Q2 2020 Flagstar Bancorp Inc Earnings Call
To date, we welcome to the Flagstar Bank second quarter 2020 earnings call. Today's conference is being recorded at this time.
The controlling Burke. Please go ahead Sir.
Thank you and good morning, welcome to the Flagstar second quarter 2020 earnings call before we begin I'd like to mention that are second quarter earnings release and presentation are available on our website flagstar dot com.
I'd also like reminds you that any forward looking statements made during today's call are subject to risks and uncertainty.
Factors that could materially change our current forward Lucky assumptions are described on slide two year to date presentation and approximately.
And our 2019 form 10-K in subsequent reports on file with Yaki.
We're also just gotten down non-GAAP financial measures, which are described in our earnings release and in the presentation. We made available for this earnings call you should refer to these documents as part of this call with that I'd like now turn the call over to start to know, our president and Chief Executive Officer.
Thanks, Karen and good morning, everyone listening that I hope all of you and your loved ones have been able to stay safe and healthy.
I'm joined this morning, but Jim slowly our Chief Financial Officer.
Our chief operating officer that Steve Figliuolo, our chief risk Officer.
Going to start the call by providing a high level view of our performance for the quarter that'll turn of the Carlo to Jim for details on our financial results.
He will then follow what they review of our business segments and strategic initiative.
Well open the line for your questions.
Well it wasn't absolutely fantastic quarter for Flagstar, and my opinion, the best in the company's history.
Not only did we report published in earnings far exceeding anyone customer, but we can appealing to build a fortress balance sheet.
We've talked a number of times about how our results are validating the earnings power of the business model. We go starting in 2013.
There have been quarters when mortgage results fell off went bad Jimmy turns a lag when interest rates sort and when next month and still we produce strong returns quarter after quarter.
Knock on flagstar by nothing has been our mortgage business, it's too much of our revenue. It has regulatory risk it's too volatile I think we've laid those concerns to west.
Not that long ago, the mortgage business was challenging as challenging as it has ever done and the rest of the company carried US now when a recession and the mortgage business is off the charts, but.
But that's not the most important story of the quarter.
The most important story is the expansion of our net interest margin, yes expansion.
Did we do it first and foremost the yield on our warehouse portfolio holds up well relative to the decrease in benchmark rates quarter over quarter. Thanks to floor rates that protected the deal that was enhanced by significant growth in income from droppings.
The yield on our warehouse portfolio increased from 3.78% the name to 4.01% in June and our overall net interest margin increased from 2.84% same thing to 2.8% Jeremy.
We've also been diligence in establishing floor rates and many of our other commercial loans what began up an extra layer of protection, we opted to put into our term sheets. That's paid off well not only has a margin improvement, but we've also grown net interest income like seizing the opportunity in the warehouse business.
That's reflected in the outstanding well, we enjoyed in the quarter ending with over $5 billion, an outstanding warehouse balances for the first time and that's a trend that's continued into July as our average balances thus far this month or above $5.1 billion.
So despite taking a very conservative stance on lending and all other commercial categories.
Succeeded in growing low risk high return assets and in turn net interest income.
As a reminder, the entire commercial portfolio and flagstar is less than $5 billion net of warehouse loans and total credit losses in our warehouse portfolio had been less than $5 million over the last 12 years.
Yes, we have well net interest income this quarter without increasing credit risk.
Another important story from the quarter was the aggressive way, we manage deposit costs and the makeup of our wholesale funding.
Deposit costs dropped dramatically in a second quarter and because we carry a large amount of wholesale funding where costs are tied to LIBOR those costs drop in tandem with fed action importantly, we think our margin will remain resilient. We also saw nice growth and banking deposits of about 606 650 million.
I was for the quarter.
I want to mortgage what can I say over 300 million a gain on sale revenue.
30 million less than all of last year pretty amazing and that run rate is continuing as we are already over $100 million and gain on sale revenue thus far in July.
And then quietly the servicing business, just keep plugging along supporting our mortgage business, providing sufficient funding and adding fee income.
Finally, let me address credit.
So far so good everything is holding up but I know that until we get to the other side of this virus the credit story remains to be Coke.
I've been a stickler about having a conservative credit allowances in my tenure as CEO and I have no intention of wavering on that especially now.
And you saw that we added $100 million to the AC out for the second quarter and improved our coverage ratios significantly.
This has nothing to do within specific concerns we have with our book.
But given current economic projections I think we are comfortably where <unk>.
My guess, though that economic forecasts are likely to deteriorate and if they do the may require greater reserves.
As always we are hoping for the best but we're prepared for the worst and I believe we will be able to add reserves as appropriate shut economic forecasts dictate without getting into for raising capital.
In closing I think we're in a very good plays a very stable interest margin outstanding non interest income generation and a fortress balance sheet.
Let me now I'll turn it over to Jim.
Thanks Sandra.
Turning to slide six net income this quarter was 116 million $2.03 per share.
This performance compared to the 46 million.
80 cents per share last quarter <unk>.
The increase on a linked quarter basis, because once you do the stronger mortgage results.
And a nice increases net interest income.
Higher earning assets.
And no net interest margin only partially offset by 102 million credit position this quarter.
We had adjusted net income 41 million or 71 cents per share lives in the same quarter last year.
Don't get deeper into this quarter's performance.
Pretax pre provision earnings the 250 million this quarter compared to 70 million last quarter.
Net interest income increased 20 million% to 14%.
Average, earning assets grew two and a half billion.
Net interest margin increased by seven basis points, excluding the two basis point impact lower yielding PPP loans.
This performance was primarily driven by the strength of our warehouse business that has reinforced in place.
Excellent margin compression due to lower rates.
And a strong core deposits.
Benefited from higher custodial balances and also some maturities tire costs Cds and exploration the promotional rate some savings.
Well you these numbers for the next slide.
Mortgage revenues were 290 million, an increase of 199 million compared to third quarter.
During the quarter. He saw gain on margins increased significantly. This primary secondary spreads remained worldwide and we worked to manage capacity.
Asset quality remained strong.
Net charge offs were only 11 basis points and up nonperforming loans were relatively flat to prior quarter.
Despite all of this and reflecting our views on the uncertainties, but then the economy.
