New York Community Bancorp's (NYSE:NYCB) recent merger with Astoria Financial (NYSE:AF) promises to deliver big quarterly interest savings for NYCB. On the surface, this looks to be a sweet-smelling "rose" of a deal. However, Astoria Financial's balance sheet may reveal a few thorns over time.

On this Industry Focus: Financials episode, Motley Fool senior banking specialist John Maxfield and analyst Gaby Lapera examine the merger and discuss how New York Community Bancorp will benefit. They also reveal some potential challenges to the continued success of NYCB and how it will stand up to competitors.

A full transcript follows the video.


Gaby Lapera: Hello everyone. Welcome to Industry Focus, financials edition. This is Gaby Lapera here with John Maxfield on the phone. And this week we're going to be talking about really exciting banking news. Yeah!

I just flew in from Miami and a guy on the plane told me to make my voice exciting when I talked about banking news so that banking news would also be exciting. And I hope it's working for everyone.

So, this week we're going to lead off with a story about the New York Community Bancorp merger with Astoria Financial. I think that I kind of want to structure this as a ... I don't know if you all went to summer camp. "A Rose and a Thorn" is a summer camp activity that you do where you talk about one rose and one thorn of your day, except we're going to do it with a bank merger. So, Maxfield, I would like for you to start. What is one rose about this bank merger?

John Maxfield: So, here's the thing about New York Community Bancorp. This has been a long-term stock that dividend investors have absolutely loved throughout the years because it's yielded something like 70%. And the reason it's yielded such a high number for so long is that it pays out an enormous share of its earnings, in terms to its shareholders being dividends. So, that's basically what the shareholders in New York Community Bancorp are there for.

Well, the great thing about this bank is that its business model really protects it or insulates it from a lot of the market pressures that other banks face. For example, its business model is focusing on multifamily owners -- lending to owners of rent-controlled multifamily buildings in the New York City metropolitan area.

Lapera: And those are apartment buildings for everyone who's not in the banking slang know.

Maxfield: Exactly. And in the New York City area, you have some buildings where the rent controls that are enforced by the government; they keep the rent in some of these buildings way below the market value. And what that does for the owners of these buildings is it keeps them full at all times.

So, the cash flow is really, it's almost like a guaranteed cash flow, which means that the loans on these things are always good. And because they're big loans as opposed to small loans, the New York Community Bancorp is also a really efficient bank because it's just writing ... for every loan it writes, it gets much more bang for its buck than, say, a small community bank that's writing residential mortgages.

Well, this merger ... the problem with New York Community Bancorp, the one issue that it had was that it relied -- because it didn't have a large retail deposit base -- it relied to a large extent on wholesale funding. And wholesale funding, this is loans from institutional investors, this is money in the money market, these are broker deposits, things like that. This is much more expensive money than retail deposits.

And so this merger, New York Community Bancorp; effectively they're presenting it as a merger, but it really is more of an acquisition of Astoria Financial by New York Community Bancorp. What this does is it brings in roughly $9 billion dollars' worth of retail, cheap retail deposits that will allow New York Community Bancorp to then use those to replace a lot of the high-cost funding on its balance sheet. So, this is going to save New York Community Bancorp a bunch of money each quarter in interest expense and that really is the good part of this deal.

Lapera: Absolutely. This is a really, really exciting thing for them. There are some problems, however. As you mentioned earlier, New York Community Bancorp is pretty famous in the banking world, I guess, for having an absolutely amazing efficiency ratio of 46%. Now, for efficiency ratios, the lower they are the better.

Astoria Financial is coming into this deal with an efficiency ratio of 74% and a big part of that could possibly be traced to the fact that Astoria tends to outsource its mortgage origination. New York Community Bancorp is really careful about who it lends to and then that helps keep its costs down because they don't have to write off loans. And they do most of that process in-house and that means that they have a greater incentive to make sure that the loans they write are good.

Since Astoria outsources its mortgage origination, the people who write those loans maybe don't have as much of an incentive to make sure that the loans are going to be definitely fulfilled.

Maxfield: Yeah and there are a number of negative aspects of the deal if you're a shareholder or prospective shareholder. That is definitely ... I would say that's one of the top three. But you know, if you think about it, one of the things that you mentioned is the fact that New York Community Bancorp's efficiency ratio ... and just to be clear the efficiency ratio, what this does is it takes a bank's operating expenses or its noninterest expenses and it divides those by its net revenue.

