Making a successful long-term investment in a quality bank like New York Community Bancorp (NYCB 1.71%) doesn't mean watching every minute-to-minute move on the ticker tape. Instead, your best bet is focusing on the bigger picture and making sure you know what to watch to gauge the bank's future prospects.
Right now, focusing on the bigger picture for NYCB means keeping an eye on these three key areas.
Dividend payout
During the financial crisis, while most banks either suspended or severely curtailed their dividends in response to massive losses, New York Community Bancorp refused to follow suit. Its shares continue to pay a nearly 8% yield, and as the bank's third-quarter earnings release proudly proclaims, it has now maintained a $0.25-per-share payout for 35 consecutive quarters.
But this extremely admirable commitment to returning capital to shareholders cuts both ways, as the bank has arguably paid out more in dividends over the past five years than it should have. The year 2008 serves as a perfect example. It recorded $0.22 per share in net income that year but paid out $1.00 in dividends. That equates to a payout ratio of 455%. If you expand the analysis to include the past five years, its payout ratio improves to 105% -- still unsustainable, but markedly better. And if you look only at the most recent 12 quarters, the ratio reduces to a much more manageable 83%.
These high payouts are a concern for two reasons. First, if New York Community Bank does become a systematically important financial institution, there's every reason to believe that its principal regulator, the Federal Reserve, will force it to retain more capital. The Fed has denied dividend requests by both Citigroup (C 2.02%) and Bank of America (BAC 1.59%) for this very reason over the past few years. Second, it follows that if the bank is required to reduce its payout, there will be an impact on its underlying share price. Make no mistake about it: NYCB is a dividend stock. Excluding the dividend, NYCB's shares have returned a negative 16.6% over the Past decade. With the dividend, however, its total return is a positive 49.2%. It accordingly stands to reason that shareholders should watch for any changes in this regard very closely.
The refinancing bonanza
If you follow the financial news, you probably know it's becoming increasingly difficult for banks to replicate the double-digit returns on equity that they effortlessly recorded before the crisis. Numerous laws and regulations have been implemented over the past few years that both add to a bank's expenses and decrease its revenue. In addition, the Fed is waging an ongoing and all-out assault on the long-term interest rates that lenders rely on for profit. To this end, it initiated Operation Twist at the end of 2011 and then doubled down this past September with QE3.
The one respite for banks has been refinancing activity. As long-term interest rates fall, homeowners and other borrowers have moved to reduce their borrowing costs by locking in the lower rates through refinancing. This drives fee activity at lenders that are positioned to exploit it. In a recent quarter, for instance, the nation's largest mortgage lender, Wells Fargo (WFC 1.36%), originated a staggering $139 billion in mortgages, a full 72% of which derived from refinancings as opposed to first-time home loans.
New York Community Bank has benefited tremendously from this trend. In a recent quarter, prepayment penalties associated with refinancings contributed $31.5 million to interest income and added 34 basis points to its net interest margin. At the same time, however, loans refinanced at lower rates drive down its yield on earning assets and, thus, net interest margin. Consequently, as time goes on, if the former fees drop out, leaving only the lower yield on earning assets, New York Community Bank could struggle to fund its generous dividend payout.
Impending transformative acquisitions
Given its history of acquisitions -- its business model is to grow through takeovers that are accretive to shareholders -- it should be no surprise that the New York-based lender hasn't shied away from this trend. It completed seven bank and thrift takeovers between 2000 and 2007, increasing the size of its balance sheet by roughly $24 billion. Since the financial crisis, moreover, it's purchased two banks from the FDIC with collective assets of roughly $10 billion. Yet none of these in isolation would qualify as transformative to the same extent as, say, PNC Financial's (PNC 0.48%) purchase of National City Bank or M&T Bank's (MTB 1.20%) merger with Hudson City Bancorp (NASDAQ: HCBK).
The benefits that could accrue to New York Community Bank from a big deal are significant. In the first case, it's a buyer's market if you're a trustworthy and well-capitalized lender. And in the second case, as I already mentioned, New York Community Bank needs to decrease its cost of funds, which is high relative to its peers because it relies on wholesale funding as opposed to deposits for a significant portion of its funds. Thus, if it could purchase an ailing lender with a deep deposit base, the deal would almost certainly be accretive to shareholders from day one.
What shareholders need to watch here is that the bank doesn't pay too much and/or saddle itself with costly operations at the same time that it incurs the added regulatory burdens of being a systematically important financial institution.