Our allowance for credit losses for Hcl, which include the reserve for unfunded loan commitments.
The 250 million at quarter end up 152 million into the first quarter.
Well provide more details will be good quality slightly take a deeper dive into diesel.
Capital also remained solid all capital ratios remained about the stress buffers that these established based on Lucky fastballs.
Total risk based capital was 11.3% at June Thirtyth proceed Q1 ratio was 9.1%.
Tier one leverage ratio was 7.8%.
We'll go into more details capital later, so let's turn to slide seven dive deeper into the income statement.
Net interest income increased 20 million to 168 million this quarter up 14% from last quarter, primarily driven by warehouse loan growth and the impact of lower interest rates on borrowing costs, especially core deposits.
Partially offsetting that will yield on earning assets.
Earning assets grew 4% led by warehouse lending and loans held for sale.
Deposit costs came down 33 basis points.
Average deposit balances increased 1.9 billion.
By a 1.4 billion an increase in fiscal year deposits.
Retail deposit growth considerably 4 billion.
Well dive deeper into net interest income and our interest rate risk position on the next line.
Noninterest income increased 221 million to 378 million due to higher mortgage revenues.
Our gain on sales revenue of 303 million, representing an increase of 213 million.
Well a lot of adjusted locks increased 24% to 13.8 billion.
And the gain on sale margin increased 219 basis points.
You saw extra ordinary levels, a gain on sale margin throughout the quarter and manage the volume levels to fit our fulfillment capacity.
The purchase market return later in the quarter end demand continues to be strong.
We also recognize the loss of 8 million other MSR.
Result model changes that we believe our concurrent with the economic forecast, we use for seasonal and higher prepayments.
The MSR Mark is beginning to come back extend into the small in the first bill.
Executed in July.
No. It had been income improved 9 million due to a decline in the London based credit.
Device, where subscription customers for the could still be biased deposits that they control.
Noninterest expense was 296 million up 61 million per quarter, primarily reflecting.
53 million increase in mortgage volume driven expenses, largely commissions and loan processing expense as mortgage loan closings increased 41%.
Overall mortgage expenses as a percentage of closings.
Consistent with the prior three quarters.
<unk> expenses also increased due to higher incentive compensation cost.
We will provide more color expense later.
Slide eight.
Which we added last quarter provides details on our interest rate this position at the end of the quarter.
There's a lot of information on the slide we added last time to support our confidence in holding the net interest margin stable.
It shows that you're still positioned well.
Well the majority of loans has variable rate many of those have reached yours, which provides protection from lower rates. Consequently, using our loan portfolio held up rather well this past quarter, we expected to hold up well for the future too.
On the deposit side the balance sheet.
We benefited from the full quarter impact of the pricing changes we made in March when the fed rock short term rates.
Additionally, as we observed last quarter deposits continued to reprice into the new curve environment.
I didn't support for our net interest margin.
Also mentioned that approximately 85% for custodial deposits those controlled by our subsurface and clients naturally price down as those rates are based on LIBOR.
In summary.
We believe the deposit rates will continue to be a tailwind remainder of the year.
Also in given the interest rate positioning on mortgage business gives us.
We've locked in future funding rates at these low levels to do this we've executed interest rate swaps and entered into long term FHLB advances to lock in lower late Sunday.
Laddering those out between three and seven years, we've now executed 1.7 billion of the strategy securing long term funding at an average cost of 57 basis points well below our cost of funds.
Oh, it's difficult to predict where rates might be in the future.
We feel that are interest rate risk position isn't a good place.
We feel that we can protect our net interest income net interest margin in this rate environment and believe that our NIM should be relatively flat, excluding the impact of higher levels of loans with government guarantees.
And that minutes.
We've sold our portfolio with PPP loans, and that's fails to close by Tomorrow.
As in the first quarter, we finished the quarter stronger net interest margin in the net interest margin will be averaged during the quarter.
Jim NIM was 2.91%, excluding the impact the lower yielding PPP loans.
We do expect that launch with government guarantees will increase.
To help explain this we've added slide 40 for the appendix, which provides more details.
In summary.
We own and MSR for Ginnie Mae loans, you had the option to repurchase those loans. After the loans have gone three months without payment due either the delinquency once the parents.
At June Thirtyth, we had 1.1 billion of such loans.
Not repurchase which the accounting rules made us we consolidate under the balance sheet with an offset the other liabilities.
These assets how to yield is 1.97% last quarter and still go reconsolidation will likely reduce our net interest margin, but not reduce our net interest income.
At June Thirtyth, we had Ginnie Mae NSR as covering 15 billion a principle.
I've got a melt.
20% or the total <unk> billion isn't forbearance and 1.1 billion of that amount had not had payment for three months, making those loans eligible for purchase as I said before we have not yet we purchased the loans.
We do not believe there were significant downside to holding one either by buying them through this accounting gross up.
If we were to repurchase these loans.
We can placements of the FHLB and they are at 20% this lead asset.
Further if you do we purchased the loans, we could we sell those loans at a later date, which is attractive for us.
We remain gotten to guarantee.
Let's now turn to slide nine which highlights or average balance sheet this quarter.
Average, earning assets increased 2.5 billion from last quarter.
This resulted from a 1.5 billion increase in warehouse loans is your point 4 billion increase in loans held for sale.
Pp loans, which are included in see an island.
Average 0.3 billion for the quarter.
Average deposits increased 1.9 billion from last quarter.
Still little deposits grow 1.4 billion of this increase.
We saw growth in two or 3 billion in noninterest bearing retail deposits.
21% increase from last quarter.
We continue to have a strong liquidity position.
Driven by the strength of our deposit base and access to multiple sources of liquidity does on balance sheet for high quality securities portfolio and off balance sheet.
Undrawn FHLB facilities.
At June Thirtyth, we had ready liquidity of 6 billion not including the ample access we have borrowed at that discount window.
Finally, we continued to demonstrate significant capital generation capabilities with growth in or tangible book value per share the 30 $1.74 cents.
$2.22 from March 31st.
$5.58, a one year ago, a 21% increased.
So, let's now turn to asset quality on slide 10.
