Good morning, everyone. This is Salvatore DiMartino, Director of Investor Relations. Thank you for joining the management team of New York Community Bancorp for today's conference call. Today's discussion of the company's second quarter 2021 results will be led by Chairman, President, and CEO, Thomas Cangemi. 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 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 investor presentation for more information about risks and uncertainties which may affect us. Now, I would like to introduce New York Community's Chairman, President, and CEO, Thomas Cangemi.
Thank you, Sal. Good morning to everyone, thank you for joining us today to discuss our second quarter 2021 performance. Joining me in our Long Island headquarters are our Chief Operating Officer, Robert Wann, and our Chief Financial Officer, John Pinto. Also joining on the line from Flagstar Bancorp are Sandro DiNello, President and CEO of Flagstar, and Lee Smith, President of Flagstar Mortgage. As you may have already seen, Flagstar reported strong second quarter results today. We also announced better-than-expected results for the second quarter of the year. This is the second consecutive quarter of better-than-expected quarterly results. I'm very happy with our strong operating performance this quarter, which was highlighted by continued expansion in our net interest margin, lower operating expenses, good loan growth, solid credit quality, and most importantly, a substantial improvement in our earnings per share.
In fact, this is the company's best quarterly operating performance in over 15 years when we reported diluted EPS of $0.35 back in first quarter 2005. On a non-GAAP basis, excluding mostly merger-related non-recurring items of $12 million, diluted earnings per share were $0.33, up 57% year-over-year, and $0.03 or 10% ahead of consensus estimates. While diluted earnings per share were $0.30 a share, up 43% on a year-over-year basis. As for the details of the quarter, starting with our net interest margin, our second quarter margin was 2.5%, up two basis points sequentially. Prepayment income was very strong during the second quarter, increasing 35% to $27 million compared to the first quarter of the year, and added 20 basis points to the margin compared to 15 basis points in the previous quarter.
Excluding prepayment income and the impact from holding excess liquidity during the quarter, the net interest margin increased five basis points to 2.38% compared to the prior quarter, ahead of our expectations. Our pre-provision net revenue was also strong during the current second quarter. Excluding merger-related expenses of $10 million, PPNR totals $218 million, up a very solid 38% year-over-year. Another highlight of the quarter was our efficiency ratio, which improved to 37% compared to 40% during the previous quarter. Total operating expenses decreased $3 million or 2% compared to the previous quarter, which was also better than what we anticipated. Moving on to deposits. Total deposits at June 30th, 2021, were $34.2 billion, relatively unchanged on a linked-quarter basis. This masks the significant progress we are making on our deposit growth strategy since the beginning of the year.
If you look at the average deposits, they've increased $2.3 billion or 14% compared to March 31st. This was primarily driven by deposits garnered from our relationship with our technology partnerships, which increased to over $3 billion during the quarter before settling back to $1.1 billion. Since being named CEO, it has been one of my top initiatives to bring in more core deposits from our multifamily and commercial real estate borrowers. These initiatives are beginning to bear fruit as loan-related deposits at June 30th increased $380 million at 22% annualized to $3.9 billion compared to December 30, 2020, balances. As a result of these initiatives, CDs as a percentage of total deposits have declined to 26% as of the current second quarter, compared to 38% in the year-ago quarter, while total deposits have increased.
We will continue to focus on growing deposits through a variety of strategies, including by further penetrating our existing borrower base, as well as expanding into the banking-as-a-service space through partnerships with fintech companies. On the lending front, we had a relatively good quarter in terms of loan growth. Total loans held for investments increased $449 million or 4% annualized on a linked-quarter basis to $43.6 billion. The multifamily portfolio increased $345 million or 4% annualized compared to the first quarter of the year, despite an elevated level of prepayments, while the commercial real estate portfolio declined modestly. The specialty finance portfolio continues to grow in its growth trajectory, increasing to $3.4 billion or 7% annualized compared to the previous quarter. As for our credit quality, our metrics continue to be very strong and rank among the best in the industry.
We reported another quarter of net recoveries while NPAs improved slightly. More importantly, 60% or $1.5 billion of the $2.5 billion of deferrals paying interest only have returned to full payment status. We expect to see a notable improvement throughout 2021 as we move closer to the full reopening of the New York City metro region. Since the beginning of the pandemic, our total COVID-19 related deferrals have declined substantially to $1 billion or 2% of total loans compared to $7.4 billion or 17% of total loans this time last year. All the while, we're actively working with our borrowers and not incurring any losses. In terms of the local economy, our outlook continues to be a positive one. Our portion of the New York City real estate market, the non-luxury rent regulated multifamily market portion, is performing extremely well.
Rent collections continue to be at the same level as they were before the pandemic, and our borrowers have plenty of liquidity. While we remain vigilant for any signs of weakness, we are looking forward to the full reopening of the region in the upcoming months. Lastly, I'd like to provide a brief update on our planned transaction with Flagstar Bancorp. We are making significant progress on multiple fronts. Integration teams have been formed. We meet at least weekly, if not daily, on the integration planning process. To date, a number of key decisions have been made, including selection of the technology platform and ancillary systems we will use and the products and services we will offer our combined customers.
In addition, in an 8-K we filed last week, subject to the completion of the planned merger, we have named our senior executive leadership team, reporting directly to me and who will support our strategic priorities going forward. All necessary regulatory applications for the merger have been filed. The joint proxy statement was sent to both sets of shareholders last month. The next milestone is both companies' special meeting of shareholders to be held virtually on August 4th, followed by an estimated closing early in the fourth quarter, which is subject to all required regulatory approvals. Since we announced the merger, I've been spending more time with Sandro and his executive management team, and our shared vision of a combined organization is more evident as each day goes by. This, in my opinion, is not a traditional merger.
It is an alliance where we are taking the best of both companies and forming a much stronger, better-positioned organization and creating significant value for everyone. The more time I spend looking at the two companies becoming one, the more excited I become about the combination. In addition to compelling financial metrics, including double-digit EPS accretion and immediate tangible book value creation, there are significant deposit growth opportunities, new lending opportunities, and a substantial amount of fee income opportunities by cross-selling Flagstar's retail product set through the NYCB branch network. This is where the benefits of scale are readily apparent. The combined company will rank at or near the top in a number of key businesses, and given a bigger balance sheet, we will have the opportunity to leverage up in a number of businesses and/or increase market share.
These businesses include both direct and indirect multifamily lending, mortgage warehouse lending, mortgage banking, as well as expanding traditional C&I lending into each of our markets. With that, we would be happy to answer any questions you may have. As stated earlier in the call, both Sandro and Lee are also here to answer any questions you may have on their results and their business model. We will do our very best to get to all of you within the time remaining, but if we don't, feel free just to call us either today or during the week. Operator, please open the line for questions. Thank you.
Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question comes from Steve Moss with B. Riley Securities. Please proceed with your question.
Morning, Steve.
Hi. Good morning. Just starting here with margin expectations and loan pricing here. Good quarter here in terms of the underlying core. Just kind of color there you could give, Tom, in terms of where you're seeing pricing going.
