Earnings Call Transcript - FLG Q2 2024

Operator, Operator

Hello, and thank you for joining us. My name is Regina, and I will be your operator for today's conference. I would like to welcome everyone to the New York Community Bancorp, Inc. Second quarter 2024 Earnings Conference call. All lines are muted to minimize background noise. Following the speakers' remarks, we will have a question-and-answer session. I will now turn the conference over to Sal DiMartino, Director of Investor Relations. Please proceed.

Sal DiMartino, Director of Investor Relations

Thank you, Regina, and good morning, everyone. Thank you for joining the management team of New York Community Bancorp for today's call. Our discussion today will be led by Chairman, President and CEO, Joseph Otting, along with the company's Chief Financial Officer, Craig Gifford. Before the discussion begins, I would like to remind everyone that our press releases and investor presentation can be found on the Investor Relations section of our company website at ir.mynycb.com. Also, certain comments made today by the management team of New York Community may include forward-looking statements within the meanings 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 presentation for more information about risks and uncertainties which may affect us. When discussing our results, we will reference certain non-GAAP measures which exclude certain items from reported results. Please refer to today's earnings release for reconciliations of these non-GAAP measures. With that, I now would like to turn the call over to Mr. Otting. Joseph?

Joseph Otting, CEO

Thank you, Sal. Good morning, and welcome to our earnings announcement, strategic plan update and forecast call. As we navigate this transition year in 2024, we will keep sharing updates about the company, including forecasts. It’s essential for our investors to stay informed and accompany us as we build a high-performing bank. When we met on May 1st, Craig and I had been in our roles for about four weeks. Now that we’ve had an additional 90 days, we believe we understand the company better and have set it on a path to success. We have a strong grip on the steering wheel of the company and are excited about our current position. This quarter has been very busy, and we feel we've achieved many positive outcomes. Earlier this morning, we announced a significant transaction: the sale of our mortgage servicing businesses and third-party origination platform to Mr. Cooper, one of the leading mortgage companies in the country. We have also established a strong relationship with Mr. Cooper, both from a banking perspective and through our connections with their team, making us confident in a smooth transition of our key assets. This follows our announcement on Monday that we closed the sale of our mortgage warehouse loans to JPMorgan Chase. We mentioned this transaction during our last earnings call without naming it, but it has now been finalized. We received $5.9 billion in liquidity on Monday, with around $200 million expected to close in the next 30 days. Both of these sales are significant milestones as we aim to simplify our business model and enhance our balance sheet. Collectively, these transactions strengthen our liquidity and improve our capital ratios. Last quarter, we outlined our strategic initiatives, and this quarter, I would like to update you on their progress. As shown on Slide 3, we have made substantial advancements in each of the five strategies during our transition year. We successfully transformed our Board, and I'm proud to say we now have one of the strongest Boards in the industry. Over the past 120 days, I’ve observed their proactive engagement; they actively challenge management and have established high standards for performance and execution, which is critical for any successful organization. Additionally, during the quarter, we welcomed nine new senior executives to our leadership team, bringing the total number of new executives to 16 in just five months. In terms of our operating plan execution, we experienced robust deposit growth of 5.6% this quarter, a solid outcome in both our private and retail banking segments. We have diversified and strengthened our balance sheet as planned, exiting two non-core businesses, and we remain on track to achieve our expense targets, which aim for over $300 million in net cost reductions. As we build our risk infrastructure and C&I platform moving forward, the strategic sales will add approximately 130 basis points to our CET ratio, which we project will be at 11.2%, above our peers. We also anticipate improved net interest margin (NIM) and net interest income (NII) through future loan portfolio pricing and the growth of our C&I business. Our pro forma liquidity post-transactions will be around $40 billion, giving us over a 300% coverage ratio for our uninsured deposits. These transactions provide a net of about $6.5 billion in liquidity to the organization through both divestitures and deposit growth. As we mentioned in the May call, we have focused keenly on credit risk management. We’ve reviewed around 75% of our commercial real estate (CRE) portfolio, which was approximately 35% in the first quarter. We continue to address problem loans with additional charge-offs, leading to an allowance for credit losses (ACL) build-up to 1.8%. We are committed to resolving problem loans and have made progress in staffing, including hiring a new leader for our workout group who is highly regarded in the industry. On Slide 4, we highlight key takeaways from the quarter, including significant gains in liquidity and capital. Our deposit growth in crucial areas shows positive progress. Since our last discussion, I've visited multiple branches in Arizona, Michigan, and Florida, where we've effectively rebranded all the branches over the past few months. I'm impressed by our branch staff’s commitment to customer engagement and their focused objectives. In addition to strong deposit growth, we are seeing robust referrals to our investment services. We have achieved notable payoffs in our CRE portfolio, aligning with our goal to decrease our CRE exposure from roughly $45 billion to a target range of $30 billion to $33 billion for better balance sheet diversification. As Craig will elaborate on in Slide 10, we noticed about a 10% annualized decrease in our CRE portfolio from the first to the second quarter, with 50% of those payoffs falling into classified categories. We continue to see payoffs and reductions in these categories as we advance our review of the largest loans. Importantly, we have focused on the implications of rapid rate increases on portfolios and credit quality, conducting an 18-month projection of loans that had a debt service coverage of one-to-one, assessing appraisals, and transferring loans with negative ratios into classified sections, which we believe clarifies current risk in our numbers. We attribute the increase in criticized and classified loans to this forward-looking assessment. More than 60% of currently substandard loans are still performing, indicating our proactive stance on potential future risks. We are also examining additional non-core businesses, with an estimated $2 billion to $5 billion under review for potential exit before year-end that could provide another $200 million to $500 million in unallocated capital and additional liquidity. We remain committed to enhancing both liquidity and capital on our balance sheet. Finally, we have made positive strides in our C&I franchise, which is a key focus for us. With approximately $20 billion in C&I assets, our goal is to reach $30 billion to $35 billion in the next three to five years. We have successfully executed similar initiatives in the past, and our experienced team is hiring additional experts to pursue this business plan, with optimism regarding entering specialized and middle-market lending. Turning to Page 5, we reflect our strong, experienced team built over the past five months. Chris has joined us as the Chief Credit Officer, previously serving in a consulting role. We are excited about the expertise he brings to our credit organization. Additionally, Rich Raffetto has joined us to lead both C&I and private banking initiatives. As a seasoned executive with a strong industry reputation, we are pleased to have him on board as we view both sectors as major growth areas for our business. Page 6 illustrates the busy quarter we've had with our sales, including Mr. Cooper. I want to emphasize our future direction, focusing on becoming a retail bank that serves small businesses and provides residential mortgages from our retail, private banking, and commercial sectors. Our emphasis on commercial industrial and commercial real estate defines our core businesses moving forward. The mortgage warehouse generated about $6.1 billion, and we sold these assets at par, adding roughly 70 basis points to our CET1 capital ratio through this transaction. We plan to use these proceeds to reduce our wholesale borrowings and facilitate future C&I growth. One of our goals is to lower overall wholesale borrowing costs, and as mentioned earlier, we expect the mortgage servicing sale to add 60 basis points, which will help reduce our volatile mortgage deposits. This transaction is valued at $1.4 billion in cash, involving the sale of $1.2 billion in assets and the subservicing business at a premium to their book value, and we anticipate closing this deal in 2024. Now, I’ll turn it over to Craig, and I look forward to addressing your questions during the Q&A segment.

