After preparing analysts and investors for the past two years, New York Community Bancorp (NYSE:NYCB) pulled the trigger on its long-discussed plan to pass the $50 billion asset threshold and become a systematically important bank. The $49 billion multifamily lender announced a merger with $15 billion Astoria Financial (NYSE:AF) on Thursday, the results of which are a mixed blessing for current shareholders.
The deal combines two banks with long ties to the New York City metropolitan area. With deposits of $28.3 billion and 269 branches, New York Community Bancorp is a leading producer of multifamily loans on rent-regulated buildings in the Big Apple. This focus has paid off over the decades, as the high occupancy rates of rent-regulated multifamily buildings provide a steady stream of revenue to the buildings' owners throughout all economic cycles, making loan defaults rare.
You can see the benefit of this strategy by looking at New York Community Bancorp's history of charge-offs. The bank's net charge-off ratio throughout the savings and loan crisis of the early 1990s peaked at a mere 0.1% of total loans, compared to the 1.5% for banks on the SNL U.S. Bank and Thrift Index. And in the financial crisis of 2008-09, its peak charge-off rate amounted to 0.2%, coming in well below the 2.9% net charge-off rate reported by comparable lenders in 2010.
New York Community Bancorp's ability to avoid credit losses, combined with its notoriously efficient business model, have fueled exceptional returns for shareholders. Its shares are up a total of 3,590% since going public in 1994, after adjusting for dividends, beating out the S&P 500 by a factor of nearly seven.
These accomplishments aside, New York Community Bancorp's Achilles' heel has been a high cost of funds. By deemphasizing retail and branch banking, the primary source of low-cost deposits, it has had to rely heavily on the more expensive money markets to fund its $43 billion portfolio of interest-earning assets. Its total cost of funds in the third quarter, amounted to 1.39% of interest-bearing liabilities, pulled up by $13.5 billion worth of wholesale funds. That compares to a cost of funds of just 0.52% for the more traditionally focused U.S. Bancorp.
But it's this weakness that New York Community Bancorp's merger with Astoria Financial seems designed to remedy. With core deposits in New York totaling $9 billion, Astoria Financial is the second-largest thrift depository in the Empire State. This influx of low-cost funds could allow New York Community Bancorp to save $50 million a quarter in interest expense, boosting its net interest income by upwards of 18%.
Importantly, however, this benefit does come with costs. In the first case, to prepare its balance sheet to absorb Astoria Financial's low-cost deposits, New York Community Bancorp will prepay $10 billion worth of wholesale borrowings. This will result in an one-time prepayment penalty of approximately $614 million, according to the company, which will be financed by issuing new shares of common stock.
"We expect that these actions, which go hand in hand, will boost our net interest income and margin on an ongoing basis," said New York Community Bancorp CEO Joseph Ficalora, who will continue to serve as president and CEO of the combined companies. "While the repositioning will result in a charge in connection with the prepayment, the benefits of this action will clearly be seen in our first quarter 2016 results."
New York Community Bancorp must also cut its dividend, and, as a systematically important bank, request permission from the Federal Reserve to increase future distributions. This is undoubtedly the least popular aspect of the deal, as the New York City-based bank had acquired a cult following among income investors thanks to its 90%-plus payout ratio and generous yield.
Ultimately, looking at the deal from the perspective of a long-term investor, it's hard not to like it -- at least as it appears today. The elevated net interest income alone should take care of the $614 million prepayment penalty in roughly three years, and the strengthening of New York Community Bancorp's franchise in its bread-and-butter market seems commensurate with the middle-of-the-road 1.5 times tangible book value that it's paying to absorb Astoria Financial. Only time will tell if the deal lives up to expectations, of course, but shareholders can rest assured that it has a lot of potential.
John Maxfield has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.