Obviously, interest rates have changed significantly throughout the second quarter. The good news for us is that we're still holding around that significant, we'll call it 275-ish spread to the five-year. We're seeing anywhere from 3% - 3.125% on a traditional product on the multi, in respect to commercial, probably getting 30 - 40 basis points above that. As far as overall economic returns in the business, as you can see, the prepayments have been relatively strong, and despite the level of prepayments, we still grew the book. We're excited about growing the portfolio.
We're still anticipating that mid-single-digit loan growth for the company. I would say if you think about margin, with the fact that we have around that 3% type yield coming back onto the portfolio and holding our portfolio at a reasonable growth trajectory for the year, our cost of funds is still declining slightly. We anticipate further decline in our cost of funds as we move into the second quarter. I'd say we're probably looking at between three to five basis points of margin potential expansion in Q2. The ongoing continuation of the expansion is occurring as we set ourselves up for the business combination with Flagstar, which will bring a lot of liquidity, more importantly, a lot of balance sheet opportunity on the wholesale side that we're going to evaluate. We haven't been specific as what we're going to do there.
It's not baked into the merger math, but we have a tremendous opportunity to look at our combined wholesale liability portfolio as we bring in the excess liquidity, and we'll make a business decision as we get closer to the closing of the transaction. We're excited about the ongoing continuing margin expansion, even though we've enjoyed a very unique opportunity over the past few quarters. I'd say it's been almost a year and a half now of reductions of our cost of funds and improvement in the margin. We anticipate that's going to continue as we focus on the consolidation of the business model into 2023.
Sure. That's helpful. Maybe one question for Sandro here. Sandro, just kind of if you give us an update on your thoughts on the mortgage banking market and kind of where you see things playing out. I do see the guidance on the deck, but just kind of color around that and what your underlying expectations are with the adverse market fee coming out.
Hi, Steve. Nice to hear from you. Yeah, look, we think that the mortgage business continues to be very strong. The projections by the GSEs and the MBA continue to look for a very strong mortgage market.
What we've been trying to do, as you know, you've been following us, is build a consistent mortgage revenue stream. I think we've found our way there, and it's shown not only in what we've done this quarter, but also in what we're guiding to for next quarter. We feel very good about the consistency of the mortgage revenue. I think what you see today is we hope will be sort of a run rate, if you will, ±10% over the long term. Let me let Lee be a little bit more specific about that.
Yeah. Thanks, Sandro. Thanks for the question, Steve. Just giving a little more color to what Sandro said. In terms volumes are holding up, Steve. The agencies and the MBA have got 2021 at a $3.9 trillion market, 2022 at $2.7 trillion, 2023 at $2.4 trillion. When you look at the primary spread, it's been pretty constant over the last several weeks between 125 and 135, as have the gain on sale margins. Furthermore, given our diversified mortgage model, we're able to find pockets of opportunities other originators cannot. What I mean by that is we originate in all six sales channels. We have a balance sheet which gives us available-for-sale, held-for-investment, and MSR flexibility. We have an RMBS program which provides execution optionality.
We executed on four RMBS deals in Q2, we're the third biggest issuer of RMBS in the quarter behind JPMorgan Chase and Goldman Sachs. We're planning on five deals in Q3. As the GSE step away from certain product classes such as non-owner occupied, we're able to step in and take advantage given our balance sheet and RMBS program. The key, as Sandro mentioned, is being consistent, and we want to bring consistency to our mortgage earnings and gain on sale revenues because we have so many different levers, we can pull to make that happen. In the second quarter, I've guided to $250 million-$270 million of gain on sale. In Q3, I'm guiding to $260 million-$280 million.
The relevance of that is if we're generating north of $150 million gain on sale in the quarter, Flagstar is going to generate over $2 earnings per share for the quarter or $8 annualized. That's a lot of capital and firepower for Flagstar and ultimately the combined company. I want to be able to provide that consistency and reliability for mortgage every quarter. When the market provides opportunity through interest rate drops, we can generate even more earnings and capital. Finally, with the bigger balance sheet that we're going to have of the combined entity, it's going to give us growth opportunities from a mortgage point of view around the HFI portfolio, holding more MSRs, the RMBS program, bigger balance sheet, we can hold more inventory, expanding new and existing origination channels, and supporting the 238 New York Community Bank branches and their customers as well.
Lee, relative to the GFCC that was eliminated, maybe a couple quick comment on that.
Yeah. It's helpful. We've seen a pickup in our pipeline from a mark-to-market point of view, and from a balance sheet point of view, given that we're delaying deliveries till after August 1 when that removal goes live. If you think about it, that 50 basis points, it equates to about a 10-basis point higher mortgage rate for borrowers. While its elimination is positive for prospective refi volume, it's not going to have a material impact. I think what is interesting more recently has been the drop in the 10-year to around 125. We've definitely seen an increase in refi volumes as a result of that. Combined with the FHFA removing their refi fee, it's helpful. The removal of the fee in and of itself won't drive a ton of volume, but it's certainly given us a bump, a pickup on our pipeline.
Great. Thank you for all that color and great quarter on both sides.
Thank you, Steve.
Thank you. Our next question comes from Brock Vandervliet with UBS. Please proceed with your question.
Morning, Brock. How are you?
Good morning, Tom. I'm doing well. Going back to multifamily, could you talk about the activity levels there and how much of the activity you're seeing is purchase versus refi? More generally, has the corrective phase within that asset class really shaken out at this point or where do we stand there?
Obviously it's been relatively slow in the past few years. More importantly, with this focus of the pandemic and coming out of COVID has been a lack of activity. We've done pretty well with our customer base. Refi has always been significant. As you can see from the quarter, we had significant prepayment activity, so we've held a lot of those deals. A lot of them did trade away, and we still grew the book, so we were very pleased with that. I'd say that we're looking forward to the second half as being more of a growth year opportunity for us. We still feel confident that we can grow. We'll call it the core multifamily at that 5% type growth rate. Where the interesting opportunity is going to be is when we combine with Flagstar, this is going to be a growth story.
I don't think anybody really has the anticipation of the capital infusion that will go into the combined entity, and we can significantly increase our exposure to a lot of Sandro's great relationships over at Flagstar, including warehouse, commercial real estate, and on the builder finance. These are positions that were extremely well managed on their end, and they are capped at certain levels. When you put a significant infusion to capital on a combined basis, we've done it when Richmond County merged with NYCB. We were capped out at $50 million a customer. Now we have substantial hundreds of millions of dollars of exposure to the best borrowers. I believe that type of growth opportunity will be there for us. We're not giving projections for next year until we close this transaction.
There's no question that the fact that the companies are combining, we can increase the best customers with an opportunity to grow with us. At the same time, really go after the deposit opportunity throughout the branch network. What we're excited about the second half, it's not going to be a double-digit on a standalone basis. We think we can make that 5% net loan growth number. As far as the specialty finance business, it's doing really well. We have about $2 billion excess sitting out there undrawn because of supply chain issues and people managing their overall capital stack given where capital markets are right now. Ultimately, as business picks up, we think they'll draw down, and we see that as also a potential high-10 grower as well. We're excited about this company combining.
