Earnings Call Transcript - FLG Q3 2021

Sal DiMartino, Investor Relations / Moderator

Good morning, everyone. This is Sal DiMartino. Thank you for joining the management team of New York Community for today's conference call. Today's discussion of the company's third quarter 2021 results will be led by Chairman, President and CEO, Thomas Cangemi; joined by Chief Operating Officer, Robert Wann; and the company's Chief Financial Officer, John Pinto. Before the discussion begins, I'd like to remind you that certain comments made today by the management team of New York Community may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements we may make are subject to the Safe Harbor rules. Please review the forward-looking disclaimer and Safe Harbor language in today's press release and investor presentation for more information about risks and uncertainties which may affect us. With that, now I would like to turn it over to Mr. Cangemi.

Thomas Cangemi, Chairman, President & CEO

Thank you, Sal. Good morning to everyone, and thank you for joining us today to discuss our third quarter 2021 performance. In addition to Robert and John, also joining on the line are Sandro DiNello, President and CEO of Flagstar; and Lee Smith, President of Flagstar Mortgage. As you may have already seen, Flagstar reported third quarter results today as well, which were also very strong. Before launching into a discussion of our third quarter results, I would like to provide you with a brief update on our pending merger with Flagstar. As you know, both sets of shareholders overwhelmingly approved the planned merger in early August. At this point, it appears that regulatory approval will not be received in time to close the merger during the fourth quarter. We now estimate an anticipated closing as soon in 2022 as we can obtain regulatory approval. In the interim, both banks continue to work closely together, and we are making significant progress on the integration and planning front. Both sides are looking forward to consummating the merger and creating a top-tier regional banking franchise with significant size and scale across multiple business lines as well as providing a comprehensive line of commercial and retail banking offerings to all customers across our footprint. Moving now to our results. Earlier this morning, we announced third quarter 2021 diluted earnings per share of $0.30 a share, up 30% compared to the third quarter of last year. Excluding merger-related expenses totaling $6 million, diluted EPS was $0.31 a share on a non-GAAP basis, up 35% year-over-year. For the first 9 months of 2021, we reported diluted EPS of $0.90 a share, up 43% compared to $0.63 a share for the same period last year. On a non-GAAP basis, we reported $0.93 a share, up 47% compared to the first 9 months of 2020. Both of these metrics are the best EPS we have reported for the first nine months since 2010. This was another solid quarter for the company, highlighted by higher year-over-year pre-provision net revenue, continued margin expansion, strong deposit growth, stable operating expenses and solid credit quality. Total loan growth was modest, but the multi-family segment increased 4% on an annualized basis compared to the previous quarter. Turning now to the details of our performance. Our pre-provision net revenues rose 19% to $198 million compared to the year ago quarter. Excluding merger-related expenses, PPNR rose 22% to $204 million compared to the third quarter of last year. The net interest margin came in at 2.44%, down 6 basis points compared to the second quarter of the year, but up 15 basis points on a year-over-year basis. The linked quarter decline was primarily due to a decline in prepayment income from very strong levels during the previous quarter. Prepayment income for the third quarter totaled $16 million and added 12 basis points to the margin. In contrast, last quarter's prepayments totaled $27 million and added 20 basis points to the margin. Excluding the impact from prepayments, the margin on a non-GAAP basis increased 2 basis points sequentially to 2.32% and 12 basis points compared to the prior year. Moving on now to deposits. We continue to make significant progress on the deposit front, both in increasing the level of core deposits while decreasing the percentage of higher-cost CDs. Total deposits grew $444 million or 5% annualized compared to the previous quarter. This reflects growth in both our Banking as a Service business, which was launched earlier this year and continued success in gathering deposits from our commercial borrowers. Banking as a Service deposits totaled $1.4 billion at the end of the third quarter, all of which are noninterest-bearing accounts. We've had several wins since we launched this initiative early in the year. In addition to a previously disclosed relationship with our technology partner, the company is actively responding to requests for proposals from states for banking services and/or reloadable benefit card solutions. To date, we have been awarded the banking service agreement for the New Jersey Department of Labor and will be the bank supporting the reloadable benefit cards for the state of Rhode Island. These are just the first relationships we have signed, and we are encouraged by the early success of our initiative and by the number of pending relationships we have in our pipeline. In addition to Banking as a Service deposit growth, deposit growth was driven by the increase in deposits from our multi-family and commercial real estate borrowers. These loan-related deposits totaled $4.2 billion at the end of the third quarter, up $652 million since the beginning of the year and $265 million during the quarter. On the expense front, our operating expenses continue to be well contained. Excluding merger-related expenses of $6 million, operating expenses totaled $129 million, unchanged compared to both the previous quarter and the third quarter of last year. Our efficiency ratio of 39% remains strong as well. On the lending side, while total loans held for investment increased $112 million compared to the previous quarter, total loans increased $858 million on a year-over-year basis. Despite the modest overall loan growth, we had good growth in the multi-family segment. The multi-family portfolio increased nearly $300 million or 4% annualized compared to the previous quarter, partially offset by declines in the other segments. On a year-over-year basis, multi-family loans have risen $738 million. Our pipeline heading into the end of the year is robust. It currently stands at $1.9 billion, the second highest level of the year. And as a reminder, we always originate much more than we traditionally have in our pipeline. As for our credit quality, our credit metrics remain solid and continue to rank among the best in the industry. Nonperforming assets declined compared to the second quarter levels and at $37 million represents 6 basis points of total assets, while we had no charge-offs in the quarter. Additionally, principal deferrals declined 8% to $914 million compared to the previous quarter, while full payment deferrals remain at zero. Compared to the third quarter of last year, total deferrals are down $4.9 billion or 84% compared to $5.8 billion in the third quarter of last year. During the quarter, loans 30 to 89 days past due increased to $447 million, practically all of which was related to one borrower and consists of several multi-family and mixed-use properties. All of the delinquencies are in the 30-day bucket. We are working with the borrower, and he has taken advantage of our CARES Act loan modification program. The loans have the original weighted average LTV of 57%, and the bank is well secured. Therefore, we do not expect to incur any losses on this relationship. Before moving on, I'd like to take a few moments to comment on the New York City economy. Parts of the city have been doing very well since early this year. Now Manhattan is coming back as the reopening gains momentum. Schools and businesses have reopened, restaurants are open and allowed to operate at 100% capacity, and tourism has increased. While not fully back to normal, Manhattan is definitely on the path to normalization. The Manhattan residential real estate market has rebounded strongly while our segment of the market, the non-luxury, rent-regulated multi-family market has proven to be very stable. Lastly, during the quarter, we announced our investment and entered into a partnership with Figure Technologies, one of the leading fintech companies focused on payment systems and lending via blockchain technology. We are very excited about this partnership and believe it will support our strategic initiatives, as I outlined earlier this year. With that, we will be happy to answer any questions you may have. We will do our very best to get to all of you within the time remaining. But if we don't, please feel free to call us later today or during the week. Operator, please open the line for questions.

