Flagstar Financial Inc (NYCB) 2014 Q2 法說會逐字稿

Good morning, and thank you all for joining the management team of New York Community Bancorp for its quarterly post earnings release conference call. Today's discussion of the Company's second quarter 2014 performance will be led by President and Chief Executive Officer, Joseph Ficalora, together with Chief Financial Officer, Thomas Cangemi. Also joining in on the call are Chief Operating Officer, Robert Wann; and Chief Accounting Officer, John Pinto.

Certain of the comments made by the Company's management today will contain forward-looking statements which are intended to be covered by the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those of the Company currently anticipates, due to a number of factors, many of which are beyond its control.

Among those factors are general economic conditions and trends, both nationally and in the Company's local markets; changes in interest rates which may affect the Company's net income; prepayment penalty income; mortgage banking income; and other future cash flows of the market value of its assets including its investment securities; changes in the demand for deposit, loan, and investment products, and other financial services; and changes in legislation, regulation, and policies. You'll find more about the risk factors associated with the Company's forward-looking statements on page 7 of this morning's earnings release and in its SEC filings, including its 2013 annual report on Form 10-K, and its first quarter 2014 report on Form 10-Q.

The release also includes reconciliations of certain GAAP and non-GAAP earnings and capital measures which will be discussed during this conference call. If you would like a copy of the earnings release, please call the Company's Investor Relations department at 516-683-4420 or visit IR.myNYCB.com. After the prepared remarks, we will have a question-and-answer period.

(Operator Instructions)

To start the discussion, I will now turn this call over to Mr. Ficalora who will provide a brief overview of the Company's second quarter performance before opening the line for Q&A. Mr. Ficalora?

Thank you, Leo, and thank you all for joining us this morning as we discuss our second quarter performance, which was notable for the continued strength of our earnings, quality of our assets, and the meaningful growth of our multifamily loan portfolio.

To begin, we reported earnings of $118.7 million or $0.27 per diluted share for the quarter, up $3.4 million or $0.01 per share for the trailing quarter amount. On a cash earnings basis, our earnings rose $2.8 million sequentially to $128.6 million, and were equivalent to $0.29 per diluted share.

Reflecting the strength of our earnings and our solid capital position, the Board of Directors last night declared our 81st consecutive quarterly cash dividend in general, and our 42nd consecutive quarterly cash dividend of $0.25 per share. The dividend will be paid on August 20 to shareholders of record as of August 8.

Our second quarter earnings were driven by various factors, including the quality of our assets, which was reflected in each of the pertinent measures at the end of June. Largely reflecting a $34.3 million decline in nonperforming multifamily loans over the course of the quarter, nonperforming non-covered loans declined $34.8 million or 30.7% to $78.6 million, representing a 0.25% of total non-covered loans at the end of June. This is the lowest this measure has been since the second quarter of 2008.

The linked quarter decline was largely due to a group of loans to a single borrower in the amount of $32.2 million that had been nonperforming at the end of March. The properties were foreclosed upon and sold in the second quarter, resulting in a gain of $6 million. This is a prime example of our ability to dispose profitably of our nonperforming assets, an ability that we made mention of in last quarter's conference call.

Another measure of asset quality that reflected real improvement was the quarter end balance of non-covered loans 30 days to 89 days past due. At the end of June, the balance of such past due loans was a modest $4 million. That's a three-month reduction of $14.6 million and a six-month reduction of $33.1 million.

We also enjoyed the benefit of recording net recoveries rather than net charge-offs. Though modest, the net recoveries we had another example of the contribution to our performance of our asset quality.

Reflecting our asset quality and the adequacy of our non-covered loans, loss allowance, we recorded no provision in the second quarter consistent with the guidance provided on our last conference call. In tandem with the improvements in our asset quality measures, we recorded a meaningful level of loan and asset growth.

Loans held for investment rose $1.1 billion sequentially, to $32 billion reflecting an annualized growth rate of 14.5%. Multifamily loans accounted for $856.8 million of the linked quarter increase, having grown to $22.3 billion at the end of June.

The increase is indicative of the volume of multifamily loans we produced in the second quarter, which was the second highest volume we've ever produced over the course of a single three-month period. The highest was $2.6 billion in the third quarter of 2013. In the second quarter of this year, we produced $2.1 billion of multifamily loans.

Largely reflecting the growth of our loans held for investment, our assets grew to $48.6 billion at the end of the quarter. I'll speak further to our asset growth later in my remarks.

Meanwhile, the loan and asset growth we achieved at the end of the quarter was similarly reflected in our average balance sheet. In the second quarter of 2014, our average loans rose $1.1 billion sequentially to $34.1 billion, and our average interest-earning assets rose $1 billion during that time, to $42.6 billion. The benefit of these increases were somewhat offset by the impact of a decline in the average yields on our loans and assets, largely reflecting the replenishment of our balance sheet at lower yields.

Meanwhile, prepayment penalty income accounted for $19.3 million of the interest income produced by our loans and interest earning assets and contributed 23 basis points and 19 basis points, to the respective average yields. In addition, prepayment penalty income contributed 18 basis points to our second quarter margin, which declined 6 basis points sequentially to 2.66%.

Consistent with the guidance we gave when we spoke with investors last quarter, the decline in our margin absent prepays was 5 basis points. While net interest income declined a modest amount to $283.5 million, non-interest income rose $15.4 million from the trailing quarter level to $52.6 million in the second quarter of this year.