Craig Gifford, CFO

Thank you, Joseph. We'll move forward and talk to some of the numbers, including a deeper dive on some of the credit position analysis. If you move to Slide 7, you can see our CET1 ratio as converted and pro forma for the business transactions that Joseph mentioned is at 11.2%. That's a 9.54% CET1 actual, about 30 basis points for the assumed conversion of the remainder of the preferred stock from the March capital raise. There were two items gating this: one was the shareholders approving in June an increase in our authorized shares, which has been approved, and the second involves regulatory approvals associated with some preferred shareholders converting to common. Once we receive that, we'll increase our capital ratio by roughly 30 basis points. As Joseph mentioned, about 70 basis points increment associated with the warehouse portfolio comes from the $6 billion balance sheet held for sale this quarter. We did receive that cash in the final closing earlier this week. Separately, the mortgage servicing business will increase our CET1 by about 60 basis points as a result of removing roughly $1.2 billion on the balance sheet carrying asset for the mortgage servicing rights, which is a high-risk weighted asset, and a small gain on the transaction associated with the premium we received for the business. We don't have significant unrealized losses on our security. You can see our CET1 ratio adjusted for the unrealized loss on securities at 10.4%. That's fairly strong compared to our Category IV peers. As for cash and liquidity position, there are slides further back that I will go through in detail, but we find ourselves in a strong liquidity position, which is beneficial. On Page 8, we've adjusted our forecast for the transactions that we discussed. Last quarter, we mentioned a potential for an asset transaction, which was the warehouse transaction. We were clear that those numbers were not included and adjusted in the forecast; now we have the mortgage business transaction reflected in this forecast. The result of these transactions pushes out our expectation of achieving peer median returns by about two quarters into the second quarter of 2027, as we redeploy the capital into lending businesses in 2026 and 2027 generated from these transactions. You see on the slide that our tangible book value per share will be between $17.50 and $18 per share at the end of 2024. As we look out to 2026 and 2027, we see that growing to the $20 to $21 share range. These numbers exclude the impact of warrants, which we will need to consider on a long-term basis in terms of share count that would arise from the warrants. On the forecast page on Page 9, you can see that our net interest income shows growth, as does our net interest margin. This is principally a result of resetting our loan portfolio to current interest rates as loans hit their reset dates over the next couple of years. We'll have metrics in a couple of slides that show you the significance of that impact as we roll through the next few quarters. From a provision expense standpoint, we will have a slide at the end detailing our experience for the quarter. We recorded $390 million of provision expense for the quarter; $350 million of that were charge-offs. Given our year-to-date provisions, we expect our provision expense for the year to wind up between $900 million and $1 billion in total for 2024. Because we anticipate loan growth, we expect increased provisioning not only through 2025 related to current market conditions but into 2026 as we have loan growth in the C&I portfolio and need to provision for that growth. If you turn to Slide 10, we can start to talk about some of the credit results. One aspect that we have seen over the last few quarters is strong results from payoffs in our CRE portfolio. So, as loans hit reset dates and maturity dates, we are certainly working to retain those borrowers where we have relationships, where they bring us deposits; however, for borrowers simply using our balance sheet, we're working to reduce our exposure to move off the balance sheet. We had almost $1 billion in CRE payoffs in the quarter, with three-quarters of that coming from multi-family. As shown on the right side, you can see the amount from our classified portfolio. As Joseph mentioned, we've been aggressive in assessing the ability of borrowers to repay and in moving loans to classified over the last two quarters. Many of these borrowers are finding options in the marketplace as their reset dates approach. Almost half of the payoffs this quarter came from our classified portfolio, all at par, so not discounted payoffs. On Slide 11, we provide an update on our portfolio review. Last quarter, we made our way through about 37% of the portfolio, totaling $18 billion. Now, we are through about 75% of the portfolio, including $33 billion in principal balance that has gone through detailed review. We remain at a high level with office loans; only about $500 million of the office portfolio remains under review. The multi-family portfolio has about $7 billion remaining in review, which primarily consists of smaller balanced loans, generally with less risk. On Page 12, our multi-family portfolio shows a year-over-year decrease of 4%. However, importantly, as I mentioned, we had $700 million of payoffs in the quarter. From a quarterly perspective, we're