Description

I believe New York Community Bancorp (NYCB) stock is an attractive risk-reward with ~15% downside and ~90% upside over the next 2-3 years. NYCB’s well-publicized issues with credit and regulators has led to a 65% YTD decline in the share price. I believe NYCB has fallen off the radar screens of many investors who haven’t recognized that a capable new management team has shored up capital/reserves and put NYCB in a good position to benefit from recent declines in interest rates.

Note ad17 did a good job writing up NYCB’s $25 par preferred in August, and I’d recommend reading that as background. I haven’t rehashed a lot of the details provided in that write-up, but rather chosen to offer my perspective on the common stock.

For three decades, NYCB was led by CEO Joe Ficalora who focused NYBC on gathering deposits and making multifamily loans in the NYC metro area (including periodic in-market acquisitions of similar banks). From 2012 to Q3 22, NYCB grew its balance sheet at a modest 4% CAGR. In the 10 years ended 2022 NYCB had a respectable average ROTE of 13% driven by an average 2.6% NIM and low charge-offs (average 0.07% of loans). While it had a respectable financial profile, NYCB’s geographic and real estate concentration were strategic issues. Prior to the Flagstar acquisition (which I will touch on below), NYCB had ~75% of its deposits from the NYC metro area and ~75% of its loan book in multifamily real estate loans.

After former CFO Thomas Cangemi took over as CEO starting in 2021, NYCB embarked on an acquisition-driven strategy designed to diversify the bank. The first large acquisition was Flagstar, which was announced 4 months after the CEO change and closed in Q4 22. Flagstar added branches in MI, OH, IN, WI and CA as well as the nation’s 6^th largest residential mortgage originator/servicer. This acquisition was favorably received by analysts due to its diversification benefits and accretion to EPS and TBV/share. Only one quarter after closing on Flagstar, NYBC struck a deal to buy certain assets of the failed Signature Bank from the FDIC. NYCB purchased $38bn of assets including $13bn of C&I loans (at a $2.7bn discount) and $25bn of cash while assuming $36bn of liabilities, $34bn of which were deposits. The acquisition announcement touted the acquisition as +20% accretive to earnings per share and +15% accretive to tangible book value. These two acquisitions increased NYCB’s total assets from $63bn in Q3 22 to $124bn in Q1 23. Analyst cheered the accretive nature of the Signature acquisition and sent NYCB’s stock price to $42/share in July 2023.

While NYCB was aggressively growing its balance sheet, there were two large and growing headwinds in NYCB’s multifamily loan portfolio. In June 2019, New York’s legislature passed limits on rent increases on rent-stabilized apartments. The new rental restrictions ruined the business model of buying NYC rent-stabilized apartments, investing money into the units and then raising rental rates. In addition, the rapid increase in Fed Fund rates from Q1 22 through Q3 23 pressured real estate owners, particularly those who financed purchases at low rates and faced rate resets at higher rates.

When NYCB reported Q4 23 earnings on 1/31/24, their aggressive balance sheet growth collided with the growing pressures on real estate loans. NYCB shocked the market with a trifecta of regulatory uncertainty, higher credit losses, and dividend/earnings cut, sending the stock down -38% on the day. Because NYCB had grown its balance sheet above $100bn, it suddenly became a “Category IV” bank in the eyes of Federal regulators, subjecting it to increased standards for capital, liquidity and risk management. The same analysts who had cheered on the diversification strategy rushed to downgrade their stock ratings. NYCB’s downward spiral continued with a Moody’s downgrade on 2/6/24 and rumors/fears of deposit outflows. Capitulation occurred on 3/1/24 when NYCB kicked out CEO Cangemi and delayed its 10-K filing, citing material weaknesses in loan reviews due to ineffective risk oversight and assessment. NYCB’s stock plunged a further -43% in the ensuing 2 trading days as it became clear that NYCB had grown too quickly given its inadequate management capabilities and risk controls.

On 3/7/24, NYCB announced a $1.05bn equity raise led by Steven Mnuchin’s Liberty Strategic Capital. The investor group installed a new CEO, Joseph Otting, and took four board seats –Mnuchin, Otting, Milton Berlinski and Allen Puwalski. For those who are not familiar with these names, these are experienced distressed bank investors who are very connected to regulators. Mnuchin and Otting led the purchase of insolvent IndyMac Bank from the FDIC in 2009 for $1.4bn, turned it around, renamed it OneWest Bank and sold it to CIT for $3.4bn in 2015. Subsequently, Mnuchin was appointed Secretary of the Treasury and Otting was named Comptroller of the Currency (the primary Federal regulator of banks) by President Trump in 2017. Berlinski is a former Goldman Sachs partner who founded the Financial Institutions Group and Puwalski is a former FDIC bank investigator who worked for John Paulson analyzing the financial sector during the GFC. CEO Otting has a strong operational background and is the key management figure leading the turnaround. He was formerly at Union Bank and U.S. Bancorp where he was head of the commercial banking group before becoming the CEO of OneWest Bank in 2010.

Since Otting took over as CEO in March, he has accomplished a lot. NYCB has replaced almost the entire senior management team. In addition, they have stabilized the deposit base, increased balance sheet liquidity and announced sales of non-core assets which increased NYCB’s pro forma CET1 ratio to 11.2% (from 9.2% as of Q4 23 and above the 10.6% average for Category IV banks). NYCB has established a plan to reduce real estate lending and grow C&I lending by hiring capable commercial banking leaders. As of Q2 24, they have done thorough reviews of 75% of NYCB’s multifamily and commercial real estate loans to establish proper credit reserves. The remaining 25% are small balance, lower risk loans, and I expect they have completed their review of this 25% during Q3 24. I’ve been looking at financial companies for longer than I care to admit, and fully realize that there is a “black box” risk as public market investors assess bank loan loss reserves. Thus, what I’m focused more on in this case is management credibility and incentives in establishing these reserves. For the reasons outlined above, I believe the new management team is very credible, and I also believe they were incentivized “scrub” the loan book and establish adequate reserves.

