New York Community Bancorp (NYSE:NYCB) is an exceptional bank. But that doesn't mean it's perfect in every respect. Its biggest weakness -- or, as a corollary, its biggest opportunity -- concerns its balance sheet, and specifically its source of funds.
A bank is nothing more than a leveraged fund -- albeit one that's heavily regulated and federally insured. A small sliver of capital is leveraged with borrowed money and then the two are used to purchase income-earning assets.
In this way, the prototypical bank is merely an arbiter of interest rates; its profit derives from the difference between its cost of funds and the yield on its earning assets. The objective is to maximize this so-called spread.
There are two levers that can be pulled on to do so. The first is the yield on earning assets. I'll leave this to the side for the time being, with the exception of mentioning one caveat: yield and risk are positively correlated. As a result, there's a limit to how much a prudent bank can depend on its earning asset yield to maximize its interest rate spread.
Alternatively, a bank could seek to minimize its cost of funds. The benefit to this approach is that it has the same impact on the spread as increasing the yield on earning assets, yet it doesn't carry the same degree of risk. And it's here, in turn, where New York Community Bancorp's biggest weakness lies.
Take a look at the following chart. This compares the New York-based bank's total cost of funds to three other banks: Wells Fargo, US Bancorp, and BB&T. See how much more expensive New York Community Bancorp's liabilities are?
The reason for this is twofold. In the first case, it relies on short- and long-term debt to a much greater degree than any of these competitors. Roughly a third, or 34%, of its funding comes from this source as opposed to deposits, the latter of which are considerably cheaper.
On top of this, when you dig into the nature of its deposit franchise, you see that an uncharacteristically small portion consists of noninterest-bearing deposits. Indeed, much of them are in the form of certificates of deposits, which are the most expensive type of all, costing 1.06% compared to the 0.41% that the bank pays on a typical savings account.
The net result is New York Community Bancorp's net interest margin, which measures "how successful a firm's investment decisions are compared to its debt situation," is markedly lower than the lion's share of its competitors.
So, what's the solution? According to New York Community Bancorp, it's to acquire a bank with an established deposit franchise already in place. As CFO Thomas Cangemi noted at a recent industry conference,
We are not a de novo grower of deposits. So historically, if you look at where we started back in 2000, at $3.3 billion in deposits, where we stand today, at $25.6 billion. Most of this is acquisition related.
This is a strategy that's worked for New York Community Bancorp in the past. And, given the continuity of management, there's little reason to conclude that it won't continue to work in the future. It's for this reason, in turn, that the flipside of this bank's greatest weakness really is perhaps its greatest opportunity.