Two Ideas Emerge In The Banking Crisis
It appears the acute phase of recent bank failures is over. Now comes the chronic phase when bank margins get squeezed. Regional banks in particular will struggle to sort out hundreds of billions in poor performing commercial real estate (CRE) loans.
Here are two companies that I think will provide a very good total return relative to risk in the midst of a lot of distress and turmoil in the banking sector.
Rithm Capital (RITM) – 12.6% Yield
RITM is a diversified residential REIT company. Its stock price has fallen in recent months – first due to last years’ mortgage rate volatility and more recently in the wake of the turmoil in the banking sector. In response, RITM has cut costs, established interest rate hedges, and de-risked its balance sheet. RITM’s investment portfolio is composed of mortgage servicing related assets (full and excess mortgage servicing rights (MSR) and servicer advances), residential securities (and associated call rights) and loans (including single family rental), and consumer loans. From an asset perspective the majority of the portfolio (about 53%) is held in MSRs, real estate and other real estate securities. The company reported $1.3 billion in cash at 12/31/22. $12.8 billion of its debt (~58%) matures this year which will likely increase annual interest expense to a range of $800-$850m representing a small 5-6% increase in interest expense. RITM generated $0.33 per share in Q422 distributable earnings, compared to its dividend payout of $0.25.
RITM’s payout ratio is 76% which is comparable to its REIT peers. In 2022, despite headwinds, the company grew its book value by 5% and generated a GAAP ROE of 15%. Yet today RITM trades at a discounted price/book of 0.67x. I believe the company will trade back to $12, or full book value, in the near future. Catalysts include a stock buyback (at a 35% discount to book), a moderation of mortgage interest rates and traction in new lines of business including its new initiative to develop an alternative asset manager business.
New York Community Bank (NYCB) – 7.5% Yield
NYCB has compressed its transition from a regional to a super-regional bank in less than a year – and at a time when getting big is important for banks. Two recent transactions will make it much larger and will improve funding sources, leading to higher net interest margins (NIMS) . The December 2022 acquisition of Flagstar helped jump-start the company’s transition to becoming a more traditional commercial bank from a niche business model with a focus on regional multifamily lending; the Signature Bank deal in March 2023 further accelerated its path to gain size.
NYCB cherry-picked Signature Bank assets at a discount and in ways that complement its existing business. The deal excludes Signature’s crypto unit Signet. The FDIC sold off about $38B of Signature’s assets in the transaction, including $12.9B in C&I loans, with another $60B remaining in FDIC receivership for further sale. NYCB said the deal included none of Signature’s commercial real estate portfolio, which totaled $35 billion at the end of 2022, or its $19.5 billion multifamily loan book. The FDIC acquired equity appreciation rights, which gives the FDIC some potential profit if NYCB’s stock goes up enough, worth up to $300M. The Signature transaction brings NYCB’s loan-to-deposit ratio down to 88.31% on a pro forma basis, its lowest level since the bank made its mutual-to-stock conversion in November 1993 and much closer to the US public bank median of 82.46%. With $34 billion in deposits from the Signature deal, NYCB increases its total deposits to $92.71 billion on a pro forma basis from $35.06 billion in 2021, prior to both the Signature and Flagstar transactions. Historically, NYCB has relied largely on wholesale funding, which has kept its annual cost of funds above its peers. Its annual cost of funds was 1.23% in 2022, compared to a 0.46% median for US public banks. This high funding cost is largely resolved by the two transactions.
On March 28, 2023, Fitch Ratings affirmed NYCB’s Long-Term and Short-Term Issuer Default Ratings (IDR) at BBB/F3, an investment grade rating. The rating outlook remains stable.
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