In NYCB’s $2.8bn office portfolio, management has scrubbed 82% of the loan balance and have charged off or reserved for 16.5% these loans. For the larger $33.9bn multifamily portfolio, they have reviewed 80% of the loan balance. NYCB has said their multifamily loans were originated at 50-60% LTVs, so even if one assumes a draconian 30% declines in value, the multifamily portfolio is at 70-85% “mark-to-market” LTVs. However, what matters a lot more for bank credit analysis is individual problem loans, as averages can be misleading. While we don’t have granular loan information, we do have insight into how management is conducting their loan reviews, as this procedure is detailed in the Q2 24 10-Q:

The Company receives financial information from borrowers annually, and most of the financial information is received in the second calendar quarter. At June 30, 2024, the Company had received updated financial information on approximately 80 percent of the multi-family loan portfolio. Upon receipt of updated borrower financial information, we perform an analysis to determine whether the cash flow from the underlying collateral is sufficient to meet the contractual loan payments, commonly referred to as the debt service coverage ratio. We consider the ability to cover debt service based upon the current contractual rate, or where a borrower’s initial fixed rate period expires within 18 months, the lowest contractual rate reset option available under the loan terms using the current level for referenced indices. Loans for which the collateral does not have a debt service coverage ratio of 1.0 or higher under this analysis are rated substandard. We order appraisals for all substandard loans. Where an appraisal does not support recovery of the loan carrying amount for collateral-dependent loans, we classify the loan as non-accrual, regardless of payment status, and charge the loan down to its recoverable amount.

Most of NYCB’s real estate loans have fixed interest rates for 5 years, which then reset to an adjustable rate tied to SOFR. As disclosed in NYCB’s Q2 24 presentation, in the 18 months from Q1 22 to Q2 24, NYCB $2.9bn rent-regulated multifamily loans reset and average rates increased from 3.85% to 8.19% at the time of repricing. As of Q2 24, NYCB had $2.0bn multifamily loans repricing in 2H 24, and $5.0bn and $5.1bn repricing in 2025 and 2026, respectively. Quoting again from the Q2 24 10-Q:

Market interest rates remain persistently high which will put pressure on the ability for certain borrowers with interest rates resetting at current levels to cover debt service. When combined with inflationary pressure on operating costs and limits on the ability to increase rental rates, debt service levels may approach or exceed some properties' net operating income, which increases the risk of loss. We believe that higher interest rates for a longer period of time will have a more significant impact on our loans that will reprice during the next 18 months. Therefore, we have incorporated a higher probability of default related to those loans as they approach their scheduled repricing date in the measurement of our allowance for credit losses.

Management’s loan reviews were done in Q2 when interest rates were higher than today. The subsequent decrease in interest rates gives me incremental comfort on the loan loss reserves as borrower interest burdens are reduced and opportunities to refinance/repay have increased. First, lower rates and greater financing availability should bolster the appraised value of real estate collateral. Second, lower short-term interest rates will help borrower DSCR coverage. In the last quarter, SOFR/Fed Funds rates have fallen 50bps and the market is expecting a further ~175bps of reductions over the next 12 months. The multifamily rates that were resetting at 8.19% are now resetting at ~7.7% and could be resetting at ~6% a year from now. Therefore, the number of borrowers who will see reset DSCRs fall below 1.0 should decline with short-term interest rates. Finally, the declines at the 5-year portion of the interest rate curve (from ~4.4% to ~3.5%) are arguably even more important to NYCB’s credit outlook. Unlike other types of commercial real estate, multifamily loans are eligible for agency (i.e. Fannie/Freddie) financing. At current interest rates, agency multifamily loans are available at 5.0-5.5%. I have talked to multifamily lenders who are seeing large increases in agency refinancing activity over the last couple of months. Thus, I believe many of NYCB’s rent-controlled multifamily loans will likely get refinanced in the coming quarters which will reduce NYCB’s real estate concentration.

At the current share price of $11, NYCB trades at 0.6x P/TBV. A believe this low multiple of TBV reflects investor concerns over the adequacy of NYCB’s loan loss reserves. However, as the impact of lower interest rates improves NYCB’s credit outlook, I believe the discount to TBV should narrow. After investors gain more comfort on the loan book, NYCB’s value will be driven by long-term earnings power. Management has published longer-term (Q2 27) targets of $2.00-2.10 of EPS, 11.25-11.5% ROTE and $21.00-21.25 TBV/share driven by 2.8-2.9% NIM and 50-55% efficiency ratio. While there are too many moving pieces for me to have high conviction on the line-by-line targets, the overall goal of low double-digit ROTE seems reasonable when looking at other public mid-cap banks. Thus, I am willing to underwrite long-term earnings power of ~$2/share based on low double-digits ROTE on $21+ TBV/share as NYCB diversifies its business model away from real estate loans and more towards C&I lending. The average US mid-cap bank currently trades at 9.5x NTM P/E and 1.5x TBV with a ROTE of ~15%. For NYCB, I am assuming a P/TBV of 1x, leading to a 2 to 3-year price target of $21/share (~90% upside). My downside case is 0.5x current TBV of $18.29, or down ~15% from here.

Catalyst

Lower interest rates reduces risk of real estate loan book

Management continues to exectute on their turnaround plan and shows path to low-double-digit ROTE