down 3% compared to the same period last year. We expect that trend to continue. On the next page, I'll show you how much will hit reset dates over the next two years. We anticipate continued encouragement for borrowers to find other options. Over the past 18 months, we've had $2.9 billion, nearly $3 billion, in multi-family rent-regulated loans that have hit reprice dates, and as I mentioned, strong payoffs were observed. Close to a fourth of those loans have paid off, while 69% have repriced. This statistic is significant: when they reprice, they do so at an average of 8.19%, up from 3.85%. This trend will continue and has substantial upside for our net interest margin going forward. In the second quarter, we received annual updates from borrowers for their financial statements. We have over 80% of the portfolio for which we've received updates. Interestingly, on average, the NOIs from those updates increased year-over-year. About two-thirds of loans have increased NOIs, while about a third decreased, averaging between 3% and 5%. On Slide 13, additional information on the multi-family portfolio shows about $6.9 billion remains under review. The average loan balance is below $5 million. Over the next couple of years, we'll have around $5 billion repricing in 2025 and 2026, and about $7 billion in 2027. This indicates significant upside potential in margin as well as opportunities to decrease CRE concentration as we work to reduce loans off the balance sheet. On Page 14, we processed approximately 75% of the office portfolio last quarter. We closely monitored that portfolio due to significant market stress impacting occupancy levels. We have now reviewed 82%, with about $500 million remaining. As a result, working through these loans, we have ordered appraisals this quarter on these properties, which have resulted in a significant level of charge-offs during this quarter. The reserve associated with the remaining loans is 6.7%, down from 10% to 11% last quarter, reflecting the charge-offs recorded for the expected loan loss. On Page 15, our non-office CRE portfolio comprises a diversified set of loans; we've reviewed approximately 48% of those loans. Their average balance is only $1.5 million, with the vast majority not tied to New York-related loans. On Page 16, our allowance for loan loss has risen to 1.7% of the total portfolio. Our credit loss reserve is now 1.78% of the total portfolio, up from around 1.5%, with increases in multi-family loans and a decrease in the allowance associated with office loans due to the charge-offs recorded this quarter. Page 17 gives perspective around asset quality. Joseph mentioned we worked diligently to identify problem loans, recognize them and work towards resolution. Non-accrual loans will conclude the quarter just shy of $2 billion, a significant increase from approximately $700 million in the first quarter. Our delinquency data spiked to $1.2 billion in the second quarter; however, subsequent to that, roughly $700 million has returned to current status. This means the increase in delinquent loans only accounts for about $500 million. Importantly, over half—61%—of non-accrual loans are still current on their payments. Within our CRE portfolio, 77% of loans in non-accrual status are current on their payments. We have been aggressive in recognizing potential impacts from market stresses on property values, which often becomes the ultimate source of repayment. Page 18 reports excellent news in relation to deposits. We have successfully raised customer deposits, not just in our retail space where our premier products increased by about $3.2 billion for the quarter, but we have also seen deposit growth in private banking, totaling roughly $500 million quarter-over-quarter as our bankers connected with our customer base and returned dollars to the balance sheet alongside new relationships. Page 19 outlines our liquidity profile, where you can see the success of deposit gathering significantly increased our already strong liquidity position. The warehouse sale will yield $6 billion, while the mortgage sale will result in a net reduction of about $2.5 billion against a total of $40 billion of pro forma liquidity. We anticipate redeploying some of that incremental liquidity within 30 to 45 days. Finally, Page 20 has our financial results for the quarter. You can see our net loss to shareholders was $333 million, primarily driven by the provision for loan losses, comprising $390 million—with $350 million from charge-offs and roughly $40 million from reserve buildup. Our net interest margin was 1.98%. Margin pressure resulted from interest reversals tied to non-accruals. A significant rise in non-accruals contributed about a 7 to 8 basis point negative impact on margin, which is a projected 9 basis point impact as we carry those loans into the future. Our balance sheet concluded at $119 billion, which we expect to decline in the third quarter due to the warehouse loan sale—closing in the third quarter—and later reductions linked to the mortgage transaction. I expect we will redeploy a significant portion of that cash to pay down balance sheet debt. Overall, this summary illustrates the numbers' story as we move forward to simplify the balance sheet, reduce operating risk, and strengthen our capital position amid uncertainty. I will now turn it back over to Joseph.

