Profile: NYCB + Flagstar Bancorp

May 4, 2021 | Premium Service | In this issue of The Institutional Risk Analyst, we assess the acquisition of Flagstar Bancorp (NYSE:FBC) by New York Community Bank (NYSE:NYCB), one of the largest Main Street community banks in the US. The transaction is remarkable for several reasons, as noted below.

First, it is the latest in a series of M&A transactions in the housing space, which we discussed last week in National Mortgage News (“Why independent mortgage banks might want to sell themselves now”). Suffice to say that we anticipate more deals in the mortgage sector in coming months, but these deals are priced at the top of the real estate market cycle.

Second, NYCB is currently trading at 0.9x book value and FBC is trading at book, so the acquirer is paying up (1.2x book) to buy a more expensive, better performing bank. FBC shareholders will control more than 30% of the post-merger entity. These stocks, of note, are up nearly 40% or more in the past year, but still trail the pack vs say top performer U.S. Bancorp (NYSE:USB) at up 50% in the past year.

Third, this transaction apparently reverses a decision by NYCB to exit the residential mortgage business not four years ago. In 2017, NYCB sold much of its mortgage business to Freedom Mortgage, the leading non-bank lender. Of note, Freedom was the largest government MBS issuer in 2020, supplanting long-time leader Wells Fargo (NYSE:WFC), which has allowed its new originations and mortgage servicing book to run off in recent months.

Four years ago, Freedom agreed to buy approximately $500 million of selected residential mortgage assets from NYCB’s mortgage banking operation and an MSR for $20 billion in residential loans. But here we go again, combining NYCB's large multifamily portfolio, which is geographically concentrated in New York, with a $1 trillion national single family mortgage lending and sub-servicing business in FBC.

New York Community Bank

At $56 billion in assets, NYCB has operating results that track at or just below peer, but outstanding credit performance, suggesting above peer risk adjusted returns. NYCB is not a stellar performer in terms of nominal asset or equity returns, and falls somewhere in the bottom third of Peer Group 1 on some metrics published by the FFIEC. Thus, looking just at the numbers, the deal seems most compelling for NYCB shareholders.

NYCB has consistently ranked among the bottom 10% of large banks in terms of credit losses, in some cases reporting zero or negative loss given default (LGD). As a result, the load on earnings from loan loss provisions is very low, in the bottom 5% of the 128 large banks included in Peer Group 1. Again, on a risk adjusted basis, the equity returns for NYCB seem to be better than its asset peers and its performance displays less variability.

NYCB + FBC

But even with the stellar credit performance, interest expense at 1.2% of average assets at year-end 2020 (vs 0.52% for Peer Group 1) is too high. The reason for this is quite simple, namely the fact that 43% of NYCB's total funding is sourced from the markets rather than from core deposits. The average for non-core funding for Peer Group 1, of note, is just 3%, in part due to the Fed’s vast expansion of liquidity in the past year. This makes NYCB an outlier in terms of this key liquidity metric, a surprising data point given the bank's community footprint.

The bank has an astounding concentration in real estate loans, mostly multifamily mortgages in the New York area, at 70% of total assets vs the peer average of 36% for large bank real estate exposures. While the historic performance of this multifamily portfolio has been excellent going back decades, like other New York area lenders, NYCB lives and dies on the health of multifamily residential assets.

Flagstar Bancorp

At $30 billion in assets, FBC is a better than peer performer relative to other banks its size, in large part because it has non-interest income that is two times the bank’s interest income. Most banks are lucky to have 25% of total revenue in non-interest bearing business lines. The Michigan-based savings and loan holding company reported $324 million in non-interest income, roughly two thirds of pretax revenue. Net interest margin was also impressive at 3% at the end if Q1 2021.

In terms of funding, FBC tracks below the industry average cost of funds at 0.21% as of Q1 with only 5% brokered deposits. Some 36% of the bank’s $20 billion in deposits come from custodial balances associated with the residential mortgage business. Mortgage originations have provided a substantial amount of income for the bank over the past year, as shown in the chart below from the FBC Q1 2021 earnings presentation.

FBC has 158 branches, mostly in WI, IL and IN, but also has branches in Southern California. FBC has a national residential mortgage business with 87 loan production offices and three regional operations centers in TX, FL and CA. More than 1,600 correspondents and 1,400 brokers sell loans to FBC, which then issues the MBS and sells the servicing.

FBC was the sub-servicer for $1.1 trillion in 1-4 family residential mortgages at the end of Q1 2021, making them the 6th largest servicer overall in the US and, of note, the third largest warehouse lender. The bank has steadily de-risked, selling its mortgage servicing rights (MSRs) and retaining the servicing business as sub-servicer. This arrangement gets the risk asset off the books but allows FBC to retain the related fiduciary deposit for the mortgage escrows. Of note, in Q1 2021, FBC sold MSRs representing $4 billion in unpaid principal balance of loans.

FBC’s credit loss profile is far more mainstream than that of NYCB, with results fluctuating between average to excellent. At the end of 2020, for example, FBC was in the bottom decile of Peer Group 1 in terms of net credit losses. More, because of the bank’s strong non-interest income, coverage of actual loss was four times the Peer Group 1 average of 22% at the end of 2020.

The Bottom Line

Combining FBC with NYCB is an interesting transaction in that the former brings funding and a broader income base to the table. NYCB has a one-dimensional business focused on community banking that now picks up a much desired commercial dimension, including a national correspondent and wholesale mortgage franchise that has relatively low risk. The plan apparently is to operate Flagstar as yet another brand under the NYCB umbrella, which currently includes a number of legacy community bank brands that have been collapsed into a single depository, including:

The new company will have nearly $90 billion in assets and operate almost 400 traditional branches in nine states and 87 loan production offices across a 28-state footprint. The headquarters will remain in Westbury, N.Y., with regional headquarters in Troy, MI, including Flagstar's mortgage operations.

The combined company will maintain the Flagstar Bank brand in the Midwest. Flagstar's mortgage division will also maintain the Flagstar brand. Other states will retain their current branding. It will be interesting to see if NYCB operates the FBC bank unit separately due to the large mortgage business.

Bottom line is that we see this transaction as a positive for both banks. Specifically:

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