Operator, Call Operator

Our first question is coming from Ebrahim Poonawala of Bank of America.

Ebrahim Poonawala, Analyst, Bank of America

I guess just first on credit. So obviously, you mentioned you don't expect any losses tied to the NPA increase, but give us some sense of what did you anticipate that this was coming down the pike over the last few months? And should we expect more of these as some of these deferrals roll off and customers take an actual assessment of where things stand cash flow-wise?

Thomas Cangemi, Chairman, President & CEO

Ebrahim, we have a long history of barely having any charge-offs and do not anticipate losses here. We feel very comfortable with the original LTV on this cluster of loans and are working closely with the borrower. We are confident he will be current by the end of the year. Historically we get paid on our loans, so this was not something we anticipated, but we are actively engaged with the customer and remain highly confident in the outcome. To be specific, these are all Manhattan-based properties. As I noted earlier when discussing the five boroughs, Manhattan is coming back very strongly, particularly in the multifamily, rent-regulated and non-luxury market. There is strong demand and limited supply on the housing side, and because these are blended buildings—some mixed-use and some pure rentals—we expect them to re-let at higher levels as the market recovers. We’re encouraged by the leasing activity we’re seeing as the pandemic recedes.

Ebrahim Poonawala, Analyst, Bank of America

Understood. Okay. And I guess just moving on to the margin. When we think about the core NIM, I think your guidance was 3 to 5 bps adjusted for a couple of bps last quarter, I think you said in the middle of that. Just talk to us in terms of how much more margin expansion is there to go as you think about funding cost leverage? And also, you made some pretty decent banker hirings on the deposit side during the quarter. Just give us, if you can, a framework around how big that noninterest-bearing bucket can get over the next few quarters, next year? And what mix do you think just organically ex-Flagstar that could look like as we think about the next year or so?

