New York Bancorp: Biggest Draw May Be Biggest Near Term Risk

| About: New York (NYCB)
New York Community Bancorp (NYSE:NYB) July 30, 2009: $10.80
52-week range: $7.68 (Mar. 9, 2009) - $22.00 (Sep. 19, 2008)
Dividend = $0.25 quarterly = 9.26% current yield

NYB is a multi-bank holding company operating about 180 branches throughout New York City, its surrounding suburbs and New Jersey. They serve both individuals and commercial enterprises.

Earnings held up much better for NYB than for most banking institutions during last year’s credit melt-down. Earnings from continuing operations dropped from $0.90 to $0.83 and book value only dipped by 5.34%.

Year-over-year comparisons turned positive in the December quarter and remained so in both the March and June interim reporting periods.

NYB reported Q2 Wednesday with non-GAAP earnings of $0.26 versus $0.14 from 2008’s comparable quarter. An announcement that NYB would issue common shares in exchange for existing equity derivative securities sent the shares down on Wednesday before they rebounded with the market to $10.80 at Thursday’s close.

The biggest draw for investors is perhaps the biggest risk in the near term. NYB has been paying twenty-five cent quarterly dividends since 2005. Earnings in 2002 – 2005 handily exceeded that level while Thursday’s payout ratio is about 94% of the expected 2009 EPS of $1.06. The current yield of 9.26% is an obvious lure for present day shareholders. If the dividend were cut, these shares might take a near term hit as ‘income investors’ sell out.

The management seems committed to the current rate but it is not a given that it can be maintained. Zacks sees 2009 and 2010 earnings coming in at $1.06 and $1.18 making the multiple on NYB about 10.2x this year’s and 9.2x next year’s estimate.

Morningstar rates NYB 4-Stars (out of 5) and lists 'Fair Value' as $14 /share.
Value Line's 3 - 5 year target price range is $20 - $30 /share.

Here’s a way to play NYB that leaves room for good returns while mitigating much of the risk involved.

......................................................... Cash Outlay .......... Cash Inflow
Buy 1000 NYB @$10.80 ..................... $10,800
Sell 10 Jan. 2011 $10 calls @$1.70 .................................. $1,700
Sell 10 Jan. 2011 $10 puts @$2.10 ................................... $2,100
Net Cash Out-of-Pocket ....................... $7,000

If New York Community is above $10 on Jan. 21, 2011:

• The $10 calls will be exercised.
• You will sell your shares for $10,000.
• The $10 puts will expire worthless.
• You will have collected $1500 in dividends (if current rates hold).
• You will have no further option obligations.
• You will hold no shares and $11,500 in cash.

That’s a best-case scenario net total return of

$4,500 / $7,000 = 64.2%

achieved in about 17.5 months on shares that:

Went up.
Stayed unchanged.
Dropped by up to 7.4% from the starting price.

What’s the risk?

If New York Community is below $10 on Jan. 21, 2011:

• The $10 calls will expire worthless.
• The $10 puts will be exercised.
• You will be forced to buy another 1000 shares of NYB.
• You will need to lay out an additional $10,000 in cash.
• You will likely have collected $1,500 in dividends.
• You will have no further option obligations.
• You will end up with 2000 shares of NYB and $1,500 cash.

What’s the break-even on the whole trade?

On the first 1000 shares it’s their $10.80 purchase price
less the $1.70 /share call premium = $9.10 /share.

On the ‘put’ shares it’s the $10 strike price less
the $2.10 /share put premium = $7.90 /share.

Your net break-even would average $8.50 /share (excluding dividends)
and $7.75 /share (including yield at the current payout).

Unless the dividend rate is reduced, NYB shares could fall by up
to 28.2% without causing a loss on this trade.

Disclosure: Author is long NYB shares and short NYB options.