So, this tells you what percentage of net revenue is being consumed by operating expenses. The corollary of this is that it tells you what percentage of net revenue is then free to pass the bottom line, or cover loan loss provisions, or pay taxes or distribute to shareholders, right? So, a lower efficiency ratio is a better efficiency ratio.

Well, New York Community Bancorp's has always been in the 40-50% range, which is an extremely low ratio when you consider that even great banks like U.S. Bancorp, Wells Fargo; their ratios are in the low 50% range. And I mean these are really well-run banks.

Well, the problem is that with New York Community Bancorp bringing Astoria Financial and its 75% efficiency ratio, 74% efficiency ratio [...], that it's going to dilute that really large competitive advantage of New York Community Bancorp. And the other problem -- and this is the point that you're getting to with Astoria Financial outsourcing its mortgages.

So, Astoria Financial, it's based in the New York area as well, which is a benefit to New York Community Bancorp in this merger. But the problem is that its balance sheet -- the majority of the assets on its balance sheet are residential mortgages. And where does it get those residential mortgages? My reading of its financial statements is that it outsources the majority of the origination of those mortgages to other banks or other mortgage brokers and then purchases those mortgages.

What we have seen throughout the years most recently in the financial crisis, and we saw it again in the 1980s with really the first too-big-to-fail Bank Continental Illinois, it did the same thing. These banks got into trouble by having other people make the credit decisions on the loans on their balance sheet. And the problem with that is that the bank that keeps that loan on its balance sheet has the most incentive to make sure that it's underwriting a really, really good loan.

It's not a guarantee that outsourcing your mortgages or your lending operations is going to be a bad thing, but it certainly increases the possibility that there's going to be a problem down the road with your loans. And that really, if you're going to look at the negative or the thorns if you will of this deal from the perspective of a New York Community Bancorp shareholder, those in my opinion are really it.

Lapera: Right, and just to throw in kind of a red herring, I've seen some kind of superficial analysis this week saying, "Oh, this is a bad deal because New York Community Bancorp is going to have to lower their dividend yield." That doesn't make this the reason that it might be a bad deal. They were going to have to lower their dividend yield rate anyway because that's what they would have to do. They needed that money to acquire another bank.

Maxfield: Yeah and the other thing to keep in mind is that -- and this is really where that change in the dividend policy came in -- is that New York Community Bancorp has been sitting at about $49 billion worth of assets for quite a while -- I think a year, two years. And it was preparing itself to cross that $50 billion threshold. And that $50 billion threshold when you're talking about banks is really important because that is the difference between a systematically important financial institution and a nonsystematically important financial institution.

And once you cross that threshold, you have higher regulatory and compliance costs. And New York Community Bancorp is getting ready for those things and has now gone past that. Well, another consequence of being a systematically important financial institution is that the Federal Reserve now has the right to veto your capital allocation plans -- i.e., how much you want to distribute via dividend, how much in terms of your common stock you want to repurchase.

So now, New York Community Bancorp is in this position to where it used to be able to distribute as much money as it wanted, right? But now it can't because now you have the Federal Reserve sitting on top of it that's probably going to veto anything that it considers to be excessive in terms of the dividend payout ratio.

So, it is a negative aspect of the deal from an income-seeking investors' perspective, but for the fundamental business model, that really doesn't change anything. It just changes the dynamics of its stock.

Lapera: Definitely. I think this is to be a really interesting stock to wait and see what happens. Do you want to move on to our next topic?

Bank of New York Mellon, which is a really interesting bank, right? It's deceptively small, its balance sheet, its assets are less than U.S. Bancorp. But what's really interesting about them is they're still required to attend all these meetings -- all the systematically important financial institutions, which we will shorten to SIFI for the rest of this episode because I woke up at 5 a.m. and I can't say that more than once in an episode when I'm that tired. It's required to attend all these meetings that all these other SIFI institutions are as well, I guess I said. Anyway, continue.

Maxfield: Yeah, I mean, so this is another New York bank and it's another unique New York bank.

So, the Bank of New York Mellon; what's great is that this traces its roots actually all the way back to the founding of the United States of America because it was one of the first banks founded in the United States.

And what's so interesting about ... I read an article about this last week entitled, "The Most Interesting Bank in America." And what makes the Bank of New York Mellon so interesting is what ... if you look at its balance sheet, you're going to see, like Gaby just said, a bank that is small. And it's got $377 billion in assets on the balance sheet. Yes, that is a big bank, right? But that's nothing like J.P. Morgan Chase with $2.4 trillion in assets on its balance sheet, or Bank of America (NYSE:BAC) with over $2 trillion in assets on its balance sheet. So it's a relatively small bank. It's a large regional bank, but it would be a small too-big-to-fail bank.

