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New York Community Bancorp, Inc. (NYSE:NYCB)

Q2 2014 Results Earnings Conference Call

July 23, 2014; 08:30 a.m. ET

Executives

Joseph Ficalora - President & Chief Executive Officer

Thomas Cangemi - Chief Financial Officer

Robert Wann - Chief Operating Officer

John Pinto - Chief Accounting Officer

Analysts

Bob Ramsey - FBR Capital Markets

Collyn Gilbert - KBW

Ken Zerbe - Morgan Stanley

Bradley Ball - Evercore

David Rochester - Deutsche Bank

Steven Alexopoulos - J.P. Morgan

Moshe Orenbuch - Credit Suisse

Keith Murray - ISI

Matthew Kelley - Sterne Agee

Mark Fitzgibbon - Sandler O'Neill

David Hochstim - Buckingham Research

Operator

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 the interest rates, which may affect the company's net income; prepayment penalty income; mortgage banking income and other future cash flows or 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 will find more about the risk factors associated with the company's forward-looking statements on page seven 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 area code (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.

Joseph 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, the quality of our assets and the meaningful growth of our multi-family 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 $0.001 per share from 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 non-performing multi-family loans over the course of the quarter, non-performing 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 non-performing 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 non-performing 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 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, for net recoveries we got 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 multi-family 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 multi-family 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 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 ORE I mentioned before.

We also are 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% to 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 lines 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 make rate 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 make 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 long-time 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 it by tip-toeing over the $50 billion mark.

Given our proximity to $50 billion, we could 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 envisioned.

Thus, our desired approach would be to grow to a meaningful transaction, one that benefits our earnings and the value of our shares. And 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 the 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 lines 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.

Question-and-Answer Session

Operator

(Operator Instructions) Thank you. Our first question is coming from Bob Ramsey of FBR Capital Markets.

Bob Ramsey - FBR Capital Markets

Hey, good morning guys.

Joseph Ficalora

Good morning Bob. How are you?

Bob Ramsey - FBR Capital Markets

Good, thank you. 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 in acquisition?

Joseph Ficalora

No. I think what we are 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 are actively discussing with both our regulators and the marketplace, the opportunities that might in fact arise.

We are 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. So 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 are automatically triggering something, because as I mentioned earlier, it takes four consecutive quarters of $50 billion in order to actually trigger an event.

Bob Ramsey - FBR Capital Markets

Okay. So, you are not worried about crossing it, but you would not want to stay over it for four consecutive quarters unless there was a deal coming right away?

Joseph Ficalora

When you look at the way it’s calculated, it’s an average number. So if we do a $40 billion deal, we cross it the day we did the deal, because 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 at $49 billion and the very next quarter we’re at $42 billion, it's a matter of averaging it over the course of time.

Bob Ramsey - FBR Capital Markets

Okay. And 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 sort of today you don't qualify and tomorrow you do situation. I know you've talked about investments you've made to prepare, but is that how you guys sort of see them I assume.

Joseph Ficalora

Oh 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.

Thomas Cangemi

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

Bob Ramsey - FBR Capital Markets

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

Thomas Cangemi

So Bob, what I would say without being specific, we don't envision any significant incremental investments to cross over the $50 billion. There’s three items that would have to be dealt with as we go through that level, which would be the LCR issue as far as we are working through that and as I said finalize the rules there.

But that’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.

So we are in pretty good shape as far as getting to that crossover. We have more work to do as Mr. Ficalora mentioned, but those are the three items that I would point to specifically as we make the transition to SIFI.

Bob Ramsey - FBR Capital Markets

Okay. Great, thank you guys, it’s helpful. I’ll step back out of the queue.

Operator

Our next question comes from Collyn Gilbert of KBW.

Joseph Ficalora

Good morning Collyn.

Thomas Cangemi

Good morning Collyn.

Collyn Gilbert - KBW

Good morning guys. Just quickly, on a follow-up to this discussion. Of the costs that you’ve incurred thus far, well number one, do you have a specific dollar amount that you can tie to those investments over the last three years?

Thomas Cangemi

I would say the range is between $30 million to $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, over $10 million in our run rate, that number will increase as we go past 50, but it’s going to be incremental. It’s not 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.