We think it's going to be a growth story as well, and that's going to be, I think, a catalyst for our investors.
Just following up on multifamily, what's the latest in terms of the threat to 1031 exchanges? Has the discussion moved on at this point?
Well, it's interesting. Yeah. That's an interesting question because obviously if I had that answer, it would be everybody would be surprised for everyone to understand it. Clearly, there's no question that it's been in people's minds. I ask my top customers all the time, is it positive? It is what it is. It's a tax strategy that may or may not go away, but right now it seems like it's losing a little bit of momentum. It's a big issue for commercial real estate. What does that do for us? Ultimately, the assets stay on longer, assuming they take it away, but the jury's out if it goes away. It's a pretty big benefit for both the commercial real estate owners, but more importantly, the city does transact. They get significant economic benefits from transactions that work within the New York City marketplace.
I think that will have implications to the budgets of New York City. As we dive into these tax strategies, and right now it seems like they're stalling, 1031 is always an issue for long-term investors. They'll find other means to look at the value. They'll do cash out refi, and they may be able to take less cash out refi. They'll cash out refi if the value is there and ultimately hold the asset a lot longer. They'll look at situations such as looking at the other tax opportunities that are out there, where there are several. Not as meaningful as a 1031. There are several opportunities such as the opportunity zones that are taking advantage of, and ultimately, they'll plan their estate accordingly.
No question that a 1031 removal was not going to be a positive for the sentiment of the owners.
Okay. Thanks for the color, Tom.
Sure.
Thank you. Our next question comes from Dave Rochester with Compass Point. Please proceed with your question.
Morning, Dave.
Hey, good morning, guys. Nice quarter.
Thank you.
I was wondering, since it has been a few months since the announcement of the deal, and you mentioned you've done some additional work and discovery on opportunities to enhance the performance just on a combined basis. Can you just frame that more quantitatively to any extent you can with some of the opportunities you expect on either the loan or deposit growth side or the fee income side? I know you've mentioned the strong deposit opportunity previously going after deposits at Flagstar's current warehouse customers, for example. That sounds like a great shot on goal. Can you just quantify maybe how large that pool is you're seeing there now and what you think the chances are you can capture some of that?
We see so many opportunities as we spend time together, as the two management teams are really working very hard to get to the finish line here. What's most important is that when you look at the announced transaction, none of those attributes are in the deal, right? We have this double-digit EPS accretive transaction with tangible value creation. We're not forecasting the benefit of a, we'll call it a wholesale shift from wholesale to retail deposits. That's going to be a significant benefit as we decide where we're going to go with our liability structure. There'll be tremendous opportunity to look at the combined entity. We're a liability center. They're asset centers. Combined, we can choose our positioning as the Fed has to make their decisions towards the end of the year is where they're heading with interest rates. That's a significant catalyst for us.
If you think about the opportunity, we discussed on the previous question on the growth opportunity. They have some very strong relationships. They're number two in warehouse in the country, and we believe we can hold that and grow it very nicely as they look at the best customer base that they have and expand into sizable concentration opportunities at very low risk. It's a very low-risk business model when it comes to warehouse. It's managed well, and they do a really good job with that. We're excited about that opportunity. All their best customers will be reignited by having a capital infusion. We've done it before. As I indicated, when Richmond County merged with NYCB, we significantly increased our tack-ons on loan growth. The loan growth opportunity is going to be real from the capital infusion on a combined basis.
We're running just south of $90 billion on a pro forma basis. This is going to have a lot of liquidity regarding the escrow opportunities to be inside those business model. There's going to be some opportunity on the deposit side in the warehouse. They turn away the deposits because they have so much liquidity. We will accept that.
Right. Yeah.
At the same time, Dave, we're also looking at tremendous opportunities on banking as a service. It's an initiative of mine. If you saw my announcement last Friday, we're reallocating resources to building out a digital platform and more importantly, banking as a service. We had a win in the first quarter. It was our first win. I believe we just got another one last night, actually two for the second quarter. This is going to build up to a nice line of business for us as we focus on getting our fair share of the payment space over time and trying to catch up on the technology side. We're excited about that. Collectively, there's so much opportunity on cross-selling product. I mean, on the C&I side, we really don't do much at all other than hold our balances on C&I.
We're going to be in the C&I business. We get our fair share of a local market with our market share. We should do very well on growing other lines of business that we call them verticals that we haven't done in the past. We're excited about a full-service commercial opportunity over time. We don't want to give any guidance right now until we get closer to closing, and we'll talk about the opportunities. I think, Dave, over time, investors will look at this as a growth story with a tremendous credit enhancement here. We know obviously both companies have tremendous track record on credit, and the businesses that we're in are very low-risk credit profile.
Okay, appreciate that. Maybe just switching gears, drilling in a little bit more on the warehouse lines this quarter. It looks like the balance held in fairly well, just given the industry trends. I was just wondering how you see that book trending from here, just given the mortgage activity forecasts out there. I know you've talked about the cash window cap that could actually help drive some more warehouse volume in the market. Can you just talk about how you see that book trending from here?
Dave, we're super excited about the business. I'm going to defer to Sandro and Lee on this because obviously they run that business currently. We're going to stand by that and make significant investment. We believe there's tremendous opportunity, I'm going to defer to both Lee and Sandro on that.
Yeah. Hi, Dave. Nice to hear from you again. Well.
Yeah
From Flagstar's point of view, as we run the business independently, the way we look at the warehouse business is we take as much as we can get in the warehouse. Whatever the market gives us, we're going to take. When the mortgage market's really strong, our balances are going to be higher. When it's less strong, they're going to be a little bit lower. In the meantime, given the upcoming combination of our two companies, we are looking at every opportunity that we can to expand the lines that we have with existing customers and also to talk to customers who were too big for us previously. I think we can mitigate some of the natural reduction in balances that we might see in a smaller mortgage market because of the business combination.
Really, when you look at the Flagstar balance sheet, don't get too focused on just the warehouse business because what we've been able to prove quarter after quarter is that if warehouse goes down, something else goes up. It depends on where the opportunity is, and that's the beauty of the diversified commercial business model that we have. That's why our net interest income is very consistent over time. If you look at that, look at it quarter over quarter, you'll see that we're going to be $180 million net interest income ±5%-10% every quarter.
If you believe that that is a run rate for Flagstar, then don't get focused on any one line of business because in any given quarter, builder finance may be lower or higher, and warehouse may be lower or higher, but we manage to the total, and then we manage to the net interest margin. We've been able to show a very stable net interest margin throughout all economic scenarios. Whether you're talking about before the pandemic or in the pandemic or now, our net interest margin went up eight basis points this past quarter. We manage to the total. We don't worry about what might be weak or strong in any particular area. We look for the opportunities to offset that in other areas.