Joseph Otting, CEO

Thank you very much, Craig. I appreciate the comprehensive overview. On Page 21, I wanted to highlight our investment profile. Pro forma, New York Community Bank currently trades at roughly 60% of fully converted tangible book value. This compares to 1.8% for Category IV banks and 1.55% for banks with assets between $50 billion and $100 billion. Our Q2 2024 tangible book value per share is $20.89, or $18.29 fully converted. We believe that as we successfully execute our strategic plan to transform the company into a focused, diversified, high-performing regional bank, this valuation gap will close. We have multiple levers to close this gap. First, focusing the portfolio on relationship banking activities is key. This will allow us to diversify the loan portfolio from being concentrated into real estate. We continue to increase core relationship-based deposits, and Craig has shown this on the deposit page. A significant portion of our deposits resides in both interest-bearing and non-interest-bearing demand accounts, which is critical. As we grow the C&I business, that will also lead to a lower deposit cost and further diversification. We believe we can also increase the level of fee income generated from fee-based businesses. Many of these products are currently offered by the company, although they might need enhancements. We are talking about cash management, interest rate derivatives, foreign exchange, 401(k), and core banking products that we can offer and improve upon for our customers. Finally, we are very focused on reducing our cost structure. As communicated, we have a plan to eliminate $300 million in expenses independent of the mortgage activities, and we are on track to achieve those reductions by the year's end, providing a sturdy base for 2025. Overall, I think this quarter showed fantastic progress. Within a five-month timeframe, we have significantly changed the culture, notably enhanced the quality of people within the organization, and established a strong focus on credit risk in our portfolio. As noted, our forward-looking scrutiny of the portfolio provides us with valuable insight into any risks arising with interest rate movement or credit risk associated with fixed charge coverage. We've also undergone an annual review of the CRE portfolio, reviewing each individual loan from the standpoint of their NOI and debt service coverage relative to potential future interest rate increases. There has been great momentum among our team at the bank. They recognize the potential for this company to become a successful regional bank, and there's a tangible energy and excitement—from ourselves and our employees to our customers. Thank you very much for your time. If you have any follow-up questions, please direct them to Sal, and we'll be happy to address those.