Other income accounted for $10.8 million of the linked quarter increase, including the $6 million gain on the sale of OREO I mentioned before. We also were pleased to report a linked quarter rise in mortgage banking income, as originations of held for sale loans rose $106.5 million to $743.3 million in the second quarter of this year. Reflecting the higher level of non-interest income we recorded, our efficiency ratio improved from 44.81% in the trailing quarter to 43.37% in the second quarter of this year. The increase occurred despite the modest decline in net interest income and a comparatively modest rise in operating expenses.

At this time, I typically would open the line for questions. But first, I'd like to say a few words about the growth of assets to $48.6 billion at the end of June.

To dispel any uncertainty or uneasiness this may create for investors, I'd like to take this time to clarify what this means for our institution and, more importantly, what it has and still may cost. First, for a bank to become a SIFI bank, its assets must average $50 billion or more over four consecutive quarters. In other words, even if our assets were to rise to $50 billion at the end of a quarter, this alone would not subject us to the requirements for a SIFI bank.

Consistent with our longtime strategy of growth through acquisition, we would expect to exceed this four-quarter threshold in connection with a highly earnings accretive transaction, rather than to exceed this by tiptoeing over the $50 billion mark. Given our proximity to $50 billion, we can exceed it quickly. We also could take longer to get there if that is the route we opt to pursue.

We could do a small deal to get there, but that would bring us the burden of growth without the benefit we envision. Thus, our desired approach will be to grow through a meaningful transaction, one that benefits our earning and the value of our shares.

Because we have every expectation of finding the right transaction, we have already allocated significant resources towards enhancing our capital planning process, our stress testing infrastructure, our enterprise risk management program, and our corporate governance. We understand where we need to be with regard to enhanced regulatory compliance.

We've also put the right people and systems in place to manage our transition and to fulfill our obligations when the time comes that we do become a SIFI bank. Reflecting the large investment we've made in preparing for SIFI status, a process that began 3.5 years ago, I should mention our efficiency ratio rose from 36.62% in the six months before Dodd-Frank was enacted, to 44.07% in the first six months of this year.

While I won't say that all of our work is done, what remains is incremental in view of how much we've already spent to prepare for SIFI status over the past 3.5 years.

Finally, I would like to say that our primary mission has always been to provide our investors with value. We are not about to take any steps to jeopardize that mission and therefore, expect to manage our growth with that primary goal in mind.

On that note, I would now ask the operator to open the line for your questions. If we don't get to all of you within the time remaining, please feel free to call us later today or this week. Leo?

(Operator Instructions)

Bob Ramsey, FBR Capital Markets.

I just wanted to be sure I understand you correctly, Joe. Is it fair to say that you guys are managing the balance sheet growth so that you won't cross over the $50 billion mark absent an acquisition?

No. I think what we're really saying is that we are very cognizant of the consequences of being bigger than $50 billion, and we would manage how that occurs. Clearly, we're actively discussing with both our regulators and the marketplace, the opportunities that might, in fact, arise. We're also at the same time, very cognizant of the day-to-day activities in any given quarter, so these are not going to be accidental moves. These will be intentional events that occur as a result of our merely deciding that we are prepared to be $50 billion in the first quarter of next year, let's say, or in any given quarter. It doesn't mean that we're automatically triggering something because, as I mentioned earlier, it takes four consecutive quarters of $50 billion in order to actually trigger an event.

Okay. You're not worried about crossing it, but you would not want to stay over it for four consecutive quarters unless there was a deal -- ?

That's right.

-- coming right away?

When you look at the way it's calculated, it's an average number. If we do a $40 billion deal, we cross it the day we did the deal. The average automatically jumps. If, in fact, we've merely allowed our assets to go to $50 billion in a given quarter, and the very next quarter we're $49 billion, and the very next quarter we're $42 billion, it's a matter of averaging it over the course of time.

Okay. Then, I guess First Republic talked about the fact that they are being held to a higher standard as they approach that $50 billion mark, and that it's not a night-and-day, today you don't qualify, and tomorrow you do situation. I know you've talked a lot about investments you've made to prepare. Is that how you guys see things too?

Yes, I think there's no question that is a very valid statement. Now, the good news and the bad news, we actually had a very large deal that we, in fact, were discussing directly with our regulators for the purpose of executing on that very large deal. It meant that we had to explicitly over the course of these years, take steps to prepare ourselves for the eventuality that we would be substantially bigger than $50 billion at a moment in time.

Bob, I would also add. This investment and this change in focusing on an action of Dodd-Frank started for us in 2011. We've been making significant investments since then.

As far as if you guys did cross $50 billion threshold, what part of the increase in regulatory cost, and if you guys have already built into the existing operating structure, and how much more cost do you think would need to be incurred?

Bob, what I would say without being specific, we don't envision any significant, incremental investments to cross over the $50 billion. There are three items would have to be dealt with as we go through that level, which would be LCR issue as far as, we're working through that and finalize, as I said finalize rules that. It's an investment that we would have to make as well as dealing with a living will, and dealing with upgrading the systems with the CCAR reporting from our office to Washington.

Besides that, the system of capital planning was built internally, and we've spent years developing that. We're in a pretty good shape as far as getting to that crossover. We have more work to do, as Mr. Ficalora mentioned. Those are the three items I would point to specifically as we make the transition to SIFI.

Okay. Great. Thank you, guys. That's helpful. I'll step back out of the queue.

Collyn Gilbert, KBW.

Quickly on the follow-up to this discussion, of the costs that you've incurred thus far, number one, do you have a specific dollar amount that you could tie to those investments over the last three years?

