Q3 2020 Flagstar Bancorp Inc Earnings Call

To date in Washington, D. Flagstar Bank third quarter 2020 earnings call. Today's conference is being recorded at this time I would now like turn the call Mr. Ken Schellenberg. Please go ahead Sir.

Thank you Gary and good morning, welcome to the Flagstar third quarter 2020 earnings call before we begin I would like to mention or third quarter earnings release and presentation are available on our website at flagstar Dot com.

Also like to remind you that any forward looking statements made during today's call are subject to risk and uncertainty.

Factors that could materially change our current forward looking assumptions are described on slide two of todays presentation in our press release and in our 2019 form 10-K, and subsequent reports on file with the FTC. We're.

We're also discussing GAAP and 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 to now turn the call over to Sandro Dinello, our president and Chief Executive Officer.

Thanks, Ken and good morning to everyone listening in so.

All of you and your loved ones have been able to stay safe and healthy.

Joined this morning by Jim slowly, our Chief Financial Officer, Lee Smith, our president of mortgage and Richard Davis, Our new President of banking as you May know, we had a bit of a change in our leadership team during the quarter.

Reggie joined US on August 3rd I'm thrilled to bring a person of his stature in the banking industry to flagstar you could have gone through a lot of banks chose to join us.

Sure Christy physical or president of mortgage flagstar on that same day or week.

It is a secret to go Fortunately, we had a great internal solution. We Smith has been with me from day, one of Flagstar has turned around.

Do you ever seen mortgage for sure, but it's part of his CFO responsibilities Catsix was also overseeing mortgage servicing.

It made all the sense in the world to placing in the role of president of mortgage, allowing us to have originations fulfillment and sort of a shade under one highly respected leader.

Given these leadership changes Jim will expand his remarks, a good state to cover some believes former areas Richie will follow with an update on the community Bank and then.

And then we will handle the mortgage segment, including servicing it's yours.

As usual, we'll then open the line for questions.

A few more comments about regimen, he's a talented leadership, so seasoned banker with a proven track record of success.

Many of you are aware diversifying our earnings has been an ongoing chief strategy and growing our community bank is a pillar of that strategy.

In a lot of progress on that strategy and therefore, I feel very fortunate to have Reggie onboard to move us forward logistics community banking within the company as a whole.

Also during the quarter, we announced a David House joined our team as our new Chief Human Resources Officer, replacing Cindy Meyers who retired.

Hated to see Christy leaves David is doing a great job of showing her shoes. Its strong background in both financial services and other industries has demonstrated results and leveraging HR to improve organizational performance and the depth and breath of his experience in all aspects of HR coding diversity equity and inclusion.

Well help ensure flagstar stays in the forefront of this important field.

Yes, that's where our performance for the third quarter it was simply unprecedented.

CD in our second quarter performance, which at the time I said it was the best supply starts history, not that long ago, I would have been thrilled to earn $3.88 per share and how your year, let alone in a quarter.

It was an all hands on deck performance led by mortgage followed by a phenomenal warehouse business and supported by a complimentary servicing business.

The second the first nine months of this year. We're also unprecedented with tangible book value per share growing by $7 or three cents a study in 25%.

There's a story here that we don't want overshadowed in our results and that's how successful we were at growing net interest margin ex the impact of.

Loans with government guarantees we were.

We were pretty much alone amongst our peers and expanding them and I think you can put that at the feet of our unique business model and the way we manage that we had the foresight to protect the yields in our warehouse portfolio what floor rates and these were yields already enhanced by significant revenue from dropped sees movies.

It was an overall increase in adjusted net interest margin from 2.8% to 2.94% quarter over quarter.

And you'll recall that credit losses in the warehouse portfolio are de minimis less than $5 million over the last 12 years.

The other important story from the quarter is the aggressive way, we continued to manage deposit costs with our average cost of deposits dropping again in the third quarter a trend that has continued throughout 2020 and because we carry a large amount of wholesale funding what costs are tied to LIBOR or these costs have dropped in tandem with the fed actions.

Importantly, we think our margin will remain resilient.

I'm also proud of the success at the retail team has achieved with respect to deposits average community banking deposits, which excludes custodial account some broker deposits increase I have $2 billion during the quarter.

Onto the mortgage.

Can I say 346 million in gain on sale revenue $11 million more than all of last year pretty amazing and then quietly the servicing business just keeps chugging supporting our mortgage business, providing efficient funding, adding fee income and even growing the number of sub service loans in the face of historically high pay offs.

Related to the current refinance boom.

Finally, let me address credit.

So far everything is holding us back a commercial loan deferrals now total only $47 million, we're encouraged by that but cautious and staying close to borrowers, especially those who are not ones have to start making payments again, that's all.

There's always a watch words, let's be careful and conservative that's why we increased our coverage ratio again this quarter not because we see any weakness in our book.

In fact, just the opposite but your guess is as good as mine as to what the future holds for the economy. So we chose to be conservative.

I don't know how I could feel much more satisfied with where we stand we moved into Q4. It was a stable interest margin outstanding power to generate noninterest income and a fortress balance sheet all things considered we're in if that's possible position as we hope for the best we are prepared for the worst let me now turn it over to Jim.

Thanks, Andrew.

Turning to slide six.

Net income this quarter was 222 million or $3.18 per share.

This performance compared to the 116 million or $2.03 per share last quarter.

Increase on a linked quarter basis was largely due to stronger mortgage results in a nice increase in net interest income is the result of higher warehouse lending and.

And a lower credit provision score.

Going deeper into this quarter's performance our pre tax pre provision earnings were 327 million.

I'm here to $250 million last quarter.

Net interest income increased 12 million or 7%.

Average, earning assets grew 2.0 billion.