Credit quality in the loan portfolio remains strong.
Early stage delinquencies continue to be relatively low only 15 million total loans with over 30 days delinquent and still accruing messaging yep.
Down from 26 million actually first.
Our allowance for credit losses covered 1.7% total each of islands.
This coverage reflects 35% the HFI loans being warehouse loans, so excluding warehouse loans the denominator given the relatively clean credit loss history, and considering with substantially all of these loans.
I don't realize with agency and government pack residential mortgage loans a coverage ratio, we now stand at 2.6%.
As required by seasonal this level of PCL coverage considers our economic forecast over the next two years and lifetime losses in the portfolio on slide 11, we can see that we ended the quarter 250 million of allowances for credit losses, consisting of 229 million of allowance for loan loss in 21 million.
It's or unfunded loan commitments, which is included in the better liabilities.
In total our allowance for credit losses at quarter end increased by 64% over what we reported that the into the first quarter 2020.
In our adoption of seasonal we used three different economic forecasts for the next few years, which didnt reverted to a long term average over a one year period. These forecast included an average projection an adverse projection that reflected severe economic distress, which was a 30%.
However at March 31st we used only the baseline forecast due to the significant amounts of uncertainty in the economy at that time in Judgmentally added 4 billion of reserves that these forecasts at March 31st.
This quarter, we returned to use in three different Moody's forecast over the next two years.
Just one growth forecasts, we added 30%.
Their baseline forecast depleted at 40%.
And there S three adverse forecasts weighted.
The percent.
The forecast is did you notice.
The resulting composite forecast for Q2.
Listen what we assumed a Q1.
Employment into your 10% as a covers only slightly in 2021.
GDP covers only slightly by the end of year.
From current levels it doesn't get back to the pre coated level until mid 2022.
Hi drops up 2% from early 2020 through 2021.
Worsening of our economic forecast increase the Hcl by 31 million March 31st in addition to this increase.
We judgmentally increased qualitative reserves by 39 million.
Primarily in our theory it seemed like portfolios.
Guided by this diesel allowance model out, but using the Moody's adverse scenarios to provide coverage for industries and customers that we believe could be more exposed to the stressful conditions in our forecast.
Finally, we reviewed or loans into full status.
While we do not have any nonperforming loans in these categories at this time.
Proactively downgraded 170 million loans to watch status during the quarter.
These downgrades in other credit changes increase the output from our Cecil model by 24 million.
We've provided a portfolio by portfolio breakdown, resulting NPL coverage ratios in our appendix.
On slide 12, we've updated our exposure to those industries that we believe are more likely to be the most impacted by coated.
In total we have a billion of outstanding loans in this category, representing less than 7% of our total loan portfolio.
In our commercial and industrial in portfolio. These balances totaled 0.3 billion.
I see that exposure here is relatively low, especially as it rolls in these portfolios total only 63 million.
We have no oil and gas exposure.
In our commercial real estate portfolio.
Zero point $7 billion outstanding in areas, most likely to be impact by coated including Sneary loans secured with hotels retail properties in senior housing loans.
Those in this category our average LTV is 56% and our average debt service coverage ratio was 1.6 times.
We've taken a deeper dive into our portfolio this past quarter and re examine borrower strengthened liquidity.
Importantly.
We didn't identify any loans that we believe will default.
While we believe that we will have losses, we continue to see strong or support across the portfolio.
We feel relatively good about our credit risk in this portfolio.
We are starting from a position of strength.
From our cheerfulness about the line to do the disciplined underwriting and those credits in the pre coded ltvs and debt service coverage ratios can see every portfolio.
Well, we know this will be a challenging time for many of our customers. We believe that we have low level of exposure to those industries most impacted by coded as a result, with our well diversified loan portfolio.
Discipline and experienced the team has experienced bankers that we have.
Turning to slide 13, our capital ratios remain solid nicely above our stress buffers.
Total risk based capital with 11.3% at June Thirtyth.
10 basis points or see Q1 ratio of 9.1% was relatively unchanged.
As expected our tier one leverage ratio of 7.8% decreased.
33 basis points this quarter, because it's based on average assets.
Interesting to see that between loans held for sale warehouse and portfolio. We have approximately 750 basis points of total risk based capital at 450 basis points, a tier one leverage capital dedicated to these two asset categories that have very little this content. If you add the 1.1 billion of on purchase loans because these guarantees.
We had to Deconsolidate, we have over 770 basis points.
Total risk based capital dedicated delivers portfolios.
In warehouse lending, which has 100% risk weight, we had under 5 million of losses cumulatively over the last 12 years I'd remind you. We also hold the collateral for those loans, while they are underlined in that collateral consisted almost entirely of agency and government backed residential mortgage loans.
Once held for sale also has very little rich content.
This portfolio is carried at fair value.
In summary, we believed that we are operating strong capital levels, given our low risk balance sheet composition.
Having I'll turn to lead for more insight into each of our businesses.
Thanks, Jim Good morning, everyone. We're extremely pleased with our net income of $2.03 per diluted share for the second quarter, which increased tangible book value to 30 $1.74 cents.
More importantly, we've strengthened our balance sheet by increasing our Hcl was up to 260 million for 2.6% of loans held for investment excluding warehouse loans.
We deliberately does all of that business model to be balanced between interest income and fee income revenues and have decent he sees the counter cyclical such as mortgage origination some warehouse lending. So we're able to generate stronger earnings in any interest rate environment.
Diversified model has delivered record earnings this quarter bolster that capital and created the liquidity, we need to fund that balance sheet growth.
Given the slow right seemed bar in the looks as though we will put six for some time. We believe we will continue to generate stronger earnings increased book value and deliver exceptional results for our shareholders.
Well now last call I'll mention how it couldn't be more proud of how we respond to it as an organization for the koby going thing pandemic and that continues to be the case.
Three nine priorities have been ensuring the health and safety of our employees.
Continued best in class service to our customers and giving them easy access to care Saxon stimulus programs.
Protecting the banks position given the uncertain C code, we've not seen has created.
The vast majority of our employees continue to work from home and that productivity levels have been affected.
We've actually seen increased productivity, so an areas and we continue to serve our customers and partners with the same exceptional standards like come to expect from us.
