Q2 2019 Earnings Call
[music]. Please standby were about to begin.
Ladies and gentlemen, thank you for standing by good day and welcome to the Flagstar Bank second quarter 2019 earnings call. Today's conference is being recorded at this time I would like to turn the conference over to Ken Schellenberg. Please go ahead Sir.
Thank you Paula and good morning, welcome to the Flagstar second quarter 2019 earnings call before we begin I'd like to mention that our second quarter earnings release and presentation are available on our website at flagstar Dot Com I would 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 and our press release and in our 2018 Form 10-K , and subsequent reports on file with the FTC.
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 the 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.
Thank you Ken good morning to everyone listening I appreciate your taking the time to join us today.
In addition to Ken I'm joined this morning, but generally Chief Financial Officer, Lee Smith, our Chief operating Officer, Christopher color President of mortgage drew Ottaway Afrezza banking see similarly, although our chief risk officer.
As usual im going to start the call by providing a high level view of our performance for the quarter.
Then I'll turn the call over to Jim for details on our financial results.
Lee will follow with a review of our business segments and strategic initiatives and I'll conclude with guidance for the second quarter.
For opening up the line for questions.
Overall I was pleased with our results for the second quarter top line revenue growth and effective expense management combined to produce positive operating leverage our adjusted net income of 41 million or 71 cents per diluted share exceeded the 37 million or 64 cents per diluted share we achieved in the previous quarter, but was down 18% from the same quarter last year, driven by the breakdown of our commercial loans and live well financial mortgage loan originator, which we disclosed as a concern in our first quarter 10-Q.
I'll touch on this matter more later.
It's important to note that the increase in non interest expenses is mostly attributable to a nice bump in mortgage originations during the quarter.
Especially in our growing retail channel Commission expenses are directly tied to originations.
Results from the quarter demonstrated once again, how our unique business model worse in this case, an unexpected drop in interest rates that put pressure on interest margins presented us an opportunity to significantly increase mortgage revenues, which helped produce a solidly profitable quarter.
It's an example of our flexible business model in action.
To expand on the commercial loan to live well, we experienced a $30 million partial charge offs.
After they unexpectedly ceased operations when we came to learn that the collateral supporting alone was not worth as much as had been consistently reported to us.
No there were some unusual circumstances around this credit as evidence by the ongoing law enforcement and FCC investigations. It would be an understatement to say that I am extremely disappointed that this happened at all.
We have conducted a rigorous pull smarter and have taken every step to reduce the likelihood of a re occurrence or an event like this.
Additionally, we are actively pursuing all legal remedies, both within and outside of bankruptcy proceedings.
This of course means that we may not be able to provide you with more details at this time.
Turning to our banking business, we once again have a solid story.
Net interest income grew 10% compared to the prior quarter driven by exceptional growth in earning assets.
This growth was led by a 70% increase in warehouse lending as we benefited from the proactive management of utilization rates, coupled with seasonally higher mortgage market.
We continue to see stable growth in our commercial and industrial commercial real estate and consumer lending portfolios.
On the strength of relationships our teams have fostered over the years.
While we have seen pressure on yields we have not compromise any of our credit standards and we have passed on a sizable number of opportunities due to fend spreads.
Our servicing segment continues to grow nicely and its contribution to our bottom line keeps growing each quarter solidifying our position as a key player in this space.
Our mortgage team delivered an outstanding quarter, they maintain pricing discipline and focus on optimizing and expanding margin.
Gain on sale margin improved 70 basis points compared to the first quarter.
The spike in mortgage originations that we saw in March carried over into the second quarter and our team did an excellent job of identifying opportunities to grow volume and expand margins while carefully managing capacity.
Well a lot of adjusted locks Rose 8.3, Doug a 26% increase from last quarter.
When you put this all together the result is a quarter over quarter increase in mortgage revenue of $25 million and industry, leading 45%.
Looking ahead, we have increased our projection for total originations for 2019 only slightly.
For the most part we see the year shaping up as we had projected in terms of the overall size of the origination market.
The key will be if we can continue to grow mortgage revenue as we did in Q2.
We do believe capacity as adjusted a bit and pricing has become more rational this positions us well to leverage our strong customer relationships, our commitment to service and the consistency of that service qualities that are the backbone of our competitive advantage.