Thomas Cangemi, Chairman, President & CEO

So Ebrahim, ex-Flagstar, this division of deposit gathering has significantly changed here at the company effective January 1. We're focusing on gathering core deposits, focusing on working with our customers, getting our operating accounts in line when we close loans, and it's working. It's a cultural shift that's working, and we're seeing good success. In addition to that, as I indicated, we are very actively pushing Banking as a Service as a product line here, and we have resources behind that and we are seeing the results. In my prepared remarks, we'd won some business throughout the quarter, and throughout the year it's been growing very nicely. I think we're close to $2 billion as of today. So it's growing very nicely, and the pipeline is building. When you think about that type of money, it's traditionally zero cost, very stable and noninterest-bearing. So I think that's a solid book of business. What we want to do, obviously, on a standalone basis, is build a better core funding base and be less dependent on wholesale funding. So we think these initiatives, both on the commercial side as well as building out a line of business such as Banking as a Service and utilizing our balance sheet to gather more liabilities that are more stable than nontraditional wholesale mechanisms, are key. So we're pretty excited about that. I'm not going to give deposit growth guidance for next year because obviously, when you put Flagstar and NYCB together, it's significant because they have a tremendous amount of liquidity that they don't need right now given their uses of funds. We will be very powerful as a combination with respect to total funding base on a blended basis. So we're excited about that opportunity. But on a standalone basis, that is the strategy right now, and we're seeing very good results throughout the year, and we're continuing to focus on the cultural shift of mandating operating accounts when we close our loans, and that's a priority for us.

Ebrahim Poonawala, Analyst, Bank of America

Sure. And outlook for the margin, Tom?

Thomas Cangemi, Chairman, President & CEO

Again, I think we're getting to a point now where our CD costs are probably in the mid-40 basis points range. So you're not going to see much more decline on the CD side. I would say that you're probably going to be in line with what we saw last quarter, a couple of basis points per quarter of margin expansion, ex the combination with Flagstar. But with Flagstar combined and as we move into next year and reposition ourselves for interest rate risk, we expect continued margin expansion. Clearly, we're confident that the cost of funds will continue to go lower, albeit by smaller increments. However, as the yield curve starts to steepen, we have an opportunity to deploy liquidity, and we're sitting on a lot of cash. We expect this quarter to be the highest quarter for growth. We have a very strong pipeline in addition to the close to $2 billion of pipeline that we have; we have a significant amount of assets that are in process. So I would envision the fourth quarter being the highest growth quarter of the year for net loan growth, which should help the margin as well.

Operator, Call Operator

Our next question is coming from Brock Vandervliet of UBS.

Brock Vandervliet, Analyst, UBS

So just to follow up on those comments on loan growth, can you talk about the fourth quarter and your comfort level with the mid-single-digit guide? I think we were all expecting a fourth quarter pickup. Could you frame that out a little more?

Thomas Cangemi, Chairman, President & CEO

So the good news is the pipeline, as you can see, the numbers are public. It's one of the strongest pipelines we've had through the year. We have a lot of loans that are ramping up and in process for approval. So we feel pretty good about where we are in respect to the momentum going into November and the quarter end. We will have net loan growth in the quarter. I think what was somewhat of a headwind is that in the specialty finance business, the supply chain constraints have impacted our book of business; we have probably an extra $1 billion of commitments that are not being drawn because customers in that portfolio are not drawing down on the lines. These are strong credits, but the supply chain is having an impact. Typically, the specialty finance book has been growing around 20% on average historically; this is probably the weakest year since we started the business, and that's why growth was only about 10% net. We think that could pick up assuming supply chain conditions ease in the fourth quarter. So absent major supply chain issues, plus a very strong commercial borrowing opportunity across multi-family and commercial, we feel optimistic that we will have mid-single-digit growth. If supply chain issues ease, growth could be even stronger.

Brock Vandervliet, Analyst, UBS

Got it. Okay. And just a question for Lee. You mentioned he was on the call. Flagstar gain on sale looked very strong this quarter. If you could just break down how much of that was EBO and any Q4 guide you wish to provide, that would be helpful?