For those employees working from flagstar facilities, we're ensuring comprehensive expensing standards cleaning regimens and about the necessary personal protective equipment is available in order our employees feel safe at all times.
150 cents on about 160 Bank branch use of now Riocan do you still always seen a comprehensive safety plan to protect our employees and customers.
We took over 3000 applications for the Paycheck protection program.
We borrow is requesting full balance for leap amendment countries for deferral relief on that consume a full commercial loans.
With facilitating the main street lending program and continue to work with the many non property goal can always stations, we supported that communities to ensure our customers and partners have access to all stimulus programs being offered by the federal government States an agencies.
Finally, we protected the bank Buck tightening the credit box the ramp so its mortgage warehouse lending products being thoughtful in conceded around new lending opportunities an increasing that ratio was up significantly in the last two quarters given the uncertainty cope ignoring team has created.
There were several of the notable developments during the quarter, which included net interest margin increase folly speaks to 2.96%.
The result of reduced the policy in borrowing costs, given the low interest rate environment.
The paycheck protection loans actually reduced our net interest margin by toothpicks during the quarter otherwise it would have been ascendant big increase quarter over quarter, and we close tomorrow on the style of all of our paycheck protection laws. So it's good politics.
Average loans held for investment increased 1.8 billion over 15%.
I'm Aeroleo result of an increase in warehouse lending balances.
The policy to increased 1.9 billion up 12% predominantly due to custodial deposits given the Hollywood payoffs, but we also saw an increasing demand deposits. A result of reduced spending because of the shut downs on stimulus programs hi, now during the quarter.
Mortgage banking revenues increased an incredible 199 million well 207 same as we continue to take advantage of the strong refinance market.
69% of our revenues in the second quarter from non each fiscal fee income business faced with over 300 million being generated from gain on sale revenues from our mortgage origination business.
Subservicing basically decreased slightly incomes of loans serviced still subserviced, a result supply payoffs given the low interest rate you bought him.
But we were able to replace most of that run off through new originations I know the strength of our business model.
We ended the quarter Servicenow Subservicing, approximately 1.042 million loans, which generates consistent noninterest income and deposits for the bank.
We couldn't be more pleased with a record second quarter from an earnings point of view, which wouldn't be possible. We got a fantastic employees team oriented approach and typically there is only business model.
I will now at launch some of the tee off pricing metrics from each of our major basically segments during the second quarter.
Please turn to slide 16 quarterly operating highlights for the community banking segment include.
Average commercial and industrial and commercial real estate loans increased 491 million or 11% with approach being driven predominantly by paycheck protection laws.
We continue to be thoughtful in terms of new facilities and believe our strong credit policies and diversified portfolio will be a strength as the fallout from mix and make becomes more apparent.
Average consumer loans held for investment decreased 193 million up 4%. A result of increased payoffs you know firstly a mortgage portfolio.
We ended the quarter with approximately 4.6 billion up consumer loans on our balance sheet with 81% being residential firstly in multi juice and he looks.
Through June Thirtyth, approximately 2400 deferrals on a non mortgage consumer loan portfolio could've been granted which amounts to 137 million or 7.5% of all outstanding balances.
Just amounts is pretty flat to where we ended last call. So let's requests for new deferrals have slowed to a trip.
Average warehouse lending loans increased 1.5 billion or 64% to 3.8 billion during the quarter due to the low interest rate environment driving strong mortgage refinance volume.
Our relationship based approach and speed of execution also enabled us to add new customers as well as increase launch for existing customers during the quarter.
At the end of Q1, we May change you still our warehouse credit box as a result of the volatility in the mortgage market.
We stopped financing non QM and jumbo loans and tighten that pharmacodynamics around several of the products in response to the market uncertainty on to protect our own position.
That's the courts have progressed and the volatility subsided, we some of those restrictions, particularly with our strongest clients.
Through July 24th average warehouse loan balances outstanding of exceeded 5.1 billion month to date.
Given the positive correlation warehouse lending has to the mortgage business. It acts as a noise hedging a low interest rate environment when refinance activity sprawl I think.
Overall average loans held for investment increased 1.9 billion, which together with all its fixed improvements in our net interest margin helped drive the 20 million of 14% increase in net interest income quarter over quarter.
Average deposits, which include all interest bearing a noninterest bearing weeks Allen custodial accounts increased approximately 1.9 billion and we also reduced the cost of interest bearing deposits 33 basis points during the quarter as we moved quickly to compensate for the lower interest rate environment.
We're very pleased with the performance of the community Bank, both in terms of where our assay growth that's being focused on managing down our cost of deposits.
We maintain a diversified lending portfolio with strong credits and no significant exposure in any wanting destroyed.
Feel at disciplined approach together with the quality of Apple will ensure continued success in the future.
Please turn to slide 17 quarterly operating highlights for the mortgage origination business include.
Fallout adjusted locks volume increased 24% to 13.8 billion quarter over quarter, while the net gain on loan sale margin increased 139 basis points to 219 basis points as a result gain on sale revenues increased the significant 230 million to three.
Hundred 3 million in the quarter.
The majority of I lost volume growth was seen in at higher margin retail broker a non delegated correspondent channels on the increasing volume was predominantly driven by the robust refinance market due to low interest rates.
Refinance activity accounted for 65% about a lot volume during the quarter on retail originations accounted for 31% of low volume.
We also saw significant margin expansion across all channels as we use marching is a lesser to keep volume in check we capacity I mean show continued exceptional service for customers.
Mortgage closings were 12.2 billion in the second quarter, a 41% increase from the first quarter as we continue to add underwriting and fulfillment capacity given the increase production volume as a result of the low interest rate environment.
Our mortgage operations team continues to deliver excellent results in each work from home environment.
Closings, a timely and we haven't seen any degradation in productivity or service level agreements. During these pandemic, which is testament to that decides to provide certainty around the quality and service studies the cornerstone about values.
We continue to be disciplines around the types of products we originate.
Beginning of the quarter, we moved to stop originating higher risk products and thoughts on the credit box in certain areas to protect that position to minimize any future brought down to the losses.
A theory, then we recorded approximately 1.8 billion in Ginnie Mae early payouts on our balance sheet.