So the numbers, again, this was a long-term guidance for us. We started this in ‘11 and here we are mid ’14 still making some investments, but we’re very happy about the system build-out and as I indicated, three items that we need to deal with when we cross $50 billion.

Collyn Gilbert - KBW

Okay, and within that $30 million or all these investments sort have been made, I guess we can assume that within that came BSA and AML investments as well?

Thomas Cangemi

Yes.

Collyn Gilbert - KBW

Okay and then just on that, do you – and maybe you sort of answered this Tom, but what percent would you say were cost tied due to testing your systems versus creating new systems?

Thomas Cangemi

I would say it’s probably between payroll costs and consulting and it’s got to $7 million, $8 million alone just on dealing with the build-out. But between payroll and up hiring the people and consultants, our total consulting fees alone, just to development system in total was $10 million all in, and again, we are not done, but it’s not going to be incrementally a material number going forward.

We are very pleased on the actually system build. 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 and we worked with the right people. We started during the crisis and literally after’08,’09 we realized what the regulatory bodies were looking for and what’s the best practice of hiring the people that weren’t with the regulatory bodies in Washington to develop their systems.

Joseph Ficalora

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

Thomas Cangemi

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

Collyn Gilbert - KBW

Okay, and then just one other question. I just want to switch gears to kind of loan growth outlook and loan demand. So 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 in taking the $50 billion threshold off the table? I just want to think about how you are thinking about the business and just future demand and that type of thing.

Thomas Cangemi

Well Collyn, what I would say to that, as you know the company for a long time, historically the third-quarter is typically the slowest of the quarters, given the holiday season and the market has always been for the multi-family line of business.

With that being said, if you look just at multi-family loan growth net, we were up 15.4% for six months. So it's a little bit frontloaded. As you know historically, the fourth quarters are always very large quarters for the company. So Q3s are typically the fourth quarter for us.

For last year it was an anomaly as far as I guess the growth we had. We had a significant third quarter and that was industry wide. It had a lot to do with whether we had a significantly rise in interest rates last year at this time and it really moved many customers to accelerate their financing needs.

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

Joseph Ficalora

I think Collyn 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 are willing to accept. Every negotiation, every single loan is a negotiated deal. So there is a rate and other terms which are adjustable during the course of that negotiation. How far we are willing to go with a particular deal, we’ll decide whether we get it or we don’t.

Collyn Gilbert - KBW

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

Operator

Our next question comes from Ken Zerbe of Morgan Stanley.

Joseph Ficalora

Morning Ken.

Ken Zerbe - Morgan Stanley

Good morning guys. 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 or do you think the OneWest deal was simply a one-off situation?

Joseph Ficalora

No, I'd say that 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 are not talking about creating giants. The giants already exist. We are talking about creating viable banks, and I suspect that we will see a great deal of activity in the period ahead.

Ken Zerbe - Morgan Stanley

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

Thomas Cangemi

I’m not going to go too many quarters out, but it’s obviously…

Ken Zerbe - Morgan Stanley

The next one quarter, please.

Thomas Cangemi

This trend has been unfortunate. But the one quarter forward visibility I would say is that, I want to sight my range for the quarter, probably down three to five again. So five being the back end of the range, three being the tight end, the front of the range, but it seems like we are getting closer to the bottom.

As I said in the last quarter, right now our asset yields are come on at around 356, 360-ish all-in, including commercial and we are rolling off the current coupons I believe is around 356 on e-multi (ph) and about 411 for commercial. So I think if you look at that phenomena, the coupons that are coming on are close to the average coupon on the book.

Unfortunately we still have some runoff, which is as I would call mid 4% loans that are running at and that are where you have some of the pressure. It feels like we are getting close to the end and I’ll be sounding like a recording and I apologize for that, but the interest rate line has been brutal. But it seems like we are getting closer to the bottom and give or take between the next one or two quarters, we should be at the bottom in this rate environment.

Ken Zerbe - Morgan Stanley

Got it, okay. And then just 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?

Thomas Cangemi

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

So what you will see in the short term before we cross over this $50 billion is that you will see securities probably shrinking this environment, because yields are extremely low and what you’re seeing leaving the portfolio predominantly calls from the ventures that we own, given the rate environment that’s being called away and we’ll probably lookout around 15% security to average of the total assets as of this environment.