I would say the range is between $30 million and $35 million of just investment, of which a lot of that was consulting fees up front. The run rate on employee base that we've had to add as well is over $10 million in our run rate. That number will increase as we go past [$50 billion,] but it's going to be incremental. It's not going to be a material number that's going to be a meaningful number to take our efficiency ratios to a level that we don't expect. The numbers, again, this was a long-term transition for us. We started from 2011, and here we are in mid-2014 still making some investments, but very happy about the system build-out, and as I indicated, three items that we need to deal with when we cross SIFI.

Okay. Within all these investments that have been made, I guess we can assume that within that came BSL and AML, BSA and AML investments, as well?

Yes.

Okay. Just on that, maybe you answered this, Tom, what percent would you say were costs tied to just testing your systems versus creating new systems?

I would say it's probably between payroll cost and consulting, it's got to be $7 million or $8 million alone, just dealing with the build-out. Between payroll and up hiring the people, consultants, our total consultant fees alone, just to develop the system total was $10 million, all-in.

Again, we're not done, but it's not going to be incrementally a material numbers going forward. We're very pleased on the actual system built. I know we said in previous quarters that we built this from the ground floor up. It's in the loan file to the actual results, instead of doing a top down approach, and it was intensive. We worked with the right people. We started during the crisis, and literally, after 2008, 2009, we realized what the regulatory bodies were looking for, and we worked with the best practices of hiring the people that worked with the regulatory bodies in Washington to develop their systems.

The people that we're working with, Collyn, are the people that have been most active in the marketplace. We have the best-in-breed doing what needs to be done.

Unfortunately, a lot of those people are now working for other banks, but they were very helpful in the development stage.

Okay. Just one other question, I just want to switch gears to loan growth outlook and loan demand. It looks like the pipeline coming out of this quarter was one of the lowest that you guys have seen over the last few quarters. How are you thinking about just the growth trajectory from here? Taking $50 billion threshold off the table, I just want to think about how you're thinking about the business and future demand and that type of thing.

Collyn, what I would say to that, as you've known the Company for a long time, historically the third quarters are typically the slowest of quarters, given the holiday season, and the way the market has always been for the multifamily line of business. With that being said, if you look just at multifamily loan growth net, we're up 15.4%, six months. It's a little bit front-loaded.

As you know, historically, the fourth quarters are always very large quarters for the Company. Typical Q3s are typical fourth quarters for us. Last year was an anomaly as far as, I guess, the growth we had. We had a significant third quarter, and that was one issue to deal with we had a significant rise in interest rate last year at this time. It really moved many customers to accelerate their financing needs. Right now, we're still in a very low rate environment.

Given the rate environment, given that we had a front-loaded pipeline up front, we're still looking well past double-digit growth in 2014, and fourth quarters are typically very strong quarters for us. I wouldn't put too much value into a lower pipeline in Q3 given that we had a significant growth in the beginning of the year.

Collyn, I think it's important to note that we actually have the ability to increase or decrease the amount of lending we do in any given quarter by merely changing the terms that we're willing to accept. Every negotiation, every single loan is a negotiated deal. There is a rate and other terms which are adjustable during the course of that negotiation. How far we're willing to go with a particular deal will decide whether we get it, or we don't.

Okay. I'll leave it there. Thanks, guys.

Ken Zerbe, Morgan Stanley.

In terms of M&A, if we look at the CIT/OneWest deal, have you guys noticed any change in regulator tone about them allowing banks to do deals? Do you think the OneWest deal was simply a one-off situation?

I'd say clearly, the most relevant player in the M&A market is Governor Tarullo, and he's made a very open and clear statement that he does believe that there should be a viable community bank market to compete in the United States for banking. One component of that would be the consolidation of banks from being smaller to being larger, more competitive banks. We're not talking about creating giants. The giants already exist. We're talking about creating viable banks, and I suspect that we will see a great deal of activity in the period ahead.

Okay. Tom, maybe one for you, just given the contraction in NIMS this quarter, which again you did guide for, how are you thinking about NIM over the next few quarters?

I don't go too many quarters out.

One quarter, please.

This trend has been unfortunate, but the one quarter of forward visibility that I would say is that I'm going to tighten my range for the quarter, probably down 3% to 5% again, 5% being the back end of the range, 3% being the front of the range. It seems like we're getting closer to bottom, as I said in the last quarter. Right now, we're at the yields coming on at around 3.50%, 3.60%-ish, all-in including commercial. We are rolling off the current coupon that, I believe, is about 3.56% on the multi and about 4.11% for commercials.

I think if you look at that phenomena, and coupons that are coming are closer to the average coupon on the book. Unfortunately, we still have some runoff, which is, I would call it, mid-4% loans that are running off. That's where you have some of the pressure. It feels like we're getting close to the end, and I've been sounding like a recording -- a recorder, and I apologize for that, but the interest rate environment has been brutal. It seems that we're getting closer to the bottom, and give or take between one or two quarters, we should be at the bottom in this rate environment.

Got it. Okay. Last question, in terms of the lower security balances, how are you thinking about those in terms of getting prepared for LCR? Or, are you waiting for a deal to get ready for LCR?

We've been working specifically on planning on LCR. As you know, the rules have not been finalized. We're evaluating it. For us, as a Company, we're more concerned about the systems build-out until we find certainty enough to deal with the operating platforms for LCR. We will be ready to deal with LCR when it pertains to our size institution. As being under $50 billion, it does not pertain to us.