Lee Smith, President, Flagstar Mortgage

Yes, sure. This is Lee. Well, first of all, we're very pleased with our Q3 mortgage results. We guided to $160 million to $180 million, and we came in at $169 million; about $18 million of that was EBO. The strong earnings was in large part due to our diversified mortgage model. We saw 5% more retail locks in Q3 versus Q2 as a percentage of overall originations and retail is a higher-margin channel. We executed on five RMBS deals in the quarter, which made us the second-largest RMBS issuer in the quarter behind Chase. We also kept costs under control. Mortgage costs actually declined $6 million quarter-over-quarter and mortgage expense as a percentage of closed loan volume declined from 1.02% to 1.00%. So we feel good about the flexibility and optionality our model affords us together with the cost control and discipline we execute with. Looking into Q4, we're guiding to $120 million to $140 million gain on sale. The main reasons for the decline in Q4 versus Q3 are just normal seasonality, and we're seeing that in the agency and MBA volume forecasts, the Fed tapering discussions, increased bond yields and mortgage rates, and we have seen a slight compression in primary-secondary spreads. Also, the FHFA reversal of certain PSPA provisions was a slight negative to us. Given we're a bank and an aggregator, we were able to step into the void the GSEs were leaving. We're planning on three RMBS deals in Q4 versus the five in Q3, and we're planning on executing six in Q1 2022. As we look further into 2022, agency and MBA forecasts are calling for about a $3 trillion market in '22 and $2.5 trillion in '23. Any time the market is over $2 trillion, that's healthy. As I mentioned, we're planning on six RMBS deals in Q1, and we'll continue to leverage that program, utilize our diversified mortgage model and find pockets of opportunities. We have the balance sheet, which gives us AFS, HFI and MSR flexibility and that RMBS program gives us execution optionality. Finally, with the bigger balance sheet as a result of the merger, it gives us growth opportunities across all of our sales channels and HFI portfolio products, holding more MSRs which benefit from a deposit point of view; the RMBS program, as I've mentioned, and supporting the 238 NYCB branches and customers. We're trying to generate more consistent and predictable mortgage earnings using all the levers I just discussed.

Operator, Call Operator

Our next question is coming from Dave Rochester of Compass Point.

David Rochester, Analyst, Compass Point

You already highlighted a number of positives on the Flagstar quarter that was pretty impressive. I noticed the warehouse was also up nicely and that’s up to trend for a lot of the banks out there. So any comments on that front would be great. And if you could just remind us everything done prior to the close of the deal here to really hit the ground running on day one post-close on the warehouse front? I know you've reached out to a lot of your top accounts to let them know that larger lines could be available. So if you can just talk about that? And then I know on the deposit side, you really haven't targeted that pool of deposit — just maybe size what that opportunity is there, that would be great?

Thomas Cangemi, Chairman, President & CEO

That question is directed to Lee Smith and/or Sandro. Yes?

Sandro DiNello, President & CEO, Flagstar

Yes, let me take it. We've been executing in the fashion that we said we would, and that was, number one, to continue to expand our relationships and take more market share as the mortgage market itself shrinks, and we've been successful in doing that. One of the ways we're doing that, ex the anticipated merger, is to do more syndications on the Flagstar side, where we're leading opportunities with bigger organizations, taking bigger positions and then sharing them with other banks. As we think about the upcoming merger, while still staying within our loan concentration limits — which we've always been conservative and disciplined around — rather than lose relationships or levels of outstanding, what we're doing is expanding relationships with our best customers because we're more comfortable taking larger positions with them, still staying within disciplined concentration limits both overall and on an individual credit basis. So it's what we've been doing for the last five to seven years as we've focused on growing the warehouse business, taking advantage of the opportunities, doing it well from a service perspective and getting paid fairly for what we do. As a result, the business has held very strong, and we're optimistic about continuing that strength going forward.

Thomas Cangemi, Chairman, President & CEO

Maybe, Lee, you want to talk about the deposit initiatives tied to the Flagstar portfolio, given the potential business combination?

Lee Smith, President, Flagstar Mortgage

Yes. As it relates to the subservicing and custodial business, there's a lot of custodial deposits tied to that. Given the size of our balance sheet, we had excess custodial deposits that we have put with other institutions. Given the merger, we're able to bring those custodial deposits back because we'll have the bigger balance sheet. So that's an advantage from a funding point of view. Just having the bigger balance sheet gives us the opportunity, given our relationships with MSR funds and warehouse borrowers, to bring in more deposits than we've been able to with a smaller balance sheet. So we think that will be another big advantage of this combination and having approximately a $90 billion balance sheet.

Sandro DiNello, President & CEO, Flagstar

Just to expand on the reference to warehouse customers: we do not seek escrow deposits from warehouse customers because we just don't need them. We do have regular deposit relationships with our warehouse customers and that's relatively significant. But the opportunity to take in escrow deposits is difficult to estimate, but I know it's meaningful because it's never been something we've needed to do. We are telling our warehouse customers that we will be in a position to show some interest in that post-merger, but it's difficult to quantify how much; I do think it's meaningful, if that's helpful.

David Rochester, Analyst, Compass Point

Yes. I appreciate that. And then, Tom, I got one for you just on the multi-family side of things. I know historically, you've seen your borrowers coming back to the banks to refinance when the 5-year jumps and there's an expectation that it will keep going higher. We have heard that from you guys, we've heard from other banks and from the brokers that we talk to in the market as well. Are you seeing any start of that, any sign of that at this point? And if not, what do you expect you would need to see in the 5-year moving higher to start seeing that kind of concern amongst your borrowers?