Now if the environment changes, we will reassess, but as far as LCR's concerned, clearly it will be a change in how we do business when cross 50 and that will be a part of our planning when we cross 50.

Ken Zerbe - Morgan Stanley

Great. Thank you very much.

Thomas Cangemi

You bet.

Operator

Our next question comes from Brad Ball of Evercore.

Joseph Ficalora

Good morning Brad.

Thomas Cangemi

Hey Brad.

Bradley Ball - Evercore

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

Joseph Ficalora

Sure. I think there's no question. There are today and have been for a while, plenty of banks that consider their strategic alternatives and 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 and 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.

So, 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. So, 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.

Bradley Ball - Evercore

Great. And then following up on that line, what specifically are you looking for? What characteristics are you targeting in an acquisition? You’ve talked in the past about deposit ridge, notability littlie asset ridge….

Joseph Ficalora

And the reality is, and then I’ll say this with the measure of consistency. We always look to do deals that are accretive to earnings and tangible. That's primary an 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 acquisition. We've done that time and time and time again.

So 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 a ongoing capacity to immediately meet our liquidity needs and our deposit needs by doing a highly accretive transaction.

Bradley Ball - Evercore

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

Joseph Ficalora

Yes, we can easily do that. We've actually consider that.

Bradley Ball - Evercore

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

Thomas Cangemi

Yes Brad, that’s correct. It was about an actual $3.5 million in the quarter that we would look as non-recurring. However, given 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. So I would definitely look at that as a net number. So you have a $6 million gain, we have some expenses, so I would definitely consider that as non-recurring. But we are seeing defiantly a trend of much lower foreclosure expenses.

And as you remember, that in the past few years that foreclosure expenses were slowing down. Our ramp-up of our SIFI expectation is a build-out, so kind of balancing itself. So now that the foreclosure expenses are probably substantially less going into the second half of ‘14 and into ‘15, you'll probably see a little bit more expense to build out the SIFI, but it should be on balance, a result guidance, and I’ll guide about $144 million for the next quarter on expenses, which is pretty much in line with the previous quarter and a change is predominantly a continued investment into the SIFI status.

Bradley Ball - Evercore

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

Thomas Cangemi

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

Bradley Ball - Evercore

$3.5 million, so about $2.5 million, the difference between the $6 million and the $3.5 million would be a non-recurring gain.

Thomas Cangemi

Yes, that’s fair to say.

Bradley Ball - Evercore

Okay. And then $144 million is the guidance for 3Q expense?

Thomas Cangemi

That's correct.

Bradley Ball - Evercore

Great. Thanks guys.

Thomas Cangemi

You’re welcome.

Operator

Our next question comes from David Rochester of Deutsche Bank.

Joseph Ficalora

Good morning Dave.

David Rochester - Deutsche Bank

Hey, good morning guys. Back on the comment on the incremental expense you might need for $50 billion, what’s the timing you expect on incurring those expenses? So by when do you expect those to be in the run rate?

Thomas Cangemi

Incrementally it’s 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 ads over time, but they are not going to be material. So I would say it's not going to be in one quarter, it’s going to be over the next foreseeable period, and the sooner we get there it will be accelerated. But I don’t think – Dave, it’s not going to be a substantial incremental number.

Joseph Ficalora

I think 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.

David Rochester - Deutsche Bank

Got you and 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 or if you could just comment on that?

Thomas Cangemi

Just we’ve increased some of our fees, our investment advisory fees and our (inaudible) is 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 with some new employee ads that have brought a tremendous amount of business to the company. We are very pleased with that operating unit. And just a general increase from a very low base on fees and obviously we don't have a lot of fees. So we are starting at such a low base. It’s nice to see this slight increase.

David Rochester - Deutsche Bank

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

Thomas Cangemi

I would say its close, yes.

David Rochester - Deutsche Bank

Okay great. Well, just one last one on the LCR with the way the rules are written today. Can you just give a sense for how you guys stand there? Do you need any more liquidity? And then what your strategy would be to build that extra liquidity if you needed it?

Thomas Cangemi

So David, I'll say that we are assessing the LCR rules and are becoming finalized. We are hoping they will be finalized shortly, but they are not finalized.