Operator, Operator

Our first question will come from Ebrahim Poonawala with Bank of America. Please go ahead.

Ebrahim Poonawala, Analyst

Good morning.

Joseph Otting, CEO

Good morning.

Ebrahim Poonawala, Analyst

I guess to follow-up on the commercial real estate book first. You’ve given sort of an outlook for provisioning and the reserves. But give us a sense of the loss content in this book as you've gone through, and where you are seeing those charge-offs come through on the CRE book. Secondly, when you talked about loans repricing from 3% to 8% plus, is that triggering some negotiation with the customer about paying down balances to kind of get LTVs in place? If you could discuss both those aspects.

Craig Gifford, CFO

Sure, I will start on the last question. For the most part, when loans are repricing, we are holding the customers to the rate options in the loan agreements. If they have solid deposit relationships or provide us with other business, we may consider other options. But in general, we’re holding them to the terms in the loan agreements, which is prompting them to look for alternatives. For many of these customers, there are cheaper options available in the market, and this is where we're seeing payoffs coming from. So we’re not actively seeking paydowns; however, we will consider them as part of structuring arrangements, especially for borrowers we want to maintain relationships with. From a charge-offs perspective, we had charge-offs primarily tied to the office portfolio this quarter, alongside some multi-family charge-offs. We’ve reviewed a significant portion of the multi-family portfolio in detail, amounting to an 80% level. The remainder of those loans are often lower-balance loans generally indicate reduced loss levels. However, as we've received updated borrower financial data, we’ve gained a more refreshed view of the loans, particularly concerning debt service coverage on repriced loans over the next 18 months. We have been diligent in assessing those loans, downgrading many to substandard status, which has resulted in charge-offs and may lead to further charge-offs in the coming quarters as we receive appraisals.

Ebrahim Poonawala, Analyst

And on those payoffs, can you discuss the appetite among the GSEs? Another bank indicated they have seen a pickup in getting these loans refined with the agencies. Have you observed similar trends? Given the recent shifts in rates, do you think this could trigger even more refinancing?

Craig Gifford, CFO

Yes, we have seen that. This is what we’ve recognized in the $700 million of payoffs in the multifamily sector during the second quarter. We expect this to continue, which is favorable for our goal to reduce commercial real estate concentrations. We have opportunities to redeploy that liquidity, including paying down debt. Thus, we anticipate that the trend will persist over the next several quarters.

Ebrahim Poonawala, Analyst

If I may sneak in one more for Joseph. You provided a medium-term outlook for the company. Given all the moving pieces, fourth quarter 2026 earnings shifted from $2.10 last quarter to $1.65 this quarter. There's evidently a lot going on. As we look at the announcements regarding the warehouse and servicing, how far are we in terms of strategically realigning the balance sheet and the company, or could we see more such actions in the coming months and quarters?

Joseph Otting, CEO

Some of that movement in the fourth-quarter 2026 earnings projection stems from the sale of the mortgage warehouse and mortgage servicing rights. The lowered forecast occurred because, as those are being sold, we are adding C&I, and a transition period is indicated until early 2026 occurs where those will intersect. We do anticipate an additional $2 billion to $5 billion in non-core activities that we’ll evaluate and look to act on between now and year-end.

Craig Gifford, CFO

To put some numbers to it, the mortgage servicing business had been generating $475 million in fee income for the 2026 timeline, with associated expenses around $410 million. This is what's been removed from the forecast for that period. Additionally, the warehouse business removed from the projections encompasses $6 billion in loans, which we expect will be swapped for C&I loans starting in 2025 and carrying into late 2026 and 2027.

Ebrahim Poonawala, Analyst

Very clear. Thank you.

Operator, Operator

Our next question comes from the line of Casey Haire with Jefferies. Please go ahead.

Casey Haire, Analyst

Great. Thanks. Good morning, guys. I wanted to follow-up on the credit front. So regarding the ACL, could you provide some numbers as to where we see your provision guidance and where you see the ACL ending following the review of the $11 billion remaining?

Craig Gifford, CFO

The remaining $11 billion includes numerous loan counts and some smaller loans. I wouldn’t suggest we’ll finish with $11 billion, but instead, we will transition into a more normalized cycle of continuing updates around credit portfolio analysis. While I expect continued charge-offs over the third and the fourth quarters, I anticipate that they will likely decrease the overall ACL reserve percentage as we allocate reserve dollars to charge-offs. We feel around the range of $900 million to $1 billion for provisioning expense this year.

