Description

Grumpy is back! After a sabbatical from the business I have returned rejuvenated, and...still grumpy.

Please, oh please let me back into your Club!

Short NYB:

New York Community Bancorp (NYB) is known as a prudent bank that makes safe loans against rent-controlled multifamily buildings in New York City funded by a large network of old fashioned savings bank branches. Management will have you believe that these loans never have gone bad...and never can as the maximum rent-controlled rents on the apartments in the buildings are less than the going market price for non-rent controlled units. Since the last real estate loss cycle NYB has dramatically outperformed other banks:

Total Return                           12/31/99-2/26/10      12/30/05-2/26/10

NYB                                        +279.4%                    +24.8%

S&P 500 Banks Index               -27.8%                     -57.1%

S&P 400 Financials Index          73.2%                      -14.4%

S&P Midcap Index                      88.54                           6.2%

I believe this outperformance is about to end as NYB finally begins to fall victim to its own success. NYB's portfolio is showing significant strain in this credit cycle and rather than build reserves and work through difficult times, management has become increasingly defensive, maintained an extremely high dividend payout ratio and allowed its franchise and reputation to be put at risk. If I am right, the stock will significantly miss numbers over the next few quarters. If I am wrong, at best, NYB is likely to be 'dead money'.

NB - Now before we do analysis of NYB we need to strip out the legacy assets from the recent FDIC-assisted acquisition of the failed Amtrust Bank (with operations in Ohio, Florida and Arizona). This was a very accretive deal that increased assets by 25%, but the stock has moved up 50% ($11.50 to $17) since the deal was announced in 12/09. So in my opinion the upside from the acquisition has significantly been priced in - and to see what will move the share price at NYB we need to look at the non-Amtrust covered loan portfolio...

So what has happened to NYB (again, not counting the recent Amtrust deal) since the end of the last real estate credit cycle in New York in 2002:

1) Explosive Growth - most think of NYB as a thrift that has grown at a measured pace especially against the likes of other competing banks and investment bank conduits that have competed against it to originate New York City Multi-Family Loans. A quick look at the balance sheet since will tell you a different story.

($M)                                        2002               2009               Growth %

Multi Family Loans                $4,494            $16,457          267%

All other loans                         $950              $6,500          584%

Total Assets                           $11,300            32,800        190%

So not only has NYB doubled in size, you can see that it has increasingly moved away from its core business of multi-family lending. Most of these 'other' loans are in much more risky areas:

($M)                                        2002               2009               Growth %

Commercial RE Loans           $533                $4,900                    819%

Construction Loans               $117                  $666                     469%

So clearly the loan book has grown the fastest in higher risk areas

2) Riskier Balance Sheet - Most of NYB's security book is quite conservative and earns a small spread over the cost of funding. However, despite a very steep yield curve, the bank has been stretching for yield and shifting its assets towards a heavier loan concentration:

                                                2002   2007   2008   2009              

Loans/Total Assets                   48%    65%    69%   70%

3) Problem loans are spiking - Non Performing Assets (NPAs) are up big time and don't look like what one should expect from a portfolio of 'safe' NYC multi-family rent controlled loans that can't go bad...

($M)                                          2002             2008               2009              

Non Performing Assets                $17             114                $593              

NPAs / Loans                            0.30%          0.52%             2.54%            

Remember - the 2009 numbers do not include assets from the Amtrust deal.

Also note that loans past due 30-89 days increased from $170M in 12/08 to $273M at 12/31/09.

Problems loans both non-accruals as well as past dues have been rising rapidly on a quarterly basis over the last year and the pace of increase does not look to be slowing down.

4) Yet Reserves are not keeping pace -

($M)                                        2002               2009               Growth %

Loan Loss Reserve                 $40.5              $127               214%

Reserves/NPAs                        238%              27%                -89%

Reserves/Loans                      0.74%            0.55%             -26%

Again - these NPLs do not include 'covered' loans from the Amtrust deal

5) Reserves aren't adequate even it we assume Mutli-family loans are fine - Even if we assume that only the non-multi-family loans are potentially a problem, NYB looks like it needs more reserves, especially against Construction lending where losses have been most severe this cycle for banks across the country.