Obviously as I indicated in my previous statements, we are not in the classification to be an LCR reporting entity. Other banks are reporting, because they have $250 billion and they are making significant changes to their balance sheet.

So my gut would say follow some of the other institutions that are $250 billion and what they are doing for their balance sheet. 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 and as we assess the LCR rules, we will address it accordingly when we become $50 billion. But we do have an internal project plan assessing it.

The one area that we have to make sure we are very clear is on the operating side. There’s going to be some operating changes on how to deal with LCR and as that comes to play, we are hopeful that the time we cross $50 billion, we will have that in place.

David Rochester - Deutsche Bank

Okay, great. Thanks guys.

Thomas Cangemi

Thank you.

Operator

Our next question comes from David Hochstim of Buckingham Research.

Joseph Ficalora

Good morning David.

Thomas Cangemi

Good morning David.

David Hochstim - Buckingham Research

Good morning. I wonder could you just talk a bit about provisioning. You have lots of loan growth and no provisions. Is there kind of I guess a movement? Are you adding any reserves for new loans put on the balance sheet and as those are kind of offset by withdrawals on better performing old loans?

Thomas Cangemi

So David, if you think about it now, the quantitatively or historical loss experience, the mildly qualitative assessments and look at where NPAs are today. We were at $750 million of total 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 amount is $7 million to $8 million. We look at the current environment; it's a very strong credit environment right now and the issue we have as a company is that those bad years are rolling off and we have a very strong historical loss experience compared to the industry.

Now remember, we are not looking at the potential of massive recaptures of other institutions and that’s the environment. We just happen to be in an environment where we are asset 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 loss, especially in the commercial real estate side.

Our commercial real estate losses are half that of multifamily and the multifamily losses are de minimis. So we have a very unique story to tell and we have a methodology which points through the back end of the range given the change in the economic climate.

Joseph Ficalora

David, it's important to note that we've had as many as 52 consecutive quarters, but we had no charges on loans that we’ve got created. So the reserve arguably is substantially greater than our actual expectation of losses. So the idea that other banks continue to add to their reserve is that 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 on recoveries than charges to the reserves.

David Hochstim - Buckingham Research

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

Thomas Cangemi

What I will give guidance to the year, and then go out on a limb here for a couple of quarters. I don’t want to take one quarter and jump into the abyss. We are looking again and I’m going to reiterate, we don't expect to provision this year given the overall climate for credit and that could change tomorrow when things get difficult, but that’s where we feel the portfolio is at as of today.

But clearly, as Mr. Ficalora indicated, the lost content is extremely low, and I want to point to our commercial book, given that’s it 50% of the historical loss expectation with the multi and the multi being so low. So again, we have a unique situation. The industry is seeing significant reserve releases; we haven't released reserves. But again, we have a – in comparison to the rest of the bad news to your reserve is significantly different given the loss content of the company.

David Hochstim - Buckingham Research

Could you give us the break down on mortgage banking origination and revenues from servicing, MSR impairment, recoveries?

Thomas Cangemi

I can give you the breakdown of the components of the income stream for the quarter. For the quarter the company generated $15.291 million of income, of which $10.368 million was for 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 and then we saw a slight down tick in June.

Now it’s very early for July and things are a little bit slow given the environment, but given that rates are relatively low compared to the previous quarter on average, you may see some volatility there. We are hoping for another flat quarter, but it's a little soon to tell as far as overall volumes are concerned.

David Hochstim - Buckingham Research

Okay. And then of the servicing how much was recovery of MSR?

Thomas Cangemi

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

David Hochstim - Buckingham Research

Okay, great. Thanks a lot.

Thomas Cangemi

You’re welcome.

Operator

Our next question comes from Steven Alexopoulos of J.P. Morgan.

Joseph Ficalora

Good morning Steven.

Steven Alexopoulos - J.P. Morgan

Hey, good morning guys. So you said quite a few times on the call this morning that you spent the time and money to get rated across $50 billion. With that, you're also saying you want to avoid the consequence of tip-toeing over $50 billion. If you've already spent the time and money on this, what's the consequence that you are looking to avoid?

Joseph Ficalora

Well, 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 the 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 acquisition. So our balance sheet is structured to accommodate an acquisition. The reality that there is 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.