Joseph Otting, CEO

It's important to note that with 75% of the portfolio reviewed and 80% of the multifamily loans assessed, we won’t have a significant quantity left to analyze. Continued further degradation in the loans' underlying assets would be necessary to foresee deterioration. Most instances allow us to predict risks that may arise within 18 months due to rate changes, which significantly impact NOI.

Craig Gifford, CFO

From the non-accrual perspective, anything non-accrual has already been appraised and charged down to the value minus selling costs, which reflects a focused condition regarding collateral values. Thus, the only potential for significant increase in reserves on non-accruals would result from market conditions worsening.

Casey Haire, Analyst

Great, thank you. Additionally, on the expense front, the forecast indicates a decent amount of expense leverage. Could you provide some color as to how that progresses and the key drivers, including your exit number for this year?

Craig Gifford, CFO

Thinking through the forecast period, we estimate a reduction in expenses of about $750 million. I mentioned approximately $400 million of that will come from exiting the mortgage business—an area known for its high efficiency ratio. This leaves another $300 million to $350 million cost reduction target out of the anticipated $1 billion arrangement. Our goal is a 15% to 20% cost reduction over the next 18 months, executed by the end of this year for a leaner structure moving into 2025. We expect some continuing reductions in 2025, particularly as we position ourselves to decrease regulatory costs in 2026 and 2027.

Joseph Otting, CEO

In addition to those take-outs in cost, we’re also factoring in growth in both risk frameworks and C&I, contributing to a net number. This is still transitioning through three organizations that haven't fully consolidated yet. We're committed to staying disciplined on cost structures, efficiency ratios, and we have set clear targets for each unit in the organization. Our bi-weekly meetings focus on these targets, and we’re confident we will achieve our run rate by Q4 of this year.

Operator, Operator

Our next question comes from the line of Mark Fitzgibbon with Piper Sandler. Please go ahead.

Mark Fitzgibbon, Analyst

Good morning, and thanks for all the detail. Joseph, I was wondering if Mr. Mnuchin decided to return to the Treasury or another agency under a new administration, would he be required to sell his holdings in New York Community?

Joseph Otting, CEO

That question is better directed towards Mr. Mnuchin. I don't know the intricacies of his agreements or portfolio situations. Stephen commented publicly that he indicated he did not have to, but ultimately, that’s up to him and Liberty. I will say Stephen has been an outstanding lead director at our company. We value his contributions, and I couldn’t ask for a better partner to help us navigate our activities.

Mark Fitzgibbon, Analyst

And just one follow-up. Could you share the number of Private Client teams you have today? I think it was 100 last quarter. Given you have many senior hires, have you brought in many commercial lenders or relationship managers to help drive the business mix change?

Craig Gifford, CFO

So for private client, while we had some attrition here and there, we’ve witnessed stability since and have lost less than 10% of the associated deposits, now seeing growth. The team, with Rich Raffetto's hiring, has rallied together and anticipates significant advancements in the C&I space, with Rich making key hires and more on the way.

Joseph Otting, CEO

We indeed added Adam Feit as a highly recognized banker from Union MUFG on the West Coast to lead our specialized industries and capital markets group. Rita Dailey, a long-time banker who worked with me at Union Bank, is set to manage our deposit-focused industries and treasury management. We are nearing the hiring of a leader for our national commercial banking operation as well. In addition to recruiting top leadership, we are also working to bring skilled personnel into existing C&I businesses.

Mark Fitzgibbon, Analyst

Thank you.

Operator, Operator

Our next question comes from the line of Manan Gosalia with Morgan Stanley. Please go ahead.

Manan Gosalia, Analyst

Hey, good morning. Regarding this quarter, were there any CRE loans sold, or is most of the reduction from paydowns? If no sales occurred this quarter, do you foresee any potential sales as rates come down? Is there market interest in any parts of that portfolio?

Joseph Otting, CEO

We did not conduct significant sales in the quarter. It’s our intention before year-end to reduce non-accrual loans through sales. We’re studying a couple of options and some large individual loans. We're thrilled to have Bill Fitzgerald on board to lead our workout group—he’s highly experienced in this area—and we are meeting weekly to strategize the ways to reduce non-accruals through sales. We believe these loans are marked appropriately. While the market conditions fluctuate, we’re optimistic about retaking a number of these assets off our balance sheet by year-end.

Manan Gosalia, Analyst

But you're not inclined to sell parts of the performing loan portfolio just to get below $100 billion?