But the interesting thing about it is that, if you're a student of the financial crisis and you read through all the things that happened there, there were a number of key meetings that were going on during the crisis; where the country's leading bankers had to be present with members of the Treasury Department, members of the Federal Reserve, members of the FDIC, to figure out how they were going to create a unified front to attacking the financial crisis. And he invariably was among the roughly dozen bankers that were present at these meetings.

And on top of that New York Community Bancorp ... now I've got both these banks in my head right now. The Bank of New York Mellon is a systematically important financial institution despite the fact ... and it's a global systematically important financial institution, which is another layer up in terms of the regulatory and compliance burden on these banks.

So, the question is why is the Bank of New York Mellon, that it just basically looks like a regional bank, why is it evidently so important in the whole scheme of things?

Lapera: I know our listeners are on the edge of their seats to find out. We should make this a cliffhanger episode.

Maxfield: Sure. And the answer to that is this: Off its balance sheet it holds just short of $30 trillion worth of assets under custody of the administration and so the question is, "What are these?" And just again, that's trillion, $30 trillion worth of assets. That's way bigger than the U.S. GDP, right?

So, this is a small regional bank holding all of these assets. And what the Bank of New York Mellon does is it acts as an intermediary in the credit markets. And it administers things like mortgage-backed securities which are just trusts that hold thousands, hundreds, thousands of mortgages that then investors buy shares in these trusts or ownership rights in these trusts, but the Bank of New York Mellon is the company that's actually administering and doing the things that you need to do to keep a trust going on a year-to-year basis.

And because it controls so much of that business in the financial markets, that is why, despite the fact that its balance sheet is relatively small in the whole scheme of things, is still considered one of the most important financial companies in the world.

Lapera: And what's really interesting about this type of business is that although there is like federal compliance regulations that come along with it, it's not really to the same degree as, say, a J.P. Morgan would face with the amount of assets that it holds.

So, there's not really a cap on a bank doing what New York Mellon is doing.

Maxfield: Right. So, the Bank of New York Mellon, it doesn't face the same stringent standards that a J.P. Morgan Chase, the biggest bank in the United States, faces.

Lapera: Of course, it has standards. Everyone should have standards.

Maxfield: Because it doesn't have as much credit risk on its balance sheet. All those assets, that $30 trillion worth of assets, those are not on the balance sheets.

So, even if they do default in the worst-case scenario, that loss doesn't go the Bank of New York Mellon. That goes to the owners of those trusts. Whereas if those assets were on its balance sheet like a large quantity of assets are on the big four banks: Bank of America, J.P. Morgan Chase, Citigroup, and Wells Fargo, those assets if they go bad, they threaten the capital of those banks, which makes the regulators look at those banks much more closely.

Lapera: Absolutely. I think I am ready to discuss our next topic; which is actually an article that showed up in The Wall Street Journal earlier last week, I believe, that talked about the culture clash of having the CEO of your business live in another city than the city in which that business is headquartered.

So, the example that came up in this article was Brian Moynihan from Bank of America. The bank is headquartered in Charlotte, and Moynihan, he came into the company with the FleetBoston acquisition and he still lives in Boston. He likes Boston. He doesn't want to leave Boston. He doesn't want to move the headquarters to Boston or New York where there are a lot more executive officers because of the acquisition of Merrill Lynch. Do you want to kind of run with that?

Maxfield: Yeah, so the thing about Bank of America is that it is a collection of a bunch of regional banks.

And if you really break it down it's a collection of Bank of America, the namesake, which was a bank founded in 1904 out in California; there's a bank called NationsBank, which is actually when we think about Bank of America we're actually talking about NationsBank. And that is a bank that is based in Charlotte, North Carolina, and it really traces its modern roots back to the 1950s when it decided to try to grow into one of the biggest banks in the United States.

And then the third big piece of the puzzle, and there's a whole bunch of pieces to the puzzle, but these are just the really big ones, the third big piece of the puzzle other than Merrill Lynch is FleetBoston Financial.

And so what's interesting is that you know this is typical at a lot of banks where you're going to have all these executives come in as a result of these mergers and acquisitions. What's so unique about Bank of America is that whereas before the crisis that top executive team always stayed in control of that North Carolina contingent. Since then it's fallen into the hands of Brian Moynihan, who's a Boston executive, right? And he's now filling the executive ranks with people that he worked with at FleetBoston Financial.