When you add the consistency of the mortgage business that Lee spoke to, if you can get yourself comfortable that the results that we've had recently and the guidance that he's comfortable giving you, that that's there, and as he said, the combination of what we're doing in our commercial banking businesses and the mortgage business, I'm just talking about Flagstar now. You get yourself very comfortable I think that $2 a share for this company on a quarterly basis is pretty possible. When you convert that to the combined company, that's a contribution of $0.50 a quarter to the total. That's $2 a share contribution coming from Flagstar to the NYCB total on a combined basis. That's what's powerful here, and that is before talking about the synergies that you asked about. It's hard for us to answer that question right now.
I ask you, don't focus on what the possibility is. Just focus on today, right? If you believe NYCB can make $0.30 a share a quarter, and if you believe Flagstar on a converted basis based on the exchange ratio can make $0.50 a share. Now you're at $0.80 per share per quarter, over $3 a year. I mean, look, the value potential is just outstanding.
Yeah, I agree. Thanks for all that detail. Maybe just one last one on expenses. Tom, those were better than expected this quarter. What are you thinking about in terms of the trajectory going into the end of the year here?
We've been working hard, Dave, on keeping the expense line obviously at a very conservative level here. We would budget it at approximately $130. We came in at about $129,
Tom. 129.
$129-ish. I think it's going to be relatively flat, Q3 $130. I'll give you some guidance for the year, we have to take the guidance off the table because hopefully the deal's closed by the fourth quarter. We're $5.25 run rate for 2021. We're doing a little bit better than that, $130-ish. Obviously Q1 versus Q2 is lower predominantly driven by payroll tax issues. It's the high quarter for payroll tax. We're pleased. We're very pleased. We're focused on efficiencies. I think there's going to be some opportunities as we combine in the longer run when we look at automation and technology. We are focusing on getting ourselves caught up on being able to be more efficient by utilization of the Fiserv conversion from the previous year. We have opportunities as we look at the combined entities.
We believe that we will clearly achieve our estimated cost savings on the transaction. We think there'll be more opportunities as we look at initiatives on dealing with robotics, artificial intelligence, focusing on the technology initiatives. That's going to get ourselves caught up to the industry as we move towards more of a commercial banking model. We are spending a lot of effort on the tech side, and we believe there's some great opportunities to even make ourselves more efficient via the tech side.
All right. Great. Thanks, guys. Appreciate it.
Thank you, Dave.
Thank you. Our next question comes from Steven Alexopoulos with JPMorgan. Please proceed with your question.
Hey, good morning.
Good morning.
Tom, regarding the deposits that came in from the relationship with Fiserv, can you give more color on the nature of those deposits and what drove such a wide fluctuation through the quarter?
Yeah. I'm going to defer to Mr. Pinto. He'll go through some of the programs. Just to be clear, that's one of many initiatives we're working on. We plan on building a banking-as-a-service initiative, but I'm going to defer to John to specifically go through the program.
With that program, Steve, it's related to the economic impact stimulus payments, both round one, two, and three. There's a large portion of it that came from the third program. What happens is when those debit cards are sent out to the individual consumers, the individual people, they start using them. As they're used, the deposit balances start to trend down. As you can imagine, it ramps up very quickly, and then there's an initial drop over a month or two, which is what we saw in the second quarter, as Tom mentioned in his opening comments, where we peaked over $3 billion and have now come down to $1.1 billion as of June 30th.
What happens after a couple of months is that decline starts to slow down as people either use part of the card and leave the rest on the shelf for a little while. That's what we've seen. We expect it to roll down much more slowly in the second half of the year. We believe it'll have a little duration here for us. As Tom said, this is just the first of hopefully many banking-as-a-service opportunities that we'll have to bring in deposits from our technology partners.
Yeah. Steve, I will tell you that as of recently, we found out we anticipate two more to come on this quarter. I believe last night we also got another anticipated win, and we had one about a week ago. For the third quarter, we should have two more programs coming on board. One's fee generated, the other one is deposit generated with zero cost of deposits. We have another large one that's in the pipeline where we're crossing our fingers. We're working hard to try to win these deals, and it's just diversifying who we are as a company, looking at the funding base. We really want to move away from our dependency on wholesale finance. Ultimately, and going back to my initial comments, we want close to $400 million from our customers from January 1 through June 30th.
That was from our lenders going back to our customers and getting our fair share, what's ours, which is our deposits. It's an initiative. It's a culture now. We're changing the culture here. We're doing lending, and you have to have your deposit relationships. We talked about initially my strategy, the low-lying fruit to be taken from the customer base that's ours. We have the technology. We have a strong partnership with Flagstar. The commercial servicing banking platform is standardized. People are very comfortable with it, and we're going to expand upon it. When we do loans, we want the deposit relationship. It's not just lending and trying to find the funding. It's getting the loans and getting the deposits as a combination of the business relationship, and we're proud of that. Our lending team and our retail strategies, we're working hard together.
The handoff goes from lending to retail, they close the deal and put them onto private banking. We picked up $400 million. It's a pretty good start. I didn't want to give too much excitement on the initiative because it's just under $4 billion now, but it's a nice growth trajectory for us, and I think we're going to have further wins. We are looking at lines of credits for our best customers, and part of that line of credits is that they also bring in more deposits. It's been working well for our very wealthy property owners that have been doing business with us for multiple decades. It's a culture that the board has clearly accepted, and we're going to move forward with this, but it's going to be the way we do business going forward.
It's going to be about changing the culture on the deposit side. We have to fund our balance sheet more like a traditional bank model, and that's the goal. Over time, we'd like to see some more room on the reduction of the wholesale. I think it's exciting to look at the combined benefit of Flagstar and NYCB combining. We have lots of optionality as we try to figure out where rates are going. We have lots of liquidity. At this point in time, Flagstar has liabilities that are funded out to other banks. We'll take it. We'll bring it back onto our balance sheet and then look at our wholesale position, and hopefully reduce our dependency. Over the long term, we want to fund like a traditional commercial bank.
Tom, if we stay with the $4 billion of deposits from loan customers, one, how do you size that potential, and what is it you're doing to get that kind of growth? Are you just basically bundling the pricing with new loans?
Yeah. Just to be very simplistic, at the end of the day, our business is a relatively short portfolio. It's not long-term finance. You're going to get a shot of these customers over and over again. Let's say average life of 2.5 to three years. As they come back to us, it's part of our culture. It's a requirement. Historically, a lot of transactions were waived. We're not changing our pricing. It's just getting our share of what's owed to us, which is the operating accounts, the lease security deposit accounts, working with extending lines of credit that they have other lines of businesses that they're more than willing to move their relationship from, let's say, the money center bank , maybe they're moving from your company, from JPMorgan to over to NYCB.
It's focusing on if you want to bank with us, if you want the money to put out, we want to have your deposit relationship, especially if we have the technology to service it. I think it becomes part of a cultural request. It's not nothing new in banking, just that historically, culturally, it wasn't a priority of the bank. I'm making that a priority of my leadership. It has to be done. That's how we're looking at the business going forward in all businesses. Once we start ramping up our C&I expectations in the marketplace and we expand with the Flagstar people under Reginald Davis, we're going to be looking at these markets and bringing in deposit relationships from the local community, which we don't do currently. That's going to be another catalyst.