($M)                                                                2002               2009              

Reserves/non multi-family loans                     4.3%               1.9%              

Construction Loans/Reserves                        288%              524%                         

How do we think NYC office building, NYC retail space and NYC spec housing prices are doing right now vs. when NYB originated its CRE and construction book over the last few years?

6) The multi-family book is also at risk -   Even NYB management admits they have some bad loans made to traditional clients who bought multi-family properties outside of NYC in NJ, PA, MD, etc. What % of multi-family loans is outside of NYC? Hmmm - it was actually 24.5% or more than $4B at the end of 2008. We don't know what it was in 12/02 (it was not broken out back then) but we know it has been increasing over time. The oldest data I can get is from 2004 when non-NYC multi-family loans were 21.5% of the total.

NYB management admits that prices and lending terms got crazy and irrational after 2005 in the multi-family space. Of course, they didn't make any of the bad loans, but don't distressed sales bring down the value of all the buildings in the market? NYB talks a lot about the low average LTV in its loan portfolio. But of course, we have all learned it is the tails that generate the losses. What's the tail look like in the multi-family portfolio? How many $B of the $17B total are +80% LTV? 90% LTV? NYB won't say.

So while NYB present themselves as being primarily a lender to 'safe' New York City rent controlled buildings the actuality is that 45% of NYB's legacy loan book is not New York City multi-family loans.

7) Even some of the NYC multi-family loans are starting to look weak. -  But hold on, if NYB only has good multi-family loans in NYC why have many of these credits gone Non-accrual in the last year? We don't get much data on individual loans of course, but a little bit has leaked out to the press:

            - How about the Pinnacle portfolio: http://therealdeal.com/newyork/articles/pinnacle-portfolios-pulled-from-broker-site

                        and,  http://www.norwoodnews.org/story/?id=1394 (when we asked NYB's  CFO about Pinnacle he became very defensive and yelled out - 'they are all performing'. Our phone conversation ended soon after this...

-          How is it that NYB would have you think that their loans are all to 'old families' that have been in the business for generations and have massive capital reserves but now we read NYB has  lent out a bundle to a private equity fund? How many other loans are to private equity funds? We don't know and NYB isn't saying

And there is strain in New Jersey as well:

http://www.mycentraljersey.com/article/20100226/NEWS/2260333/Connolly-Properties-to-auction-off-apartment-properties

-          And how much 'extend and pretend' is going on here? http://therealdeal.com/newyork/articles/world-product-centre-backs-out-of-gary-barnett-and-extell-development-proposed-555-west-34th-street-skyscraper-west-side-rail-yards

Note the final line of this article, "Extell's interest-only $60 million mortgage on the site is due at the beginning of July to New York Community Bank, but that deadline could be extended, according to the Post." Is this $60M loan even in the $110M of C&D NPA/NPL totals? What's NYB's total loan reserve - oh right, $127M.

So, to conclude on these several points - NYB is clearly taking a lot of chances that its loan book won't keep deteriorating and that the non accrual assets won't lead to charge-offs. This seems an increasingly risky course especially in the face of a continued weak economy in the New York City area with pressure on local employment levels, massive public finance problems, and generally lower real estate prices vs. a few years ago.

8) Amtrust was a great deal but - NYB stock has soared on this deal not only because it was accretive, but also because it took investors' eyes off the deteriorating loan and reserves situation. But the stock is now up almost 50% since the deal was announced late last year and no one seems to be considering the potential operational risk of a local savings bank located in Long Island now in charge of branches located in Cleveland, Florida and Arizona and managed day-to-day by the same people who blew up Amtrust in the first place. NYB claims that it is interested in additional FDIC-assisted deals in New York or in its new Amtrust footprints. However, there are few other troubled banks of similar size to Amtrust in these areas that are likely to come up for bid. Also competition for deals has heated up. Note that there were two banks closed last weekend by the FDIC in Manhattan and NYB did not win either of them (Valley National was the winning bidder).

