Description

Investment Thesis

On April 24, 2021, NYCB ($61b in assets) & FBC ($23b in assets) announced they intended to merge pending regulatory approval at a fixed exchange ratio of 4.015 shares of NYCB for each share of FBC.  FBC operates as a mortgage lender in the Midwest and CA, while NYCB operates as a multifamily lender in AZ, FL, OH, NJ and NY.  The deal has relatively low cost savings at 11% of noninterest expense, median cost savings for recent bank M&A deals is closer to 30%.  The strategic benefit of this transaction is leveraging new markets for lending opportunities and FBC’s lower cost funding base. No revenue synergies were modeled.

The transaction was expected to close late 2021, but due to what is believed to be regulatory pushback by the FDIC – pushing a national bank charter vs state, the timeline has been extended.  Management announced on April 27, 2022, that they had extended the merger agreement and changed the structure such that the combined entity will operate under a national bank charter.  This also shifted approval from the FDIC to the OCC.  Management remains confident the deal will be completed by the extension date and both management teams have been acquiring shares throughout the process.  At 9-10x 2023 projected pro forma EPS and 1.5x TBV, this implies a $16 share price for NYCB (which currently trades at $9.50) : 60% upside. 

From a risk reward standpoint, we prefer participating in the transaction via FBC shares.  FBC currently trades at 7.0x 2023 Consensus EPS of $5 and 0.9x TBV.  FBC is one of the few liability sensitive banks with a large wholesale mortgage funding operation that relies on gain on sale income. Thus its earnings will be negatively impacted by rising interest rates. Looking at FBC’s historical performance, gain on sale income as a percentage of total revenue peaked in 2020 at 68% / gain on sale margin peaked at 2.31%:

Based on recent conversations with senior management at FBC, they agree that gain on sale has bottomed at 60bps. While management has guided to a $50-60 million 2Q22 gain on sale, we think it may slightly miss in the $45mn range. While refinance activity in the mortgage space has been dramatically reduced, FBC is bolstering NIM and other income through HELOC originations and MSR valuations. This should drive better overall earnings results.

Additionally, it is important to note that FBC has a very attractive deposit franchise touching 206k households and 29k businesses across its geographic footprint.  As of 1Q22, FBC has $18.1 billion in deposits (10% CDs & Brokered) at a total cost of 0.14%.  FBC has ample liquidity with a loan to deposit ratio of 84%.

While the combined franchise is powerful from an earnings generation capacity, in the event of a broken transaction, FBC still has significant upside potential.  

The single most important factor being the accumulated excess capital position. Over the last two years FBC has added 300bps of additional TCE/TA capital. It has been unable to return this capital due to the transaction agreement. Currently we think FBC has over $600mn of excess capital (> 35% of mkt cap). If the merger fails, we expect this to be returned to shareholders via buybacks and dividends fairly quickly. 

Excluding the excess capital, the stock is trading at 5x PE significantly below historical ranges and peers. This provides us with adequate cushion and margin of safety if the economy does go into a recession.

In fact, liability sensitive banks outperform during recessions as the potential for rates to come lower gets priced in. 

Looking at historical P/ LTM EPS and P/ TBV ratios, FBC has averaged 8.7x and 1.13x, respectively, over the past 5 years.

Transaction Update

On 4/27/22 NYCB and FBC announced that they had extended the merger agreement to 10/31/22.  In connection with the extension, both parties amended the merger agreement to provide that the combined company's ongoing banking operations will seek to operate under a national bank charter.  The companies changed the structure of the merger, so that FBC will 

initially convert to a national bank charter and NYCB will merge with and into the national bank, with the national bank as the surviving entity.  The companies amended the definition of Requisite Regulatory Approvals such that approvals of the NYDFS (for which they had already received approval) and FDIC are no longer required, replacing such approvals with the approval of the OCC.  Under the Amendment, the only bank regulatory approvals required to consummate the merger are the OCC and the FRB.

Having spoken with a number of sell-side analysts and investors it is believed that the regulators were pushing the national vs state charter.  All parties feel this is a positive for getting the deal across the finish line.  The question now is how long will it take to get the OCC approval?  Management suggested on recent calls that the deal would be approved by the extension date of 10/31/22.  Tom Cangemi, Chairman/President/CEO of NYCB, in response to an analyst question on timing of approval: “…you would assume that the Fed has had our application since May of last year. So they're very familiar with the process. We gave a relatively short window to get this closed, which is October which is few months. And we're confident that that's the adequate timeframe to achieve these approvals based on where we are in the approval process.”

Importantly, multiple FBC management and board have purchased stock in the open market in the past few weeks. FBC insiders own 2.8% of the shares outstanding. 

Modeling Assumptions

For modelling purposes, assumed an 8/31/22 deal close.  Additional modeling assumptions include:

·         6 more rate hikes (1x50bps in 3Q22);

·         Annualized 5% loan growth in major categories beginning in 4Q22;

·         Noninterest bearing deposits decline at an annualized rate of 7.5% beginning in 4Q22;

·         Gain on sale projections (0.59% 2Q22; 0.65% 3Q22; 0.62% FY2022; and 0.73% FY2023);

·         Increased mortgage market share % for proforma entity (1.12% standalone, 1.16% by FY2022, 1.33% by FY 2023);

·         Cost savings of $125mm 75% realized in 2023; and

·         Merger charges of $225mm ($57mm in 2022 and $120mm in 2023)

It is important to note, that not included in the modeling assumptions are any revenue enhancements.  Back-office functions will be consolidated, and they are on the same core systems. 

The upside potential lies in NYCB’s ability to leverage the lending capabilities on the Mutifamily / Commercial side while giving FCB access to AZ, FL, OH, and NJ/NY markets.

Risk reward table

Risks

There is always risk that the deal will not receive regulatory approval, but given that there is no branch overlap / anti-trust issues, this should be mitigated.  There is also the potential that the OCC could take longer in the approval process, as they just been brought into the fold, and stall the deal further leading to investor fatigue.  Management, investors and sell-side analysts remain confident the deal will close.  Additional risks include a severe economic downturn leading to losses in NYCB’s multifamily portfolio and/or FBC’s residential portfolio.  1Q22 Asset quality (NPAs/Assets) at NYCB of 0.11% / FBC of 0.48%, reserve coverage (ALLL/NPLs) at NYCB of 313% / FBC of 136% and strong capital positions with CET1 ratios for NYCB 9.5% / FBC 13.8% mitigate this risk.

Catalyst

Deal closes with OCC approval