Data by YCharts
"We are in growth mode, we're very focused on growth"
Tom Cangemi - NYCB CFO on Q1 conference call
One amazing thing I can tell you about investing is that even when a company can outline a clearly improving future, if everyone's recent memory is littered with only negatives, it can take years of positives to truly reverse sentiment. For the three years leading up to 2019, New York Community Bancorp (NYCB) has been on the defensive. Net interest margins have been under pressure from a combination of rising interest rates and a liability sensitive balance sheet, and growth was stunted by a Federal Reserve who refused to allow New York Community Bancorp to grow their assets, something that would have been able to offset margin pressures.
This reality has kept earnings under constant pressure for years, and it has left NYCB management with only a few options to support earnings, one of which was to cut costs. While it has gone unnoticed by many observers who solely focus on earnings per share, NYCB management has done a magnificent job of controlling what they could control in order to offset falling margins. Fixed annual expenses have declined by over $160 million since 2017. FTE headcount was reduced by over 20%, and an earnings accretive and cash flow positive debt funded buyback have helped to defend earnings per share throughout a period that saw net interest margins decline by nearly 100 basis points.
This nightmare scenario of trying to operate a bank with your hands mostly tied is finally behind us, earnings per share have bottomed and now have a base with which to grow from, and for those that are paying attention, New York Community Bancorp is officially back in growth mode, a position that most shareholders aren't even familiar with.
Going forward, New York Community Bancorp has a very clear path to doubling earnings from here. Shorts, who have enjoyed being right about the direction of NYCB shares over the past few years, are now in a position where their bear case is dead, and they must either cover or be stuck paying substitute dividends on borrowed shares that amount to almost 10% of NYCB's share count. NYCB owners, however, can sit back, collect a generous dividend, and know that for the first time in five years, New York Community Bancorp, one of the most well run and certainly the safest bank I know of, is back in growth mode.
Historical growth has been remarkable
From the beginning of its life and up until about 2014, growth was all NYCB shareholders knew. We can see this in the slides that the company publishes with their investor presentations.
As we see below, NYCB's historical growth, made during a time when there was no ceiling on their size, allowed the company to grow from zero to $40 billion at an eye popping 25.7% CAGR in their early life. That growth led to massive shareholder returns that today, even after half a decade of no growth, are still strong enough to make most investors envious of early NYCB shareholders.
Thanks to a change in Dodd Frank regulations, May of 2018 marked the moment when NYCB was no longer restrained in its ability to grow. Some shareholders, myself included, instantly turned bullish of NYCB from that moment on, as the company can now get back to what it does best: growing.
Huge earnings growth is just around the corner
For the first time in years, it's quite safe to say that earnings growth is imminent. There are four significant catalysts that give us confidence in this forecast.
Net interest margins have stabilized
The balance sheet is growing
Shares outstanding have been reduced
Non-interest expenses are not going to move up anytime soon
Net interest margins have stabilized and NYCB's balance sheet is growing
NYCB's net interest margin has declined almost 100 basis points since 2016 when the Fed began raising interest rates. It currently sits at just 2.03%, but for the first time in years, we can begin to anticipate increasing margins going forward. Importantly, NYCB management is indicating that total net interest income could begin to rise again as soon as the back half of this year. In addition, over $8 billion of loans that were originated in 2015 will need to refinance between now and 2020, and these loans are priced at least 50 basis points below where today's new originations are pricing. This implies that net interest margins will be improving by next year, which removes a major headwind for both earnings, as well as investor sentiment.
If we want to make a rough estimation of future earnings potential, we can simply multiply NYCB's existing loan book by a normalized NIM and quickly find that NYCB has a massive opportunity to grow earnings simply through the reversion to historical margins. For example, an extra 50 basis points of NIM on the existing $40 billion loan portfolio would add an incremental $200 million of pre-tax income. If the Fed were to cut interest rates going forward (a likely scenario), NIM could expand even more.
New York Community Bancorp is now getting aggressive on growing its balance sheet, and has added $3 billion of assets in just the last five quarters. For those who aren't familiar with the company, New York Community Bancorp was, for about five years leading up to 2018, forced to sell around $1 billion per year of high-quality multi-family loans each year. The fact that these multi-family loans are now being held on the balance sheet, combined with rapid growth coming from the specialty finance division (35% CAGR since 2014) is allowing for total balance sheet growth that could easily bring total assets to $60 billion within a couple of years. By just doing a little simple math, we can estimate the impact of this growth on earnings. For example, adding $10 billion of assets at a 2% NIM gives us $200 million of pre-tax income. At 2.5% NIM, it's $250 million pre-tax.