What you'll see in the short term, before we cross over $50 billion is that you'll see securities probably shrink in this environment because yields are extremely low. What you've seen leaving the portfolio, predominantly calls from the ventures that we own that, given the rate environment, are being called away, we're probably looking at a 15% security to average to total assets as of this environment. Now if environment change will be assessed, but as far as LCR's concerned, clearly will be a change in how we do business when we cross $50 billion. That will be part of our planning when we cross $50 billion.

Great. Thank you very much.

Brad Ball, Evercore.

Following up on the M&A, I wondered, Joe, if you could talk about the target environment. The banks that are out there that would be willing to or might consider selling in this environment, what are the pressure points? Also, you mentioned Governor Tarullo. What are your thoughts about the prospects of raising the $50 billion threshold for a SIFI requirement?

Sure. I think there's no question; there are today and have been for a while, plenty of banks that consider their strategic alternatives. A combination with us, and we've done 11 deals of various types, a combination with us is always highly beneficial to the shareholders of the company that makes that decision. The outcome is going to be significantly improved by the reality of how the metrics bring together two different companies. The marketplace has, without being specific about who, the marketplace has several large institutions that can see a good reason to be combined with us.

Over the course of the years past, we've had constructive dialogue with just about everybody -- no, I shouldn't say that -- with large numbers of banks that one would not expect would be actively considering doing something. It is prudent for boards and executives to consider their alternatives. We, in fact, have the benefit of many informed discussions with responsible people throughout the country running very large banks. The idea that there will be transactions in the future, I think, is significantly enhanced by the current environment.

I do believe that Governor Tarullo is being very direct in his approach to saying that banks should be regulated below the $100 billion or $250 billion plateau in a manner that does not reflect the extra burdens or regulatory expectations or consequences of being a giant in this environment. We do not present the risk profile that banks smaller than we present. Size is not a determinant of risk. The actual assets determine the risks inherent in a particular business model. Our assets have demonstrated cycle after cycle, decade after decade, that we, in fact, have a very low risk profile, and the outcomes through the cycle demonstrate this time and time again.

I think it's really very constructive that there is active consideration of what is, in fact, the appropriate determinant of more diligent requirements from a regulatory perspective to manage risk. I think the good news is in the period ahead, there will be less emphasis on size and more emphasis on the individual institutions risk profile.

Great. Following up on that line, what specifically are you looking for? What characteristics are you targeting in an acquisition? You talked in the past about deposit [risk], relatively little asset risk.

The reality is, and I will say this with a measure of consistency, we always look to do deals that are accretive to earnings and tangible. That's primary and evident in the announcement of the deal. The reality is, we do deals for franchise. We do deals to acquire deposits.

That is how we're structured. We're structured to grow our liquidity, to grow our deposit base by acquisitions. We've done that time and time and time again. The good news is that we are very consistent in our approach to doing transactions. There are plenty of transactions out there where we could acquire lower-cost deposits and have an ongoing capacity to immediately meet our liquidity needs and our deposit needs by doing a highly accretive transaction.

In terms of size, Joe, would you be willing to go as far as an MOE- type transaction?

We can easily do that. We've actually considered that.

Okay. Then shifting gears to the quarter, real quick the gain on sale in the quarter related to the ORE, Tom, there was an increase in expenses linked to that gain on sale?

That's right. That's correct. We ended with actually $3.5 million in the quarter that we would look as nonrecurring. However, even the size of the [MTA] book being the lowest it's been, we don't envision significant foreclosure expenses in the short-term, given asset quality is in a pristine fashion. I would definitely look at that in that number. You have the $15 million gain. We have some expenses. I would definitely consider that as nonrecurring. We are seeing definitely a trend of much lower foreclosure expenses.

As you remember in the past few years that foreclosure expenses were slowing down, our ramp-up of our $50 billion expectations are built out. It's balancing itself. Now that the foreclosure expenses are probably substantially less going into the second half of 2014 and into 2015, you'll probably see a little bit more expense to build out the SIFI, but it should be on balance. A reasonable guide, I'll guide about $144 million for the next quarter on expenses which is pretty much in line with the previous quarter, and the change is predominantly the continued investment into the SIFI status.

Okay. Just to clear, Tom, did you say $3.5 million of the $6 million you would consider, that's the net number?

No, we had a gain of $6 million, but in addition to that we had expenses of about -- foreclosure expenses that are not typical recurring foreclosure expenses, to take control of assets in the quarter, about $3.5 million.

$3.5 million. About $2.5 million, the difference between the $6 million and the $3.5 million would be a nonrecurring gain?

Yes, that's fair to say.

Okay. Then, $144 million is the guidance for 3Q expense?

That's correct.

Thanks, guys.

David Rochester, Deutsche Bank.

Back on the comment on the incremental expense you might need for $50 billion, what's the timing you expect on incurring those expenses? By when do you expect those to be in the run rate?

Incrementally, it's not going to be a material number over the next few years, depending on when we get there. Our project plans are in place. We have a plan to deal with living wills, dealing with the potential of CCAR reporting, upgrading the system, personnel, additional adds over time, but they're not going to be material. I'd say it's going to be -- it's not going to be in one quarter. It's going to be over the next foreseeable periods. The sooner we get there, we'll be accelerated. I don't think, David, it's not going to be a substantial incremental number.

David, it's important to recognize that as that expense is actually incurred, the chances are great that we'll have additional income at the same time.

Got you. Just real quick on the other income line, I know you mentioned that $6 million. If I pull that out, it looks like that line was still up another $5 million or so. I was just wondering what was the rest of that increase? Were there any other one-time things in there?

