Recent acquisition of New York Community Bancorp is a good start on its planned transformation

New York Community Bancorp (NYSE: NYCB) continued the wave of regional bank consolidation with the recent announcement of its intention to acquire the Michigan-based company Flagstar Bancorp (NYSE: FBC). The deal will create an institution of $ 87 billion assets with a presence primarily in the Northeast and Midwest. It is also making significant progress towards NYCB CEO Thomas Cangemi’s primary goal of shifting the bank from its current savings model to the more typical commercial banking model that has become popular today.

Break the deal

NYCB is a nearly $ 58 billion asset bank that operates largely in New York City, but also has a presence in New Jersey, Ohio, Florida, and Arizona. Almost three quarters of its loan portfolio consists of multi-family loans. The bank has long operated on a savings model, which means that a large part of its loan portfolio is made up of fixed rate loans, while a large part of its funding comes from deposits and borrowing at high cost.

The savings model, which has really fallen out of favor with investors, has made NYCB responsive. This means that, unlike most current banks, the bank performs best in a declining interest rate environment, where the cost of its funding corrects itself downward with the benchmark federal funds rate, while good many of its fixed rate loans maintain their yield.

Flagstar Bancorp is a nearly $ 30 billion asset bank that operates in Michigan, Indiana, Wisconsin and Ohio, and has a small presence in California. He manages a large mortgage transaction that flourished last year in a declining rate environment that generated record profits in the mortgage industry. Flagstar generated a 29% return on average tangible common stocks last year, which is nothing short of superb.

Image source: Getty Images.

NYCB plans to buy Flagstar in an all-equity transaction that values ​​the bank at $ 2.6 billion, or 115% of tangible book value (equity less intangibles and goodwill). If you are a Flagstar shareholder this probably seems like a very low premium right now with many bank valuations at all time highs and with Flagstar just having a good year. But keep in mind that Flagstar, due to its incredible mortgage income, increased its tangible book value by over 41% between the end of the first quarter of 2020 and the end of this last quarter. That’s a ton of growth. In addition, mortgage bank income is not as valued as other sources of income because it is cyclical.

NYCB shareholders are probably quite happy with this price, as the acquisition did not dilute their equity, but rather increased equity immediately after the deal was closed by 3.5%. It also increases its profits by 16% in 2022, which means that once the acquisition is complete, NYCB profits are expected to be 16% higher in 2022 than they would be on a stand-alone basis. Additionally, the NYCB will be able to maintain its high dividend of $ 0.68 per common share, giving the bank a 5.4% dividend yield at its recent price of $ 12.53 per share, which represents also a considerable increase for Flagstar shareholders.

Become a commercial bank

Remember that part of Cangemi’s grand plan is to really change the bank’s lending and funding mix, and this acquisition takes significant steps in that direction.

On the lending side, the acquisition cuts NYCB’s reliance on multi-family loans from 75% of its total loan portfolio to just 56%. It also adds Flagstar’s mortgage warehouse lending business and makes combined bank assets sensitive, meaning the bank will see more net interest income when the Fed raises rates.

Combined bank loan portfolio.

Image source: NYCB and Flagstar investor presentation.

On the funding side, Flagstar gives the NYCB about $ 10.8 billion in unpaid, interest-free deposits, which are the best type of deposits a bank can have. It also reduces NYCB’s heavy reliance on Federal Home Loan Bank borrowing and high cost certificates of deposit. Overall, the acquisition reduced Flagstar’s total cost of funds by 17 basis points (0.17%).

NYCB financing cost.

Image source: NYCB and Flagstar investor presentation.

Now, even after acquiring Flagstar, I still wouldn’t say NYCB’s funding base is good. Its financing cost is still quite high in this zero rate environment, and more than 40% of its financing still comes from loans and FHLB certificates of deposits. In addition, commercial and industrial (C&I) loans – those to businesses, which typically provide high-quality deposits – will still only account for less than 10% of the new bank’s total loans.

A good start, but work to do

The acquisition of Flagstar is a big step for NYCB, but it is still only one step in the larger process. To reduce this 40% more expensive financing, the combined bank will have to provide better deposits. The good news is that all banks have a lot of liquidity right now, so hopefully the NYCB can start off by liquidating over $ 3 billion of its FHLB loans that will mature this year. It will be important to observe how quickly the NYCB can deplete these wholesale deposits.

Next, the combined bank will need to increase its C&I operations to attract more relationship lending. Cangemi certainly seems committed to this, and the NYCB has already focused on turning more of its existing banking relationships into deposit relationships or commission income opportunities. But the point is, every bank wants C&I loans, and those might be harder to get than the bank thinks. The good news is that the bank will soon have $ 87 billion in assets, giving it a strong presence and plenty of resources it needs to hopefully grow into more holistic business relationships.

While there is undoubtedly a lot of work to be done, the acquisition is certainly a very significant step in the right direction. NYCB, which doesn’t trade at a high premium, managed to score a big acquisition that progresses on its goals without diluting its tangible common stocks, or having to reduce its attractive dividend yield. In addition, the bank is starting to create a very clear story for investors to follow on how it can finally recover. And all of this certainly deserves some recognition.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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