New York Community Bancorp Stock: Idling Until Flagstar Merger (NYSE:NYCB)

At this point New York Community Bancorp (NYSE:NYCB) shares remind me of an F1 driver that has to start the race from pit lane; they’re sitting there watching the pack fly by while the company waits for regulators to wave the green flag and clear the transformational merger with Flagstar (FBC). Since my last update, these shares have fallen more than 10%, underperforming regional peers by more than 15%.

I don’t see any evidence that NYCB and Flagstar won’t get that clearance, and that’s key to the bull argument here. While there are several good things going on at NYCB beyond that deal, a liability-sensitive effectively single-market lender is not going to fare well in this market. I still expect the deal to close in 2022, though, and I still believe that the combined bank will generate mid-single-digit core earnings growth that supports a fair value in the $15-16 range today.

And The Wait Goes On…

There has been a definite slowdown in approvals for larger bank combinations recently; M&T Bank (MTB) and People’s United (PBCT) announced their merger agreement in February of 2021 and didn’t get the final regulatory clearances until March 4 of this year, and Toronto-Dominion’s (TD) recent merger agreement with First Horizon (FHN) explicitly included a mechanism to increase the payout to First Horizon shareholders should the deal not close before November 27 of this year (something that looks increasingly likely to me).

For those interested in the “why” of all of this, it has a lot to do with turnover at regulatory agencies and delays in Senate confirmations of nominees, as well as Biden’s Executive Order 14036. The latter has led to the FDIC undertaking a comprehensive review of how it evaluates bank mergers, and from an external perspective it just looks as though the entire system has bogged down.

None of this has any bearing on the merits of the NYCB-Flagstar deal and even acknowledging some legitimate grievances (or at least concerns) about how lax antitrust enforcement has become, this deal isn’t an example of a deal that will meaningfully harm in-market competition.

I still expect NYCB and Flagstar to get their approvals and close the deal, but approval may well not come until May or June of this year.

Near-Term Challenges Absent A Deal

I’m not going to rehash all of the arguments for the merger, and I would encourage readers to read that prior article if they’re interested, but I will reiterate that this deal is important to the long-term future of NYCB. While NYCB’s future merits without Flagstar is a topic for another article (hopefully one I won’t need to write), the biggest near-term issue is that NYCB is not particularly well-structured for the current banking environment.

NYCB has a loan/deposit ratio well above 1 (130% on a period-end Q4’21 basis), forcing the bank to rely on more expensive sources of funds like FHLB advances (as well as CDs within its deposit base). Not surprisingly, the bank doesn’t have much excess cash on the balance sheet (less than 4% versus a peer average close to 10%). With strong loan originations in the fourth quarter and healthy loan demand continuing into this quarter, NYCB can definitely use those cheaper deposits at Flagstar.

Taking that a step further, NYCB is predominantly a commercial real estate lender, and specifically mostly a lender to multifamily property owners (apartments) in the NYC metro area. With less exposure to lending categories and that lack of core non-interest-bearing deposits to fund loans, NYCB actually has negative asset sensitivity, meaning that an increase in interest rates drives their net interest income lower – not what you want at the start of a tightening cycle.

NYCB can survive this intermediate period of turbulence, but the near-term outlook for the bank is definitely not as strong without Flagstar and the opportunity to improve its funding base and diversify its lending operations.

Self-Help Still Relevant

Okay, so having made the case that NYCB really stands to benefit from its merger with Flagstar, I think it is important to note that there are positive drivers here above and beyond the Flagstar deal; drivers that would still continue even in the unlikely event that the Flagstar deal were to collapse.

On the deposit side, management is actively looking to improve its deposit base, including engaging directly with its multifamily lending clients to encourage them to move their deposit business to NYCB. Management also continues to advance its “banking as a service” (or BaaS, I suppose) initiatives, looking to this as a way to reel in more deposits and generate service income with high incremental margins.

The basic idea here is fairly straightforward – amidst an explosion in fintech companies looking to disintermediate banks and offer bank-like services directly to customers (usually through digital/mobile channels), the reality is that those companies still need banks to house the deposits and handle a lot of the “back office” functions (including regulatory/compliance functions like anti-money laundering).

From a starting point of zero, the bank accumulated $1B in deposits in 2021 and it sounds as though that growth has continued strongly into the first quarter. It doesn’t remake the deposit base overnight, but it’s a good start and I believe the fee income will follow in the years to come.

There has also been progress on the loan front. Multifamily lending is still overwhelmingly important here (up more than 5% qoq to $34.6B, or 76% of loans), but specialty lending grew almost 11% qoq (to $3.5B, or almost 8% of loans), and I see good growth potential ahead for the asset-backed, equipment finance, and deal floorplan lending businesses that fall until this umbrella.

The Outlook

Whatever you think about modeling (math, guesswork, voodoo), the reality is that the uncertainty on the timing of the Flagstar deal makes modeling 2022 even more challenging than usual. I have my number, $887M in core earnings (or $1.40/share), but the timing of the deal is going to have a big impact on that, with a later close driving a lower earnings number.

Longer term, though, not much has changed and I mean that pretty literally – my 2031 core earnings number changed by less than 1% relative to my last update. Long term, I’m expecting core organic earnings growth of around 5%.

The Bottom Line

NYCB is trading well below the discounted value of my estimated core cash earnings stream, with investors apparently staying clear of the bank until there is certainty on the deal. Likewise, the shares look very undervalued on a PE basis, with the stock currently trading at less than 8x my 2022 EPS estimate – far below historical norms for regional banks and the group today. In a more normal setting, I think these shares should trade more in the $15 to $16 range.

I continue to believe in the virtues of the Flagstar deal, and I still believe that the deal will close. While I understand why investors may be nervous about regulatory uncertainty, as well perhaps as some lending turbulence at Flagstar due to weaker mortgage demand, I think patient investors can still expect to be well-rewarded here.