Update: New York Community Bank & Mr. Cooper

July 29, 2024 | Premium Service | Last week, Mr. Cooper Group (COOP) acquired the mortgage servicing business of Flagstar Bank, N.A., the sole bank subsidiary of New York Community Bancorp (NYCB). The transaction disposes of Flagstar’s residential mortgage servicing business, including mortgage servicing rights and the third-party origination platform, for approximately $1.4 billion. The transaction is expected to close during the fourth quarter of 2024. 

As readers of The Institutional Risk Analyst appreciate, this sale essentially unwinds the acquisition of Flagstar Bancorp by NYCB and represents a substantial destruction of shareholder value for common stockholders. The $1.4 billion in consideration paid to NYCB by COOP represents only a slight premium to the fair value of the mortgage servicing rights (MSRs) and the roughly $4 billion in related escrow deposits. These deposits will eventually leave the bank, which seems to be in a managed windup. But the transaction is a huge windfall for COOP.

COOP Chairman and CEO Jay Bray commented, “We have the operational capacity to onboard Flagstar’s customers with a smooth and positive experience, which will be our top priority. We also look forward to welcoming Flagstar team members to the Mr. Cooper family. We have long respected Flagstar as a mortgage servicer, and we feel very closely aligned with their cultural values.”

COOP funded the acquisition with available cash and credit lines, providing the leading mortgage servicer with an accretive means of deploying capital and growing earnings. Of note, Mr. Cooper will subservice loans/HELOCs remaining on Flagstar's balance sheet since the bank no longer has the capacity to perform these functions. The addition of the Flagstar MSRs and servicing book is enormously accretive to COOP and will provide future income for the group as shown in the chart below. 

COOP was already headed for another strong quarter in Q2 2024, but the NYCB acquisition positions the firm nicely for the rest of the year and an eventual rate cut by the FOMC. Indeed, a number of analysts and institutional investors had been reducing exposure to COOP after a long and very positive run for the stock.

Mr. Cooper | Q2 2024

The same investors and analysts who have been reducing exposure to COOP equity may now need to reconsider that calculus. COOP continues to grow operating income faster than expenses, a trend that could accelerate as the leading non-bank lender absorbs the assets and people from Flagstar. Note in the chart below the striking disparity in equity returns between the two companies.

For NYCB, this transaction is the latest chapter in an unfolding disaster. The new management team of NYCB characterizes the Flagstar servicing platform as a “non-core” business, but in fact the income and liquidity generated by the mortgage servicing activities was supporting the bank. Once these assets are gone by the end of 2024, we expect that the rest of the bank will be sold or recapitalized in short order. 

NYCB lost $300 million in Q2 2024 and executed a 1:3 reverse stock split in a pointless effort to window dress the ongoing value destruction under the new management team. Net interest income was down 40% YOY and 11% sequentially, reflecting asset sales and loan charge-offs.

The fact that the portfolio of 1-4 family residential loans is growing is nice to hear, but this is less than 10% of the loan book vs 60% for commercial credits. We suspect that NYCB will be forced to sell those performing residential loans for cash as losses on the multifamily portfolio grow. By shrinking the bank's revenues, NYCB is making itself less valuable and less stable, but the new team seems to be powerless to change the situation.

The consideration paid by COOP to NYCB is a pittance compared with the future value of Flagstar’s mortgage operations, including MSRs and subservicing contracts totaling approximately $356 billion in unpaid principal balance (UPB) and over 1 million customers. Unlike many subservicers, Flagstar controlled the escrow deposits for most of the sub-servicing assets. Flagstar was one of the last bank issuers in the government loan market.

Because NYCB does not currently have an investment grade rating, the Flagstar escrow deposits will likely move to another depository when the transaction closes. NYCB states that only $3.7 billion out of $9 billion in mortgage related deposits will be lost when the transaction closes, but as and when the 1-4s are eventually sold to raise cash, the rest of the mortgage-related deposits will likely disappear. 

NYCB | Q2 2024

Notice that the NYCB team characterizes the escrow deposits from residential mortgages as "high-cost and volatile," neither of which statement is true. NYCB states that the residential mortgage servicing business was “non-core,” evidence of the fantasyland atmosphere which prevails under the new team. Consider the statement of Chairman, President, and Chief Executive Officer Joseph M. Otting: 

"The Flagstar mortgage servicing platform is well-respected throughout the industry, which we believe is reflected in the premium we received. While the mortgage servicing business has made significant contributions to the Bank, we also recognize the inherent financial and operational risk in a volatile interest rate environment, along with increased regulatory oversight for such businesses.”