Thomas Cangemi

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

Steven Alexopoulos - J.P. Morgan

Okay. So Joe, are you saying that you will not cross $50 billion organically or without a deal and then how do you control that? Was there some loan or asset build?

Joseph Ficalora

We 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 are 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. So the reality is that we would have to virtually manage our position during that process. So it's very hard to know what would be the right place to be, averaging 49.5 versus averaging 50.1. 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.

Steven Alexopoulos - J.P. Morgan

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

Joseph Ficalora

Yes. I think the most important message is that we will manage our position based on our activity with regard to opportunities. So 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.

Steven Alexopoulos - J.P. Morgan

Okay. And sorry to keep beating at that horse on this, but have you guys already started working with new regulators you are going to have out of Washington and have they expressed any comfort of 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 are all getting extended. How do you address that concern?

Joseph Ficalora

I think your 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, and for a variety of reasons that evolved over an elongated period. So, 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.

Thomas Cangemi

Steve, I would just add that it's fair to say that most CEOs and management teams that evaluate any deal making, they understand that the regulatory bodies are actively working with those teams in order to get a sense of what they are 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 body, in order to get a flavor for what you can expect to get something done. I believe that the deals that are being announced that are sizable deals, they are taking that path.

Steven Alexopoulos - J.P. Morgan

Okay, I appreciate all the color guys.

Joseph Ficalora

You bet. Thank you.

Operator

Our next question comes from Moshe Orenbuch of Credit Suisse.

Moshe Orenbuch - Credit Suisse

Good morning.

Joseph Ficalora

Good morning Buch.

Moshe Orenbuch - Credit Suisse

Thanks. Yes, on this whole kind of 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 as such as it is right now into doing a deal or do think it might be easier if the regulator felt that (Cross Talk).

Joseph Ficalora

It's very hard to know that. The reality is that each specific deal will present its own strength and concerns, so 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 and as Tom mentioned earlier, some of the requirements are still evolving. So 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 and we’re balancing all of that in a manner that ultimately through design to get to a conclusion of a transaction at the earliest possible date.

Thomas Cangemi

And Moshe, what I would also add to that, if you take company A and company B and put them together and those companies collectively are a safer and a better company for the system, that's not a bad thing, that's a positive change.

Moshe Orenbuch - Credit Suisse

No doubt.

Thomas Cangemi

So I think if you look at some of the deals, and we’ll point to the one that was announced yesterday, very interesting dynamic; a great funding for them; it makes a lot of sense. I think that would be driving towards a situation where you have an institution that has a better funding base. So I think that's well received in the view of, the eyes to the various regulatory bodies.

So it’s not about creating a bigger company or a more valuable company, at the end of the day if you can create a company that is a better operating institution and for us a historical value of creation has been a hallmark. We are very patient, but ultimately putting company A and company B together will create a better company.

Moshe Orenbuch - Credit Suisse

Since you brought it up, wouldn't that have made, couldn’t have you made that argument about yourselves, also? I mean it seems like it would…

Thomas Cangemi

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.

Moshe Orenbuch - Credit Suisse

Yes, got it.

Thomas Cangemi

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

Moshe Orenbuch - Credit Suisse

Right. Just as a clean-up question, the prepayment penalty income declined a little bit. What's your outlook is it going into …?

Joseph Ficalora

As we said many, many times over the course of decades, repayment income is not something that we in fact try to 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. So, if there’s 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. Its complex and we do believe that we are still in a robust period for this kind of income.

Moshe Orenbuch - Credit Suisse

Great, thanks so much.

Joseph Ficalora

You’re welcome.

Operator

Our next question comes from Keith Murray of ISI.

Joseph Ficalora

Morning.

Thomas Cangemi

Morning Keith.

Keith Murray - ISI

Morning, thank you. Just 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. So going over organically, is it really preserving dividend that that's the big concern?

Thomas Cangemi

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

Joseph Ficalora

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

Thomas Cangemi

So hypothetically if we are organically to grow past that mark, you are looking at a 2016 capital plan filing, not a ‘14 or a ‘15 filing at the earliest.

Keith Murray - ISI

From a conceptual point of view, let's say for argument 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?