We've increased on the fees on, that's advisory fees on our [B2B] (inaudible) are doing extremely well. Our assets are over $3.5 billion, which is a nice milestone for us. We've increased that over $1 billion this year. New employees adds that have brought a tremendous amount of business to the Company, we're very pleased with that operating unit. Just a general increase from a very low base on fees. Obviously, we don't have a lot of fees. We're starting at such a low base. It's nice to see the slight increase.

If we back out that $6 million in gains from other income, that should be a good run rate going forward?

I would say it's close, yes.

Great. One last one on the LCR with the way the rules are written today, can you give a sense for how you guys stand there? Do you needed any more liquidity? Then what your strategy would be to build that extra liquidity, if you needed it?

David, I'll say that we're assessing the LCR rules as they end up becoming finalized. We're hoping they'll be finalized shortly, but they're not finalized. Obviously, as I indicated in my previous statements, we're not in the classification to be an LCR reporting entity. Other banks are reporting because they are at $250 billion, and they're making significant change to the balance sheets.

My gut would say follow some of the other institutions that are through $50 billion, and what they're doing for their balance sheets. We would be probably somewhat consistent there. There's no question that there will be a balance sheet change when we cross $50 billion to deal with LCR. As we assess the LCR rules, we will address it accordingly when we become $50 billion. We do have an internal project plan assessing it. The one area that we have to make sure that we're very clear is on the operating side. There's going to be some operating expense changes on how to deal with LCR, and as that comes to play, we're hopeful that the time we cross $50 billion, we will have that in place.

Great. Thanks, guys.

David Hochstim, Buckingham Research.

Could you just talk a bit about provisioning? You've had lots of loan growth and no provisions. Is there a movement? Are you adding any reserves for new loans put on the balance sheet and those are offset by withdrawals on better performing old loans?

David, if you think about quantitatively or historical loss experience, from our qualitative assessments, and look where our and [NPAs] are today, we were at $750 million with no [NPAs] going back to March, which was the peak for the Company coming out of the great recession. Right now the total amount of accrual is about $78 million. We look at the current environment. It's very strong credit environment right now.

The issue we have as a Company, is that those bad years are rolling off. We have a very strong historical loss experience compared to the industry. Remember, we are not looking at the potential of massive recapture of other institutions. That's the environment. We just happen to be in an environment where we're at the back end of our range, and despite the loan growth, the environment is very strong. When you look at the losses that would pertain to actual loans, and we have a very strong history of de minimis losses, especially in the commercial real estate side. Our commercial real estate losses are half that of multifamily. The multifamily losses are de minimis. We have a very unique story to tell, and we have a methodology which points to the back end of the range, given the change in the economic climate.

David, it's important to note that we've had as many as 52 consecutive quarters, where we had no charges on loans that we had created. The reserve arguably is substantially greater than our actual expectation of losses. The idea that other banks continue to add to their reserves is what the other banks continually have losses on their assets. We just do not, and when we look at the period ahead, we could actually have more in recoveries than charges to the reserves.

Right. Should we expect some reserve releases then as we go forward?

When I would give guidance to the year, I'm going to go out on a limb here for a couple of quarters. I [don't want] to take one quarter jumping into the abyss. We are looking again, I am going to reiterate, we don't expect a provision this year given the overall climate for credit. That could change tomorrow if things get difficult, but that's where we feel the portfolio is at as of today. Clearly, as Mr. [Ticular] indicated, the loss content is extremely low.

I want to point to our commercial book, given that it's 50% of the historical loss expectations with the multi, and the multi being so low. Again, we have a unique situation. The industry is seeing significant reserve releases. We haven't released reserves. Again, we have in comparison to the rest of the banking industry, our reserve is significantly different given the loss content of the Company.

Could you give us a breakdown on mortgage banking originations in revenues from servicing, MSR impairment, recoveries?

I can give you the breakdown of the components of the income statement for the quarter. For the quarter, the Company generated $15.291 million of income, of which $10.368 million was from mortgage servicing, and the origination side was $4.9 million. That's up slightly quarter-over-quarter.

As I indicated in the previous call, we expect it to be at the first quarter level. Interesting phenomenon about mortgage banking is that from December of last year, our rate loss has increased every month from December through May, then we saw a slight downtick in June. Now it's very early for July, and things are a little bit slow given the environment. Given that rates are relatively low compared to the previous quarter on average, you may see some volatility there, and we are hoping for another flat quarter. It's a little too soon to tell as far as overall volumes are concerned.

Okay. Of the servicing, how much was recovery of MSR?

We had loan servicing fees of $12.45 million. The change in MSR was a negative $16.3 million. We had a gain from hedging effect of $14.2 million, which nets out to $10.368 million.

Okay. Great, thanks a lot.

Steven Alexopoulos, JPMorgan.

You've said quite a few times on the call this morning that you spend the time and money to get ready to cross $50 billion. With that, you're also saying you want to avoid the consequence of tiptoeing over $50 billion. If you've already spent the time and money on this, what's the consequence that you are looking to avoid?

I think there's no escaping the fact that there are differences in actually being bigger than $50 billion. Even though the economics are such that we've spent huge amounts of money, there are explicit people demands, intellectual resource demands. There are many reasons why it might be better to actually be in a position to identify a transaction from being sub $50 billion to being bigger than $50 billion in that discussion of a transaction.

Our business model over the course of time, our whole public life, has been to grow by acquisitions. Our balance sheet is structured to accommodate an acquisition. The reality that there's a material change in how the bank actually would operate and spend money, being bigger than $50 billion, means that we will manage our position as best as we can up to that plateau.