Thomas Cangemi, Chairman, President & CEO

Dave, it's a great point. This is clearly a change in the shape of the curve. The back end has moved up considerably and the 5-year has also moved higher. This is actually favorable for our business because the decision to go agency versus portfolio makes it more towards the portfolio, which benefits us. We're seeing that. So I would say with conviction that we are getting more opportunity to be competitive. On the rate side, with higher levels, customers are focused on their next financing alternatives, which are relatively short-term. If tapering takes place and impacts the back end of the curve as well as the overall curve, it will be very favorable for our business. We see some good property transactions occurring in Manhattan, which is favorable. We also see seasoned players expanding operations into new demographics we're following. So we're bullish about the recovery and expect more refinancing and purchase activity as market participants make decisions. These are short-dated assets, and with rates moving up, traditional 5- to 7-year financings will come into play sooner, which should create opportunity for us.

Operator, Call Operator

Our next question is coming from Ken Zerbe of Morgan Stanley.

Kenneth Zerbe, Analyst, Morgan Stanley

In terms of the deal getting pushed out just a little bit towards next year, can you just talk about what regulators are looking for or asking for or any kind of color behind why this seems to be getting pushed just a little bit?

Thomas Cangemi, Chairman, President & CEO

I would just be very clear. As I said in my opening remarks, it's very clear: it is in the hands of our regulators. We're waiting for approval. We're very optimistic about the merger. However, it's a regulatory process and in the regulators' hands. As you know, Ken, we can't specifically discuss details of our communications with regulators, so we're at the mercy of the regulatory timeline.

Kenneth Zerbe, Analyst, Morgan Stanley

Understood. I guess, my second question... Just going back to that large borrower in Manhattan. I get that you're very well secured. Obviously, really low LTVs. But can you just provide a little more color, like why is he having problems at this point? Because obviously, the New York market is coming back...

Thomas Cangemi, Chairman, President & CEO

Yes. I'll give you specifics. We were very generous from day one with the CARES Act relief, and many customers took that relief. He was one of the few customers who did not take relief; he was paying through the depth of the pandemic, which could have bolstered his balance sheet. That decision was made. When you look back, he probably leased up at a lower level and realized the pandemic effects were worse than expected. The end result is that he needed to adjust. Ultimately, we don't typically have loans that go past 30 days. These are low-leverage properties, and we could exit the relationship quickly if needed and be comfortable with the collateral. We're confident given the CARES Act relief we offered and ongoing dialogue that the borrower will be current by the end of the year. Many customers did take relief early and came back to paying; he was one of the few who did not. Given current market conditions and lease renewals at higher levels relative to pandemic lows, we expect a favorable outcome.

Operator, Call Operator

Our next question is coming from Chris McGratty of KBW.

Chris McGratty, Analyst, KBW

I want to follow up on the deposit growth that you've seen, particularly the noninterest-bearing that you cite with the Banking as a Service. I may have missed this, but expectations for noninterest-bearing deposits to continue to grow — I think there's a view in the market that most banks will not see as much growth in noninterest-bearing given the move up in rates and some parked money. Interested in your thoughts specific to that?

Thomas Cangemi, Chairman, President & CEO

Chris, this is the type of deposit we’re focused on. These are preloaded card programs and similar, very sticky deposits driven off stimulus payments and other benefits. These programs are technology-enabled and require a bank partner to house deposits. We are providing that. We are actively putting proposals out across the country for these programs, and it's not limited to local areas. We've brought in new people focused on Banking as a Service and technology initiatives, and we expect to continue seeing wins. While we started at zero and now have about $2 billion in roughly ten months, there's a sizable pipeline and many opportunities. We're also pursuing opportunities to structure term funding associated with mortgage servicing and other escrow-like arrangements. So we view Banking as a Service and related technology partnerships as an important strategy to build more stable, low-cost funding for the bank.

Chris McGratty, Analyst, KBW

Just a follow-up on overall rate sensitivity given the markets and the move up in rates. Could you help us with a longer-term view? It seems like there's a funding advantage when Flagstar comes on. If the market prices in a couple of hikes by the end of next year into '23, how should we think about margin development pro forma?

Thomas Cangemi, Chairman, President & CEO

On a big-picture basis, the NYCB and Flagstar combination is beneficial. Flagstar's loan portfolio is more asset-sensitive and floating-rate, while our portfolio has traditionally been more fixed. When blended, the combined balance sheet will be in a favorable position and managed well. That's one of the merits of the transaction. I'll turn it over to John to dive into some of the details on a standalone basis.

