In today's regulatory environment, mergers and acquisitions can be beneficial for regional banks; but as seen with New York Community Bancorp, they're rarely a silver bullet.
In March 2023, NYCB's acquisition of Signature Bank made sense for two key reasons. One, it addressed the bank's high loan-to-deposit ratio, reducing it from 118% to 88%, a move likely welcomed by regulators. Two, it improved NYCB's customer acquisition strategy. Before the acquisition, NYCB focused mainly on "mass" banking. Signature's wealth management practice provided access to "affluent" and "high net worth" products, expertise and clientele.
In that regard, the Signature buy seemed like a logical move with relatively low regulatory risk. So, where did things go wrong?
NYCB (and regulators) were focused on solving a problem, but other factors were at play.
An LDR exceeding 100% suggests a bank has lent out more money than it holds in deposits. This signals potential issues, including liquidity risk, heavy dependence on alternative funding sources, financial instability, imprudent lending practices and credit risk.
Therefore, the deal presented an opportunity for NYCB to strengthen its position and contribute to financial stability while expanding its reach. All of that resonated positively.
However, other factors, compounded by a prolonged high interest rate environment, caused a dramatic turn of events when NYCB held its fourth-quarter earnings call. One was commercial real estate conditions. The Signature acquisition left NYCB with a $34 billion CRE loan portfolio, mainly in New York City. This portfolio faced pandemic-induced challenges of remote and hybrid work, including increased risk of office loan defaults, reduced rental income and property valuation challenges. This led to an unexpected $260 million loss in Q4, primarily due to anticipated loan losses from office building loans.
There have also been execution and integration risks. Before acquiring Signature, NYCB had already absorbed Flagstar Bank. The acquisitions of Flagstar and Signature elevated NYCB into a higher asset category, pushing the bank over the $100 billion threshold and triggering stricter capital and liquidity requirements and additional expenses, which impacted profits.
Additionally, the operational system conversion with Flagstar didn't finish until almost a year after NYCB acquired Signature. Simultaneously integrating NYCB, Flagstar and Signature — each with its own unique systems, processes and culture — presented substantial execution risks. One of the biggest challenges banks face is managing data and analytics. The root of the problem often lies in outdated systems and incompatible data, hindering integration. The compatibility issue could have also impacted NYCB's ability to properly assess execution and integration risks, even if they had all the required financial statements and reports. NYCB's announcement in January revealed delays in Signature's integration that could potentially stretch into next year. Analysts subsequently expressed waning confidence in NYCB's integration capabilities.
Finally, internal controls and governance played a role. M&A requires robust internal controls and governance. Did NYCB use adequate risk models? Did the risk committee have access to Signature's real estate exposure? What financial ratios were considered and assessed beyond LDR? Including dissenting voices would have helped. Also, compliance alone isn't enough; transparency is crucial. NYCB's delay in disclosing key executive exits raised "governance concerns" among analysts.
So, what's the solution? Merging financial institutions is no small feat, especially when dealing with rapidly changing market dynamics, legacy systems, differing processes and regulatory headwinds. NYCB's journey highlights that regional banks eyeing an acquisition must consider a few factors. One is broader market dynamics. A lot of CRE is still sitting on regional banks' balance sheets. If considering an acquisition, assess the CRE portfolio that will be inherited.
Another issue is carefully assessing execution risks and planning the integration strategically. Ensure someone on the risk committee is playing devil's advocate and challenging assumptions.
Finally, potential buyers must prioritize robust internal controls and governance. Ensure adequate risk models and governance frameworks address all aspects of the deal, good and bad. Assign responsibility for monitoring financial ratios beyond basic metrics and embrace diverse viewpoints to enhance decision-making. Compliance is just a baseline; prioritize transparency to build trust. Learn from instances like NYCB's governance lapses and prioritize openness.
So, was NYCB's acquisition of Signature a mistake? It was the right decision at the time. However, in hindsight, there were several crucial factors which could have been further reviewed.