Joseph Ficalora

Well, 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. So 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 are 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 are just paying the dividend that we've been paying for the last decade.

So I think there are many factors to be considered. The reality is that our capacity to pay would only be increased.

Keith Murray - ISI

And then the last one; let's say for argument sakes 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 and would you be concerned that doing some loan sales with that impact to relationship with your long-standing borrowers that you'd…

Joseph Ficalora

No, we’d never do that.

Thomas Cangemi

So, it's Tom. I would say that we have effective tools and talent to manage that growth. Obviously it would be a participation specific asset classes that are not the core for the company. The 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 were generating a similar level of originations, the company was not growing, because we had accelerated prepayment activities. When prepayment activities tends to slow you have hyper growth and when we've done deals we've had situations where our target was at 20%, 30% loan growth, because of the changing of the targets balance sheet. So we have the ability to deal with our targeted growth, but more importantly, this is a relatively short asset class.

I believe our public financials have an average life of 2.8 years for the multi-family books, but the relatively short asset – it's going to turn relatively quickly. So we’re constantly in the state of replenishing what’s either refinancing or rolling off the book and we are doing significant origination.

And I go back to the point when the company was not growing. Although our originations were significant, we are 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 ours come back to the table to refinance. Instead of paying 50 basis points, say they would be paying 200 basis points in the future. They may make the choice to accelerate their refinancing alternatives. So we monitor it, we have the tools internally and we will evaluate as we get there.

Joseph Ficalora

But I think it’s very important for you to recognize that we would never sell our relationship. 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 different entities in the marketplace would love to have a piece of. So we decided to sell pieces of some of the best assets in the market that have for example, CRA value, we in fact have plenty of buyers to take it.

Keith Murray - ISI

Thank you.

Joseph Ficalora

You’re welcome.

Operator

Our next question comes from Matthew Kelley of Sterne Agee.

Joseph Ficalora

Good morning Matt.

Thomas Cangemi

Good morning Matt.

Matthew Kelley - Sterne Agee

Hey, good morning. Since 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 had mentioned 15% near term, but 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 at those levels again?

Thomas Cangemi

Matt, depending on the environment, obviously beyond our control if rates were to go significantly lower in the year, they could go back down a 10% just running the mere call effect of the portfolio. We do have a higher concentration of Fannie Mae (inaudible) assets on the books, so that call feature is less than it was about four years ago.

If you remember three or four years ago the rates were significantly lower and we had a substantial amount of cash flow coming back in that portfolio. So the average duration is a little bit longer now, but you can expect to see ongoing shrinkage in this low rate environment. If rates go low it will shrink faster.

If we stay where we are, we’re probably going to see around 14%, 15% is from the current environment. If rates were to spike and we move towards breaking to 50, that portfolio could actually go back to 20% depending on how we manage the balance sheet. I can assure you, given the lower rate environment, are looking to put securities on the books.

Matthew Kelley - Sterne Agee

Yes. And then we’re certainly aware of your desire to do a large transformation on an accretive deal, but we haven't seen anything to this point. Have there been any restrictions at all in your ability to execute a large transaction and you just look at the OneWest and that would've solved a lot of problems from a funding perspective, accretion perspective, right in your wheelhouse for what you want. Any restrictions on your ability to do something like that?

Thomas Cangemi

Well, I would say – and again, I really would not want to specifically mention any company inappropriate. However, given the environment, you would assume we evaluate all transactions. We look at what the merits of that transaction would do for us and we have certain IOR 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 out, in addition guys we've been very frank about it in the marketplace, when we do it and 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. But 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.

But our returns are much different, our hurdle target returns are much different than others and we are very patient. This is not a situation where whatever trades we missed is the next trade. We have an ongoing dialogue as Mr. Ficalora said with many institutions that make logical sense and are highly accretive to both tangible book value and earnings per share.

So 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, so every deal has its own dynamic.

Matthew Kelley - Sterne Agee

Got you, okay. And then, with what you know about LCR today, I was wondering if you could talk about two things? One, your loan to deposit and just the way to fund your own balance sheet and your business in multifamily commercial real estate, how that changes over time. And then number two, what the composition of the securities portfolio might look like and how that could change over time and what an LCR HQLA compliant security yield might look like?