And the reported net interest margin decreased by eight basis points. These.

These were impacted by loans with government guarantees that have not been repurchased and are only the result of an accounting gross up.

Excluding these assets that interest margin actually increased six basis points.

This performance was primarily driven by the strength of our warehouse business has rate floors in place to protect from margin compression in our core deposits, which benefited from higher custodial balances and also for the maturity of higher cost Cds and the expiration of promotional rates on savings accounts.

Won't be these numbers in a couple of slides.

Mortgage revenues were 358 million, an increase of $63 million compared to the very strong number we reported last quarter.

During the quarter, we saw a gain on sale margins increase.

Asset quality remains strong net charge offs were only five basis points and early stage delinquencies stayed low.

Nonperforming loans ticked up slightly as we had one commercial credit of 10 million that we put on nonaccrual status.

Despite all of this we increased the allowance for credit losses, 280 million up from $250 million up into the second quarter.

This reflects our views of the continued uncertainties within the economy as a reminder, the allowances for credit losses, where Hcl includes the reserve for unfunded loan commitments.

We'll provide more details when we get to the asset quality slide and take a deeper dive into seasonal.

Capital also remains solid.

Our risk based capital was 11.3% at September Thirtyth our.

Our C.T. one ratio was 9.2%.

Tier one leverage ratio was 8.0%.

We allow these capital ratios to come in at slightly lower levels than where they otherwise would be to support higher levels warehouse loans.

We don't expect any losses coming from these assets. So there is a lower need to support them with capital.

We'll go into more details on our capital ratios. Later finally, we continued to demonstrate significant capital generation.

Growth in our tangible book value per share to $35.60 at your at quarter end.

A $3.86 from June Thirtyth seven.

$7.98 from one year ago, a 29% increase so let's turn to slide seven and dive deeper into the income statement.

Net interest income increased 12 million.

Hundred 80 billion this quarter.

Up 7% from last quarter average, earning assets grew 9% led by warehouse lending and a full quarter's balance of loans with government guarantees that are we consolidated due solely to forbearance.

Deposit costs came down 50 basis points, while average deposit balances increased 2 billion.

We'll dive deeper into net interest income at our interest rate risk position on the next slide.

Noninterest income increased 74 million to $452 million due to higher mortgage revenues and servicing related fee revenue.

Non interest expense was 305.009 billion from the prior quarter.

Finally, you'll notice that the tax rate ticked up this quarter. This is.

This is a function of a higher level of pre tax income, which is much more than the tax benefits we have in our run rate earnings.

With our higher level of earnings we decided to delay certain tax planning strategies as we expect that they will provide more value should corporate tax rates to be higher in the future.

Considering this.

Would be appropriate to use our year to date effective tax rate of 23% for future periods.

On slide eight beginning this quarter, we've combined our average balance sheet with details on our interest rate risk position at the end of the quarter.

Average, earning assets increased 2 billion from last quarter. This.

This resulted from a 1.9 billion increase in warehouse loans and a 1.3 billion increase in the loans with government guarantees that have not been repurchased.

Declines in Securities of 0.6 billion and in mortgage loans held for investment of 0.2 billion were were due to faster prepayments, partially offset the balance sheet growth.

She and I balances also declined by 0.4 billion with the sale of the TPP loan portfolio at the end of July.

We expect loans with government guarantees peaked this quarter and we will start to see balances gradually decline through the rest of 2020 2021.

Where we own the MSR for Ginnie Mae loans, we had the option to repurchase these loans. After the loans have gone three months without a payment due either to delinquency or forbearance.

<unk> September Thirtyth, we had.

We had 1.8 billion of such loans, we had not repurchased which is consistent with what we indicated on the second quarter call, but which the accounting rules made us reconsolidate onto the balance sheet with an offset to other liabilities.

We do not believe there is significant downside to holding the loans either by buying them where through this accounting gross up.

If we were to repurchase the loans, we can touch the loans to the FHLB and they are at 20% risk weighted asset.

Further if we do repurchase the loans, we could we sell those loans at a later date, which is attractive for us and they remain government guaranteed.

Average deposits increased 1.8 billion last quarter custodial deposits drove $1.1 billion. This increase.

We also saw growth of 0.3 billion in noninterest bearing retail deposits, a 16% increase from last quarter and is your point 3 billion increase in government deposits due to seasonal tax payments.

[noise], we manage deposits costs lower by 15 basis points from the impact of pricing changes, we've been making since March when the fed truck short term rates.

Additionally, as we observed last quarter.

Posits continued to reprice to the new curve environment, which provided support for our net interest margin expansion.

Well, it's difficult to predict where rates might be in the future. We feel that our interest rate risk position is in a good place due to the actions we've taken this lower interest rate environment, we feel.

We feel that we can protect our net interest income and net interest margin and believe that our net interest margin should be relatively flat to where its been the last two quarters.

The interest rate floors that we have the commercial loan portfolio should protect us against further margin compression we've.

We've completed a $2 billion program to lock in these low rates are funding cost for the long term using a combination of interest rate swaps and fixed cost purchase money laddering that out for three to seven years, while this will make us more asset sensitive in our banking business, our mortgage origination business is liability sensitive so.

We believe this program will set us up for future success, regardless of where rates are.

We continue to have a strong liquidity position driven by the strength of our deposit base and access to multiple sources of liquidity both on balance sheet with our high quality securities portfolio and off balance sheet with our Undrawn FHLB facilities.

September Thirtyth.

We had ready liquidity at 5.6 billion not including the ample access we have to borrow that discount window.

Let's now turn to slide nine which details our noninterest income and noninterest expenses.

Noninterest income rose $74 million in the prior quarter on the strength in mortgage revenue for gain on sale revenue of 346 million represented an increase of 43 million fallout adjusted locks increased 9% to 15 billion and the gain on sale margin was 231 basis points.