We're not going to put a growth number on that, but that's starting at zero. I'm very excited about that opportunity. I know that we're going to be ramping that up as we get towards into next year. We're excited about getting people out in the field and getting our fair share of the customer base that's within our marketplace. We have huge deposit share when it comes to deposits, but now we need the people in the field to bring in the deposit relationships. That's going to be a focus of mine.
Got you. Thanks. Just finally, the prepayment income was obviously very strong in the quarter. Tom, what portion of the loans prepaying are staying with you guys? Given where rates have moved, are you starting to see more now move to take advantage of the government option? Make a lock and longer-term funding.
It's a great question. We have $27 million totaling. $5 million was from our DUS portfolio. We have about a $600 million portfolio left on the DUS. That's something we don't control. That's a securitized multifamily package. We do get that from time to time. When it comes to the business, we had a couple of one-offs. I'd say when you take out the large one-offs, we're still probably around 50%, 60%. I'd like to see higher. I think we should do better. Unfortunately, when the government's offering very attractive financing. I'll tell you what's interesting about the combined company, we will be offering an alternative to the government program, which is being able to offer them capital markets activity where we can swap out their instrument to allow us to be competitive and offer another product to keep the business.
We may decide to package it up and sell it. We are losing some to the government and some of the larger trades that went through the quarter. It is what it is. The customer makes a choice. When we fight for those long-term relationships, we don't want to lose a large pool of strong relationships, loan portfolios. From time to time, they make business decisions on that portfolio. I will tell you that it seems like, going into the second half, we're going to be very focused to ensure that we get a lot of the bread-and-butter business. We're mining the portfolio. We're very focused on looking at some other ways to get these borrowers to the table if rates were ever to go up sometime in the future. This is a short book, so they have to make decisions.
I'll tell you that. The government has been somewhat aggressive as to rates. We're going to be overall competitive as we merge with Flagstar and take some of the capital markets activity that we can offset some of these losses that go to the government. I mean, clearly, having the derivative opportunity to embed the same financial structure into the loan book and work with our customers to retain the business is going to be an option for us. It is what it is. It's always been. I call it the 800-lb gorilla in the room. Historically, it's been the U.S. government, and we've done pretty well. We've grown the book, and prepay has been strong. It's been two quarters back-to-back of strong prepay.
Usually Q3s are generally slower in general because of the holidays, but we usually ramp it up in Q4, and it seems that we're focused on, obviously, growth. With the current growth where we are today, going into the end of the year, I still feel confident we can grow the book mid-single digits on a standalone basis, not including Flagstar.
Yeah. It was a very helpful color, Tom. Thanks for taking my question.
Thank you, Steve. Sure.
Thank you. Our next question comes from Christopher Marinac with Janney Montgomery Scott. Please proceed with your question.
Good morning, Chris.
Thanks. Hey, how are you? Tom, I wanted to ask about the share buyback timing. How much time has to pass after the merger closed before you can deploy the additional earnings? Is that something that's on the near-term horizon?
I think it's fair to say it is on the near-term horizon. We're in proxy solicitation right now, both sides. I know that Flagstar had an opportunity to generate significant capital. Those numbers are actually better than expected. On a combined basis, on a very conservative assumption, we anticipate an extra $0.5 billion of additional capital outside of our current run rate that will generate for potential capital alternatives. I think when the company combines, we're in the midst of closing of the transaction. Assuming once the transaction closes, we'll look at all capital market opportunities, including our current dividend, which is very strong, and we stand by, as well as the opportunity to look at, from time to time, the buyback opportunity, depending on market conditions. At the end of the day, we want to put this money into growth.
We think that there's a great growth opportunity in our town. Interesting because the bank has not been growing at double digits, but collectively, you have a real opportunity here to grow this company as a growth story and pay a very strong dividend. Depending on market conditions, we can always move that over to dividend and the buyback over time, depending on how much capital is generated. Sandro illustrated, they generate a ton of capital. We're expecting very conservative assumptions when we put this deal together in excess of $500 million after all fully vetted cost saves go through. That's a lot of excess capital that we would have to either grow and/or buy back our stock, depending on market conditions, as well as paying a very strong dividend. That half a billion-dollar excess includes us continuing paying our current dividend.
It's a significant amount of capital generation.
Right. The payout ratios should improve, but the absolute distribution could rise as you're successful.
Yeah, absolutely. In the best world, we're going to look at all our alternatives, but we believe there's growth. Sandro and I spend a lot of time on opportunities looking at the customer base. We're modeling that as we speak right now. They have great relationships. They're capped out. They will have significant runway when the capital gets infused together and go after their current customer base, and also going after on the warehouse some larger relationships that they were just probably too small to offer any terms we can now offer collectively and offer them more opportunities to build out a good business. That's the priority. Growing the business is a priority. Reinvesting back into the company and building a better platform for us is going to be the priority. Subject to marketing conditions, we'll put all options on the table.
Great. Last question, Tom. It's just on the integration of the system side. How much will get done by year-end 2021 versus what's pushed into the first half of 2022?
Look, this is our largest transaction. The beauty of it is Fiserv. It's a Fiserv DNA platform. You can't ask for a better core conversion. This is great. They're our partners. They're Sandro's partners. We're collectively, by far, their largest customer. We're all hands on deck here. We anticipate a lot of work has been done. We will convert the systems. We're shooting for early in the second half of next year. Assuming we close the deal early in the fourth quarter, we should be able to have the system converted by mid-year next year. In the meantime, a lot of great decisions are made. We talked about my leadership team. We've established that. We made that public. Just to be clear, and I stand by my alliance here, it's 13 directly reports to me, six Flagstar, seven NYCB. This is not a traditional merger. This is an alliance.
We've spent a lot of time culturally integrating the fabric of the two franchises. It's super important that we make this company one. It's not us and them. It's combining the strengths of both sides and building a powerful combined entity where the culture integrates, and that's the culture throughout the organization. My leadership has been set. My direct reports will set their leadership. It's going to be a blended culture. We're excited about it. We'll have dual headquarters, we'll have unique verticals, and we're going to build onto it. We're looking for other lines of businesses. We're not just stopping at what we have today. There are opportunities out there. It doesn't have to be bank acquisitions. It could be lines of businesses that are out there. There's been significant consolidation in our marketplace as well as in Sandro's marketplace. We should capitalize on that.
There's going to be a lot of fallout within the system that we want to take advantage of. We're excited to close this deal. We're excited to blend the cultures, and Sandro's team is excellent, and we're excited to partner with them.
Great. Tom, thank you. Sandro.
Maybe Sandro wants to add a couple of comments. I know he's on the line, I just think we've been having a very good partnership, we're looking forward to coming together here.
I think the question was about the integration. The integration is moving along at a nice pace. Teams are working together really well. I think that, as Tom said , the Fiserv relationship that we both have is a big plus. I think that getting the basic system, core system converted won't be particularly difficult. If you think about the Flagstar business and the mortgage side, nothing needs to convert there. It's going to stay where it's at. We view this as, I don't want to oversimplify it, because when you look at it, there's over 400 different systems that you have to deal with.
