In the banking industry, consolidation has been the name of the game in the wake of the financial crisis.
With the exception of Citigroup (NYSE:C), the so-called "too big to fail" banks all grew considerably after the crisis began. JPMorgan Chase (NYSE: JPM) devoured the investment bank Bear Stearns and the largest savings and loan association in the country, Washington Mutual. Wells Fargo (NYSE:WFC) paid pennies on the dollar for the nation's fourth largest bank holding company, Wachovia. And Bank of America (NYSE:BAC) shackled itself to Merrill Lynch's thundering herd and the subprime-mortgage originator-cum-shady enterprise Countrywide Financial.
What's much less understood are the similarly transformative changes that have occurred at the regional level.
A brave new regional world
It's no exaggeration to say that a bank analyst from 10 years ago would hardly recognize the industry today. Capital One (NYSE: COF) remade itself completely, evolving from a one-dimensional credit card issuer into the nation's fifth largest bank by deposits. PNC Financial (NYSE: PNC) more than doubled its size by acquiring National City Bank. And M&T Bank (NYSE: MTB) recently struck a blockbuster deal for Hudson City Bancorp, one of the largest mortgage originators in the New York City metropolitan area.
It's in this push for consolidation that we find significant opportunity for New York Community Bancorp (NYSE:NYCB).
The New York lender is following suit in a calculated and conservative manner. As opposed to paying a premium for acquisitions, and thereby saddling its balance sheet with intangible assets, it's chosen instead to assume the assets and liabilities of failed institutions from the FDIC.
Its most notable deal was the 2009 acquisition of Cleveland-based AmTrust Bank, one of the nation's 100 largest lenders, with assets of $12 billion. According to a news account announcing the transaction (emphasis added): "New York Community Bank, one of the nation's 25 largest banks and one of its strongest, paid nothing to take over AmTrust's $8 billion in deposits." In this way, New York Community Bank has quietly but responsibly grown its balance sheet over the past five years from $30 billion in assets at the end of 2007 to $44 billion today.
To grow or not to grow?
Given its current size, New York Community Bancorp now stands poised at a precipice. If it chooses to grow larger, it could incur the added regulatory burdens of being a systematically important financial institution, which kick in at the $50 billion threshold. These include higher capital requirements, annual stress tests, and the subjugation of autonomy over decisions affecting capital allocation such as dividend payouts and share buybacks. Yet if it chooses to remain the same size, its acquisitive competitors will ultimately dwarf it in both absolute bulk and market share.
Initially, it's hard to deny that these two options resemble a Morton's Fork -- that is, a choice between two equally unpleasant alternatives. But in reality, nothing could be further from the truth. Because it relies on warehouse loans to finance a large portion of its operations, New York Community Bank's cost of funds is uncharacteristically high, and its pivotal net interest margin is thus woefully low. In the most recent quarter, for example, its cost of funds came in at 1.8%. To give you some context, BB&T's (NYSE: BBT) was 0.78%, M&T Bank's was 0.71%, and US Bancorp's (NYSE:USB) was 0.88%. What New York Community Bank needs are deposits, and the easiest way to acquire them is through a large-scale acquisition.
With this in mind, on a 2012 earnings conference call, longtime CEO Joseph Ficalora telegraphed two critical points. The first is that the bank is indeed preparing for the heightened regulatory scrutiny that will accompany growth.
"I think the reality is that this is an environment that necessitates a great deal of preliminary work in preparing for the crossover of a $50 billion plateau that changes regulatory requirements," Ficalora noted. "So we're doing a lot of work to be prepared to be bigger than $50 billion. And as you might imagine, there's money and people and external experts that are used for that purpose. So that is where our concentration is on being prepared, so as to take advantage of the opportunities that may arise."
Once the proper regulatory preparations are in place, Ficalora doesn't seem gun-shy about the idea of doing a sizable deal as opposed to a collection of smaller ones. In other words, it's not so much a question of if New York Community Bank will do a deal aimed prudently at driving down its cost of funds, but rather when it will do so, and how much it will cost. And therein lies the bank's biggest opportunity.