Well channel margins did come down slightly from last quarter. The overall margin expanded slightly doodle due largely to the gain we booked but our RMBS transaction [noise].

This quarter.

Your execution improvements.

[noise], we also recognized.

Yes, a return of 12 million on our MSR.

The current quarter represented a more normalized run rate as well.

Last quarter, we made certain model changes that we believe are can grow it with the economic forecast, we use for Cecil and for higher prepayments.

These results were achieved even with the average value of the MSR falling two basis points.

85 basis points of view PB at the end of the third quarter.

We would observe that the MSR market continues to show signs of improvement.

As demonstrated with a small MSR sale to be executed in August.

Lunenberg income improved 5 billion due to a decline is LIBOR based credit that we provide our sub servicing customers for the custodial deposits that they control.

From a higher level of fees furloughs and forbearance.

Non interest expense increased to $305 million for the third quarter compared to 296 million last quarter, reflecting a 10 billion increase in non mortgage related expenses.

This increase was primarily due to the capitalization of origination costs in the second quarter for the P.P. loans and the accelerated vesting certain components of executive compensation that resulted from the recent secondary share offering.

Despite increased volume mortgage expenses were flat quarter over quarter as the ratio of mortgage noninterest expense to closings or more.

Our mortgage expense ratio actually declined.

This improvement was due to certain expenses in the second quarter that did not recur this quarter and are not expected to recur in the future, including certain performance related incentives related to our Opus Advisors Division.

So, let's turn to asset quality on slide 10.

Credit quality of the loan portfolio remains strong early stage delinquencies continued to be relatively low only 14 million of total loans were over 30 days delinquent still accruing as of September thirtyth.

Relatively flat from 15 billion at June Thirtyth.

Nonperforming loans ticked up slightly as we had one commercial credit of 10 million that we put on non accrual status.

The RCC completed its review of shared National credits recently.

This resulted in no rating changes for our loans.

Our allowances for credit losses covered 1.7% of total HFI loans fixed.

Excluding warehouse loans for the denominator given their relatively clean credit loss history, and considering that substantially all of these loans are collateralized with agency or government backed loans are.

Our coverage ratio would stand at a very strong 3.1%.

On slide 11.

We can see that we ended the quarter with 280 million of Hcl, consisting of 255 million of allowance for loan losses, and 25 million in the reserve for unfunded loan commitments.

Total or a feel at quarter end increased by 12% over what we reported at the end of the second quarter.

This quarter, we continued to use three different Moody's forecast for the next two years to guide our allowance level.

S. One growth forecast weighted at 30% a baseline forecast weighted at 40%.

In an S three adverse forecast weighted at 30%.

Forecasts U.S September release.

The resulting composite forecast for the third quarter was roughly equivalent to the scenario we used in the second quarter unemployment into year, 10% that recovers only so.

Recovers only slightly in 2021.

G.P. recovers only slightly by the end of year from current levels does not returned to near pre coated levels until 2024.

H.P. eye drops about 2% from mid 2020 through 2021.

While there are signs that point to a possible V shape recovery, we're going to be cautious and our confidence about the recovery until we see more success on the medical side of combating this pandemic.

Accordingly.

We have a qualitative reserves of 63 million, primarily in our series C and I portfolios guided by the Cecil model output.

Using moodys adverse scenarios to provide coverage for industries and customers that we believe could be more exposed to the stressful conditions in our forecast.

We provided a portfolio by portfolio breakdown of resulting use your coverage ratios in our appendix.

Slide 12, Weve updated our exposure to those industries, we believe are more likely to be most impact.

In total we have a billion outstanding loans in this category, representing 5.7% of our total loan portfolio. It's interesting to know we have almost no loans in deferral of these portfolios today down even from September Thirtyth.

In our commercial and industrial loan portfolio. The cobot impacted loans totals. Your point 3 billion you can see that the exposure here is relatively low, especially as deferrals in these portfolios total only 2 million, we have no oil and gas exposure.

Our commercial real estate portfolio, we have 0.7 billion outstanding the areas most likely to be impacted by cobot, including commercial real estate loans secured with hotels retail properties and senior housing.

[noise] opposed to this category our average pre cobot LTV was 55% and our average pre kobin debt service coverage ratio was 4.6 times we.

We still don't have any loads of these portfolios that we believe will default in our hotel portfolio, we're seeing occupancy levels of 53%.

Now this is not quite to the point covering debt service, but at this level of occupancy there cash burn slows considerably.

Well, we believe that we will have losses, we continue to see strong borrower support across the portfolio.

Feel good about our credit risk in this portfolio as we're starting to see.

Starting from a position of strength from our carefulness about who he led to to the disciplined underwriting of those credits and the pre cobot Ltvs debt service coverage ratios in the commercial real estate portfolio.

Turning to slide 13, our capital ratios remained solid in nicely above our stress buffers total risk based capital was 11.3% at September Thirtyth and our Cetone ratio was 9.2% both relatively unchanged from the prior quarter, Despite 2 billion of asset growth.

As expected our tier one leverage ratio of 8.0% increased 28 basis points this quarter if we.

If we just waited or warehouse close to 50%.

The weighted at 100% current risk based capital rules, you'd see that our capital ratios compare favorably to most other midsize banks now this makes sense. The loans are fully collateralized by 50% risk weighted assets and those assets remained under our custody while the loans are on our lines.

Further there is even an outstanding proposal to make this distinction in the risk based capital rules. The proposal that we wholeheartedly support.

So adjusting the risk weighting on the warehouse loans to 50% our total risk based capital would be 13.4% over 200 basis points higher which would put that ratio above the average for all midsize banks are see tier one ratio would be 10.9%.

