North Fork Bank and Capital One

Why now? I can certainly understand why North Fork Bank (NFB) would want to sell. Financial services companies tend to have a tough time in a rising interest rate environment but banks in particular face a few other challenges.

My sense is that there is ever increasing competition for both loans and deposits. The rising rate environment tends to be associated with higher loan provisioning as banks seek to maintain their credit quality.

Finally, banks seem to be interested in improving their customer relationships by improved servicing and improved convenience.

All of these factors contribute to a less than robust earnings picture.

North Fork Bank is the most important factor in Long Island banking for Suffolk County where it has close to 30% of deposit share and also in Nassau County where it has 15% share. In New York City, NFB has only about a 2% share of deposits.

The NYC metropolitan area is a very attractive area for banking with very high median incomes. NFB has been a terrific operator with superb expense control. Its return on tangible equity was about 31% and return on assets 0f 1.81%.

Capital One (COF) obviously wanted this footprint badly. The premium to deposits paid was 34% versus a more “normal” premium of 25-28% for premium MSA’s in New York and Florida, often viewed as the "hot" areas of banking where takeover prices are highest. The price to tangible book value was 4.9 times; again well above a median level of around 2.5 times.

COF transforms its earnings base to being much less credit card and sub-prime lending oriented. NFB has enjoyed strong credit quality over time with loan losses miniscule. The reserving policy to me seems quite liberal based on the good experience of the past with reserves to loans of only 1.28% for commercial loans. Contrast this with a battleship mentality at Wells Fargo where the reserves to loans ratio is 2.28% in the most recent quarter.

Over the long run, the acquisition of NFB and the previous acquisition of Hibernia should prove beneficial to COF. Acquisition of a retail deposit base will lower funding costs and increase liquidity. Access to a broadened customer base will help in generating other high margin fee income.

But, as I said earlier, this is a fairly tough environment for most financials. The group represents 21% of the S&P with almost 60% of it banks, thrifts, mortgage, and consumer finance related. The outlook for these companies is neutral at best. Insurance and asset management is the balance of the financial sector. I believe that the outlook for these companies is much more positive.

What remains in New York that could yet be acquired? In my view, this deal should reflect positively in the valuations of Bank of New York (BK) and Sterling (STL.)

But a rising interest rate environment will not be kind to anything in this sector.

I, my family and clients have a long position in Bank of New York.