Joseph Otting, CEO

We will review all options. Looking at this quarter alone, we can expect approximately $1.65 billion in escrow payments through payoffs. We estimate about 40% of that portfolio could clear this quarter, equating to approximately $500 million or $600 million that will be eliminated through payoffs. Ultimately, we will focus on reducing non-accrual and substandard loans before the year concludes.

Manan Gosalia, Analyst

Looking longer, your NIM outlook for 2026 indicates margins rise significantly compared to flat projections in 2024 and 2025. Could you attribute that spike to C&I leaning or maturities in the CRE side? Can you elaborate?

Craig Gifford, CFO

About three-quarters of that margin lift will stem from loan repricings. We expect the multi-family segment, with $5 billion in the next two years, will have a significant impact as these loans reprice from 3% and 3.5% to 7.5% and 8%, showing a material influence on margin. Moreover, redeployment into new lending at current market rates will further enhance these margins.

Manan Gosalia, Analyst

Great, thank you.

Operator, Operator

Our next question comes from the line of Bernard von Gizycki with Deutsche Bank. Please go ahead.

Bernard Von Gizycki, Analyst

Hey, guys. Good morning. Regarding the non-strategic asset sales, you mentioned an additional $2 billion to $5 billion. Was that after a thorough review across all loan portfolios? How do you balance the non-relationship, non-strategic assets with a potential exit at par? Are these potential sales excluded from this current forecast?

Joseph Otting, CEO

Yes, future sales are not targeted at the $2 billion to $5 billion range. The mortgage warehouse and servicing rights are both excluded from the forecast for now; having set our sights on identifying core versus non-core businesses based on our relationship with borrowers. We evaluate businesses lacking limited interactions or future growth opportunities for customer relationships.

Craig Gifford, CFO

From this lens, there's about $10 billion to $15 billion of loans that we could exit quite readily at or near par, based exclusively on capital metrics. However, that also risks earnings, so we need to tread carefully while also factoring in client retention. We are left with an estimated potential of $2 billion to $5 billion for evaluation in the upcoming quarters as part of our strategy.

Bernard Von Gizycki, Analyst

That’s helpful, thank you. Regarding updated financials from borrowers, you mentioned receiving 80% of the portfolio. The reported NOIs seemed higher than expected year-over-year. Can you elaborate on that data and whether the borrowers’ financial situations have improved?

Craig Gifford, CFO

What it confirmed is that inflation markedly impacted the especially rent-regulated sectors. Steady rates have established a much more favorable return for those borrowers—this is promising for our lending perspective. However, specific loans still warrant concern regarding how they’ll fare. Hence, we’ve managed to assess a significant portion of the portfolio, ensuring we gain accurate data quickly and flagging issues as they arise.

Bernard Von Gizycki, Analyst

Great, thanks for your insights.

Operator, Operator

Our next question comes from the line of Jared Shaw with Barclays. Please go ahead.

Jared Shaw, Analyst

Hey, good morning. I want to address the loan reset this past quarter; you noted an 8.19% rate. Can you provide context regarding the debt service coverage for that type of borrower?

Craig Gifford, CFO

That coverage has become quite thin. With rent-regulated trends showing 3% increases and major price rises, the ratio has dropped. Historically, we had considerable debt service coverage nearing 200%, but now we are approaching a concern with many loans sustaining around 1% to 1.1% multiples.

Jared Shaw, Analyst

Regarding loans placed into substandard or non-performing status—are the majority interest-only or rent-controlled? What are their underlying characteristics?

Craig Gifford, CFO

The reprice accurately mirrors the general characteristics of our portfolio. There are interest-only and rent-controlled loans, but this is not confined to a specific segment.

Jared Shaw, Analyst

For classification of loans as substandard or criticized these days, is the 18-month look forward serving as a cutoff? How about loans maturing further out in 2026 and 2027?

Craig Gifford, CFO

Indeed, that’s how we are currently classifying. A prolonged elevation of rates will worsen credit conditions for the future.

Steve Moss, Analyst

In the appraisals you've ordered here, can you disclose the types of cap rates? What cap rates are you seeing or utilizing on appraisals or multi-family loans?

Craig Gifford, CFO

Cap rates vary across asset classes and geographies. It is a wide range, from 6% to 9% based on the product type and location.

Steve Moss, Analyst

Great, appreciate that. I have one last concern concerning the CRE side; you disclosed there are a number of three-year interest-only loans. How much of the commercial real estate is interest-only? What full principal and interest debt service charge ratios are represented in that portfolio?