As we pointed out with our warehouse loan portfolio loans held for sale loans with government guarantees we have more than half our balance sheet and 962 basis points to total risk based capital dedicated asset categories that have very little risk.

It's held for sale turned over every one to two months and this portfolio was carried at fair value the portfolio of loans with government guarantees has no real downside and perhaps some modest upside.

When you take all of this into consideration we.

We believe that we are operating in strong capital levels, given our low risk balance sheet composition.

I'll now turn it over to Reggie to cover community banking. Thanks.

Thank you Jim and good morning.

As this is my first opportunity to be encroached on many of you I'd like to comment on the potential I see in the community banking business at Flagstar what access.

What excited me about coming Flagstar was the tremendous potential of this franchise.

Looking at this company from the outside I've been impressed with the way that the company has been able to grow its loan book and a well diversified manner with a focus on building advisory relationships with our clients now having been inside for nearly 90 days I'm, even more impressed with the energy and commitment of the flagstar team.

This team is only very deliberate journey to build a best in class client focused organization the two.

The two deposit acquisitions meaningfully transformed the retail deposit base to where we can focus more on full relationships.

This will continue to be our focus as we build out an omni channel experience for our retail clients.

In the near term, we want to focus on sustaining strong performance, we've seen from the warehouse lending team.

And take this opportunity to improve our productivity across all businesses in community banking [noise].

Please turn to slide 15.

Quarterly operating highlights for the community banking segment include average warehouse lending balances increased 1.9 billion or 51% to 7.6 billion in the quarter due to the low interest rate environment driving strong refinance volume.

Our relationship based approach and speed of execution also enabled us to add new clients as well as increased lines for existing customers during the quarter we can.

We continue to maintain our disciplined underwriting in this business.

Average commercial and industrial and commercial real estate loans decreased 450 million or 9% with the decrease being driven predominantly by the sale of PPP loans that we closed in July.

We continue to be thoughtful in terms of new facilities and believe our strong credit policies and diversified portfolio will be a strength as a fall out from a pandemic becomes becomes more pounds.

Average consumer loans held for investment decreased 219 million or 5% are result of increased payoffs in our first lien mortgage portfolio, partially offset by growth in other consumer loans, which is predominantly our indirect marine RV loan portfolio, which is performed round rather nicely in this environment.

Yes.

I'm also proud of the success at the retail team has achieved.

Average community banking deposits, which include custodial accounts and brokered deposits increased half a billion dollars or 5% over last quarter to 10.3 billion.

We saw nice growth in balances in governmental deposits due to seasonal tax collections noninterest bearing D.D.A. and low cost savings account.

We also saw CD balances country contract point 3 billion.

The overall cost of these deposits declined by 22 basis points to 42 basis points from 64 basis points last quarter.

The retail team did a great job in retaining Cds, which emerged a win where they're maturing and redeploying these deposits into D.A. and savings accounts.

Turning to commercial lending on the next slide we continue to manage our well diversified commercial loan book.

The warehouse lending book, we've been using our quarter end balance sheet to accommodate the needs of our customers. Despite this having a direct impact on our period end capital ratios.

Through October 19th we've averaged 7.4 billion demonstrating these efforts to sustain the business grow are succeeding.

Commercial real estate, we're in a constant and we're in constant contact with our customer base. The homebuilder book has performed beyond our expectations.

We also have strong management teams and the close working relationship that those teams have with our lenders here at flagstar.

The scene I book remains well diversified and we're starting to see our customers get their business back on track.

We're taking steps now to build our relationships in markets. So that we can be in a position to fully serve these customers when the opportunities present itself.

I'll now turn things over to Lynn.

Thanks, Richard and good morning, everyone, we couldn't be.

We couldn't be more pleased with how our mortgage servicing businesses are performing right now providing significant and valuable non interest fee income in the slow interest rate environments.

346 million of gain on sale revenue generated during the third quarter was a record of flagstar as mortgage banking revenues increased an incredible 63 million or 21% quarter over quarter as we continue to take advantage of the strong refinance market.

Furthermore, we ended the quarter. So the single Subservicing, just over 1.1 million loans, an increase of 6% from the previous quarter. That's we added over 100000 non flagstone originated loans to our best in class servicing platform.

Our unique one stop shop mortgage business model allows us to originate mortgages across multiple CPR on retail channels provides optionality in how we sell or distribute the loans and also enables us to sell to mortgage servicing rights, creating and retain the subservicing on those loans.

This is complemented by a warehouse a mortgage lending capabilities on the custodial and escrow deposits generated by the servicing business also help us fund that balance sheet.

This model allows us to build the partnerships remain nimble and flexible maximise earnings throughout the mortgage log cycle.

I will now outlawing additional key operating metrics from our mortgage and servicing segments during the third quarter.

Please turn to slide 19 course.

Quarterly operating highlights for the mortgage origination business include fallout adjusted locks volume increased 8% to 15 billion quarter over quarter, while the net gain on loan sale margin increased 12 basis points to 231 basis points as a result.

As a result gain on sale revenues increased a significant 43 million to 346 million in the quarter.

The majority of our volume growth was seen in a high marching retail broker non delegated correspondent channels right.

Refinance activity accounted for 67% about loan volume during the quarter on retail accounted for 31% of low volume.

We continue to use Martinez OLED, but to keep volume in check with capacity and ensure continued exceptional service for our customers.

Mortgage closings were 14.4 billion in the third quarter.

The only 2% increase from the previous quarter as we continue to add underwriting and fulfillment capacity given the increased production volume as a result of the low interest rate environment.

Our mortgage operations team continues to operate effectively in this work from home you bought them and we haven't seen any degradation in productivity during the pandemic and we continue to hire and train new fulfillment staff that full building capacity throughout.

