The main source of revenue for any bank is lending out money, and then getting the money back with interest. Anybody can lend out money -- that's not the hard part. Lending it to people who will repay their loans is much more difficult. The major risk of a banking business is lending money and not getting the money back.
SOURCE: NEW YORK COMMUNITY BANK
New York Community Bancorp (NYSE:NYCB) (the holding company for New York Community Bank) is much less risky than other banks because it has perfected extremely conservative, but still profitable lending.
New York Community Bank's lending niche
New York Community Bank operates in a niche that boasts better loan repayment than almost any other bank can manage. New York City, where New York Community Bank is based, has many apartment buildings which are part of a rent stabilization program. That means that the buildings are subject to many rules -- principally that the rent of the apartments in those buildings can rise by only a very small amount each year. There are roughly one million rent-controlled apartments, all of which typically have much lower rents than the free market rent would be. That means that the revenue from the building is very stable. The tenants rarely leave, and when they do, the landlords are allowed to raise the rent a little bit and can still get new tenants immediately (because the rent is still below the market rate). Because of those super desirable apartments, the landlords almost never have trouble making their monthly mortgage payments. Those landlords have very little up-side, but also have very little down-side risk.
From its last earnings announcement, you can see that it currently has only 0.12% of its loans classified as non-performing. A non-performing loan is a loan which is 90 days or more overdue. At the average bank, about 0.98% of bank loans are non-performing, so NYCB is performing much better than a typical bank. After a loan has been non-performing for several months -- it is charged off. In the first nine months of the year 0.45% of loans were charged off by banks overall. NYCB charged off 0.00% of its loans. Both of these measures vary over time, but NYCB has consistently been performing much better than the banking industry as a whole.http://ir.mynycb.com/finl.aspx?iid=1024119
By lending -- typically around five million dollars at a time! -- to these landlords, NYCB has a much lower loan default rate than other banks. According to the FDIC, all banks in aggregate have loan loss allowances equal to 0.73% of their assets. That means that for 0.73% of loans (for banks in general) instead of earning a small profit, that the bank actually incurs a large loss. Because NYCB is so much less risky than other banks, it has a loan loss allowance of 0.36% of its assets. That means that part of the cost of running a bank is only half as much for NYCB as for a typical bank. NYCB has around $180 million being used to earn profits for the shareholders, rather than being set aside to cover losses because of its lower losses. .
Last year's loss
New York Community Bank did have a large loss last year. The loss was indeed a one-time, non-operating loss, and is not indicative of the strength of the underlying business. The background is that NYCB gets a lot of its funding from the Federal Home Loan Bank of New York (FHLB-NY). FHLB-NY does not just deposit money, they lend money with terms and conditions. NYCB had borrowed billions of dollars with long term fixed rate notes going out to 2025. They paid a fee to the FHLB-NY to refinance those loans to have much lower interest rates, and much shorter terms. The refinancing was related to its proposed merger with Astoria Federal, which was subsequently cancelled, but it did have the benefit of reducing the interest rate on its borrowings from the FHLB-NY from 3.16% to 1.58% -- so ultimately this was a very good thing for NYCB's profits, even though it resulted in a loss for one year.
Downside risk
The Fed raised interest rates in 2016, and it seems likely that it will continue to do that in 2017. Most banks are expecting to make more profits, because they will be able to take in more interest by increasing the interest rates paid by borrowers, but their costs will not increase because they will not need to increase the interest rates they pay on deposits very much.
Interest rates rising will do a lot less to help NYCB, because most of its assets are loans for which the interest rate is fixed for five to seven years. It might take two or three years for the bank's profits to respond to increases in rates as it issues new mortgages with higher interest rates. NYCB also does not have as much low-cost funding as a typical bank. . A typical mid-size bank funds about 87% with deposits; NYCB only has deposits for 67% of its funding. Deposits are an extremely cheap form of funding because banks often have to pay little to no interest for the funds, as opposed to loans, which can carry steep interest rates. Much of NYCB's funds come from loans from the Federal Home Loan Bank of New York (FHLB-NY), and those loans are much more expensive than deposits. As of its last 10K, its outstanding loans from the FHLB-NY are:
| MaturityYear | Amount | Interest Rate |
|---|---|---|
| 2017 | $1.6 billion | 1.29% |
| 2018 | $4.4 billion | 1.50% |
| 2019 | $2.7 billion | 1.74% |
| 2020 | $1.5 billion | 1.93% |
By contrast, right now interest rates on deposits are practically zero. If interest rates rise, then, for each of the next few years, NYCB might need to replace some of the money they are borrowing from the FHLB-NY with higher interest debt, while the mortgages it issued remain outstanding. Since its profit margin is essentially the difference in interest rates between the money it takes in (from deposits and the FHLB-NY loans) and the money it lends out.
Another potential risk is increased regulatory scrutiny. If and when the NYCB grows to $50 billion in assets (just over 1% larger than it is now), it will cross the threshold as a Systemically Important Financial Institution (SIFI). That means that the bank will be subject to a slew of regulatory requirements, including stress tests and capital allocations, that it does not have to spend money on now. Additionally, NYCB could be required to reduce its dividend payout -- which at 57% of its earnings is higher than other large banks -- because SIFIs are required to get dividends approved by Federal regulators and that doesn't always happen. If the dividend is an important part of your investing thesis, than you'll want to watch out for that.
Valuation
New York Community Bank looks a little cheap now since its price has not risen with the rest of the industry since the election. Most banks have had a sharp price increase since November. The bank's price-to-earning ratio is lower than other mid-cap banks. Adjusting for the one-time refinancing charge above, NYCB trades at about 15.1 times earnings. After the post-election rally, the average mid-sized bank has a P/E ratio of around 18. NYCB has been lagging most other banks, probably because of the stability discussed above. NYCB has very stable earnings, which are less likely than those of other banks to rise or fall in the short term.NYCB now has a price of 2.1 times its tangible book value, which is about average for a mid-sized bank. Prior to the November rally in bank stocks, NYCB generally had a price to book value ratio higher than other similar banks.
The President Trump and his Treasury Secretary designee have said that they intend to reduce corporate taxes significantly, and have fewer loopholes. No one knows if that will actually come to pass, but if it does, it will benefit NYCB a lot. NYCB pays income taxes at just about the full statutory rate. NYCB's only tax-advantaged investment is some life insurance deals which amount to less than two percent of its assets. Some other banks already have very low effective tax rates because they use a lot of tax advantaged deals. Therefore, a decline in corporate tax rates will advantage NYCB more than many other banks.
In short, this bank has the fundamental advantage that the loans they make get paid back. That means that it has a more stable, less risky business than most other banks. If you believe that corporate tax rates will be reduced, NYCB will probably outperform other banks. Whether or not tax rates are changed, it's valuation tells me that this stock is trading at a fair price for a low-risk way to enjoy stable earnings and high dividends for years to come.