9) The Sell-side is all bulled-up on NYB - Not only does the sell-side trumpet that NYB may get some other FDIC-assisted deals (without being able to point to any actual troubled banks in NYB geographies that could move the needle), but they are completely sanguine regarding the bank's asset quality despite the massively lower levels of reserves/loans and reserves/NPAs compared to almost all other 'healthy' banks in the US today. Of the 16 analysts with ratings on the stock, 7 are 'Buys', 10 are 'Holds' and only 1 is a 'Sell' (this last rating is from the poor drone at Sterne Agee who downgraded the stock when it was $10 in February of 2009).

10) Lots of Retail ownership due to 'Buys' and aggressive Dividend - More than 30% of NYB is held in the retail channel which is not surprising as there are 'Buys' on the stock from retail channel Sell-siders such as Citi, Raymond James, Stifel, and Morgan Stanley. Also, NYB pays out close to 100% of earnings as dividends which is fine, as long as the company doesn't need to significantly top up reserves...

11) NYB looks out of step with its peers - NYB can claim that its NYC multi-family loans just don't generate losses so it doesn't need reserve levels similar to other banks. However, there is a pretty interesting peer of NYB in Dime Community (DCOM) which also concentrates on making multi-family loans in New York City. The latter bank has been much more conservative than NYB and only grown by 50% since 2002 vs. NYB's faster balance sheet expansion. It seems that DCOM got the memo that there is a credit cycle going on and has built reserves despite a much less troubled loan book:

                                    NYB                DCOM

Reserves/Loans        0.55%             0.72%

NPAs/Loans              2.54%             0.33%

12) So let's size the problem here. NYB earned $144M pretax on an operating basis in 4Q09 with a loan provision expense of $30M. The Sell-side expects about $190M per quarter in 2010 with a $20M quarterly provision and a stable Reserve/Loan ratio.

Now if we assume that NYB has to build its Reserves/Loan ratio to 1% it would need to spend an additional $117M in provision expense. Hey - $117M is only a 15% hit to EPS. True, but is a 1% reserve enough? The average commercial bank in the US now has Reserve/Loans in the 2-4% range. Look at some other 'healthy' banks thought to have good asset quality:

WFC - at 3.1% Reserves/Loans (remember the WB option ARM loans were marked down on the acquisition

PNC - 3.1%

JPM - 5% (ok - they have lots of credit cards so it isn't a good comp)

BBT - 2.5% (really higher if you strip out the CNB covered loans)

USB - 2.6%

So, what if NYB had to build its reserves to a whopping 1.5% of loans? That would mean an additional $230M in provision which would reduce profits by 30% and put the dividend payout well over 100%. To put this in context, at a 1.5% Reserve/Loan ratio NYB's reserves would equal a 40% coverage of 12/31/09 non-covered problem assets at the bank ($351M/$866M).

And problem assets have been growing quickly. Why are they going to stop rising now? They have yet to peak at other banks around the nation. NPA's grew more than 30% linked quarter 3Q09-4Q09. Past-due 30-89 day loans grew at an even faster rate in the last quarter of last year. What if problem assets keep growing at the same (or even a higher) rate?

12) Where's the upside? - So even if I'm wrong and problem loan levels drop and there are no losses and no need to increase reserves - what is the upside for the stock?

NYB is more expensive on a P/Book ratio than the supposedly cult stock JPM (1.4X vs. 1.1X) despite the latter's race to build up 'fortress' reserves. On a Price/Tangible Book this difference is even more pronounced (2.2X vs. 1.6X) Even with a supposedly credit-cycle depressed level of profitability and excess capital, JPM's ROE is expected to be very similar to NYB's in 2010 and 2011. NYB

NYB is also more expensive on a consensus P/E basis than DCOM which appears to have already built prudent reserves (13.4X vs. 12.3X for 2010 and 11.8X vs. 11.1X for 2011).

Conclusion - NYB is expensive, needs to cut its dividend and use the cash to build reserves. Problem assets have been growing quickly and will likely continue to do so over the next few quarters. The Sell-Side is overly enthusiastic on the name and can only get more pessimistic over time. The chances of another large FDIC-assisted deal is low and the legacy loan book is now close to 50% non-NYC multi-family loans which stands in stark contrast to the image most investors have of the company.

Regards, Grumpy

-

Catalyst

- Rising provision expense

- Rising problem loans

- Potential dividend cut

- Lack of expected accretive acquisitions