We also maintained a disciplined approach to the types of products being originated as effectuated at the outset of the pandemic, where we move to stop originating high risk products and taught in the credit box in certain areas to protect our position a minimalist any future write downs or losses.

Period end, we have approximately 2.5 billion EGD my early buyouts on our balance sheet of this approximately 1.8 billion were result of borrow was opportunity to forbearance as a result of pandemic. The accounting consequence of owning the M. I saw you used to show them as early buyouts, whether you buy them out as well.

Oh, and therefore, the biggest impact from flagstar use against capital.

These loans world performing before the pandemic and we believe a significant number will go back to making payments I get reinstated after the pool Barents period expires either on their own well through the partial claims process once.

Once salamis reinstated it's no longer categorized as an early buyout.

We believe a small number will get modified out ROI multiple I think in conjunction with the partial Cline at which point, we will buy them out and re securitized alone relaunching the gain on sale benefit of doing so.

Given the increasing home prices over the last few years, an equity milestone. This happy now homes, we don't anticipate many borrowers going into full closure following the end of the forbearance period.

The overall impact to flagstar, a fixed asset class you somewhat neutral it does create an operational need to work through these loans and as I mentioned it impacts capital given the accounting rules. Some recognition [noise] loans will only be bought out if we can modify the long I'm re securitize, therefore, relaunching the gain on sale.

Well benefit would be generated.

Finally, we expect volume and margin to decline in the fourth quarter because of the usual seasonality impacting the number besides on the winter months affecting the post you smoke in particular on full cash gain on sale revenues to be approximately 200 million in Q4 as well.

Very pleased with the performance of our record setting mortgage based finishing the quarter I believe it will continue to be a meaningful contributor to the bank soon into future periods.

Moving to servicing quarterly operating highlights for the mortgage servicing segment on slide 20 to include we ended the call to Servicenow Subservicing, approximately 1.1 million loans of which almost 894000 or 81% a sub service for other MSR owners of the one.

Of the 1.1 million loans, we service so sub service, 93%, a backed by Fannie Mae Freddie Mac or Ginnie Mae then.

The number of lung so it'll be still subservicing increased slightly in the quarter as we added in excess of 100000, not Blackstone originated loans. Despite the high levels of refinance activity, we were able to replace runoff with new loans from our mortgage origination business. Another advantage of our business model.

Today, we have the capacity to service, so subserviced 2 million loans as well as provide ancillary offerings, such as recapture services and financing solutions to MSR owners if you.

If you look at Slide 38, you will see that we are generating five to 7 million up operating profit before tax for every 100000 loans, we add to the platform. This season.

She is an increase from our previously reported four to 6 million as we continue to achieve economies of scale benefits in this business.

As it relates to forbearance through September Thirtyth, 112, 427, borrowers representing 10.6% first lien mortgage portfolio that we the service for sub service have requested forbearance for lead because of COVID-19.

We've seen a significant decrease she knew full barents request seeks to peak weeks at the outset of the coking pandemic into.

Interesting like 28% of those borrowers who requested forbearance have continued to make that monkey payments through September 30, and if not taking advantage of the forbearance option.

Effectively mange that right now 7.6% of the loan book, we service or Subservice are actually using forbearance.

As part of the full Barents period were also waving certain fees and there will be no negative reporting to the credit bureaus.

The peak number of loans in full balance was 129332 and as of September Thirtyth that number has declined by approximately 17013% as borrowers who was initially off duty of emptied out paid off their loans reached out to say that hardship has been resolved and that long.

When these current or had a lot of modest following.

During the third quarter, we have onboard need approximately 10000 non flagstar originated loans that were in full barron's, so comparing period over period forbearance activity isn't as meaningful.

During the quarter, we sold 800 million in flow MSR deals the marquee premise Aussie certainly coming back after drawing up at the outset of the pandemic and RMS off to see one ratio is currently 16 assaying significantly below the 25% threshold before it becomes castle punitive.

Finally, custodial deposits average 7.3 billion in the quarter, an 18% increase compared to the prior quarter against the she's just another benefit we get from our Subservicing business as it provides liquidity that helps fund that balance sheet.

Our subservicing business continues to flourish and be successful when combined with our mortgage origination capabilities. We believe the scale and quality of both operations give us one of the most valuable mortgage business models in the industry.

This concludes our prepared remarks, and we will now open the call to questions from our listeners. Thank you. If you would like to ask a question. Please signal by pressing star one on your telephone keypad.

Your phone please make sure that your mute function is turned off to allow your signal to reach our equipment again that is star one to ask an audio question well pause for just a moment to allow everyone the opportunity to signal.

Our first question [laughter] Mayo from Raymond James.

Hi, Danny.

Hey, good morning, guys congratulations.

Congratulations on a great quarter.

Just wanted to talk a little bit about first the you know that.

You know the sustainability I asked this last quarter, but clearly holding up and the inability of the warehouse yields if you're still able or you know given kind of the competition there, but if you are still able to charge a.

These higher rates for for clients using that period end balance sheet or if there's some other factor going on there and if and if if you envision that changing at all going forward.

I do not envision that change we are we have not had to comp at all on any of our any of the rates that we are charging as you probably know Danny most if not all of these warehouse lines are at their floors.

So I think the sustainability of the yield is.

The likelihood of that is pretty high in terms of the balances as Reggie noted through the <unk> through yesterday or so we're at 7.4 billion dollar average balance that's far in October so that's hanging in there as well. So I think you know I mean, we do have a disciplined concentration policy and so.

Great well.

Well it will be measured against our capital growth, but I think.

I think the opportunity there going towards.

The strong let me Steve Reggie has anything you want to add to that.