Leased approximately 1.1 billion we're results at Genie borrow was often into full parents at the beginning of Kopec 19.
Accounting consequence to Boenning BMS saw is to show them as early buyouts, whether you bought and I also will not and therefore, the biggest impact the flagstar is against capital.
These loans rule performing before the pandemic and we believe a significant number will go back to making payments and get reinstated after the full barents period expires either on their own or through the partial claims process.
Once along these reinstated it's no longer categorized as an early Oh yeah.
We believe a small number will get modest followed out ROI or modified in conjunction with the partial claim a weak point, we will only them out and reach securitize the loan relaunching the gain on sale benefits at doing so.
Given the increase in home prices over the last few years, an equity milestone as having their homes. We don't anticipate many bar was going into foreclosure. Following the end of the forbearance period.
The overall impact to flagstar, a fixed asset class C somewhat neutral it does create an operational need to work through these loans unless I mention it impacts capital given the accounting rules and recognition.
However, you'd only impacts liquidity, if we actually by the loans out and we would like how many do so if we can modify the loan re secure it's always therefore relaunching the gas cane onsite benefit that will be generated.
With thrilled with the performance of our mortgage business in the second quarter, which has always been a key component of that business model and strategy. It generates significant noninterest income for the bank and he is a natural hedge some of our other businesses in a declining interest rate environment.
Through July 24th gain on sale revenues Rose 100 million month to date.
Moving to surfacing quarterly operating highlights for the mortgage servicing segment on Slide 18 include we ended the call to serve a single Subservicing, approximately 1.040 million loans, which over 855000 right to 2% Subserviced further MSR onus of the one.
1 million loans, we service was subservice, 94% backed by Fannie Mae Freddie Mac or Genie Mac.
The number of loans serviced go subserviced decreased slightly in the quarter, but despite the high levels of refinance activity, we're able to replace runoff with new loans from our mortgage origination business another advantage about business model.
Today, we have the capacity to service a subset of 2 million loans as well as provide and Hillary offerings, such as recapture services I'm financing solutions to MSR around us.
If you look at Slide 13 point, you will see that we're achieving that four to 6 million about pricing profit before tax guidance for 300000 loans, we asset platform.
As it relates to forbearance through June Thirtyth, 110176, borrows representing 11% the firstly in mortgage portfolio, but we need to service the subservice requested pull barents relief because of cold feet 19.
We've seen a significant decrease in new forbearance request since the peak weeks at the end of thought speaking in April I would say new record ret request, such as trickling in I'm happy for the last several weeks.
Interestingly, 34% oppose borrowers who have requested forbearance night that Writepro may and June payments and not taking the time teacher the full barents option.
This effectively means but right now 7.3% loan book, We service was sub service are actually using forbearance.
As part of the full Barron's period, we're also waving certain fees and there will be no negative reporting to the credit bureaus.
We've set up a hardship really task force, we do not default servicing team to proactively reach out to borrowers and wolfcamp inappropriate solution. After they actually full parents. The peak number of loans in full balance was 129332 and as of June Thirtyth that number is 110100.
From 76, a reduction of approximately 19000 of 15% as borrowers who the initially off team of up to now paid off their long reach out to say that hardship has been result than that loans current well have the alone while default.
During the quarter, we sold 1 billion in a bulk MSR fail and retain the subservicing on these loans the market frame. It saw strong dip immediately following Toby 19, given the volatility in the market uncertainty around liquidity needs on the it fancies. However, the volatility has dissipated and there was much more so.
Since the around the liquidity needs for advantage as a result, the market premise sausage beginning to come back and show signs of block the gang.
I ran a soft to see tier one ratio is currently 14.6%. So we have plenty of room before we start to approach the 25% Nx off to see won't capital level and intend to use the runway we created through the ended the year if necessary.
Finally, custodial deposits average 6.2 billion in second quarter, a 1.4 billion increase compared to prior quarter.
Again. This is just another benefit we get from mass Subservicing business as it provides liquidity that helps fund that balance sheet.
I Subservicing business continues to go from strength to strength of provides benefits to business opportunities to other parts of the bank. We believe we have one of the best team some platforms in the industry and expect it will continue to thrive in the future.
Moving onto expenses on slide 19, I total noninterest expenses increased 26% or 61 million to 296 million quarter over quarter on total revenues increased by 241 million or 69% to 546 million.
If you look at slide 20 core non mortgage noninterest expenses were 147 million in Q2, an increase of 8 million from the prior quarter.
This increase was predominantly driven by variable compensation a results of the stronger earnings during the quarter.
Expenses tied directly to the mortgage origination pace mix were 149 million, an increase of 53 million or 55% versus Q1 mortgage closings, which drive mortgage expenses increased 41% I'm retail closings, which have a higher cost to close made up 31.
Sen of all closings in the quarter, we'll see 24% in Q1.
Furthermore, we continue to add capacity given the strong origination forecast from the agencies on mortgage bankers Association.
Our efficiency ratio was 54%, which was an improvement of 23% from the prior quarter because of our strong fee income revenue growth quarter over quarter.
We will not be providing Q3 non interest expense guidance at this time.
It's an unprecedented calling on the health and safety at the Flagstar family our employees customers partners communities and stakeholders is our number one priority.
Despite the uncertainty created by Kopec 19, the performance at the Flagstar team Fanapt business model has been nothing short of outstanding.
We've reported record earnings for the quarter and believes the resiliency and balance but that Castlereagh Desal business model will enable us to continue to be successful generate stronger earnings and create significant value for shareholders in the future.
This concludes that prepared remarks, and we will now open the colts questions from Maliciousness.
Thank you if you'd like to ask a question. Please go by pressing star one on your telephone keypad. If you are using the speaker phone today. Please make sure that your mute function is turned off like yourself to reach our equipment again, not a star one a signal and our first question today comes from Scott Siefers of Piper Sandler.
Good morning, Scott.
Hey, how are you done.
Very good thank you.
Good good so very very strong quarter. So congratulations.
Hoping maybe maybe either Jim or Sandra Lee.
She could talk a little bit more about how this.
Issue with the Ginnie Mae loans sort of plays out any sounds like you have.