And so now you have their executives that are split kind of evenly between Boston, where its wealth management operations are based, or in that area, [and] New York, which is where its investment banking operations they acquired from Merrill Lynch are principally based, then Charlotte where the traditional headquarters are. Well, the problem is that Moynihan the CEO, still lives in Boston. So, he's commuting all the time down to Charlotte.

And so when you think about as a company, thinking about a company that you want to invest in, the question you have to ask yourself is, "Do you want to invest in one?" I'm personally a pretty big fan of Brian Moynihan, but this is a legitimate question for investors. "Do you want to invest in one where the CEO is not even willing to make the commitment to then move to the headquarter city (i.e., Charlotte, North Carolina)?"

And the one company that comes to mind when you're talking about this issue is JCPenney. JCPenney brought in a guy named Ron Johnson, I think it was in 2011 if my mind serves me correctly. And he came from Apple. He was the head of Apple's retail division and he went to all these changes at the Dallas-based JCPenney, but he never moved down to Dallas. And it always caused consternation among the folks at JCPenney and he eventually almost drove JCPenney into bankruptcy and he was eventually fired.

Now, I don't think Brian Moynihan is going to do that at Bank of America to be very clear, however, the point being it is not a good precedent as a general rule to have your CEO living in a city that is not your headquarters' city.

Lapera: And I think another component to think about this is that Brian Moynihan -- he's not flying economy class back and forth from Boston.

Maxfield: Like us?

Lapera: Like me this morning.

Maxfield: He's definitely not flying like we travel.

Lapera: Shout out to the guy sitting next to me who had chips spilling out of his pocket, like just loose potato chips this morning. I don't know who you are, but you go -- you do you, sir.

They have private company jets. I believe that the figure stated was that Bank of America spent something like $448,000 last year on flying CEOs back and forth on their private company jets.

Maxfield: Flying Brian Moynihan.

Lapera: Oh, just Brian?

Maxfield: Just Brian Moynihan.

Lapera: Sorry. I'm talking about it like I know him.

Maxfield: Yeah, it was like leaps and bounds more than other bank CEOs. So, what you're talking about, you're talking about personal miles that he rung up on the company jet. And the reason he rings up so many personal miles is because every week it's got to take him back to home to Boston.

And so, in the whole scheme of things, is the corporate jet cost going to sink Bank of America? No, you're talking this is a negligible cost for a bank that size.

Lapera: No, but banks are required, all companies are required to report the type of compensation that they give to their executives and this isn't something that's really factored into that.

And people, I guess, don't really think about that, but the cost of having a corporate plane that your executive has to use to basically commute every week, or limo drivers, or dinners people get. People don't really think about that in terms of compensation. But people do get a lot of stuff, a lot of extras, a lot of side benefits, perks for the CEO.

Maxfield: They do. And no perk is better than a company plane. And just to be clear, I'm not saying shareholders shouldn't care about this because they absolutely should care about this. But it's my opinion that they should care about the company plane -- they should look at that as more of a symptom of the issue as opposed to the issue itself.

The issue itself is, "Do you want a CEO of a company who is not willing to live in a headquarter city of that company?" I've no doubt that Brian Moynihan is willing to make a lot of sacrifices for Bank of America. He's probably worth a lot of hours for the past decade at that bank, but it still sets a bad precedent.

Lapera: Right. I will say that the -- just to play devil's advocate -- maybe companies do this so that they can attract better talent -- someone who says, "You know what? I'll come work for you, but I don't want to leave my home city. And this is this is the bargain that you get as a result of having my talent."

Maxfield: Yeah, but these guys also get paid tens of millions of dollars.

Lapera: That's true.

Maxfield: That's what they get for their talent.

Lapera: I guess if you're a football player you're not going to be like, "You know what? You just have to fly me into Miami every week." It's not going to happen.

Alright. I think that's it for the week unless you have anything else to say.

Maxfield: Nope.

Lapera: Alright, well, then thank you for joining us. I hope you like this week's episode. Write to us at to let us know what you think or to tell us what's on your mind about anything. Maybe you can explain why a man had chips falling out of his pockets to me this morning on the airplane.

As usual, people on the program may have interest in the stocks they talk about, and The Motley Fool may have recommendations for or against. So, don't buy or sell stocks based solely on what you hear. Thanks very much and I'll see you all next week.