No no nothing to add I mean, we've got a fairly disciplined approach we like that business. We think we can get paid for it and we're seeing more and more.

For two entities as our competitors struggled to execute.

All right terrific.

And then maybe just stepping back a little bit you know it's.

As the potential for equal your steeper yield curve comes into play here.

If you could talk about what levers you have to pull you know kind of overall in order to mitigate that how that might impact the business.

The business overall and then.

You know you've talked a lot about.

Capacity being you know outstripping demand on the on the volume side on mortgage for for the last several quarters.

How much of that you know maybe maybe a delta there is there that if you do see we do see a steepening yield curve and lower demand before you would see a significant reduction in.

What kind of volumes on the mortgage side. Thanks.

Yeah, well you know, it's hard to look out that far into the future Danny but I guess I'd say this I think our view is that we've got some runway in the mortgage business and we're going to continue to take advantage of that as long as we can you know should we see rates start going the other way a stick to your curve I think there's other piece.

Is that the business that kick in at that point that might mitigate that could probably would mitigate any reduction we'd see in the mortgage business. Let me see if lee or anybody else wants to add anything to that I agree with those comments Danny you really have to look at the palace model, we have and so while that could you know crimp the mortgage business a little bit I think about how.

Well the servicing business would do in that kind of an arrangement and think about how the community banking business is going to perform.

In that scenario and so you know were not really able to predict where rates are going to be obviously, but are we positioned the company to do well, regardless, where they're going to be yeah, that'd be she's late so I want to emphasize that the diversified model Weve always said, we can be successful whatever happens to interest right. So wasnt really anything.

Thanks, Rob and Jim have said on the mortgage side and we've said this before you know 70% to 75% of that expense sees a variable or semi variable and so as the volume goes down you're going to have some natural flex your expense base as well.

That's terrific appreciate all the color maybe just the last one on on that on the expenses you mentioned you know.

Lower than that than they have been running in the quarter related to mortgage you mentioned that the.

Opus advisors incentives have come out is that.

Is that just the driver there and you think that that percentage is going to be lower than kind of what weve seen prior to this quarter going forward.

Yes, the main driver for that Danny Danny East, a Oh of course, Oh now coming to an end and so that's come out you won't see going forward I think in terms of where are you seeing the run rate on mortgagees, we'd got Shaw I think slide 42, I think that's the Z code give us.

Hi, I'm a way you can expect expenses to be as a percentage of closings.

Okay.

Terrific. Thank you for all the color.

With that thing.

Our next question will be from Scott Siefers from Piper Stanley.

Good morning, Scott. Good morning. This good what is actually JV Benjamin on for Scott. Thanks for taking my questions.

After start again.

Yeah, I'd say on margins held up very well with some benefit from the securitization transaction quarter. I was wondering if you could clarify what that benefit was this quarter.

How much of the benefit was from the RMBS, Yes, yes slows down.

No, but it was it was rather.

It was.

Sizeable, but Ah, it's only maybe half of that.

After that benefit the other half was really what I call other execution improvements to be made on the school side.

I'll just jump in on Jim's Roy <unk>, whose RMBS, we got better execution around to hedge and we did see an increase in and no doubt correspondent channel quarter over quarter from a margin point of view, that's our biggest channel volume won't so those were the three drawings.

Perfect. Thank you and then one follow up.

We see it the the clarity around.

Decrease in deposit cost was wondering more Moreover, could you tell us a little bit about what additional levers you could flex on the net interest margin or whether its balance sheet movements more deposit cost deposit cost leverage et cetera. Thanks.

Well, so I think we're pretty we feel pretty confident that the yields are going to hold because of the influence of the warehouse side and on the <unk>.

But are there still some run off from a higher rate Cds that are going to come into play and the and the stronger discipline. I mean, let me comment on that yeah. I think one of the things we've been pleased with this year is.

The image Ford has happened with the CD portfolio, we've been able to him to move that into a lower cost products. We know because of the maturity schedule. We've got additional opportunities for the balance of the year. So we would expect that trend to continue.

Perfect. Thank you very much.

[noise] Yeah welcome.

Our next question will be from Henry Coffey from Wedbush.

Yes.

Morning, everyone and thanks for taking my questions.

Two specific carriers or once you know you talked a little bit about the Ginnie Mae He bought E B O opportunity.

Exactly how does that work.

Especially those with the servicing you may own or with the servicing you may be subservicing. So what.

I mean, I I know, what's the capital impact et cetera, but I'm thinking about it more as it as an opportunity.

And what is the governor behind converting that 1.8.

End of loans in forbearance into E. B O and then EBITDA went to re.

Re securitization gains.

Yeah. So let me take these Henry and then Jim will probably want to point in terms of the the 2.5 billion Genie iOS, we referenced in the 1.9 sites that are on the back.

They are on the balance sheet, because the borrowers are in forbearance that easel flagstar around Jimmy I saw so that flagstar owned E. B a those the accounting consequences I mentioned in the prepared remarks, I mean do you what do you do you own them or you're just putting them on your balance sheet.

We were putting them on the balance sheet, we have not bought them out and this is where.

And this is where you'd want all explained the accounting consequence of owning the M. I saw you used to show them as an early boa out whether you bought them out or not and so the biggest impact for roasteries against capital.

These loans were all performing prior to the pandemic and we think a big portion will go back to making payments and get reach Daiichi. After the full barron's period expires either on their own well through the partial Klein process once the reinstated they no longer categorized as need be up so.

A small number will get more of the folly to outgrow our you know get modified in conjunction with the partial Cline.

If that's the case, we will then be laid them out and realize the gain on sale benefit of re securitizing, the modified loans <unk> and what is the size of that number.

We don't know yet.