Between a growing balance sheet and growing margins, one can easily see how an incremental $400-$500 million of pre-tax income could be added in just a couple of years, which would add around $350 million to the bottom line. For comparison's sake, NYCB's net income for 2018 totaled just $422 million.
Shares outstanding have been reduced
Between November and today, NYCB repurchased 23.9 million shares at an average price of just $9.54/share. As a result, shares outstanding have declined by nearly 5%. This reduction in shares was funded with relatively inexpensive debt, and has served to help stabilize earnings per share. More importantly, the reduced share count will have an even larger impact on earnings per share once earnings do begin to rise from the earlier mentioned NII and NIM growth.
Non-interest expenses aren't going to move up anytime soon
I'm sure some of you are thinking that I'm cherry picking the numbers and that I'm excluding rising expenses that would naturally accompany a growing balance sheet. I am basing my numbers off of the current $500 million annual run rate for expenses, and off of the fact that on the most recent conference call, CFO Tom Cangemi said that they hope to hold expenses in the $500 million level even with balance sheet growth into 2020. This is the key here. If NYCB can hold expenses at $500 million, yet grow their balance sheet while increasing net interest margins and do so with fewer shares outstanding, this will be a quadruple win for shareholders, and it all points to an earnings per share level that is nearly double the current level.
A 6.2% dividend that has a greater chance of growing than being cut
For all the criticism surrounding NYCB's dividend, the reality is that the entire time that earnings have been under pressure, management has been reacting to offset these pressures, and earnings per share have remained comfortably above the dividend payout. Now that earnings are bottoming and there is a clear path to growing them significantly, it's not wishful thinking to assume that one day the dividend will actually increase.
To be completely fair, I am not calling for an increase in the dividend, but more just highlighting the fact that it's more likely to be increased than to be reduced. In the meantime, a 6.2% dividend still offers investors a chance to pocket a large amount of cash while they wait for the inevitable earnings growth that will accompany a growing balance sheet and rising net interest margins. And let's not forget that with a 6.2% dividend, NYCB shares need only to rise 4 cents per month on average to give shareholders a double-digit total return going forward.
Another interesting note on New York Community Bancorp's 6.2% dividend is the fact that nearly 10% of NYCB shares have been borrowed and sold short. These shorts are betting that shares will decline, but in the meantime, they are required to pay the dividend to whomever they borrowed shares from. I have a strong feeling that shorts will simply become unwilling to remain short and to continue paying this dividend in the face of growing earnings.
NYCB will grow in a strong economy, and will thrive in a recession
With a steadily growing economy, it's business as usual of course. New York Community Bancorp will continue adding a few billion per year of assets. But given where we are in the cycle, I would expect investors to be considering how their portfolio would react in a recession. For New York Community Bancorp investors, a recession is almost welcomed. It's not that we wish for job losses and asset values to decline, it's just that for NYCB specifically, job losses are unlikely to lead to any loan losses, and the falling interest rates that accompany a recession would be very beneficial to NYCB in the short term as they could immediately reduce interest expenses.
Recessions also bring about great opportunities such as the FDIC brokered AmTrust transaction in 2009, in which New York Community Bancorp was handed the deposits and assets of a failing bank, but with a loss sharing agreement that left the FDIC bearing the losses that arose from any bad loans acquired. These types of deals present themselves more frequently in hard times, and New York Community Bancorp can bid for a company at a fire sale price, acquire a large deposit base, dispose of the newly acquired companies assets, and use the new deposits to fuel further growth in multi-family, as well as specialty finance loans.
NYCB is back in growth mode and investors almost can’t lose here
Even though shares of New York Community Bancorp have had a nice run year to date, they have corrected 12% in the last two months. For investors who are looking for a growth play, NYCB is finally back in growth mode. If you are seeking income, NYCB is there for you with a 6.2% dividend yield. If you are positioning your portfolio with a risk-off mentality, I cannot think of a better risk-off trade than a bank which benefits from interest rate cuts, and thrives in recessions. That's NYCB. You almost can't lose here. It's one of my largest positions, and I'm buying more right here.
Disclosure: I am/we are long NYCB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.