When the Federal Reserve dropped its benchmark federal funds rate from 2% to practically zero last March, most banks prepared for a significant drop in the interest income they would receive on loans, as many of their current assets repriced down with the Fed's move. But a small portion of banks actually benefited from this large rate decrease in 2020, and will continue to do so in 2021.
New York Community Bancorp (NYSE:NYCB) is one of those banks that are positioned for a nice year. And with a new CEO, it may now be in a position to shift its long-term strategy to address some of its long-standing deficiencies.
A liability-sensitive bank
Banks are sensitive to movements in interest rates, meaning their business is directly affected by how the Federal Reserve moves the federal funds rate. Beyond that, banks can be either asset-sensitive or liability-sensitive. If a bank is asset-sensitive, that means more of its interest-earning assets, such as loans, will reprice when rates change than its interest-bearing liabilities, such as deposits. Liability-sensitive banks are the opposite. Therefore, asset-sensitive banks benefit from rising interest rates, while liability-sensitive banks benefit from falling interest rates.
The $53 billion asset New York Community Bancorp is a liability-sensitive bank, specifically because of its model as a leader in non-luxury, multifamily loans in New York City. Nearly three-quarters of the bank's loan book is in multifamily lending. Most of these loans are fixed-rate, meaning they are locked in at a specific interest rate and therefore don't reprice with the federal funds rate.
On the other end of the equation, multifamily lending doesn't bring in a lot of core deposits. So the bank has to resort to higher-cost and more rate-sensitive sources of funding, such as certificates of deposits, savings, and money market accounts, as well as borrowed funds. When the federal funds rate declines, the cost of these funds declines. Ultimately, that's why a drop in interest rates benefits New York Community Bank -- the cost of deposits reprices down, while the yield on many of the bank's loans holds up, widening the bank's profit margin, or net interest margin, on its total loan book.
Strong earnings in 2021
Net income through the first three quarters of 2020 grew 9% at New York Community Bancorp, compared to the first three months of 2019. Net interest income was up 11% and the net interest margin grew 30 basis points (0.30 percentage points) over the last year to 2.29% at the end of the third quarter. And the bank's management team believes there is more room to improve in 2021.
As a result of the Fed dropping interest rates, New York Community Bancorp saw its average cost of deposits fall to 0.85% at the end of the third quarter of 2020. Former President and CEO Joseph Ficalora said that during the Fed's last easing cycle, the bank's cost of deposits dropped to 0.54%, and Ficalora thinks the bank can get its cost of deposits below that level this time around. Between September 2020 and September 2021, New York Community Bancorp has a total of $19.5 billion of deposits and borrowed funds that will mature and reprice down or get replaced by lower-cost sources of funding to keep decreasing the bank's cost of deposits and cost of funds.
At the same time, New York Community Bancorp also grew total loan volume at the bank by 1% between the second and third quarter of 2020, and 5% year over year in the third quarter, driven by multi-family lending and specialty finance. The yields on these new loans seem to be holding up, with the average yield of the bank's loan book at 3.60% at the end of the third quarter. The bank expects double-digit percentage earnings-per-share growth in 2021.
New York Community Bancorp also has spectacular credit quality. New York City was one of the hardest-hit places early on in the coronavirus pandemic, and many investors worried about the multifamily sector. But the bank has seen virtually no loans sour; very few borrowers are missing payments, and loan deferrals have come down as well.
A change in management
Very recently, New York Community Bancorp announced that Ficalora would abruptly retire after 55 years at the bank and its predecessor bank. Ficalora has done a lot for the bank and is credited for growing it from $1 billion in assets in 1993 to roughly $55 billion in assets now.
But the bank's stock price has struggled to perform. It's down significantly over the last decade, even if you look at the stock price prior to the pandemic. The problem with New York Community Bancorp's business model is that because it's liability-sensitive, and its deposit base and funding sources benefit so much from lower interest rates that the bank gets hit hard when interest rates rise. Since stocks are traded based on their future potential, that scenario is always a threat to some degree. One of the primary characteristics that bank investors look for is a low-cost deposit base that can remain sticky when interest rates rise, and New York Community Bancorp has never had anything close to that.
New York Community Bancorp's board appointed CFO Thomas Cangemi as the new president and CEO. While Cangemi has been at the bank a long time, he is also a lot younger than Ficalora and may be more willing to change the structure of the bank's deposit base and also further diversify its revenue streams.
A good year lies ahead
From a profitability standpoint, a good year lies ahead for New York Community Bancorp as the bank takes advantage of the low-rate environment to reprice deposits down, and grow loans at stable yields. The Fed is also not expected to move interest rates to 2023 at the very earliest, which is another plus for the bank. It will be important to watch what moves, if any, Cangemi makes as it relates to the bank's business model for the long term, but 2021 should be a nice year regardless.