It's an undertaking, but I'm very comfortable with the progress that we're making, and I don't think there will be any integration issues that will have a negative impact on the business operations as we get to legal day one and then eventually to the full conversion.
Great. Thank you both for all the background, though. We appreciate it.
Sure.
Thank you. Our next question comes from Peter Winter with Wedbush Securities. Please proceed with your question.
Morning, Peter.
Good morning. Morning, Tom. Tom, with the new potential lending opportunities combining with Flagstar, I was just wondering, how are you thinking about office space? The reason I ask is from a credit standard, it's doing great, but it does seem like some level of work from home is going to be permanent, and in fact, would affect the office value buildings longer term.
Yeah. Listen, Peter, great question. That's going to be interesting to find out how that all pans out in New York City. You know who we are. We've lent to some very strong borrowers, so the collateral that we have is low leverage. If you think about, we'll talk about criticized assets, that may lead to the office discussion. We believe we peaked in February as far as assets moving into criticized category. We're seeing the ongoing decline as they're getting their cash flow reevaluated and moving back to a higher rating. That's very encouraging along with a substantial drop on loans that were paying interest only now are full payment. That trend's going to continue. We deal directly with our large customers on the office side. I think we have about maybe $500 million that's sitting out there that's in a classified situation.
The LTV in that book is around 66%, just under 60%. I think we have enough room there that there's enough equity in the position that there's not going to be a loss to the bank. We feel comfortable. They have ample liquidity and capacity to pay. Yes, there's going to be changes in how the employers think about their office space. That's why we're concerned. We're going to be very focused on continuing lending to our customers we feel confident in and building out their expectations on what their future needs are, which is in the event that they're looking at moving out of the city, that's fine, as they can stay in New York City.
They're leasing up, and the actual discussions I've had with many of my customers are that at the end of the day, they're comfortable that they could continue having a very strong cash flow and reevaluate those cash flows. I think it's important to understand that when you think about our exposure, we're a low leverage lender. I can't make a statement for all of the office space in New York City, but for our predominant New York City portfolio, it's low leverage. To the best customers with significant backing, so they're very strong sponsorship. I don't envision any losses there.
Do you think that's a portfolio that it would decline over time, just given the changes on the dynamics?
It could decline a little bit. I mean, look, commercial is commercial. We're going to be very active to bank the best customers in our backyard. We're going to expand that into Sandro's marketplace. We're going to think about, remember, we're going into new markets, and we're going to be on the ground. Come Florida, we'll be on the ground in Florida. We'll be on the ground in Arizona. They're in the ground in Michigan and other markets that they serve. We have opportunities for future growth. I think having the right leaders in the lending verticals is going to bring business to the bank, and we're going to do solid conservative underwriting. That's who we are culturally. That's how Sandro's team is. They're culturally conservative, and we're going to do conservative lending for the best opportunities.
Okay. Thanks, Tom. If I could follow up on the core margin outlook again. I know that was one of the first questions, can you just clarify again what you're looking for in the third quarter and some of the drivers to the margin for the third quarter?
I think the driver's going to be consistent from the previous quarter. We're about three basis points. I think my guidance was two-five. We came in at up five in Q2. Again, that range is reasonable for Q3. Let's just say three-five-ish. Ultimately, I think that as we bring on these technology initiatives that have zero cost of deposit, that helps us. We are sitting on some excess liquidity. At the end of the day, we have an opportunity here to continue to drive down the cost. We have some borrowings coming due, not a whole lot of borrowings coming due, but some that will be reduced.
Next year, we have a significant amount of opportunity, ex Flagstar, on the macro hedge that we probably save about 200 basis points on $2 billion of derivatives, that when we combine with Flagstar, it's not necessary to have on the balance sheet the macro hedge against the fixed portfolio. They're predominantly asset sensitive. We'll pick up a significant benefit there. It's about $40 million of pre-tax earnings coming to the margin. It seems like we'll have an ongoing margin expansion throughout going from 2021 into 2022, albeit with the consolidation of this business model. What's driving it in the short term, it's going to be lower cost of funds and holding reasonable yields on the multifamily side.
Okay. Thanks, Tom.
Thank you. Our next question comes from Steven Duong with RBC Capital Markets. Please proceed with your question.
Morning, Steven.
Hey, good morning. Good morning, guys. Tom, I think you have about $2 billion swaps rolling off in February. Can you remind us how much of a boost it gives to NII? Should we see that in the second quarter of next year?
I would say to you, and I think I just said it on the last question, we anticipate clearly with combining with Flagstar, the company will be asset sensitive. Having that derivative on more likely than not will be removed. We'll take that off. It's probably picking up about $40 million of pre-tax. It's a 2% benefit, 200 basis points savings on about $2 billion going into next year. I think it's priced in February, John, is that right?
February.
February of next year. Assuming mid Q1 2022 that comes off, one of many benefits we're going to have when we combine the franchise, which is not indicated in our forecast when it comes to the merger math, right. We're expecting margin expansion, and we'll have optionality when we go into the transaction, right. We're going to have a large wholesale finance book that we can make decisions upon. We have a substantial amount of liquidity coming from the Flagstar company in respect to their escrow business and opportunities within their client base that we will maximize value on and look at the best use of the funding opportunities. Ensure ourselves to set ourselves very nicely for next year as we combine. We'll have some very good optionality on how we're going to position our margin.
We're excited about the opportunity because we always were very dependent on a standalone basis going to the Home Loan Bank to finance the company. We want to move more towards traditional finance for banks.
That's great to hear. It's nice to have another tailwind in the first half of next year coming on.
Right.
Maybe, Tom, you talked about that banking as a service. Is that mainly just your focus on growing deposits there, or is there a credit component to it?
Right now, we haven't rolled out the credit component yet. That has been the long term, but in the short term, we're looking at fees and deposits on opportunities. I believe last night we notified on some very interesting opportunities. These aren't huge opportunities, but there is a fee income opportunity I believe we won. That's a positive. We think in Q3 we'll have two more coming on, one depository, one fee benefits. Clearly, utilizing our technology opportunities to go out there and get other revenue/depository benefits. Over time, we're looking at other initiatives, which I'm not going to discuss on this call until we get more closer to finality. We think there's a tremendous opportunity to focus on our digital banking platform, which we're almost there. We intend to build it out.
When we do build it out, we have some significant plans there and ultimately being able to access the consumer marketplace as well as the underserved banking market. There's a whole host of opportunities that are out there where that individuals are underbanked or underserved. We think through technology we can offer products and credit enhancements for the customer. That could be something that'd be very useful as we build out this platform. No question, it's a priority. I carved it out as a leadership role reporting to the CEO because it's important. We have to catch up. We've named a head of digital. We're going to be hiring in that particular area. We have some very good initiatives that are in the pipeline.
I think if all goes well this year, we should have three or four wins this year, and we're going to build it out as we look at other alternatives that are very attractive in the digital space. By the way, including evaluating how we're going to play our financial services opportunity in the blockchain. There's opportunities there, and we're spending a lot of time there.
