NYCB - NewtekOne: This Is Not The Dividend Policy You're Looking For

Summary

• We previously covered NewtekOne five months back and told you what needed to happen to make it a solid prospect.
• The stock edged a bit higher since then and then came crashing down on Q4-2022 earnings release.
• The company chose the exact opposite direction of our capital return framework, and we tell you how low we think this goes.

Dividends matter. Investors love a growing dividend supported by sound fundamentals. NewtekOne Inc. ( NEWT ) had it all at one point. A BDC business model with fat dividends. That model got an extra boost during COVID-19 with the government largesse. The company could do no wrong, and investors chased it to a new high based on larger dividend payments.

And yet, the company abandoned that model to move to a bank holding company. Around the time, we told investors to exit as the valuations were absurd for a BDC and at nosebleed levels for a bank holding company (See " A Good Point To Exit "). In our more recent piece in September 2022, we defined what was required to steady the stock price.

A poor capital return policy (say $1.00 in dividends) would likely erode confidence further and in that case, we can easily see it trade at 0.8X tangible book value, or closer to $13.00. While we were tempted to upgrade this, we see too many better stocks here today and hence on a relative basis are still keeping this at neutral/hold.

Source: A Logical Capital Return Framework Would Make Shares Attractive

Q4-2022 results released and the associated guidance showed that NEWT did not agree with our analysis.

Q4-2022

Q4-2022 results gave the bulls a rude shock. The miss in the non-GAAP net operating income was huge, coming in at 6 cents vs. the 63 cents expectation.

With many companies, the GAAP number does fly around, and we would expect there to be even more of that with NEWT as it moves out of the BDC structure. The adjusted number is one that's designed to match analyst expectations and strips out all things abnormal. It's hard to show directly where all the shortfalls appeared on adjusted numbers, but expenses were definitely a big factor. In Q3-2022, for example, you can see expenses and total investment income matching toe to toe.

In Q4-2022, most expense categories were up strongly. Interest expense was up almost $2.0 million quarter over quarter.

What's even more surprising is that NEWT declared a $0.70 dividend in Q4-2022 on Dec. 19, 2022. At that point, they would likely have had some visibility into these numbers. The end results of poor Q4-2022 results and the massive 2022 dividend was that tangible book value dropped to $15.25 per share, compared to $16.72 per share at end of 2021.

Guidance

NEWT coupled that poor Q4-2022 performance with a massive guide down of expectations.

We are updating our EPS projections to a range of $1.70 to $2.00 per share in 2023 and to a range of $2.80 to $3.20 per share in 2024. Given our market leadership in various segments of our business, we feel comfortable with these forecasts. In addition, today NewtekOne's board of directors declared our first dividend as a financial holding company of $0.18 per share.

Source: NEWT Q4-2022 Press Release

The street was at $2.97 in earnings for 2023 before the announcement. NEWT is going to pay 18 cents as its first dividend after the conversion. At a 72 cents annualized rate, NEWT is going to disappoint the former BDC crowd by a huge margin as the yield on the pre-announcement price is about 3.7%.

Our Thoughts

NEWT has been caught a bit flatfooted as interest rates took off in 2022, possibly far more than what they expected when they announced the transition. These are challenging times to be a lender, and the yield curve inversion alongside prospects of a recession makes it hard to increase or even maintain profits. We saw this in our recent analysis of the top-tier bank, New York Community Bancorp, Inc. ( NYCB ). Even its earnings are expected to decline by about 10%, and we believe analysts are actually off their target. So this is an interest rate story, one where NEWT will now have very expensive funding via bank deposits and will have to pay top dollar to retain those deposits. Put another way, the bank holding model was designed for a ZIPR (Zero Interest Rate Policy) world and not for one where you can get over 5% from a 1-Year Treasury note. As shocking as the news was, we would be hesitant to accept the 2023 guidance or the 2024 one, at face value. We are sure the company believes those numbers can be met, but our macro concerns suggest that things could get far worse before they get better. There are risks from a credit standpoint, and historically, most companies have contracting earnings in a recession. So we would look for perhaps the same earnings in 2024 as the company is guiding for in 2023.

Verdict

With the stock trading near $16.00 as we write this, the round trip appears close to be completed. Those that ignored the value of tangible book value and chased the temporary high dividends into the "mid $30s" have now lost the dividend yield and suffered a huge loss. We will add that in no realistic timeframe is that capital loss going to disappear. The guide down to about $1.85 in earnings means that the stock is nowhere near cheap. We use our NYCB analogy again, which is trading at under 8X earnings. We would use the capitulation lows in 2016 and 2020 as the benchmark for where this could ultimately trade. In both cases, the stock traded near 0.7X tangible book value.

Note that the drop in Q4-2022 tangible book value has not been incorporated into the chart.

The 0.7X multiple hence works to about $10.75 per share. Assuming that NEWT delivers expected earnings and this target is reached toward the end of 2023, our price target would move to about $11.50. This is because retained earnings would boost tangible book value. At the absolute upper end, we would think this would trade at about 0.9X tangible book value in a year. Hence, we think the stock has some downside bias, and we would look for $11.50-$14.50 as a range where to consider buying. While we see solid downside risks, the stock is not a compelling short as it was when we assigned a sell rating at a $30.00 price. We currently rate NEWT as a Hold and think investors should be cautious in making the assumption that it's all priced in.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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