There are risks in owning any public company, and to combat them, start by knowing about them. Our premium research reports break down the risks for key banks in the industry; this is an excerpt from our report on New York Community Bancorp (NYCB 0.49%).
Interest rate risk
Unquestionably the biggest risk confronting New York Community Bancorp is interest rate risk -- the risk that the spread between high long-term interest rates and low short-term rates will contract or invert entirely. Over the last two years, the Federal Reserve hasn't concealed the fact that it's intent on driving down long-term interest rates to spur lending and spark a more robust economic recovery. Because short-term rates are already near zero, however, any downward pressure on long-term rates necessarily compresses the spread that most banks rely on to make money. Since the fourth quarter of 2010, for example, the difference in rates between the 2-year and 10-year Treasuries has compressed by a staggering 44%.
At first blush, you'd be excused for concluding that this isn't a big issue for New York Community Bank. In the most recent quarter, its net interest margin -- an institution-specific, weighted average of the interest rate spread -- officially weighed in at 3.17%. While this is worse than some of its peers, which reported NIMs of 3.5% to 3.9%, it's still better than the typical rate at other large banks. According to a recent study cited in the Wall Street Journal, the average margin for these institutions is 3.12%, or five basis points less than New York Community Bank.
Yet there are two factors that actually make it more of a concern for New York Community Bank than for many others in the industry. First, because it doesn't have an investment bank like JPMorgan Chase (JPM 0.10%) or Bank of America (BAC -1.14%), it relies on net interest alone for the lion's shares, or roughly 80%, of its overall revenue. And second, a staggering 35 basis points of New York Community Bank's current NIM derives from elevated prepayment penalties associated with the ongoing refinancing boon. When this tails off, New York Community Bank's NIM will too, along with its revenue, earnings, and ability to fund its generous dividend payouts.
Regulatory risk
The second risk that New York Community Bank faces is regulatory risk. For better or worse, the legal and regulatory landscape has changed dramatically over the last five years. To name only the most commonly cited examples of this: Banks are no longer allowed to charge overdraft fees for debit card transactions unless customers opt-in to overdraft service, the lucrative interchange fees on debit card transactions that banks used to line their pockets are now severely curtailed, and new regulatory guidance this past quarter obliged banks to charge-off loans associated with borrowers who filed for Chapter 7 bankruptcy protection -- regardless of whether or not they're up to date on their mortgage payments.
This burden is particularly robust for New York Community Bank. As I discussed above, it's on the verge of crossing the $50 billion threshold that will make it a systematically important financial institution. Along with this designation comes a multitude of additional regulatory burdens, including heightened capital requirements, annual stress tests, and the obligation to file capital allocation plans that can be approved or denied by the regulators as they see fit. While none of these will spell the end to New York Community Bank's success, the cumulative effect could very well dampen its return on equity.
