New York Community Bancorp Stock Hit Hard By Uncertainty

Conditions have not improved for New York Community Bancorp (NYSE:NYCB) since my last update on the shares. The company’s liability-sensitive balance sheet is a significant vulnerability during a period of rising rates and there is still substantial uncertainty around the proposed Flagstar (FBC) deal – not just in whether the deal will be a synergistic positive, but whether the deal will even happen. On top of that, a high deposit beta and softer loan demand just further worsen the near-term sentiment.

Down about 20% since my last article, NYCB has significantly underperformed regional banks as a group, even though the bank’s core performance hasn’t been quite that bad. At this point, the story remains the same – there are a lot of positive things happening at this bank, but it’s not well-positioned for the current environment and the Flagstar deal remains a huge source of uncertainty. I still see value in the shares, but the underperformance over the last couple of years has been brutal and I can understand why investors may want nothing to do with the name.

Weak Core Results Undermine An “In-Line” Quarter For NYCB

NYCB’s third quarter results weren’t without a few positives, but the shares need more than just a “few” positives to reverse the very weak sentiment here. Reported earnings per share were in line with expectations for the quarter (after a $0.03 beat in the second quarter), but pre-provision profits came up short on weaker spread results.

Revenue rose 3% year over year and fell 9% quarter over quarter, coming in about 4% short of expectations. Net interest income (including prepayments) rose less than 3% yoy and fell more than 9% qoq, missing by around 5% or $0.02/share, as growth in earning assets (up almost 3% qoq) was offset by weaker than expected spreads. Net interest margin fell 17bp yoy and 23bp qoq on a core basis (to 2.15%), while reported NIM fell 30bp to 2.22%, missing by over 10bp. Fee income (up 20% yoy, flat qoq) met expectations, but is a trivial contributor.

Adjusted operating expenses rose a little more than 2% yoy and fell about 2% qoq, a little better than expected in absolute terms, but softer on an efficiency ratio basis (missing by around 60bp). Pre-provision profits rose 4% yoy and fell 13% qoq in a quarter when many banks have posted strong double-digit growth, and PPOP missed expectations by about 5%, or $0.015/share. Lower provisioning gave back about that amount, allowing the company to report in-line results at the bottom line.

Soft Loan Growth Coupled With Rising Costs

Relative to Street expectations, NYCB came in soft on loans, with end-of-period net loans up 12% yoy but up just under 1% sequentially (average balances were up 12% yoy and almost 3% qoq); relative to the published average estimates I saw before the quarter, that’s a roughly 6% miss. Multifamily loans rose 13% yoy and 1% qoq, and still make up about three-quarters of the loan balance. Commercial real estate loans fell 2% yoy and 2% qoq, while specialty lending continues to grow – up 34% yoy and 3% qoq – and is closing in on 10% of the total.

Loan originations were up 27% yoy, but down 29% qoq (normal seasonality), and the bank goes into the next quarter with a $2.3B pipeline (versus a closing loan balance of $48.8B). Yields rose 16bp yoy and 3bp qoq to 3.64%, weaker than what many banks have been reporting, as multifamily loans are not especially high-yield and there is still meaningful competition in the New York metro market.

Deposits were also weaker than expected, with NYCB reporting 20% year-over-year growth in period-end deposits, but just 1% sequential growth. Non-interest-bearing deposits were particularly weak, falling 21% yoy and 12% qoq, and deposits tied to the company’s Banking-as-a-Service (or BaaS) offerings rose just slightly (1% qoq).

Management has been working to increase its core deposit base, not only expanding its BaaS business with fintech companies, but also engaging with lending clients to win their deposits. There’s been progress here, but not enough, and deposit costs jumped 76bp yoy and 60bp qoq to 1.07%. With that, NYCB’s cumulative interest-bearing deposit beta is now 40% – one of the higher levels I’ve seen.

While the loan weakness surprised me some, the deposit beta and deposit cost issues aren’t a surprise. This was one of the main challenges for the bank that I identified earlier this year – it simply doesn’t have the right balance sheet structure to thrive at this point in the cycle, and there isn’t enough loan growth to patch over the funding cost issues, nor enough “fat” left in the expense structure to drive operating leverage through further efficiency drives.

The Clock Is Ticking On The Flagstar Deal

NYCB extended the deadline on the Flagstar deal earlier this year, moving the termination date to Oct 31, 2022, but also announcing a conversion from a thrift to a national charter. That moves the regulatory oversight of the deal to the Fed and OCC (from the FDIC and NYDFS), and that could explain some of the additional delay.

Unfortunately, the company said nothing about the deal in its prepared release or on its call, even though the deal was still featured prominently in the quarterly presentation. Obviously there’s still huge uncertainty here – uncertainty as to whether the deal will be approved and/or when it will close, not to mention how well NYCB can execute on the not-inconsiderable task of integrating two very different banking franchises.

The Outlook

There’s really nothing to do now but wait. I continue to believe that the Flagstar deal is a high-risk high-reward opportunity to significantly transform the bank and accelerate management’s strategic plans. I do think there are still reasons to own the stock if the deal collapses, but I don’t ignore the reality that NYCB is still in for a rough period of standalone performance if that happens due to the structure of the balance sheet – management is taking what I believe are smart steps to transform the business, but it will take time.

Given the significant uncertainty around the deal, valuation is much more complicated than it would otherwise be. Even so, I would peg standalone fair value at around $10 based on long-term discounted core earnings, ROTCE-driven P/TBV, and P/E. Should the deal happen, the fair value is quite a bit higher; I’ve increased my discount rate substantially to reflect the uncertainty (as well as the weak present-day balance sheet position and weak sentiment) and that still gives me a $12 or so fair value on long-term core earnings growth in the 4% to 5% range.

The Bottom Line

There’s still huge short interest here (over 11%), or at least huge for a regional bank, and clearly there are a lot of investors willing to bet that the deal won’t happen and that NYCB will have to go it alone – struggling with much weaker growth than its peers during this phase of the cycle due to its liability-sensitive balance sheet. While that downside scenario is valid in the short term, I think it still ignores the real efforts that management is making to improve the bank’s long-term operating structure. This remains a high-risk call that absolutely has not worked, but if NYCB can close on the Flagstar deal and integrate it successfully, I still see significant long-term upside.