Plenty of Optionality, but.
What has to happen in your guys mines for them to resolve just as if they were not.
In forbearance in other words, what has to happen for this to just sort of go away as an issue.
Yes, so we try to provide a lot of detail on that and the speech more Jim and we addressed it. So let me let them will enhance their responses here.
Yeah, Let me go first Scott so.
Side, we had 1.8 billion Intuniv goes on the balance sheet to the ended the quarter 1.1 billion.
Well results of Genie auto was opting into forbearance and the accounting consequence of owning the MX saw is the stuff showed them as early fall I asked whether you follow them out or not because we actually haven't put them out at this time.
The loans, we are all performing go need to the time damage as I've said on so we believe a big portion will go back to making payments and will that full reinstate date. After the forbearance period expires either on their own all through the partial fine process and once they have reinstated and no longer.
Categorize this may be up we think a small number I won't get modified out Roy will that will be modest fall I think things junction with a partial play we will likely boy those loans out because we would realize the gain on sale benefit of we secure it's always seen those law.
Loans.
So we bought them out.
As I mentioned, a lot of borrowers have equity in their homes, because it's been rising home prices for a period of time now. So we don't matching a lot of these will go into full closure and a net net we think a class is somewhat neutral it does impact capital it only impacts liquidity.
We choose to buy them out and we're only going to follow them out if we can reach securitize them and realize the gain on sale benefit.
Yes, so Scott good question.
What we've raised this with our regulators we've we've put in front of Ginnie Mae we've put in front of even FASB.
It's it's a court that I don't think anyone anticipated that loans in forbearance could be could be reconsolidated on the balance sheet.
But look Theres no downside.
There could be as Lee elaborated there could be some upside from here in that these loans are going to be more likely to have lease securitization gains that we can take advantage of in the future.
No, yes from a capital perspective from a liquidity perspective, it's not something that I'm I'm necessarily concerned about but you know just like not had the cosmetic issue on our balance sheet as well.
Yeah. Okay. That's it that's good color I appreciate it maybe just as a follow up.
Hi, could those balances going and I guess my my inclination went to be would be that if forbearance requests of they've already kind of slowed to a trickle, while they might increase it's not as if they're going to double or triple I'm going to realize that that's the risk rating is very low so that the regulatory capital impact is kind of.
Negligible, but.
All assets are treated the same from the standby Tc, which a lot of investors look at so just just curious how sort of what's the appetite is to allow.
The balance sheet to to be impacted by Oh this phenomenon.
Well, let me say I'm worried about the impact on the balance sheet trying to predict what might happen. There's a lot of questions. You might ask me about the future that I, just I'm not going to try to answer because as pandemic as such that we just don't know we don't know how long forbearances going to go beyond on how much the government is going in.
Trevino anything so I would not want to hazard a guess.
And that except to say that I think that we're in a position that the nature of those assets, but not to be.
A negative impact in any material way at all.
And.
You're right about the low risk weight and are you keep in mind, our tier one leverage ratio is where we have the most.
Capital buffer over well capitalized status.
And so this will impact.
Leverage ratio little bit more because it's based on average balances, but it's not.
It's not going to bring that ratio, India competition with the risk based capital ratios for the what we're concerned about.
Got it okay.
Okay perfect. Thank you guys very much.
All right Scott sealed air.
And again that is far wonderful go for question at this time well go next to boast Georgia of KBW.
Hi Bose.
Good morning.
Just one on the on your loan production mix. It looks like your Ginnie Mae production was down quite a bit is that pricing that credit box is that related to.
The the balance sheet issues that were just discussed as well just curious any color though.
Well, it's a lot of all of that.
Both what we determined as we got into this pandemic was that the smart way to go with originations is going to be principally in the agency. So we really down say that non QM and jumbo limited that to portfolio product and we minimize the Ginnie maes.
Certainly we left it out to a little bit for our retail originators, but.
Doing very very little of it and the profitability as you can see has been very very strong. So lot of margins are a little wider and Ginnie Mae right now given certainty around a lot of that from a servicing point of view and MSR point of view.
Given the fact that the agency activity is so strong we chose to focus there.
Okay. Thanks, It makes sense and then just given the relative increase in the retail share for you guys is that being driven by increased recapture just curious there and also just the gain on sale margin trends for direct lending versus recapture does that is the big difference there.
Well first of all relative to the retail so we are controlling the growth in retail, but we've had opportunity to.
To lift out some very very strong originators from other organizations and that's why you see the production being greater coupled with just the strength in the market of course.
But we're being very careful there because we want to make sure that we we preserve the variable cost model that we put in place and so right now we're getting paid her for that retail volume and a pretty favorable fashion given the margins there.
So we're comfortable with the growth that we've seen there with respect to recapture on me this but the answer that part of yeah. Thanks, Andrew Thanks for the question Bose. So on the retail so we've seen just really good growth both from a distributed retail point of view Andina consumer direct channel now the margins in the.
Consumer direct channel or a little Lex when you're factoring the recapture which you can imagine.
But the margins are still pretty robust at the moment given the current market.
On the margins are very very strong on the on the distribution reach how saw it but we've seen healthy growth across all of our retail channels.
Okay, great. Thanks.
In Q bumps.
Our next question comes from Daniel Please give me Daniel Tomorrow of Raymond James.
Hi, Dan.
Hey, good morning, guys congratulations on the strong quarter.
Yes so.
I guess just staying on the on the gain on sale quickly here you mentioned, the 100 million plus so far in July what is the spread look like in July relative to to what you saw this and the second quarter.
Well given what we told you.
The gain on sale I think I'm comfortable saying that that spread has held up pretty well this month.
Okay.
Longer term.
Thank you guys have talked about as.
As we see this.
Healthy profit margins in the business and certainly strong volumes that that would invite increased competition over time are you seeing that yet and how long until you think that starts to impact spreads.
Competition in the mortgage business, yes, I don't I don't Yeah I think.
I think capacity is what's going to drive what happened to margin. So I think whether there's new entrance to the business or not I think a lot of mortgage originators have continued to build capacity, what we try to do to offset that a bit and I think have been successful is manage the capacity there a this.
Upland fashion and look for where the best opportunities where to grab business with the best margins.
