ETF Investors Weigh Troubling NYCB Downgrade

Moody’s decision to cut the bank’s rating to junk status raised concerns about a repeat of 2023’s regional banking carnage.

Reviewed by: Staff
Edited by: James Rubin

Just when banking supervisory officials thought they were out, to paraphrase a famous movie line, “they pull me back in!” Nearly a year after Silicon Valley and a couple of other banks created a panic weekend that threatened the U.S. economy’s core, the banking sector, New York Community Bank (NYCB) said, “hold my beer.”  

The bank’s credit rating was cut to junk status earlier this week, and the market responded with the proverbial Bronx cheer. NYCB is one of the more prominent community banks. And its latest price crash (more than 55% in about a week) is a perfect example of how ETFs are not only outstanding investment vehicles to consider, but they are also great analytical tools for investment advisors and self-directed investors. 

Here's what I mean: As of Tuesday’s close, NYCB’s stock was still in the top 10 holdings of the SPDR S&P Regional Banking ETF (KRE) at a 2.3% weighting. That fund’s six largest holdings are all around a 4% weighting. After its recent shelling, there’s a good chance NYCB just moved down the list like a recent hit record from a pop star who was suddenly “cancelled.” 

 What does the NYCB drama mean now for investors following and perhaps investing in bank ETFs?  

There are several of them, and they will be interesting to watch as barometers of this part of the banking sector, and possibly even the broader economy. After all, local banks are the lifeline for small businesses, and if their issues go from isolated to systemic, the results could be disastrous.

ETFs Targeting Community Banks

In addition to KRE, another ETF to track the latest chaotic events include the somewhat off the radar First Trust Nasdaq ABA Community Bank Index Fund (QABA), a $98 million ETF that starts by eliminating from consideration the 50 largest banks based on asset size.  

QABA hyper-targets community banks, versus regional banks, which are the next higher level, before the mega-cap “money center” banks that are household names. That latter group may be called upon again to rescue some of the smaller, more locally focused banks if we see more debt downgrades, and if the trend toward deposit flight and balance sheet drag from higher, long-term interest rates re-accelerates in the future. In short, the smaller end of the banking sector is on thin ice this winter. 

And that’s not where the risk ends. A prominent small cap stock index, the Russell 2000, is loaded with small cap banks. Financials are 22% of the iShares Russell 2000 ETF (IWM), a $67 billion fund that has had its struggles even without the specter of additional banking industry woes. IWM is off to a rough start in 2024, down 3.5% through Tuesday’s close. 

These isolated banking blowups, whether through deposit runs, credit impairment or other factors, are likely to remain an issue in the sector. ETFs can help investors monitor, dissect, and evaluate this developing story. 

Rob Isbitts was an investment advisor for 27 years before selling his practice to focus on ETF research and education. He is based in Weston, Florida. Contact him at  [email protected] and follow him on LinkedIn.