Steven, you have to realize that when crossing a certain point in time, when you pass $50 billion, there's a formal submission of a capital planning process that goes to Washington. That's a significant change in how you do business.

Okay. Joe, are you saying that you will not cross $50 billion organically or without a deal? Then how do you control that? Is this a loan or asset sales?

It would be very mindful of what we would be ending each and every quarter at. It would not be accidental that we cross $50 billion. There might be activities, for example, that would suggest to us that crossing $50 billion in the immediate period before a discussion with our regulator or a discussion with a particular bank, might very well happen because we're comfortable that we'll be in the process of executing on a deal.

No one knows, today, how long it takes to go from agreeing to doing a deal and doing a deal. The reality is that we would have to virtually manage our position during that process. It's very hard to know what would be the right place to be, averaging $49.5 billion versus averaging $50.1 billion. The reality is that the important thing is that we are in sync with our regulators and a particular transaction at the time that we, in fact, move over $50 billion.

Okay. You're definitively saying to us today that you're going to slow growth over the next few quarters to buy yourself more time, right? That's the key message?

Yes. I think the most important message is that we will manage our position based on our activity with regard to opportunities. The idea that we'd be slowing growth over the year ahead or the two years ahead would not be an appropriate assessment. We, in fact, might choose to continue to grow because we are confident that we're in the process of being ready to announce a deal. The reality is that there are many factors that will have to be considered as we close each and every quarter.

Okay. Sorry to keep beating a dead horse on this, but have you guys already started working with new regulators you're going to have out of Washington, and have they expressed any comfort in approving such a large deal? We've seen a lot of banks announce deals. It's a totally different business of getting them closed. It seems like they're all getting extended. How do you address that concern?

I think you're raising a very prudent question. I obviously do not know the answer. The reality is, there are many, many, many factors that will drive how an approval process will evolve.

What people think on day one -- let's just look at public circumstance. In the case of the transaction with M&T, they had a very conscious public position that they were prepared to do a deal. For a variety of reasons, that evolved over an elongated period. There is no certainty as to how long it takes to actually come to a conclusion of that process. The good news is that we just saw a very large deal announced yesterday. That's a directional move that is very positive.

Steve, I would just add that it's fair to say that most CEOs and management teams that are evaluating dealmaking, they understand that the regulatory bodies are actively working with those teams in order to get a sense of what they're trying to accomplish on their M&A strategy. That's the change in the past three years, that will be driving M&A to have the elongated dialogue with the appropriate regulatory bodies in order to get a flavor for what we can expect to get something done. I believe that the deals that are being announced, the sizable deals, they're taking that path.

Okay. I appreciate all the color, guys.

Moshe Orenbuch, Credit Suisse.

On this whole M&A front, do you think that it is actually going to be easier to get approved from not being already in that SIFI bucket such as it is right now into doing a deal? Or do you think it might be easier if the regulator felt --

It's very hard to know that. The reality is, that each specific deal will present its own strength and concerns. It's very hard to know. The important thing is that we need to be consistently involved, consistently evaluating choices, and preparing to meet requirements. As Tom mentioned earlier, some of these requirements are still evolving. There is no certainty as to all the things that need to be done before you go ahead and announce a deal.

We are being very proactive with very many different people in understanding opportunities and requirements. We're balancing all of that in a manner that ultimately is designed to get to a conclusion of a transaction at the earliest possible date.

Moshe, I would also add to that if you take company A and company B and put them together, those companies collectively are safer and a better company for the system, that's not a bad thing. That's a positive change. If you look at some of these deals, and we'll point to the one that was announced yesterday, very interesting dynamic, great funding opportunity for them. It makes a lot of sense. I think that would be driving toward the situation where you have an institution that has a better funding base. That's well received in the view of the eyes of the various regulatory bodies.

It's not about creating a bigger company or a more valuable company. At the end of the day, it's if you can create a company that's a better operating institution. For us, our historical value of creation has been a hallmark. We're very patient. Ultimately, putting company A and company B together will create a better company. (multiple speakers)

Since you brought it up, couldn't you have made that argument about yourselves also? It seems like it would --

I would not comment specifically on a transaction, but you would assume that most deals that have been through the process, we've had an opportunity to spend time on.

Got it.

I wouldn't specifically mention that company on a speculation base.

Just as a cleanup question, the prepayment penalty income declined a little bit. What's your outlook as you go into --

As we said many, many times over the course of decades, prepayment income is not something that we, in fact, try and project. The marketplace is such that for a variety of reasons, prepayment income goes up and goes down. We are in a place today where the values in real estate are very, very strong and therefore, we can wind up having a lot of trade. A lot of our guys sell high and buy low. The market today is high.

If there is a lot of transactions occurring, our prepayment income will go up. The multiple ways by which prepayment is determined, rates and values and other factors driving who the buyers are and who the sellers are, all of that comes into play. It's complex, and we do believe that we're still in a robust period for this kind of income.

Great. Thanks so much.

Keith Murray, ISI.

To go back under the $50 billion for the millionth time, sorry. It sounds like on the expense side, yes, it would be incremental but not material.

Correct.

Going over organically, is it really preserving the dividend that that's the big concern?

I think what we did mention, capital planning, submitting a capital plan to Washington, and having Washington evaluate how you manage your capital position is a major change for our corporate culture.

