High-Yield Opportunity or the Next Dividend to Go?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I've been accused in the past of manipulating numbers to meet my thesis, but usually in investing, the numbers are what they are. In a recent article by John Maxfield on Fool.com, he extolled the virtues of New York Community Bancorp (NYSE: NYCB). Almost anyone can spot the main reason many investors might consider NYCB, and that is their dividend of nearly 8%. However, if there is anything that the last several years have taught investors, it is don't assume all dividends are created equal. In addition, though an 8% yield is attractive, that is just one of the reasons to consider a stock.
There is no question that banking has been a tough business in the last few years. Though some bad bets have made headlines, there are thousands of banks that never made these crazy loans or trading bets. These banks stuck to what they knew by attracting deposits and making good loans to creditworthy borrowers. NYCB appears to be one of these latter types of banks. John Maxfield likes the company's business and named a couple of reasons to give the stock a second look. Let's see what is going on that might make this an attractive investment.
A High Dividend Is Great, But Is It Too High?
NYCB's dividend was John's first reason to consider the stock. There is no question that income focused investors should give the stock a look with a 7.89% yield. John's point was that in recent years companies have shifted their focus from returning value through dividends to repurchasing shares. NYCB on the other hand, has been returning 80% to 100% of earnings to shareholders primarily through dividends. John believes that this proves that NYCB has, “shareholders interest in mind more than their own.” However, investors get nervous when a payout ratio exceeds 70%, and I suspect that this high return of earnings is hurting earnings growth, and could be a problem longer-term. In addition, there is a good reason for NYCB to return earnings through dividends, their CEO owns a large chunk of shares and this pads his pockets as well as the common investor.
The Bigger Problem Is Organic Growth That Seriously Lags Their Peers:
The core issue for NYCB is something that John Maxfield thinks is a reason to consider the stock. Banks lend to qualified borrowers, but how they fund these loans comes from two places. Very successful banks gather deposits and make loans against their deposits. Banks that can't grow deposits fast enough often have to borrow to meet funding requirements. NYCB falls into this latter category. John says that an acquisition could solve this problem. The CEO of NYCB affirmed an acquisition was on the table by saying, “the idea that we would entertain the opportunity to do a deal is very real.” There are two problems that I see. First, the recent acquisition that NYCB actually made is not the type the bank needs. The bank acquired $2.2 billion in deposits from Aurora Bank, but of this amount $1.7 billion was in CDs. While it's true that CDs are a cheaper funding source than borrowing, this is still the most expensive and least stable type of deposit funding. Many CD customers are very interest rate sensitive and if a better rate is available from another institution they usually have very little loyalty. A much bigger and better opportunity just presented itself in the form of Hudson City Bancorp, and unfortunately for NYCB investors, M&T Bank (NYSE: MTB) jumped on this purchase.
Though M&T's acquisition of Hudson City for about $4 billion would have been challenging for NYCB, it would not have been impossible. The bank's market value is about $5.6 billion so this would have been a merger of almost equals. NYCB by virtue of this missed opportunity could have added about $25 billion in deposits, and a similar amount in loans to its portfolio. Instead, M&T takes over the bank and creates a much stronger competitor to NYCB. This was a great opportunity to dramatically advance NYCB and gain not only market share, but also change the company's net interest margin for the better.
Slow Deposit Growth Is Hurting Net Interest Margin:
In the most recent quarter, NYCB showed a net interest margin of 3.17%. By comparison, M&T's margin was 3.77% in their most recent quarter. In addition, two of the better performing super regional banks BB&T (NYSE: BBT) and U.S. Bancorp (NYSE: USB) report net interest margins of 3.94% and 3.59%. Clearly NYCB's high usage of borrowings to fund loans is hurting the company's results. The organic way for the bank to improve their margin is for deposit growth to exceed loan growth. This did not happen in the current quarter:
As you can see, NYCB is not only growing loans faster than deposits, but the bank is seriously underperforming many others when it comes to both loan and deposit growth. The fact that all of the above banks are much larger than NYCB is actually another reason NYCB should be able to outperform its larger peers. A smaller bank doesn't need as much in deposits to dramatically improve their growth rate.
Better Deposit Growth = Better Earnings:
If you want proof that more deposits and the resulting higher net interest margin equals better earnings, consider the following:
In each case the bank with a better net interest margin is growing EPS faster today and is expected to outperform in the future. While it's true that NYCB could benefit from a deposit heavy acquisition, until this happens, there appear to be better opportunities.
The bottom line is while NYCB's yield is attractive, there is more to investing than just picking the highest yield. Each of NYCB's competitors is expected to grow faster for the next few years. Each of these competitors has shown a willingness to return capital to shareholders through dividend increases in the past and there is no reason to believe this will change. This should mean higher dividends in the future for BB&T, M&T, and U.S. Bank, while NYCB hasn't increased its dividend since 2004. If NYCB can solve its deposit problem that might change the numbers, but for now, I would suggest investors look at the long-term growth available at these three competitors instead. The fact that these three banks sell for a forward P/E ratio below NYCB doesn't hurt either. Say what you want, but the numbers speak for themselves.
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