At that we could do.
That we could do by not adding a lot of fixed expenses. So right now it's working really well how long we can continue to do that you know again, it's anybody's guess, but the mortgage market certainly looks like it's going to continue to be strong through the rest of this year.
The 30 year rate, but is that 2.9% something like that housing markets very strong year over year purchase activity is up.
Look at our build their portfolio only one small credit has asked for a payment deferral. So people are still building houses buying houses. So I think the fact that we didnt have what was that some price increase we don't have a bubble that we're dealing with here in the real estate world. So.
With that feel real optimistic about the opportunity for continued strong volume and mortgage the rest of this year.
Margins as a big question, then we'll see how that goes but I'm pretty comfortable with where.
Got it and I want to add anything around yeah, I mean, I think you're exactly right. Sandra I think the obviously I would add is I mean look when you look at the latest forecast from the agencies in the N.B. I that forecasting 2.9 trillion 2020 sake.
And we'll probably go above three trillion I think in the first half of this year.
There was 1.5 trillion of origination. So you know there's good runway at forecasting 2.2 trillion. After 2021 right now I mean, it's all about capacity, but as Sandro said, we managed volume to capacity not tamales through product and channel mix.
So that would maximizing returns and we want to we ensure with consistent quality customer experience. Then we'll continue to do that.
Alright, great. Thank you for other color.
And if I could sneak one more in on the mortgage warehouse yields. So obviously, you've been successful with the floors, there and keeping those yields a relatively high another they're higher than your cnine C or yields I'm. So given the duration of these loans in the floor or do you have in place.
Is it sustainable for the for those yields to remain above this theory and see an eye books do you think.
Well I think theres good chance that have sustainable it's hard to say for sure. The yields are enhanced as I said in my prepared remarks by the draw fees.
So if the activity continues in the and the number of draws and you've seen in the last quarter continues in this current quarter I think theres a really good chance that we could continue to sustain that level of yield I certainly don't see a declining very much. So I think it's a feel that's very much protected given given the floors that we have in that.
Portfolio and as I say, coupled with the drought fees. So.
That's a business I love the and then right now it's got very very little credit risk as both Jim and I noted less than $5 million and losses over the last 12 years, that's through a economic recession by the way and no share another little story with here.
Could we had a we made a decision in late March that we were going to stop accepting.
Non QM and jumbo product as collateral for our warehouse lines at the time, we had about $300 million of that collateral.
And we were able to work together with our clients, who didnt have very many investors at that point in time to wind that that collateral down to literally nothing today and and we did that without experiencing any wants I think that tells you a lot about how strong that businesses and if you manage the quality of the collateral.
Really how there's very little listen I remind you we had.
An originator last year and live well that abruptly close their doors.
I think it was a 20 million dollar line outstanding to them at the timing within 45 days, we rounded down and actually collected more than what was on the line. So it really isn't very safe business, so to be able to grow our commercial loans in this environment and grow our yields in our and our net interest income I mean I couldn't move.
More please.
Thanks for all the color that's all I have.
And our next question comes from Steve Masa B. Riley FBR.
Hi, good morning.
In terms of just following up on capacity within the retail business you guys mentioned, adding a couple more originators as core just kind of curious.
No.
With the mortgage work being as strong as is what how much more could we see in terms of.
<unk> for you guys.
Paul.
Well look I think you got to be careful right. So why we've continued to add capacity to take advantage of the opportunity that weve been presented with as I said, we're being really careful not to do in such a way us increase.
Long term fixed expenses and anyway. So you can get over your skis in this business and get excited and add a lot of a lot of capacity internally that it's hard to get rid of when though when the volumes go the other way, so where were laid it out or people to work as much overtime as they're willing to work.
We're paying them.
Yes, the to work longer hours to get more more more work done we're leaning on our third party.
Vendors to do as much as possible for us everybody's working nights and weekends. So.
We're we're stretched in this thing out as far as we can stretcher and but I'm not going to go chase. Another couple hundred million dollars a business a day and that a year from now explaining to wire expenses of two high we're just not going to let that happen. So hey, if we can do what we're doing and here in July.
In here on what has today the 28 the July with over $100 million through last Friday.
Hi, guys say I think are management has been pretty well.
Absolutely.
And then in terms of the just on the margin.
I think the guidance just for relatively stable this quarter.
Which telecom commitments mortgage warehouse yields are up funding costs are coming down and what sort of some pretty good room, just kind of curious what else can be a little bit of an offset.
Here.
So Steve as you think about it.
The primary secondary spreads come in.
I am looking at how low can that overall mortgage yield go I don't think there's.
A lot of risk of that moving meaningfully below 3%.
But.
You know, we fund that we fund that portfolio that held for sale portfolio short.
So right now it's it's accretive to.
It's accretive to NIM, but if that mortgage.
We'll go to follow a lot sales went to two and a half which I think it's just absolutely crazy.
Then we could see some pressure on the them from from that portfolio.
In response to that we would shorten we would shorten our turn times.
But we still you know that's just a function of how long we went down in the balance sheet with the average balances are.
Did that answer your question I wasn't sure.
Yes, yes.
Net interest margin.
Got it.
He will.
Uh huh.
In dollars and downgrades from the.
$107 million got great just kind of wondering what portfolio that's.
What portfolio that was welcomed.
Those were predominantly in decree portfolio, Yeah. As you as you look at where our bigger concerns are its hotel it's free its its retail and you keep in mind big piece of our retail our single tenant buildings or what we called neighborhood centers neighbors centers are not all that predominantly anchored by a grocery store so.
Single tenant buildings neighborhood centers, you're doing fine, but as you move up ido into bigger box anchored type structures than those are experiencing some stress. So no. We don't see any any weakness we've got strong borrowers support across the portfolio, but we bought it merited.
I'd gotten married to that watch status in the quarter.
Okay. That's helpful. And then last question for me just on hotels kind of curious as to if you have any data as to what activity.
Were seeing a oxford activity, you're seeing within those portfolios.
The hotel portfolio specifically.
I'm, sorry them to send hotel, yes, I'm sorry.
Yeah. So hotel is obviously, the most difficult piece of the hospitality.