No escaping the fact that, as we mentioned earlier, all deals that we actually do are accretive. We're not just building a better bank, we're actually going to have better earnings. The reality is that our ability, based on our earnings capacity, would be increased by any deal that we would mention.

Hypothetically, to organically grow past that mark, you're looking at a 2016 capital plan filing, not a 2014 or a 2015 filing at the earliest.

From a conceptual point of view, let's say for argument's sake, you could keep a 90% payout ratio, but the dividend would have to go to a 40% payout, and let's say the other 50% would be share repurchase. What's your philosophy around that?

I think our philosophy over the course of the last 10.5 years has been to pay the dividend rather than to buy back the stock. In any future period where we're making those decisions, our preference would be on the dividend, the ability to pay the dividend. If we do a deal, our ability to pay the dividend actually goes up. The need, for example, contribution to capital, in our case we're not talking about establishing a new dividend at a 30% or less payout ratio; we're talking about maintaining a dividend that we may have had 11 years or plus paying.

In other words, we're not setting a new dividend. We're just paying the dividend that we've been paying for the last decade. I think there are many factors to be considered. The reality is that our capacity to pay would only be increased.

Last one. Let's say for argument's sake, you get above $50 billion. There is not a likely deal in the pipeline for whatever regulatory reasons. How would you manage staying below or going back below the $50 billion? Would it be loan sales? Would you be concerned that doing some loan sales, would that impact relationship with your long-standing borrowers that you've --

No. We'd never do that.

It's Tom. I would say we have effective tools and talent to manage that growth. Obviously, it would be participations, specific asset classes that are not the core of the Company, portfolio runoff. There's lots of securities portfolio runoff. There's lots of other, we'll call it, triggers to pull to manage the balance sheet.

Remember, when we would generate a similar level of originations, the Company was not growing because we had accelerated prepayment activities. When prepayment activities tends to slow, you have hypergrowth. When we've done deals, we've had situations where our [CAGR] is at 20%, 30% loan growth because of the changing of the target balance sheet. We have the ability to deal with our targeted growth.

More importantly, this is a relatively short asset class. I believe our public financials have an average life of 2.8 years for the multifamily book, relatively short asset. It's going to turn relatively quickly. We're constantly in the state of replenishing what's either refinancing or rolling off the books. We are doing significant origination. I go back to the point when the Company was not growing; although our originations were significant, we were running in place.

In the event you have a -- we'll call it a significant rise in interest rates, you may have a substantial flurry of borrowers come back to the table to refinance. Instead of paying 50 basis points today, they would be paying 200 basis points in the future. They may make the choice to accelerate their refinancing alternatives. We monitor it. We have the tools internally, and we will evaluate as we get there.

It's very important for you to recognize that we would never sell our relationship.

Correct.

We would always maintain the servicing of the loan. We would always maintain the opportunity to refinance the loan. We would always be a participant in the loan. The good news is we have extraordinarily attractive assets. Those assets that we have are, in many cases, CRA qualified. In many cases, high-quality assets that many, many, many, many different entities in the marketplace would love to have a piece of. We decide to sell pieces of some of the best assets in the market that have, for example, CRE value, we, in fact, have plenty of buyers to take it.

Thank you.

Matthew Kelley, Sterne Agee.

As you manage the size of the balance sheet over the next couple of quarters while you're hunting for a deal, how low would you be willing to bring the securities ratio down? You'd mentioned 15% near term. I think historically you've gone down to 10% or 11%. Would you be able to bring it down -- have a willingness to bring it down to those levels again?

Matt, depending on the environment, obviously beyond our control, if rates were to go significantly lower in here, they could go back down to 10% just from the mere call effect of the portfolio. We do have a higher concentration of Fannie Mae [bus] assets on the books. That call feature is less than it was about four years ago. If you remember three or four years ago when rates were significantly lower, we had a substantial amount of cash flow coming back in that portfolio.

The average duration's a little bit longer now, but you can expect to see ongoing shrinkage in this low rate environment. If rates go lower, it'll shrink faster. If we stay where we are, we're probably going to see 14%, 15% just from the current environment. If rates were to spike, and we move towards breaking through [$50 billion], that portfolio could actually go back to 20%, depending on how we manage the balance sheet.

Okay.

I will assure you, given the low rate environment, we are looking to put securities on the books.

Yes. I'm certainly aware of your desire to do a large transformational and accretive deal, but haven't seen anything to this point. Have there been restrictions at all on your ability to execute a large transaction? You look at OneWest, and that would've solved a lot of problems from a funding perspective, accretion perspectives, right in your wheelhouse for what you want. Any restrictions on your ability to do something like that?

Again, I really would not want to specifically mention any company inappropriate. However, given the environment, you'd assume -- we evaluate all transactions. We look at what the merits of that transaction would be for us, and we have certain IRR thresholds. We have certain funding needs that may be different than others, and we have certain types of cost efficiencies that will be different than others.

When we model that up, in addition to that, we've been very frank about in the marketplace, when we do it. If we are fortunate to get a deal, we will restructure, as well, to right-size our funding needs, and we have that opportunity on our balance sheet. Clearly, every deal that's out there, we have an opportunity to at least understand that it may be an opportunity for the balance sheet for this Company, and we evaluate it. Our returns are much different. Our hurdle target returns are much different than others, and we're very patient.

This is not a situation where whatever trades we miss, there's the next trade. We have an ongoing dialog, as Mr. Ficalora said, with many institutions that make logical sense and are highly accretive to both tangible book value and earnings per share. We would be less inclined to do a cash transaction because that would significantly change the way we look at tangible book value. If you look at the transaction that was announced yesterday, it was a high component of cash. Every deal has its own dynamic.