John Pinto, Chief Financial Officer

As you know, on a standalone basis, we have been and continue to be liability sensitive, but that has begun to moderate. As Tom mentioned, attracting noninterest-bearing deposits will limit our reliance on wholesale funding, which is the goal: to reduce about $15 billion of wholesale borrowings and replace them with core deposits. That will be the primary way we limit the liability-sensitive nature of our standalone balance sheet. Once the Flagstar transaction closes, NII sensitivity should turn more positive given the amount of floating-rate loans and the asset structure at Flagstar.

Thomas Cangemi, Chairman, President & CEO

I'll add to John's point. We have a substantial amount of wholesale borrowings coming due that currently carry relatively high costs. Those are expensive in this environment. Over 2022 and 2023 we have additional maturities, and that presents an opportunity to refinance at much lower costs, which is favorable to our margin. We estimate it to be several billion dollars in the near term that we can restructure or pay down with cash and low-cost deposits. The combined balance sheet with Flagstar gives us a holistic opportunity to look at the liability mix and will be to our advantage. We're excited about that opportunity, though we haven't put a specific number on the benefit until the transaction is closed.

Chris McGratty, Analyst, KBW

And then just a follow-up. The one regulator approval, can you specify which regulator you're waiting on now?

Thomas Cangemi, Chairman, President & CEO

Because of our structure, we need FDIC and state approvals. After those are in place, it would then go to the Fed. It's the normal regulatory process associated with this type of transaction.

Operator, Call Operator

Our next question is coming from Steven Alexopoulos of JPMorgan.

Steven Alexopoulos, Analyst, JPMorgan

So first, regarding the past dues and the $447 million relationship, how many other relationships do you have in that size range? And what's the house limit in terms of loan concentrations to a single relationship?

Thomas Cangemi, Chairman, President & CEO

We don't publicly disclose our house limit, but we do have sizable relationships with wealthy property owners that have significant portfolios, all collateralized individually. This is part of our relationship lending business model. We are comfortable with our credit underwriting and documentation. Again, on that specific borrower, we feel confident that we will be current by the end of the year and that we have adequate collateral should we need to exit the relationship.

Steven Alexopoulos, Analyst, JPMorgan

On the margin, regarding the sizable decline in prepayment fee income this quarter, was that attributable just to rates moving up a bit? And do you expect refinance activity to slow further?

Thomas Cangemi, Chairman, President & CEO

Rates do make a difference. There was a real change in the curve. Many customers will react. During the pandemic, refinance activity slowed, but we're hearing about transactions and many players on the sidelines with significant liquidity looking to buy assets. The returns can still be compelling if bought at the right cap rates, and we're seeing transactions at reasonable cap rates between roughly 4.5% to 5.5% in some cases. So the market can be ripe for a rebound, especially as Manhattan recovers. We are seeing customers move toward refinancing and purchases in our pipeline, and a continued rise in rates may prompt customers to act sooner, which would increase prepayment income and loan growth.

Steven Alexopoulos, Analyst, JPMorgan

Finally, Thomas, could you give color on the decline in securities yields in the quarter? It was down quite a bit quarter-over-quarter. And from a spot rate view, where are new loans and securities pricing today?

John Pinto, Chief Financial Officer

We haven't been buying many securities recently. The balance has continued to decline quarter-over-quarter as some higher-yielding securities rolled off. In the second quarter we had significant prepayment fees on our securities portfolio, which impacted the prior quarter's numbers. When you look at yields excluding those prepays, the decline is not as large. We're limiting security purchases to avoid adding duration in this interest rate environment. We'll sit on extra cash for now until we're ready to deploy it into loans or securities as market conditions dictate.

Thomas Cangemi, Chairman, President & CEO

We intentionally have an ample cash position by design. We are avoiding adding duration risk at the moment and prefer to be patient until we see meaningful opportunities to put that cash to work. We're also looking forward to the opportunity to reassess the combined balance sheet and potentially reshuffle assets and liabilities after the merger closes. We won't exhaust liquidity until we see a significant movement in interest rates that creates attractive opportunities.

Steven Alexopoulos, Analyst, JPMorgan

And the spot yield on new loans?

John Pinto, Chief Financial Officer

It's north of 3%, roughly 3.25% to 3.5% now, so that's a positive movement. We like the direction of the yield curve and expect that as customers approach refinancing decisions, they're seeing higher rates, which is favorable for new loan yields. The yield curve steepening benefits our decision-making around agency versus portfolio placements.