Thomas Cangemi

So again, I'm not going to be too specific LCR. 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 higher qualifying type security that we are all aware of. Again, that’s part of our evaluation.

In the big picture we're looking at being ready compliant to LCR as is appropriate for the company. The good news is that we have time and we are still eagerly awaiting the final rules that the Fed should put out shortly and from there we’ll make our internal assessment. There’s not much to talk publicly, because it doesn't apply to us.

Matthew Kelley - Sterne Agee

Okay, and if you see changes on the deposit pricing side, I know some of the costs went up a little bit sequentially, what should we expect just on your own deposit pricing and deposit growth over the next couple of quarters while you hunt for a deal.

Thomas Cangemi

So Matt, we're hopeful to continue growing our deposit base as an alternative than the traditional wholesale financing for the company has 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 as you can see from your average balance sheet where the cost has risen, we’ve been making an active push to bringing in retail deposits to fund the company’s growth.

Matthew Kelley - Sterne Agee

Okay, got you.

Thomas Cangemi

The rate is still relatively low across the retail spectrum, so it's not like we are 100 basis points different. You’re talking maybe 10 to 15 basis points different than your competition.

Matthew Kelley - Sterne Agee

Yes. And then just coming back to the regulatory costs of going through that $50 billion number. You've given some numbers earlier in the call, $30 million, $35 million in consultant fees. I think it was a $10 million run rate on people and headcount. How much of the total cost of crossing through $50 billion, do think you've already incurred? What percent?

Thomas Cangemi

So what I would say Matt, again we don't have the crystal ball here. We're working real hard to get those numbers in the right direction in that foreseeable period, but 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’ve mentioned dealing with CCAR compliance, upgrading the systems, dealing with the LCR. The LCR is an unknown. That's more of a balance sheet issue and that balance sheet issue as Mr. Ficalora indicated, we would just grow the company through acquisition. That will be part of our total rate of return as we look at the pro forma entity.

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

Matthew Kelley - Sterne Agee

Got you. Okay, thank you.

Thomas Cangemi

You bet.

Joseph Ficalora

You’re welcome.

Operator

Our next question comes from Mark Fitzgibbon of Sandler O'Neill.

Joseph Ficalora

Good morning Mark.

Thomas Cangemi

Good morning Mark.

Mark Fitzgibbon - Sandler O'Neill

Good morning. Just to follow-up on the expense question, you would say that operating expenses would be flat in the third quarter at about $144 million. You had also said that there’d be an additional, roughly $10 million of incremental spending. When do think that $10 million starts to flow into the cost structure?

Thomas Cangemi

So let me clarify it. I said the $10 million in our run rate for the payroll cost is to deal with being close to the SIFI Bank. The incremental change from Q2 versus Q3 is a function of the fact that the foreclosure expenses 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.

Mark Fitzgibbon - Sandler O'Neill

Okay. And then 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.

Joseph Ficalora

Well, I don't know that they look at us differently. I think the reality is that the regulator have been pretty clear that they believe that 100% payout ratio is fine for an 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 are not in a situation where we would be going to a buyback and a dividend. So the circumstance is unique and it is different and it's something that we’ll address when the time comes to address it.

Thomas Cangemi

Yes, so Mark what I would add. I probably have said this in many, many other conference calls. Historically since the company's been public, we've allocated 100% of the shareholders value that’s created during the year through earnings, back to the contribution back to the value in the form of buy back and dividends.

Since 2004 that changed towards dividend and the buyback has been on hold, but we are very flexible on return involving our shareholders, the return of capital from our creation depending on the risk profiles. As Mr. Ficalora indicated, transactions could create different companies and we have to look at the ongoing run rate of the combined company, but we are focused on returning value back to shareholders.

Mark Fitzgibbon - Sandler O'Neill

Okay, so the fed’s 30% payout target you just don't think applies?

Joseph Ficalora

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.

Thomas Cangemi

And Mark, I would say specifically that would typically be ironed out in conjunction with dialogue before you actually grow the company past $50 billion into a transaction. I assume that those hard discussions would have been made.

Mark Fitzgibbon - Sandler O'Neill

Thank you.

Joseph Ficalora

You’re welcome Mark.

Operator

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

Joseph Ficalora

Thank you. One 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.

Operator

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.

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