Flagstar Bancorp (FBC) – Merger Arbitrage – 5%+ Upside

Current Price: $41.82

Offer Price: $44.05

Upside: 5%+

Expected Closing Date: Aug’21

Presentation

 

This is a quick note on a $2.6bn bank merger with 5% current spread that has been flagged by one of our members. It is likely this transaction will be rejected by target’s shareholders and this might prompt higher bid from the buyer. With cheap borrow and limited downside to pre-announcement prices this is a low-risk option on the potential bid increase before/after the shareholder meeting in early August.

On the 26th of April, Flagstar Bancorp announced a merger with New York Community Bancorp. Consideration stands at 4.0151 NYCB shares per FBC share. 17m shortable shares are available on IB at 0.25% annual fee. Regulatory issues are unlikely, however, the transaction also requires approval of both FBC and NYCB shareholders. The meetings are set for the 4th of August. Closing is expected in late 2021, providing a potential 5.3% return in around 5 months. The downside to pre-announcement prices for both sides of the trade is a bit less than 5%. With the merger announcement, both banks have also issued positive Q1 results, so it should not impact the downside by much.

The deal seems great for NYCB – its assets will increase from $55bn to $87bn, add much cheaper FBC deposits, diversify the portfolio by reducing exposure to mortgage and commercial RE, expand geographical presence, etc. Most importantly, NYCB is paying only just a bit over 1x TBV, while the transaction is expected to be 16% accretive to EPS in 2022. The pro-forma profitability (ROE) is expected to increase from current 12-13% to 16%. As summed up by the CEO:

When I was appointed President and CEO of New York Community earlier this year, one of my top priorities was to seek out a like-minded partner that would provide NYCB with a diversified revenue stream, an improved funding mix, and leverage our scale and technology, as we transition away from a traditional thrift model. In Flagstar, we have found such a like-minded partner. The combination of our two companies will allow each of us to continue our transformation to a full-service commercial bank by broadening our product offerings while expanding our geographic reach with no branch overlap.

Overall, NYBC shareholder approval is very likely.

However, I am far more sceptical about the approval of FBC shareholders. At current prices, the merger comes at just 1.05x TBV, which is much lower than the target’s historical valuation and Midwest peer M&A multiples (1.54x) and also offers no premium to Dec’20 valuation. FBC has been a beneficiary of the booming RE market and saw its profitability skyrocket in 2020 and Q1’21 due to massive gains on loan sales. Obviously, these profitability levels should drop back to normalized levels once the RE market cools off, however, I can not imagine FBC shareholders agreeing to sell the company for such price, especially, on the back of massive, albeit temporary, profitability tailwinds. FBC main shareholders are index funds and large asset managers (top 4 largest owners hold 40.7% shares), so I believe that most of them are waiting for the proxy firms’ recommendations, which should come shortly as shareholder meetings are less than a month away. It is very likely that those recommendations will be negative, which could potentially push NYCB to adjust the exchange ratio upwards. As stated by the CEO, NYCB is looking to grow through acquisitions and there’s a good chance that they won’t drop a merger with FBC as there are not that many efficient similarly sized banks with cheap deposits and relatively complementary loan portfolios that also trade significantly below NYCB multiple (to make it accretive on TBV basis).

 

FBC historical performance

 

NYCB historical performance

 

Additional info

Branches:

Loan portfolios:

5 COMMENTS

  1. Lukas

    FBC’s Q2 earnings are out:
    – TBV/share increased to $44.38 from $41.77 in Q1’21;
    – Diluted EPS $2.74 vs $2.03 in Q2’20 and $2.80 in Q1’21;
    – ROAE 24% versus 23.5% in Q2’20 and 26% in Q1’21;
    – Gain remains elevated compared to pre-COVID, although fell down 26% QoQ.

    The offer now stands at 1.09x TBV, which seems too low even in light of slowing profitability tailwinds from loan sales. The remaining spread stands at 3.6%.

    https://investors.flagstar.com/news-events/news-releases/news-details/2021/Flagstar-Bancorp-Reports-Second-Quarter-2021-Net-Income-of-147-million-or-2.74-Per-Diluted-Share/default.aspx

  2. snowball

    FBC/NYCB merger was approved on August 4, and closing is expected in Q4.
    ~2% spread remains.

    HICKSVILLE, N.Y. and TROY, Mich., Aug. 4, 2021 /PRNewswire/ — New York Community Bancorp, Inc. (NYSE: NYCB) (the “Company”) and Flagstar Bancorp, Inc. (NYSE: FBC) (“Flagstar”) jointly announced that, at their respective special meetings of shareholders held earlier today, they each received the necessary shareholder approval for the consummation of their planned merger. The transaction is expected to close during the fourth quarter, subject to the satisfaction of certain closing conditions and the receipt of all necessary regulatory approvals.

    https://www.prnewswire.com/news-releases/merger-between-new-york-community-bancorp-inc-and-flagstar-bancorp-inc-receives-shareholder-approval-301348449.html

    1. snowball

      Spread has widened to 3.5% after Q3 results (presumably disappointing as both FBC and NYCB stocks sold off).
      The deal is expected to close within two months (i.e. in Q4), making 3.5% quite attractive on an annualized basis.
      Is there anything that we should be worried about?

    2. snowball

      I missed the delay announced by NYCB:

      “As for our pending strategic merger with Flagstar, both sets of shareholders overwhelmingly approved the planned merger on August 4th. We continue to make significant progress on the integration planning front, while we await regulatory approval.
      At this point, it does not appear that regulatory approval will be received in time to close the merger during the fourth quarter of 2021. We now estimate an anticipated closing as soon in 2022 as we can obtain regulatory approvals.”

      also some color from the NYCB conference call:

      Analyst: And just going back to the regulatory approval front. First, I’d assume you need New York State approval, but who is Flagstar regulated by at the bank level and how does that factor in here?

      Cangemi: They’re OCC in the applications with NYCB. So we would need FDIC statement and after that happens, we get the Fed and then we close.

      Analyst: Okay, and then just to hone in the deal closed down the timing a little bit. Do you anticipate this being like a first half of ’22 event? I think someone said first quarter, but I don’t remember reading or hearing that from you or in the release.

      Cangemi: And Matt, I was very clear, obviously this is in the hands of our regulators. It’s going through the application process and we’re anticipating closing as soon as we can in ’22. Other than that, I can’t get specific.

      Analyst: Thanks. Good morning, Tom. In terms of the deal getting pushed out just a little bit toward first quarter, can you just talk about like what are the regulators looking for, asking for, or just any kind of color behind why this seems to be getting pushed just a little bit? Thank you.

      Cangemi: I would just be very clear. I had in my opening remarks as very clear, it’s in a position that is with our regulators. We’re waiting for approval. We’re very optimistic about the merger. However, it’s in the regulatory hands. So we clearly are working toward our common goal of getting this transaction closed as soon as possible. As you know, Ken, we can’t specifically discuss what we do with our regulators. So, obviously, in the hands of regulatory process.

      Analyst: Thank you very much. And then just a follow-up. The one regulator approval. Can you just specify which regulator you’re waiting on?

      Cangemi: The way our structure is, we were FDIC states. So we have not received our FDIC and State approvals. Then after that, it would then go to the Fed. It’s just — it’s the process of our regulatory structure.

  3. Ilja

    As the spread narrowed down to 1%, we are closing Flagstar Bancorp merger arbitrage idea with 4% gain in 2 months.

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