Interesting. If I could just squeeze in one more, maybe this is to Sandro. Just on the warehouse business. Obviously, it ebbs and flows with the interest rate environment. When you're in the business for the long haul, how do you differentiate and grow your market share in that business?
Well, I'd give you the same answer regardless of what line of business at Flagstar you ask me about, and it's about providing the best service in the marketplace. I think we do that in the warehouse business. We've been in that business for 30 years. We know what we're doing. Customers like us. We don't always have to be the best price. I think that's why you've seen our ability to, once we focused on it, to grow from a very small line of business. I think when Lee and I got into our positions at Flagstar eight years ago, that was a $300 million balance in that business. We've grown our commitments actually, and we've grown that now to over $10 billion. As Tom noted earlier, number two in the country behind Chase.
I think that the service model that we provide, the ability to be there no matter what the economic conditions are. When we got into this pandemic, there were a lot of warehouse lenders that were not providing the support that their customers needed, and we were there to pick that up. That has allowed us to gain relationships with customers that we didn't have before. We always keep enough dry powder there to be able to be there when someone is in need of a lender. It's all about the service equation, frankly, and it's proven itself to work, and we're going to continue to do that. I think we're going to continue to be one of the top warehouse lenders in the country.
If I could just add. Obviously being a big originator, we understand the mortgage business. We buy loans from certain of our warehouse customers, and we also offer ancillary lending services, MSR lending servicing advance lending that can be helpful to some of the bigger warehouse customers. We're a one-stop shop in that regard, and I think that's all part of the service equation that Sandro just alluded to.
People come and go, right? We get people that leave the business, people that come into the business. There's one company, one, that's been there for 30 years providing warehouse lending in this country, and that's Flagstar.
That's great to hear. I appreciate the color, gentlemen.
Thank you. Our next question comes from Ebrahim Poonawala with Bank of America. Please proceed with your question.
Morning, Ebrahim.
Good morning. I'm sorry if I missed this, just had a few follow-ups. One, I think, Sandro, you talked about just the earnings power of the combined company. When I look at your PPNR, give or take about $150 million this quarter, we've seen a big reset in gain on sales. Do you still see more room to go in terms of a decline in the PPNR power relative to 2Q? If you could just talk to that, because that's been a big source of uncertainty around where Flagstar's PPNR shakes out as we look forward into 2022 and beyond.
Well, if you look at our capital, we've leveraged capital I think really well. We're taking advantage of the capital base that we have in the company, and we maximize the return that we can get from that. Ebrahim, if you look at 2015 through 2020, Flagstar's total shareholder return was 162%. I think that stacks up pretty well against almost anybody. The reason for that is because we focus on the end number, right? How do we get to a number that gives the market confidence that they can see value creation? You got to be able to move left, move right, whatever way you got to go in order to get the bottom line to where you need it to be.
That's by investing your capital in the smartest way possible, where you can get the growth and the margins and the consistency of earnings. We have never historically spoken very much about the future other than the next three months, and we've given guidance in our release about the next three months. I'm not going to go any farther than that, but I'd ask you to look at history, and if history means anything, I think you can get yourself pretty comfortable with the opportunity for growth in the future.
Understood. Just a separate question, Tom. You talked about bringing on teams, some of that under the leadership from Reggie Davis. Should we expect any onboarding of hiring commercial lenders prior to the deal close, or is this going to be more of a 2022 event? Even if so, are you already talking to folks to bring them on early next year?
Ebrahim, we're extremely active. What's interesting about the consolidation wave we're seeing, it's to our advantage. Obviously, Reggie's been very busy sourcing out the opportunities in our marketplaces. We're doing a lot on leadership roles right now. Obviously, we're integrating the company culturally. There's a lot to do. We think there's tremendous opportunity. We talked about lines of businesses. We talked about having individuals out in the field, even down to the branch managers, having people at the market managers getting out there and going after the business. That's culturally what we never did here at NYCB. That's what Flagstar is doing, but we want to do that for the combined company. Reggie has a very substantial task in front of him. We're working together very well.
We're excited about people calling us, both not only just on the retail side and the C&I side, but also on the mortgage side. I think the fact that this company beginning just south of $90 billion in the mortgage space, I think we're bigger now. I think there's going to be a lot of excitement on Lee Smith business that people will want to gravitate here. Talent is knocking, which is always great, and we're looking at opportunities, and we're standing by these businesses. We're excited about the opportunity. We talked about initially when we announced the deal, we called it the Picasso. We're starting with a blank page. What are we going to paint here? Starting from zero is a good start. We have a lot to do on the retail side. I know Reggie truly believes that our share is strong.
We don't have our share of the loan book, and we're going to get it. We're going to get it with people and processes and being out there and offering competitive products and work, as Sandro indicated, with loyalty and trust with the clients. That's the plan. I think it's going to be a very interesting opportunity for this company. We'll look back a year from now and talk about growth and what we've accomplished. Every day we accomplish something, and it's going to be focused on building a better company.
That was great. Thanks for taking my questions.
Thank you, Ebrahim.
Thank you. Our next question comes from Matthew Breese with Piper Sandler. Please proceed with your question.
Good morning.
Matt, I didn't see you changed firms.
Yeah, I'm at Stephens now.
I said Piper Sandler.
Must be old. Hey, Tom, could you give us a sense for how much of the loan portfolio combined will be floating rate and able to reprice with Fed hikes? I appreciate that with and without floors, if you have it.
It's a great question. I don't have the specific number in front of me. John maybe could add some insight. At the end of the day, Flagstar has always been a floating rate franchise. They look at all of their deals, they have it tied to a floating instrument. We've been the fixed rate lender for the beginning of time. We will have capital markets activity on a combined basis. We're going to have the tools in our tool shed to utilize for the customer base, we could put on the derivatives to manage that on an individual basis. By culture, it's a fixed-rate lender combining with an adjustable rate lender. Collectively, I think it's a good balance. Obviously, depending on what line grows faster will really determine the floating rate side of it. For the most part, I think they'll be well balanced.
[inaudible]You can do the quick math. We have a very large multifamily book, which is predominantly fixed rate. We don't do a lot of floating rate in the multi-sites because we don't really offer specific derivative contracts per instrument. That'll change as we combine, and we'll have that offering for the customer base. At the same time, we also plan on working with, on the capital market side, alternatives versus the government alternative because it's difficult when your customer has to go to the government and you lose that opportunity. Perhaps we can capitalize with some of our partnerships that we have on the brokers' side. We have a very strong relationship with Meridian Capital.
I look at them as very strong partners. We're working with their team on getting opportunities there for the customer base so we can partner together on opportunities. We're going to have a blended portfolio with different verticals and hopefully over time, new verticals we offer to our customer base and have more than just the traditional lending products that we have here. Going back to the traditional commercial bank, we are transitioning to commercial banking. We will look at conservative opportunities. Culturally, Sandro's team, our team historically have been tremendous conservative lenders. We look at that as part of our hallmark of our business. Any business we go into has to have conservative attributes on the lending side for sure.