Portfolio, we're watching it very closely Fortunately, we do have very very strong.
Sponsors and the hotel space and so far so good they're hanging in there are there had been some deferrals as weve as we've shared with you but at this point we haven't.
We haven't got any feedback from anybody that they're thinking about going into town. So everything looks like it's holding up right now and you know they I will tell me in a number of them I have the opportunity to speak to myself regularly you know there are enough for the long haul. They think it's going to come back and then there there are going to do it. It takes a stay out there in that business and one in particular I talk to refi.
Certainly going to have a capital coffer partner, so it could put more money into the project and so you know so far we feel pretty good about the way of sponsors are handling their obligations.
Alright, thanks, very much like that.
Okay. Thank you.
And again that star one for any other questions at this time start when the signal and we'll go next to Henry Coffey of Wedbush.
Hi, good morning, everyone. Good morning, great quarter.
I will try to make sure about mortgage anymore. It sounds like you're cued up for a previous second half.
But never it wouldn't be right. If you didnt ask us about mortgage Wow I mean, the Fannie Mae's at 3.1 trillion, so that's where all the realized [laughter].
Thank you felt it it's it's pretty transparent we go back to a couple of issues.
One and in terms of reserve Phil.
How do you manage around.
The movies forecasts, if that's what you're using like it's kinda like the price of oil they get did they get to change at whatever they change. It and then your models have to react to it is there a way to.
And minimize that if the impact so any future reserve build or more a function of actual credit metrics.
Well I'll, let Jim get into the detail Here's what I'll tell you about how I view the reserve build into reserve what the right reserve is.
In our it's not a science, but we are being pretty true to the model and as you noted it's heavily swayed by the movies economic forecasts, we do apply qualitative judgments to the model output and we try to do that and what we believe those.
Conservative when so we want to be in the best place, we possibly can be and I think that we feel like we're in the right place and again, if anything maybe a little bit the higher sensitive.
You May recall I started my career as an example, maybe part of that.
Randy never left me I really believe that's the right way to manage the overall reserve for credit losses, and that's the way we're doing it here, we always have and during my tenure as CEO now to the specifics of Moody's Let me, let our CFO.
Hey, thanks.
Well I point. This slide 12, when you look at slide 12, you'll see that forecast changes drove 31 million of the increase and our judgment changes drove 63 million more than two X, but the forecasted so look.
We're pretty.
We're pretty much as under SEC conservative when it comes to doing what is necessary to protect the balance sheet.
Yeah. He's made the referenced a fortress balance sheet. It a couple of times in his prepared remarks.
But.
Well I've seen some people take the Moody's forecast gallon qualitatively, we've actually taking it up and so there's a lot of room in that number.
Two.
Have moody's catch up to where we think our conservative.
Meaning with us.
That's helpful.
Yeah.
I'm sorry go ahead.
Have you thought about selling any of these commercial real estate assets.
Now you've got a good performing well maybe the answer is to offload some other risk given how much strength you had in your other businesses.
No we really haven't there hasn't been a topic of discussion at all and maybe that's because the we know these borrowers well and we speak to them regularly and we just feel that that they're going to be okay. So I'm just said in his prepared remarks, we know there's going to be losses here, but knowing exactly where they're going to be.
I don't know, whether exactly where they're going to be so.
At this point I think I think a hanging in there with them working with them is the best long term will produce the best long term result for us.
Great. Thank you for answering my questions and congrats on a great quarter.
Thank you.
And with no further questions in the queue I'd like to turn the call back over to Mr. standard then allow for any additional or closing remarks.
Thank you.
Well, while flagstar was busy having a spectacular quarter the world around us erupted in social unrest.
Just to be that we could keep the office in the world outside pretty much in separate compartments, but I don't think thats an option today.
When we started our diversity and inclusion journey, our focus was on flagstar I'm, making it work place where everyone would feel comfortable being their authentic so.
I now now that we can't build a wall between our company outside World. We're all part of the larger community, we are bringing the outside in and vice versa and as a company needs to do our park to make things better.
That's why when it filling of George Floyd sent shockwaves around the World I felt it was important to speak out and started dialogue with our employees. Since then we've probably stop talking and hopefully never will and one of the first things. We did was to add the word equity to our discussion around diversity and it.
Solution and I'm really proud of the way our employees has suggested and embraced opportunities to engage and social justice issues.
Some of the things we did.
We held let's talk about a panel discussions with external leaders and diversity and inclusion.
We pulled their advertising from Facebook in July to support the stop Kate for profit initiative.
We held the June team celebration, we communicated to employees and how the discussion about the Supreme Court's recent rulings on Docker and equal rights for LGBT workers, we publicly supported a ballot proposal in Michigan to ban LGBTQ discrimination.
We celebrated pride month with virtual events and speakers and we introduced a learning moundsville for all employees on the international day of trends gender visibility and have Webinars Unquoted 19 racial disparities and the basics are voting.
We understand trying to reverse decades of systemic and equities the marathon not a sprint, but were often running committed to making our company and our communities there and more equitable for all.
Start we are playing a million dollars in grants for minority owned small businesses when another million dollars in grants to nonprofits that support diversity inclusion and equity.
Additionally, our board of directors has approved adding two seats to the board and those seats will be filled by women represent a minority groups.
Well, maybe wondering why am I talking to you about this.
First because I believe getting involved in social justice issues is the right thing to do.
Second I believe it makes glass are better and yes, more profitable company, it's a virtuous circle, where employees, who feel valued and respect it for the differences treat their customers in a life manner. In the end result is the more profitable company.
I also want to make sure I think all of our first responders to protect us so well who find themselves in a very difficult position right now.
In closing it was a knock out quarter and will take at any time, but the real message the underlying strength of flagstar the strength of our net interest margin, which is sustainable the strength of our servicing income, which is sustainable and the strength of our diversified business model, which is also sustainable.
And of course, a huge out shout out to all our employees quarters. Like this don't just happened they represent a lot of long hours extra effort and planning unvarnished hard work.
Thanks to all of you the success of the quarter belongs to you.
And thanks to all that took the time to dial in today have a great thing.
And this does conclude today's call. Thank you for your participation and you may now disconnect.
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