Craig Gifford, CFO

I don’t have those precise statistics on hand. When we risk-rate, we review borrower financials on a principal and interest fully amortizing basis. We assess their ability to cover both types, not just interest-only loans.

Operator, Operator

Our next question comes from the line of Chris McGratty with KBW. Please go ahead.

Chris McGratty, Analyst

I want to revisit the loan sales regarding targeted non-strategic assets and their projected effect on long-term ROE. Can you clarify the potential ROE impact from those sales?

Craig Gifford, CFO

We intend to focus on portfolios that lack significant margin contributions, thus I do not anticipate a considerable negative impact on ROE from these sales.

Chris McGratty, Analyst

Understood. Will deposits accompanying the servicing sale be quantifiable?

Craig Gifford, CFO

Yes. The servicing deposits can be quite volatile. Lately, they were above their typical low point for the month, estimating $3.7 billion in deposits within the servicing business. We will receive approximately $1.3 billion back from the cash on the sale transaction. Thus, the overall liquidity impact nets to about $2.5 billion.

Chris McGratty, Analyst

Thanks.

Operator, Operator

Our next question comes from the line of Matthew Breese with Stephens. Please go ahead.

Matthew Breese, Analyst

Hey, good morning.

Joseph Otting, CEO

Good morning.

Matthew Breese, Analyst

I wanted to discuss balance sheet size for the remaining part of this year and 2025. The guidance suggests that earning assets will stay between $108 and $109 billion. I’m wondering how you're balancing the decision to remain over $100 billion versus below. If you do stay over $100 billion, when will you be subjected to Category IV bank stress tests?

Craig Gifford, CFO

Our current estimates indicate we wouldn't be dipping below the $100 billion asset level. We expect earnings assets to decrease from $111 billion at the end of June down to around $104 billion by year-end, primarily due to the anticipated sale of the mortgage warehouse loans occurring in Q3. As you might expect, we have a higher level of balance sheet liquidity as a Category IV bank. Officially, we became a Category IV bank as of October 1, 2023. Category IV banks undergo stress testing every other year in even years. Therefore, we don’t expect to face Federal Reserve run stress tests until the 2026 cycle.

Matthew Breese, Analyst

That’s helpful. Could you also outline the NIM outlook for the next couple of quarters, please? I would appreciate insights into what the accretable yield was this quarter and expectations through the end of the year.

Craig Gifford, CFO

Accretable yield is declining; we estimate it adds likely 7 to 8 basis points to the margin, tapering down into the middle of next year. As for the margin expectation, we foresee a continued reduction mainly influenced by the warehouse sale coming off the balance sheet in the upcoming quarters. We have conveyed the full-year margin guidance and prefer not to predict specific quarter numbers, but we anticipate a slightly downward movement over the next two quarters.

Matthew Breese, Analyst

I appreciate those insights. Referring to some cash levels, what will the cash-to-assets ratio look like by year-end, and is that a desirable level to maintain into 2025?

Craig Gifford, CFO

The deposit growth from Q2 gives us the latitude to let go of the costly mortgage deposits. The net cash from the warehouse sale will assist in reducing wholesale borrowings, ensuring we maintain an appropriate cash-to-assets ratio for moving forward.

Matthew Breese, Analyst

Understood. Regarding preferred conversions, I appreciate the information on common shares outstanding with the reverse share split. What will thewarrants’ impact be on diluted shares going forward?

Craig Gifford, CFO

That depends a great deal on the anticipated share price. The net sellable grounds exist in public information. However, at current price levels, they have limited impact; at higher prices they could lead to an increased share count if holders opt to convert.

Matthew Breese, Analyst

Thank you for that clarification.

Craig Gifford, CFO

Thank you.

Operator, Operator

I will now turn the call back to Joseph Otting for any closing remarks.

Joseph Otting, CEO

Thank you very much, operator. I appreciate everyone for joining. There's a lot of good energy around the company and the direction we're heading. We have a very experienced executive and leadership team to execute our business plan. With the asset sales and our forward momentum, we’re simplifying operations while maintaining liquidity and capital. Importantly, we are focused on growing the bank across our identified sectors, particularly private banking, retail banking, small businesses, and the C&I segments within our operations. Often, it’s easy to get caught up in problems rather than solutions. I assure the investment community and our investors that we’re looking ahead to what the company will become. Thanks for your time and interest. Please reach out to Sal for any follow-up questions.

Operator, Operator

This concludes our call today. Thank you all for joining, and you may now disconnect.