"We are focused on transforming the Bank into a leading, relationship-focused regional bank,” says the former Comptroller of the Currency Otting, reflecting the evident confusion among the bank’s new management team. “Consistent with that strategy, we will continue to provide residential mortgage products to the Bank's retail and private wealth customers.” Joe Otting does not seem to understand the value of the Flagstar mortgage servicing business.

Contrary to Otting’s statements about growing the bank, NYCB seems to be winding down. The bank is closing offices and shedding assets in an effective liquidation of the business. The fact that the Flagstar sale increased the bank’s capital slightly (70 bp) is irrelevant given the scale of the bank’s remaining asset quality problems. Meanwhile, the bank’s cost of funds has risen sharply in the wake of the Q1 2024 restatement. Here is the key passage from the Q2 2024 earnings statement:

“For the six months ended June 30, 2024, the net interest margin was 2.13%, down 81 basis points compared to the six months ended June 30, 2023. The year-over-year decrease was primarily the result of the impact of higher interest rates and competition on our cost of funds. The average cost of funds rose 142 basis points to 4.36% driven by a 180 basis point increase in the average cost of borrowings and a 128 basis point increase in the average cost of deposits, along with an increase in average interest-bearing liabilities.  This was partially offset by higher asset yields, which increased 40 basis points to 5.50% along with an increase in average interest-earning assets.”

Fortunately the bank has been rebranded as “Flagstar,” but the legacy NYCB commercial and multifamily credit exposures are now the dominant asset. The table below from the NYCB Q2 2024 earnings presentation gives readers a sense for just how small is the consideration from the sale of the Flagstar assets to COOP relative to the bank’s asset quality problems. 

NYCB | Q2 2024

The stated non-accrual loans for NYCB at the end of Q2 2024 were almost $2 billion, a figure that we suspect understates the actual delinquency in the portfolio. Given that pain in the office CRE channel is only starting to surge and defaults in the multifamily sector are already mushrooming, we view NYCB’s credit outlook as problematic.

NYCB | Q2 2024

A reasonable starting haircut for the bank’s CRE and multifamily exposures would be in the neighborhood of 20-25% of par value. Obviously this would leave the bank insolvent.  Or to put it another way, you could use the $1.4 billion proceeds from the sale of the Flagstar mortgage business -- two quarters from now upon close -- to clean out the bank's delinquent loans. But we suspect you'd be putting more loan loss provisions aside immediately

We view the sale of the Flagstar business as a huge and unexpected positive for Mr. Cooper, but troubling evidence that NYCB is headed for a sale or failure. The national mortgage lending, correspondent and servicing business of Flagstar was the future of NYCB, not the retail branches that Otting et al. have retained and are now slowly eliminating. We view the attempts to right the sinking ship as commendable but largely futile.

Long-time readers of The Institutional Risk Analyst will recall the Fall of 2008, when Wells Fargo & Company (WFC) acquired Wachovia Corporation in a government-assisted sale to prevent the bank's collapse. An all-stock deal with WFC worth $15.1 billion was announced in October 2008, overriding a bid by Citigroup (C) to acquire Wachovia Bank from the FDIC.

The Citi deal would have forced the Wachovia parent bank holding company into bankruptcy, following the parent of Washington Mutual and Lehman Brothers in its entirety earlier that year. A third financial firm filing bankruptcy in Q4 2008 might have cratered the US credit markets.

Wachovia shareholders approved the merger proposal on December 23, 2008, and WFC announced the merger's close on January 1, 2009. Upon close, WFC charged off the total equity of Wachovia, creating an accounting reserve that allowed WFC to clean up the Wachovia mess over time.

In our view, one way or another, NYCB will either be acquired by a larger bank that can replicate the scale of the Wachovia merger transaction, or the FDIC will take over the bank and sell the net assets at 50 cents on the dollar. Indeed, the prospective discount on the NYCB legacy CRE and multifamily books may be too large a burden for a private investor.

NYCB is an example of why we have suggested in previous comments that the scale of problems in the office and multifamily sectors may be too large for the private sector to fix alone. Remember, the FDIC is still sitting on the rent-stabilized assets of Signature Bank, deeply impaired assets that NYCB refused to buy and is no longer servicing for the bank insurance fund. Stay tuned as the situation around NYCB evolves through the rest of 2024.

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