Last week I offered up three reasons why investors should consider picking up shares of regional lender New York Community Bancorp
Today, let's take a look at a few reasons why NYB may not be such a hot stock.
1. The growth picture
One particularly attractive aspect of New York Community Bancorp's stock is its whopping 8.2% dividend yield. That's not a misprint, joke, or one-time special payout -- that's the $1-per-year that NYB has been paying out for roughly seven years.
The downside to that though is that while many banks grow though retaining some of their earnings and reinvesting them in new loans and branch growth, NYB is busy paying out substantially all of its earnings to shareholders through that hefty dividend. That means that organic growth isn't really part of NYB's game plan.
Observant investors may notice, though, that NYB's book value rose by 45% between 2006 and 2011. That's because management's focus is on growing the bank through targeted acquisitions. Most recently, the bank has been taking advantage of the fallout from the financial crisis and had made multiple Federal Deposit Insurance Corp. (FDIC)-backed acquisitions. In these savvy deals, NYB gets the deposit base of the acquired bank, but has a pledge from the FDIC to cover the majority of the losses from the bad loans on that bank's book.
The "but" in that strategy, though, is that since NYB doesn't keep dry powder around to make these acquisitions, it needs to raise money for them -- and that's typically through new share sales. This is tricky business, as ill-timed share sales can destroy shareholder value. And, in fact, if we look at the per-share book value of NYB between 2006 and 2011, it grew a scant 1.4%.
So there's a lot to like about an 8.2% dividend yield, but de minimis organic growth and a somewhat risky acquisition strategy may not sit well with some investors.
2. Loan-loss provisions
In the banking business, management doesn't just sit around and wait until loans completely crap out before recognizing their deterioration on the books. Instead, they estimate the likelihood that troubled loans will lead to losses and run that through the income statement.
While I'm all for a management team that's confident, I also like to see management err on the side of conservatism. According to S&P Capital IQ, KeyCorp
New York Community Bancorp, however, only has loan-loss provisions equal to 26% of nonperforming loans. That's not exactly an apples-to-apples comparison with those other banks because of the FDIC-backed acquisitions that NYB made. However, even looking at just the non-FDIC-covered loans, NYB's loan-loss provisions still only cover about 45% of non-performing loans.
That could, of course, prove to be an accurate estimate on the actual losses on the loan book. Or it may prove an optimistic assessment, and if that's the case, the bank will have to increase provisions in the future, which will put a drag on earnings.
3. Better opportunities
There's an opportunity cost to investing in any stock. In exchange for the expected returns from the stock you're investing in, you give up the opportunity to earn more elsewhere.
Because the banking sector has been so beaten down and vilified following the financial crisis, basically every bank listed on U.S. exchanges trades at lower valuation multiples than it did back in 2005 and 2006. This is certainly the case with NYB. In 2006, the stock traded at 1.3 times the bank's book value. Today, it fetches slightly less than book value.
Should investor comfort in banks rebound, we could see NYB regain its valuation from six years ago. But, if that scenario does come to pass, there are bank stocks positioned to have much stronger rallies than NYB. KeyCorp had an average price-to-book of 1.9 in 2006, while today it's 0.7. Regions Financial's price-to-book fell from 1.5 in 2006 to 0.6 today. And at the mega-bank end of the market, Bank of America
In other words, investors looking for the biggest potential gains in the banking sector may prefer to look at more beaten-down names than NYB.
Even if not NYB, is banking where it's at?
Despite the concerns listed above, I think New York Community Bancorp is a good buy at today's prices, and I've backed up that view with an outperform call in my Motley Fool CAPS portfolio.
But even if New York Community Bancorp doesn't strike your fancy, you may not want to overlook the banking sector as a whole. Some of the best investors out there have taken an interest in the sector, and my fellow Fools examined why that is in a recent special report: "The Stocks Only the Smartest Investors Are Buying." You can grab a free copy by clicking here.