Operator, Call Operator

Our next question is coming from Steve Moss of B. Riley Securities.

Stephen Moss, Analyst, B. Riley Securities

Maybe just following up on credit here. Modifications coming down, I’m curious about CECL — how should we think about the reserve and provision expense going forward here?

Thomas Cangemi, Chairman, President & CEO

I'll start and then turn to John on CECL. Big picture, as CARES Act deferrals roll off, we expect the principal deferral balance to decline substantially over the next few quarters. You should see a noticeable reduction by our next reporting period in January, and likely further reductions into March and April as CARES Act programs wane. We'll be left with a much smaller bucket of modified loans, and those remaining are highly manageable and well reserved given our CECL methodology. John will add color on the provision expectation.

John Pinto, Chief Financial Officer

As you saw with our CECL results and the small benefit this quarter, we expect to be in that similar range going forward, of course depending upon loan growth. If we do have substantial loan growth, that will affect CECL because you have to provide for new loan originations. But overall, the economic forecasts have been improving quarter-over-quarter, and we don't see anything in the portfolio today that would lead us to expect larger provisions in the near term. If anything, provisions are modest and tied to loan growth expectations.

Stephen Moss, Analyst, B. Riley Securities

Okay. That's helpful. And then just in terms of expenses here, it came in a little bit better than expected. Thoughts on expenses for the fourth quarter?

John Pinto, Chief Financial Officer

We expect fourth quarter expenses to be flat to the third quarter. We're comfortable in this roughly $130 million range on a baseline basis, excluding merger-related items.

Operator, Call Operator

Our next question is coming from Matthew Breese of Stephens.

Matthew Breese, Analyst, Stephens

Just going back to the regulatory approval front. I assume you need New York State approval, but who is Flagstar regulated by at the bank level, and how does that factor in here?

Thomas Cangemi, Chairman, President & CEO

Flagstar is a national bank chartered entity regulated by the OCC. Our approvals will involve the FDIC and state regulators, followed by the Fed as part of the process. It's the standard regulatory sequence for this transaction.

Matthew Breese, Analyst, Stephens

Got it. So it really is not a factor. If you could just hone timing a little bit, do you anticipate this being a first-half 2022 event? I think someone said first quarter, but I don't remember reading or hearing that from you or in the release.

Thomas Cangemi, Chairman, President & CEO

As I said earlier, this is in the hands of our regulators. We're anticipating closing as soon as we can in 2022, but I can't provide a specific date beyond that. We're focused on getting approvals and will close as soon as regulatory approvals are received.

Matthew Breese, Analyst, Stephens

Understood. I was also hoping you could talk a little about the partnership with Figure. There's some public comments from Figure about Fed settlement, credit sponsorship, and you did the private securities transaction this quarter. What are some of the economics for you in these partnerships and transactions? What are the balance sheet and income statement impacts as this progresses?

Thomas Cangemi, Chairman, President & CEO

It's an interesting collaboration. We're invested in Figure and are excited to work with their engineering team. We're combining resources to beta test blockchain-enabled solutions for mortgage and payment systems, focusing on clearing, AML/KYC processes and regulatory considerations. We completed a small beta transaction this quarter as part of testing. We believe there's potential for deposit-related liquidity opportunities, fee income opportunities and eventual lending opportunities. In the long run, we think blockchain could create efficiencies across mortgage origination and securitization workflows. Right now it's early stage beta testing, and we won't quantify metrics until public launches are ready, but we're encouraged about the potential.

Matthew Breese, Analyst, Stephens

Great. And then last one for me: in the past you've discussed the combined entity New York Community / Flagstar being able to generate double-digit loan growth. That seems to require more significant multi-family and commercial real estate growth. What's the strategy to expand that business — more New York City, or nationwide?

Thomas Cangemi, Chairman, President & CEO

We're excited about the opportunity. When the transaction closes, we'll bring together Flagstar's direct lending and NYCB's branch and relationship capabilities. NYCB historically did less field-originated lending, while Flagstar has a strong direct lending presence. Combining them gives us substantial opportunities in robust markets like New York, Florida, Ohio and the Midwest. We'll put people in the field, expand deposit initiatives, and pair deposit gathering with C&I lending. We'll turn on Flagstar's lending products in our branches and provide many more products to our customers beginning day one post-legal close. The combined platform and distribution should allow us to scale direct and indirect origination channels, plus RMBS and warehouse capabilities, which should support double-digit growth over time.

Operator, Call Operator

Our next question is coming from Steven Duong of RBC Capital Markets.