Okay. Maybe turning to the core margin guide + 3 to five basis points. Curious if that's again adjusted for liquidity like this quarter. I was hoping for a bit of a definition for what you're calling excess liquidity. There's $2.1 billion of cash on the balance sheet this quarter. There was $2.7 billion last quarter, I didn't see the same adjustment. I was hoping for a little bit of a definition there.
I'm going to defer to Mr. Pinto, but I will tell you that the number I gave is just we anticipate that's the overall margin. Depending on where we put this cash out, we have excess liquidity. I'm hoping for more growth in Q3 and Q4. Obviously, it's going to be mirrored by the transaction. We anticipate the closes transaction hopefully by early fourth quarter subject to regulatory approval. Clearly, we have a margin that's continuing to rise. It's an ongoing track record for now a number of years now. Going into the Flagstar transaction with further margin expansion. We look at 2022 being another margin expansion year regardless of where interest rates are. John, if you want to expand upon some of the questions on the margin side.
Yeah, just quickly. It's really not an ending deposit balance. It's an average deposit balance thought process. Right. If you look at the first quarter, our average non-interest bearing deposits was $3.2 billion, and then we went up to $5.5 billion in the second quarter. That's the change right there. That's really from our first technology partner relationship. That's the piece that we carved out when we looked at the margin this quarter because as it was our first one and we didn't really know the duration of those deposits, and we did realize that it would peak very quickly and run down very quickly, and that all happened within the quarter. When you look at it from a quarter-over-quarter perspective, it's down a little, but it did peak almost $2 billion higher.
From an average balance perspective, that's why we carved it out because it really hit during the same quarter.
Matt we talked about these other initiatives. I believe we have another win that we have coming on that should be a sizable amount of deposit flow as zero cost of funds, which would be attractive for the bank as an alternative than using the wholesale markets for growth. We also picked up, we believe we have another fee income opportunity on banking as a service, and we have a very large one that's out there. If it hits, it's going to be significant. We're very excited about looking at alternative deposit initiatives or funding strategies. We believe that it's the right direction for the bank. We believe we have opportunities on the technologies by working with partners.
Not only just with our existing partners, but other partners that we're bringing to the table to bring in deposit opportunities, feeing opportunities, and ultimately potentially lending opportunities over time with the utilization of technology. Stay tuned. We hope to update the marketplace soon as we get closer to getting some things done here, but we're excited about it.
Okay. You mentioned expanding your financial services offering to the blockchain, and I was curious what capabilities are you envisioning adding or what markets you plan on attacking? Just a little bit more on that comment.
Matt, I'm going to be very careful specifically what I say. I will tell you that we're spending a lot of time understanding where the financial services industry is heading. We're going to be a diversified company. I believe, and I think Sandro and Lee believe, there's going to be changes in how the blockchain will benefit banking services. We are very much actively looking at how that could create value for both of us on the efficiency side as well as business opportunities. I'm not going to be specific, but I will tell you that it's here. We're beyond paying attention to it. We're working very hard on looking at how it can benefit us. On a combined basis, we have very large businesses that via the blockchain could generate significant efficiencies and potential customer opportunities.
I'm not going to be specific but just stay tuned and we're excited about where we are today.
Okay. Last one for me is the tax rate stepped up a little bit this quarter. What is a good run rate going forward? If you have it, a combined tax rate would be helpful.
John?
We're still looking through the potential of the combined tax rate. We don't believe it's going to move dramatically from where we are. Maybe it'll be a slight benefit when we put the two together based on state apportionment. If you look at the second quarter, there's two reasons why it was higher. Our merger-related expenses are primarily non-deductible given the type of expenses that they were. New York State increased the tax rate from 6.5% - 7.25%. We did have a 1x hit to revalue our deferred taxes for that tax increase. On a run rate basis, I would say we're just under 26%, is a good run rate for us on a standalone perspective. We're still doing a lot of work on the combined basis. We don't expect it to be significantly different than that, though.
Okay. That's all I had. I appreciate you taking my questions. Thank you.
Thank you, Matt.
Thank you. Our next question comes from Andrew Leischner with KBW. Please proceed with your question.
Morning, Andrew.
Hey, how's it going? It's Andrew on for Christopher McGratty. You guys had a very clean quarter in terms of credit, and you're able to bring deferrals down further. I'm just wondering what your deferral outlook from here looks like and what your overall outlook on New York City and any potential problem areas you foresee going forward. Thanks.
Yeah. Great question. Obviously, in our prepared remarks, we talked about the drop in the loans that were subject to interest only. It's down to, I believe, $1 billion. That's from $2.5 billion at the beginning of the quarter to $1 billion at the end of the second quarter. You'll see that continually drop. There's going to be, as we get closer to the end of the CARES Act, which I believe is the end of this year, we believe most all of our customers will be out of any form of relief. We have zero clients on full deferral, which is great, and it's been an ongoing strategy of ours, and we've been very good with our customers to work with them. We're seeing significant benefits as far as, in particular Manhattan. Reopening of Manhattan has been very favorable.
It's been the last borough that was in the waiting game. Our customers that are exposed to Manhattan, which was about 85% of the loans that were considered classified. I think the most important note out of this statement here is that we think we've peaked. We think that the classified assets peaked in February. We're seeing the trends start to decline. That'll also bode well for expenses as these assets start to decline and go back into pass-rated assets. We also get the benefit of the FDIC expense on that. That's going to be another favorable event as we manage our operating costs. On the credit side, it's been a very good story. Sandro talked about his credit portfolio, a very strong story. He has zero loans on deferral as well. Very strong credit on both sides.
We're seeing a significant momentum on the reopening. I will tell you that Manhattan was the last borough to get there. The other boroughs were doing fine as early as January. Now that we have the vaccine rolled out and the city's reopening and we see more employers have their employees come back to work, you see a lot of the supply and demand issues when it comes to rentals. Very strong. We've been meeting a lot of our customers. They're very pleased. There's some work to do on office and retail, but I think that'll follow as the employees and the traffic start to pick up in Manhattan. You're going to have, hopefully, the theaters open up. Look, the Delta variant is what it is. I'm not going to make a healthcare prediction. We're going to follow CDC guidelines.
I think it's encouraging to see New York fare well regarding the pandemic, and it's good to see the city moving in the right direction. Our customers are very pleased, and we're seeing tremendous asset quality results because of that.
Great. Thank you for the color. Just one more, if I can. Was there any reason why you moved your PPP loans back out of held for sale into the held for investment portfolio?
Thanks, yeah. Our PPP loans were down to $95 million. We were very comfortable with holding those. Given where the market was and the excess cash we had, we were just very comfortable holding those loans long-term. We decided to move them back into held for investment.
Okay. Thank you.
Sure.
Thank you. There are no further questions at this time. I'd like to turn the floor back over to management.
Great. Thank you again for taking the time to join us this morning and for your interest in NYCB and Flagstar. We look forward to chatting with you again at the end of October when we will discuss our performance for the three and nine months ended September 30, 2021, and provide further updates on the planned merger. Thank you.