Local bank makes good
Saying 'no' during the housing boom is helping a conservative lender survive the current bust.
NEW YORK (Fortune) -- Joseph Ficalora, New York Community Bancorp's longtime CEO, likes to tell a story to institutional investors and analysts.
In 2005, his $3.8 billion regional bank lent $11 million for a redevelopment project called Riverton Apartments in New York City's Harlem neighborhood. Developers were upgrading 1,200 rent-stabilized apartments to fetch higher rates. But soon, as real estate and construction forecasts grew rosier, the owners wanted a bigger loan.
NYB (NYB) stuck to its conservative model: Value loans based on current cash flows from apartment rents - not market value of the buildings or projected future rents - then offer 40% less as a cushion against default.
A competitor upped the loan to $125 million. Then a year later in 2007 Deutsche Bank offered $225 million, and with other banks including Citigroup, sold it as part of a $6.6 billion commercial mortgage debt offering, according to Bloomberg data.
Now, the property is in foreclosure - it was last valued at $196 million, down from $340 million in 2007 - and bondholders are on the hook.
"It was a bad loan the day it was redone," Ficalora said in a recent interview.
Gone, of course, are the heady days of the real estate boom. With many rivals either out of business or restricting lending to conserve capital, NYB looks ready to rebound.
"We designed our business model back in 1992-93 for the purpose of dealing with the next credit cycle turn," says Ficalora, who's been CEO of the bank since 1993. "We just didn't expect it to be this far out."
Shares trade around $11, down from $20 in October, and offer a healthy 9% dividend yield (analysts call it safe). One positive sign: Its payout ratio dropped below 100% in the last quarter for the first time in a year, meaning quarterly earnings covered NYB's dividend.
"NYB is coming through this as a winner," says Anthony Polini, a Raymond James analyst who rates the stock a "strong buy." "In 2008 it had four quarters in a row of earnings growth, four quarters of margin expansion, double-digit loan growth, and the trends all look positive this year."
Polini notes that as earnings grew in 2008 for the first time in years, write-offs, or charges for bad loans, remained small at only 0.03% of loans. (That compares with 1.84% at Wells Fargo (WFC, Fortune 500), for example).
"That tells you that integrity of this portfolio is incredibly strong," says Polini.
NYB is a bank holding company with $32.5 billion in assets. It operates under various names in the New York metro area such as Queens Community Bank and Atlantic Bank.
The bank owes its success to strict underwriting standards. Its primary business of making loans to apartment owners and developers hasn't suffered a loan loss since 1987.
But it fell out of favor with investors during the real estate boom as investment banks like Bear Stearns and others - Washington Mutual, Fannie Mae (FNM, Fortune 500), and Sovereign Bank - rushed to make bigger, ever-riskier loans in the expanding New York metro real estate market. As the S&P 500 grew 34% from 2004-07, NYB shares fell 15%.
"Not only were i-banks lending more dollars than NYB was willing to," says Peter Winter, who follows NYB for BMO Capital Markets, "they were cutting the rates on top of that."
Winter points out that NYB's loans during that time only earned about 1.5 points over the five-year Treasury Constant Maturity rate, which banks lend against.
That spread now tops 4.5% as competitors have fallen, and bigger banks like JP Morgan (JPM, Fortune 500) and Citi (C, Fortune 500) are forced to keep extra capital (reducing loans they can offer) to protect against losses from consumer and residential loans. Analysts expect NYB's 2009 earnings to increase 14% because of the spread. (It gets 90% of its earnings from interest income.)
NYB's entire portfolio isn't safe. In recent years it took on more commercial property loans, where defaults are picking up. Sterne Agee analyst Matthew Kelley downgraded the stock to "sell" in February on concerns its loan loss reserves of 0.43% - money set aside for potential losses - doesn't take into account its riskier portfolio, a quarter of which is commercial real estate and construction loans.
"We feel it is important to note that the company has lower reserves today, yet higher risk loan composition," he wrote Feb 4.
Still, Diane Jaffee, portfolio manager of TCW's Dividend Focused Fund, which holds NYB shares, thinks many of those loans remain safe because they are linked apartment rents.
"If there is a multi-family apartment in their portfolio but it has a storefront on the ground floor, the whole entity is categorized as commercial real estate," she said in an e-mail. "NYB's portfolio of commercial real estate is relatively strong."
If losses remain as low as many analysts predict, the conservative bank with its healthy dividend looks like a smart investment to ride out regional banking's recovery. 
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