Steven Duong, Analyst, RBC Capital Markets

Tom, when you look at Figure's white papers, it seems they can achieve cost savings on the mortgage side of around 125 basis points from origination through securitization. With Flagstar touching many parts of that process, have you started to size roughly how much of that 125 basis points you could realize? For example, could Flagstar add another 50 basis points to gain-on-sale through this partnership?

Thomas Cangemi, Chairman, President & CEO

Let me turn that to Lee, but I'll say up front: Figure has shown the ability to transact private label mortgage deals on-chain, which can reduce costs in certain parts of the process. For RMBS transactions specifically, blockchain can reduce due diligence and settlement frictions. That could lead to materially reduced costs if broadly adopted. It's early, but the RMBS space is a near-term focus where we see discrete advantages. Lee, do you want to add?

Lee Smith, President, Flagstar Mortgage

You can't put exact numbers on it yet because it's a new relationship and we haven't closed the deal. The blockchain is an ecosystem — to realize the full benefits you need multiple players in that ecosystem. For RMBS specifically, there are immediate opportunities: if the blockchain is a trustless ledger, you don't have to due diligence every loan individually if you trust the process, which yields immediate savings. Transfer and payment are instantaneous, too. So RMBS could see more immediate benefits, but full industry adoption would take more participants. It's early, but we view it as an opportunity and are plugged into the leading players should it prove out.

Steven Duong, Analyst, RBC Capital Markets

I appreciate that. And then, on CDs running off: how low do you think current CD rates can go, and are CDs moving into savings accounts?

Thomas Cangemi, Chairman, President & CEO

I think some CD rates will migrate lower toward the deposit base, and some balances will migrate into savings. We're at a point where we've enjoyed multiple years of margin expansion, and the next several billion of maturities are at mid-40 basis points on average, so moving them to lower-cost funding is part of our plan. The cultural shift toward noninterest-bearing accounts and operating account mandates when we close loans is ongoing and is expected to support margins. Combined with Flagstar, which has different funding dynamics, we expect a favorable blended outcome.

Operator, Call Operator

Our next question is coming from Christopher Marinac of Janney Montgomery Scott.

Christopher Marinac, Analyst, Janney Montgomery Scott

Tom, could you or Lee or Sandro talk about the nonqualified market? How much opportunity exists here? Is that another source of revenue as the merger closes?

Sandro DiNello, President & CEO, Flagstar

I don't have precise sizing to give you, but I will say this based on our history: if there is an opportunity in the nonqualified market, we will go after it. Our mortgage business has many delivery channels and levers we can pull to take advantage of opportunities. I won't speculate on size, but if the market conditions create an opportunity, we will seize it.

Thomas Cangemi, Chairman, President & CEO

I'll add that if the slope of the curve changes and rates move higher, we have the ability to balance-sheet prime residential loans and other products onto the portfolio. We have done that before and can do so again. With Flagstar's distribution, we can do it at a much larger scale. We can hold loans, securitize privately, or use the RMBS program depending on market conditions. The combined company gives significant optionality.

Lee Smith, President, Flagstar Mortgage

To reiterate, if an opportunity arises we can execute. We have a balance sheet, an RMBS program, and multiple sales channels — TPOs, retail, direct — so we can ramp up quickly if market dynamics favor nonqualified or portfolio lending.

Christopher Marinac, Analyst, Janney Montgomery Scott

Tom, on stock repurchases post regulatory approval and closing, is the opportunity still as attractive as you thought when the merger was announced in April?

Thomas Cangemi, Chairman, President & CEO

We're pleased with Flagstar's results; they've outperformed internal forecasts. On a combined basis, the earnings and capital generation profile is materially different: we'll have significantly more earnings and a lower blended dividend payout ratio, which gives us more capital management flexibility. We're not discussing buybacks in the midst of the transaction, but once the combined company establishes its capital profile and earnings power, we'll evaluate all capital tools, including share repurchases, while continuing to invest in the business and return capital through dividends. If the market presents attractive buyback opportunities, we'll consider them in the context of overall capital management.

Operator, Call Operator

At this time, I'd like to turn the floor back over to management for any additional or closing comments.

Thomas Cangemi, Chairman, President & CEO

Thank you again for taking the time to join us this morning and for your interest in NYCB. We look forward to chatting with you again at the end of January 2022, when we will discuss our performance for the fourth quarter and full year December 31, 2021 period.

Operator, Call Operator

Ladies and gentlemen, thank you for your participation and interest in New York Community Bancorp. You may disconnect your lines at this time or log off the webcast, and enjoy the rest of your day.