A Straightforward Analysis of New York Community Bancorp's 2Q Earnings

New York Community Bancorp (NYCB 0.17%) reported higher second-quarter earnings on Wednesday, fueled by increased noninterest income from the sale of previously repossessed real estate, and a recovery of funds formerly set aside to cover loan losses.

For the three months ended June 30, the New York-based bank earned $123.7 million, or $0.28 per share, compared to $118.7 million, or $0.27 per share, in the year-ago period.

Source: New York Community Bancorp's 2Q'15 Earnings Release.

As you can see in the table above, New York Community Bancorp's earnings rose on the back of higher revenue relative to operating expenses and net loan loss provisions.

The lion's share of its revenue boost came from a $7.8 million gain on the sale of a multi-family building owned by the bank since the underlying mortgage defaulted in or around 2013. Coupled with a $1.8 million boost from income received under a loss-sharing agreement with the FDIC, New York Community Bancorp's noninterest income rose by $9.3 million, or 17.7%, on a year-over-year basis.

The bank also managed to eke out a slight increase in the amount of money it generates from its asset portfolio. Net interest income for the quarter rose by $1.6 million, or 0.6%, compared to the second quarter of 2014.

While lower interest rates weighed on New York Community Bancorp's net interest margin, which measures how much a bank makes from reinvesting borrowed money into interest-earning assets, the income from its asset portfolio nevertheless rose on the back of higher prepayment fees.

These fees are a central component of New York Community Bancorp's business model. The bank embeds them in loan contracts with the owners of large, rent-controlled multifamily buildings in the New York City metropolitan area. The fees allow it to offset the natural tendency of borrowers to refinance their loans when rates fall.

On the expense side, higher compensation and occupancy costs led to a $4.1 million, or 2.8%, increase in operating expenditures. Critically, however, New York Community Bancorp kept its efficiency ratio -- which measures the percent of net revenue consumed by expenses -- roughly even with the year-ago period, at 43.4%.

The significance of the efficiency ratio can't be overstated. Not only does a lower ratio mean that more revenue can fall to the bottom line, it also seems to influence a lender's underwriting discipline. In short, a less efficient bank is inclined to offset its higher expense base by reaching for yield in its asset portfolio. This, in turn, corresponds to riskier investments that default at a higher rate when the credit cycle takes a turn for the worse.

But all of this is much ado about nothing for New York Community Bancorp. Due to its focus on fewer but bigger borrowers, as opposed to more but smaller loans, it has one of the best efficiency ratios in the industry. Generally speaking, a figure in the 50% to 60% range is the target (lower is better). New York Community Bancorp's comes in well below that, as noted above.

The bank also saw a material increase in its loan loss provisions. It set aside $2.2 million in the latest quarter compared to only $188,000 last year. This was partially offset by a $1.9 million release from previously established reserves. The bank recorded a corresponding $1.8 million in additional noninterest income stemming from funds received under a loss-sharing agreement with the FDIC that was entered into, presumably, when New York Community Bancorp purchased two ailing consumer lenders in the wake of the financial crisis.

A final point to keep in mind is that New York Community Bancorp is purposely holding the line on asset growth for the time being -- which, all else being equal, translates into slower year-over-year earnings growth. With $48.7 billion in total assets, it's on the verge of exceeding the $50 billion threshold associated with systematically important financial institutions, or SIFIs.

While the bank has been preparing to cross the SIFI threshold for years, its long-stated preference is to do so by way of a large, transformative merger. This follows from the fact that a SIFI designation translates into elevated regulatory and compliance costs, as well as the Federal Reserve's direct influence on capital allocation decisions.

It's accordingly in New York Community Bancorp's best interest to offset the detriments of being classified as a SIFI with the benefits that come with scale. Thus, shareholders shouldn't be surprised to learn in the foreseeable future that the bank is either merging with, or acquiring a sizable financial firm -- and presumably, one with a large amount of inexpensive consumer deposits to help drive down New York Community Bancorp's atypically high cost of funds.

But either way, current shareholders in New York Community Bancorp can rest easy knowing that it continues to be one of the best-positioned banks to safely generate a respectable rate of return for years to come.