We don't know yet well keep remember you've got to remember that the first six month period pose a camera Soc. The full balance is expiring now I'm. So borrowers that have the option to extend for a second six months all they can opt out because they just continue to pay and they don't need pull back.

Parents, who were sort of working through.

Those loans that don't want to extend and we can either correct for a partial client process for a modification on a partial client. So we're working through that but we cannot say right now ex marks the spot because there's so many moving parts.

Have you looked at the one on the <unk>, though the one point.

The 1.8 billion in foreclosure.

In Ginnie Mae.

It seems coherent speeches.

So I'm, sorry, I misspoke and not so good if you look at the 1.8 billion in forbearance.

In Ginnie Mae land those.

Those are counted as delinquent right.

And so if they go 180 or longer delinquent is is there an opportunity to buy the loan out or.

Oh, yes, I'm thinking about it from an opportunity point of view not from a capital constraint point of view, yes.

Point $8 billion of loans that.

Our.

Surely healthy that that are that are still theoretically in delinquency status when forbearance is over.

And then they have to get don't they have to all go through some kind of modification to get.

Get current and.

Restate no principal and all those sorts of things that we see in with Fannie and Freddie loans or.

No not all of them some of them some of them have continued to pie and so they remain current and they will just take out some of them will get corrected through a partial client process only and then those that need to be corrected through a partial client and a modification.

Oh, just on modification then yes, we will boy those out but this is a CLIA waterfall that you have to follow but we don't know is how much each one of those buckets correct.

No no. This is helpful. I'm, just I'm thinking of it more as an opportunity that is a problem because you have lots of liquidity and you have lots of capital.

Yes.

No comment.

You know could could have some upside we just don't know what it is at this point right.

We haven't quantified that yet, but also keep in mind that a lot of our sub servicing clients [noise].

You don't have a good relationship with us and whatever that opportunity as I'm sure, we'll be able to partner with them to develop the opportunity as well with within their own loans no.

No no I agree I'm, just trying to figure out what the what the benefit ultimately could be gain on sales for the fourth quarter. The number was the revenue number you quoted me could you give that to me again Lee.

At 200, 200 200 million. So that's that's that's obviously down from what we saw in the last two quarters and is there going to be sort of a disconnect with locks being down because of the seasonality of the business.

But originations you know actual closings still being fairly high and then you get some cost compression in there or how do you think that plays out.

Yeah, no doubt about it but I think you'll find the closings will remain strong because originations will fallout adjusted locks were hard in Q2 Q3. So we're going to continue to push those closings through into the fourth quarter fallout adjusted locks that there is going to be a reduction.

In volume and marching up because of the seasonality that we usually see in Q4 fewer business days in the winter months affecting the poetry, Smokies particular, and if you look at the agency and MD I pull cash they got volume coming down in Q4, as well consistent with what I've just said no.

Hi.

How how all these ipos affecting the competitive landscape for you all right now.

Secret number to call. If you include the specs were six since August so.

Yeah, no it's not it's not impacting us at all from a business point of view, what all I would say, though is I won't be sweet thrilled to see a number of new investors looking up mortgage favorably or I would hope and think that that could bring more new investors into the flagstar stop.

I can I can only agree with all of that so thank you. Thanks for the <unk> because the comments. This is very helpful and congrats on a great quarter.

Thank you.

Thank you our next question from Steve.

Rallies security.

Hi, Steve Hi, good morning.

Most of my questions have been asked here, but just on credit here is kind of curious with regard to where our criticized and classified loans. These days.

Yeah. We're wondering the same thing, we really don't see them in our portfolio.

Yeah, Okay honestly.

Got to be facetious, I'm being honest with you we.

We we said this last quarter on a precautionary, Matt you know basis when.

When loans were up in deferral, you know, we took a stance unless proven enlisted proven that those loan should be passed watch still pass that they're not they're not that criticized.

But at this point in time, we're not seeing a significant amount of criticized.

Criticized loans in our own portfolio.

Yeah, you know if you don't.

You don't want to get over confident about that and that's why my comments are cautious around.

What might happen going forward and that's why we've we've.

We've taken the liberty to push our A.C.L. as high as we think we can given the economic scenarios that that our model uses and the qualitative adjustments that were permitted to make I mean, we're pushing it as much as we can because we're just gonna be careful here. So we're with you you know we we we were.

Under like why.

Well surprise really and and but please let us hold that up as strong as it is.

And you know I guess, we'll wait and see as as we get through the pandemic <unk> how it all shakes out I mean, right now I don't believe that we're going to use us. This reserve I think our sponsors are are up high integrity and quality and they're going to work through these.

Difficult times, and we're going to be okay, but if were not as I said you know were hope for the best but we're we're we're prepared for the worst should it happen and go back to my comments in my prepared remarks about what our view on the economy as both in terms of Cecil add.

And we're not yet convinced that we've got a V shape recovery.

Yeah, and remember you know look at the balance sheet, you and identify what really our commercial loans in this organization if you take away.

Are the lows our residential loans that are available for sale and you take away the warehouse loans, where we've had only $5 million of losses over the last 12 years, including through the great recession.

The the the part of that prefer to that's really exposed to two losses is small compared to the size of the company and compare to a typical there.

Midsize bank with $29 billion in assets.

Okay. That's helpful and then on the return on the mortgage servicing asset just kind of wondering you know how sustainable.

Low income is here you know what would the downside potentially be let's say mortgage rates come down another 25 or 50 basis points.

Let me, let me comment than Jim might want to add here look I historically, we've been pretty satisfied if we can get a 4% to 6% return on our MSR asset and we've consistently been able to do that or better at times because of the particular market circumstances, but.