Okay. With what you know about LCR today, I wonder if you could talk about two things. One, your loan to deposit and just the way that you fund your own balance sheet in your business, in multifamily commercial real estate, how that changes over time? Number two, what the composition of a securities portfolio might look like, and how that could change over time? What an LCR, HQLA compliant security [yield] might look like?

I'm not going to be too specific in LCRs. It doesn't pertain to us. We are managing through the current environment. I will tell you that we're very comfortable that unfortunately you do have an extension situation on the security side to get high qualifying type security, as we're all aware of. Again, that's part of our evaluation. In the big picture, we're looking at being ready for applying to LCR as is appropriate for the Company. The good news is that we have time, and we're eagerly awaiting the final rules that the Fed should put out shortly. From there, we will make our internal assessment. There's not much to talk publicly because it doesn't apply to us.

Okay. Have you changed anything on the deposit pricing side? I know some of the costs went up a little bit sequentially. What should we expect on your own deposit pricing, and deposit growth over the next couple quarters, while you hunt for a deal?

Matt, we're hopeful to continue growing our deposit base as an alternative in the traditional wholesale pricing the Company had historically. In the meantime, we should be around these levels, give or take a few basis points. That's also driving the margin down a little bit, but you can see from the average balance sheet where the cost has risen. We've been making an active push for bringing in retail deposits to fund the Company's growth.

Okay. Got you.

Our rates are still relatively low across the retail spectrum. It's not like we're 100s of basis points different. You're talking between 10 to 15 basis points different than your competition.

Yes. Then just coming back to the regulatory costs of going through that $50 billion number, you've given some numbers early in the call, $30 million, $35 million in consulting fees. I think it was a $10 million run rate on people and headcount (inaudible).

That's about right.

How much of the total cost of crossing through $50 billion do you think you've already incurred? What percent?

I would say, Matt, again, we don't have the crystal ball here. We've been really hard to kick the numbers in the right direction in the next foreseeable period. Incrementally, there's not a material amount that we expect to spend in the short term as we get our natural project plan in place. We've mentioned the living will. We mentioned dealing with CCAR compliance, upgrading the system, dealing with the LCR. The LCR is an unknown. That's more of a balance sheet issue. That balance sheet issue, as Mr. Ficalora indicated, we would just grow the Company through acquisitions. That would part of our hurdle rate of returns as we look at the pro forma entity.

Absent LCR, the two other items, there's going to be consulting fees. It's not going to be material. We have a low risk balance sheet and a low risk operation. When you look at, let's say, the living will in particular, we are not complex. To put together a living will process, unfortunately costs money, and it has to be worked with the government, and they have to opine on it. We view ourselves as not as a complex organization. We're very simplistic. We are large, very large, we'll call it a super community bank.

Got you. Thank you.

Mark Fitzgibbon, Sandler O'Neill.

Just a follow-up on the expense question, you had said operating expenses would be flat in the third quarter at about $144 million.

That's right.

You had also said that there'd be an additional, roughly $10 million of incremental spending. When do you think that $10 million starts to flow into the cost structure?

Let me clarify. I said the $10 million is in our run rate for payroll cost to deal with (inaudible) $50 billion bank. The incremental change from Q2 versus Q3 is a function of the fact that the foreclosure spend should be lower, and you'll have some elevation as far as dealing with being a SIFI bank, a couple million dollars, not $10 million.

Okay. Secondly, from a dividend standpoint, I'm curious why you think the regulators -- it sounded like you thought the regulators would look at you all differently than the other SIFI institutions in terms of dividend payout ratios.

I don't know that they look at us differently. The reality is that the regulators have been pretty clear that they believe that 100% payout ratio is fine for the institution that can accommodate that, excepting they did not want to have the institutions that had been literally pulled back to zero come out with a dividend payout ratio greater than 30% because of the idea that it would be more difficult to change a payout ratio for a dividend than it would be for a buyback.

In our circumstance, we, in fact, are not establishing a new dividend. It is a long-standing dividend, and we're not in a situation where we would be going to a buyback and a dividend. The circumstance is unique, and it is different. It's something that we'll address when the time comes to address it.

Mark, what I would add, I've probably said this in many, many other conference calls, historically, since the Company's been public, we've allocated 100% of the shareholder value that's created during the year through earnings back to contribution, back to values in the form of buyback and dividends. Since 2004, that's changed to a dividend. The buyback has been on hold.

We are very flexible, and when we're rewarding our shareholders the return capital from our creation depending on risk profile. As Mr. Ficalora indicated, transactions create different companies, and we have to look at the ongoing run rate of the combined company. We're focused on returning value back to shareholders.

Okay. The Fed's 30% payout target, you just don't think applies?

I wouldn't be so bold as to say that. The reality is the regulator will make their decisions when the facts that we present are available for them to consider.

Mark, I would say specifically that would typically be ironed out in conjunction with dialog before you actually grow the Company past $50 billion through a transaction. Assume that those hard discussions have been made.

Right. Thank you.

At this time, I would like to return the conference back to Mr. Joseph Ficalora for any concluding remarks.

Thank you. On behalf of our Board and Management team, I thank you for your interest in the Company, our strategies, and our performance. We look forward to chatting with you in October when we report our earnings for the third quarter of 2014.

Thank you. This does conclude today's second quarter 2014 earnings conference call with the Management team of New York Community Bancorp. Please disconnect your lines at this time, and have a wonderful day.