Author: Andy Schornack
Covestor model: Financial Services
Disclosure: Long NYB
The marketplace continued to punish the financial services sector in August. The performance of the portfolio for August was disappointing, but the portfolio outperformed the benchmark SPSY (S&P Financials Index). It underperformed the S&P 500 Index.
European sovereign debt issues and mortgage litigation continue to create headline attention in the news media. These issues are not likely to be solved quickly or without expense to the financial industry. The lesser discussed, but just as concerning in the near term, is the flattening of the yield curve and the potential to contract net interest margins in financial institutions. This is a direct result of the most recent FOMC meeting statement on the decision to keep rates at current levels until 2013 (Fed release 8/9/11 http://www.federalreserve.gov/newsevents/press/monetary/20110809a.htm).
The financial institutions to watch in the current interest rate environment are banks with stable and/growing loan demand, and/or banks with a higher cost deposit base that remains to be repriced over the past couple of years. The banks that have already driven their interest costs to low levels will only be squeezed on a net interest margin basis during the upcoming years, as loan demand lags and margins contract. One of the banks I see opportunity in is one of my favorite financial institutions, New York Community Bancorp., Inc. (NYSE: NYB).
New York Community Bancorp, Inc. is the 38th largest bank holding company in the United States according to the FFIEC as of June 30, 2011 (http://www.ffiec.gov/nicpubweb/nicweb/top50form.aspx). The bank prides itself on providing multi-family loans in New York City, with an emphasis on apartment buildings that feature below-market rents. These are also known as rent-regulated apartment buildings. While these are not the only loans the bank makes, it is the largest concentration in their book, and their loss history has been excellent in this marketplace. I added to this position in the portfolio during August after exiting positions in ABBC and O.
It would not surprise me to see NYB take the opportunity in the current marketplace to prepay some of its wholesale funding, thereby locking in some long-term, lower rate funding. A penalty would be incurred, but given the existing borrowing rates the bank could in this way trade down to its significant benefit over the next two years. In the meantime, CEO Joseph Ficalora has stayed committed to the $0.25 quarterly dividend, indicating a yield of 8.35% as of close of trading on September 6, 2011 (Yahoo Finance https://finance.yahoo.com/lookup?s=NYB). The pipeline remains positive for new loans, although rates leave much to be desired. Long-term I am very bullish on this stock at the current trading levels.
The other position increased in size during the month is a contrarian investment when compared to recent market reactions. On August 24, 2011, I added to the position in Morgan Stanley (NYSE: MS). The stock had fallen significantly from my opening the position in July 2011, yet the company remains well positioned to work through the European sovereign debt crisis and the downgrade of the US AAA rating.
Some referred to its last 10-Q (for the quarter ended June 30, 2011) warning as harsher than others in the industry (SEC filing: http://sec.gov/Archives/edgar/data/895421/000119312511213320/d10q.htm). The company indicates it has exposure to Greece, Ireland, Italy, Portugal and Spain and hedges of $2 billion, which is manageable for a firm that has $68 billion in capital. The stock still trades as a significant discount to tangible book value, and the CEO James Gorman recently purchased a significant position in the stock at higher levels along with a couple other Director/Officers of the bank (Yahoo Finance: https://finance.yahoo.com/quote/MS/holders?ltr=1 as of 9/1/11). I believe Gorman is making the right moves, refocusing the bank’s business model into areas that should prove positive for shareholders.
My optimism for the remainder of the year has tempered, but I do maintain the position that the financial sector is currently positioned very well for long-term gains. The market is counting every negative, while mildly ignoring any potential long-term positive for the American economy.
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