We haven't achieved that in a particular quarter, but what you saw this past quarter was particularly phenomenal and to think that that couldn't happen quarter over quarter. I think is unlikely, but I think if in your model you're looking at four or five 6% return on the MSR asset I think you're going to be in pretty good place yes.

Yes, I completely agree with that comment look I mean this quarter was just you know things bounce the right direction for us.

But part of it also is you know we've been very cautious in how we value that asset we can be made some remarks last quarter that we took up we took a very conservative pen to the fair value on that asset in second quarter and taking that conservative Penn is just going to set you up to be at the.

High end of the range that that Sandro you know outlined there I might add you got to have really good people and we have some really really good people that manage that asset.

That's helpful. And then one last question just in terms of expenses dedicated to the bank 10 million quarter over quarter kind of curious is that the new level.

New level run rate.

I'm, just thinking about that going forward.

Yes, so in my prepared remarks, Steve there was a comment that some of it was.

Credit that was in last quarter, it isn't going to recur and that's having to do with the capitalized origination cost and the P.P. loans, we sold those in July.

The other there was some there was some costs related to the M. The MP secondary that happened last quarter.

That said triggered some some payments under some executive compensation arrangements those are not going to recur. So there's just some some nonrecurring things that are inflating the level.

Oh Q3 expenses right now and deflating Q2 expenses.

So to answer your question, it's not a new relic.

That's helpful. Thank you very much I appreciate that.

Well thank you.

Thank you our next question from Bose George from KBW.

Hi, Bose you guys. Good afternoon, Hey, you have to keep most of mine have been asked as well, but a couple of little things you already spoke about the NIM a little bit but can you just talk about you know how it looks next year. If you know rates remain the same but its mortgage banking it slows at some point and what that does with the you know the warehouse.

Business and loans held for sale, just how that impacts the margin.

Next year.

Look I think I think the if rates remain the same I think that we're in a pretty good position to sustain our net interest margin. That's hard for me to look farther out than a quarter and you know Jim I think both Jim and I suggest that for the next quarter, we feel pretty good so.

So going out farther Matt, Matt I'm going on in Ilim here, but I'm not sure pretty good about what what our position is there I think even if the mortgage business declines in the numbers that are the M.B.A. Fannie Mae Freddie Mac think next year I think that the warehouse balances can stay pretty strong because we're gaining market share and that.

Area and we could do more than were doing right now, we're being pretty selective about who we're doing it with.

And and we're being pretty firm on our pricing. So you know I think that the prospects for warehouse being strong even even though.

Weaker mortgage market are pretty good but.

Hey, you know how things change from quarter to quarter. So it's pretty hard to go out and talk about next year, Yeah, I also add to that.

Yeah. If you look a couple of quarters ago warehouse balances were lower even <unk>, even in second quarter they were lower.

We're still delivering you know pretty pretty consistent levels of net interest margin, excluding those loans with government guarantees we talked about so I think there's room to have the warehouse balances rotate down that that we think thats going to happen. This Sutter said, but I think there's room to have those rotate a little bit.

Lower.

And still be able to sustain that and net interest margin at the levels. We've been reporting the last couple of quarters.

Okay, Great. That's helpful. Thanks, actually just one more on the the Ginnie Mae buyouts no. Some of your peer banks it purchased quite a bit of this ahead of you know sort of curing. There's somebody is I'm just curious what your thoughts are there is it are they sort of institutions would just liquidity to park somewhere just thoughts why.

There's been a fair amount of buyouts already.

Yeah, I mean, both as you know we don't comment on of the institutions and what they do and I'll kind of any comment on our approach and you know I think helping over that we will buy them out or where we can modify.

Modify either outright or as part of a partial climb and re securitize, yes, there's no benefit to buying them out quickly, but that we see there buying them out as also permanent so you can't undo that and so when we buy them out he was talking through with a head.

He is earlier question, we're going to be sure that that we want to buy out the loans that that we're buying out.

Okay that makes sense thanks, guys.

Hi, Carlos.

Thank you I'm showing no further questions at this time I'd like to turn the call back over to our speakers for closing remarks.

Thanks Kerry.

My closing for the second quarter I talked about how the calls for social justice in the world around US had inspired a cultural change at flagstar, how in the past we have not communicated much with our employees about what was going on in the world.

How we set out to change that and how we're not turning back in the third quarter. We continue to engage employees on issues that are important to them. It continued with our diversity equity and inclusion initiatives. This is not a passing fad for us it's the real deal fundamental cultural change, we're changing the composition of our leadership team and we will change.

The composition of our board of directors to achieve more diversity, we're putting money behind support for minority small businesses and nonprofits that support the Eni, we're taking a harder look at our hiring practices and we're taking cues from I'm pleased about how we can do better and I'm doing my best equipped the arm on fellow bankers and business leaders through.

Organizations, they belong to to support the Eni and their own companies.

Hi, well first because it's the right thing to do and second because I firmly believe that makes for a better company. These past two quarters also happen to be the best in class starts history is it a coincidence or is there a connection with our cultural change in my mind. There's no question about that the seeds of the success that is playing out today.

Were planted when we recruit a top notch executives to run our businesses. When we built the front about risk management structure, when we carefully diversified into commercial lending when we developed our fee and deposit generating subservicing businesses and when we leverage relationships, we have nurtured for years to make warehouse lending a profitable low risk.

Operation not one of the top five warehouse businesses in the country, but I have to think that what we're doing on the d. and I front, it's not just underpinning, but it is accelerating our success well much better company today and expect to be even better in the future because of that.

Last but not least thank you to our employees who own this success I'm going off of what you have accomplished and circumstances beyond the imagination.

And thanks to everyone who has taken the time this morning to hear the story of a most successful quarter talk to you in January please stay safe and healthy.

Thank you ladies and gentlemen. This concludes today's teleconference. You may now disconnect.

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