are well-poised and well-valued right now, certainly, there must be other banks that also have some idiosyncratic risk right now. At a time when rates are still high, the Fed's not cutting yet. So are there other places that you're looking for potential risk at the moment?

CHRIS MCGRATTY: Sure. We're looking pretty hard. The biggest concentration that we see on balance sheets is in commercial real estate. We've talked a lot about that.

We've analyzed that in detail. Within commercial real estate office is a segment that we're very cautious on the banks are cautious on. And so banks have 40% of their balance sheet in commercial real estate.

We're looking at situations where maybe they do have the exposure, but they haven't grown the balance sheet nearly as quickly as others. So we don't believe in banks are being incentivized to grow the balance sheets today. So we really want to be careful. But there's really no rock that's been uncovered. Commercial real estate is where it's at.