In closing it was a quarter that highlighted a primary strength of our business model, our ability to consistently meet earnings expectations without adding significant risk.
All of our business segments are critical to our success and we can leverage anyone depending on market conditions to help us continue to deliver consistent and durable earnings.
That concludes my comments now let me turn it over to Jim.
Thanks Sandra.
Turning to slide six our adjusted net income this quarter was $41 million or 71 cents per diluted share.
Even with a $30 million charge offs.
This performance compared to the $37 million or 64 cents per diluted share and adjusted net income last quarter.
This quarter was highlighted by revenue growth of 20% leading to strong operating leverage of 8%.
Our results for the quarter were led by strong growth in net interest income.
At a higher level of mortgage revenue.
We'll discuss earnings in more detail when we get slide seven.
Asset quality negatively impacted this quarter by the $30 million look well loan charge off discussed earlier.
As a result, our nonperforming loan ratio increased 30 basis points. Additionally, we reduced our reserve by 17 million, mostly driven by the full pay off of three substandard loans, but also due to the continued low levels of charge offs and the rest of our loan portfolio.
Our allowance coverage of the loan portfolio decreased the 0.9%.
Reflecting the charge off activity for the quarter.
The reserve reductions.
Strong growth in period end warehouse loan balances.
I'll provide more details when we get to asset quality.
Expenses also scaled nicely this quarter show only 12% growth that we actually do a 20% increase in revenues.
Mortgage origination volume drove $20 million increase.
On the basis of $1 billion period end loan warehouse loan growth.
Our capital ratios were lower this quarter.
While the total risk based capital was 11.6% at June Thirtyth. This capital ratio would have been relatively flat to last quarter without that warehouse loan growth and we believe those warehouse loans have little to no credit risk.
Capital simplification will improve this ratio by 38 basis points. It will take us through a more extensive analysis of our capital later.
So, let's turn to slide seven dive deeper into the income statement.
Net interest income grew 12 million $138 million for the second quarter, which was 20% higher than last years second quarter.
And excluding the fourth quarter was 29 million dollar hedge gain surpassed $130 million in a quarter for the first time.
The results primarily reflect a 9% increase in average earning assets led by 22% growth in average commercial loans.
On the basis of this loan growth the net interest margin was relatively flat.
We'll discuss earning assets more on the next slide.
Non interest income increased $59 billion to $168 million.
For the quarter benefited from a $25 million reduction.
The fair value of the DJ settlement liability.
The lower value of this liability reflects a reduced likelihood and longer timing for any payments that will be made related to the settlement agreement.
Excluding the DJ benefit second quarter, non interest income increased $34 million or 31% to $143 million.
The increase was led by mortgage related activity as mortgage revenues increased $25 million.
Loan fees and charges increased $7 million.
Our gain on sale revenue of 75 million, representing an increase of $26 million or 53% from the prior quarter.
Improved gain on sale revenue was driven by a 70% 70 basis point increase the gain on sale margin as our mortgage team targeted higher margin sales channels at more attractive prices instead of chasing volume.
Additionally.
Fallout adjusted locks increased by 26% for the quarter.
As you'd expect the return on the mortgage servicing asset decreased by $1 million due to lower rates impacting prepay speeds.
Our treasury team did an exemplary job in hedging our MSR position, despite the volatility in the quarter.
In fact due to the changes in rates during the quarter and other factors, we had a negative impact to our MSR position of $40 million and we were able to sell hedge $39 million that impacts and still deliver a return of 6%.
Load administration income decreased $5 million or 45% driven by an increase in interest paid on facility will deposit.
Saw significantly for the quarter.
I'll cover the increase in average custodial balances later.
Non interest expense was $214 million up 23 million in the prior quarter.
The increase was primarily related to mortgage volume driven expenses, such as commissions loan processing and compensation.
Due to higher levels of production and a shift in mix towards the retail channel.
The remaining expense categories were relatively flat with prior quarter, demonstrating the scalability of our business.
I'd also note that our effective tax rate increased to 19% as a result of the DJ benefit in the quarter.
Nonetheless, we expect that our effective tax rate for the full year will be at or slightly lower than our weight.
First quarter, which was 18%.
Freight costs reflected the will charge off this quarter as well as a higher level of charge offs coming from the unsecured loans that we acquired with the Wells Fargo Branch acquisition.
These smaller balance loans at a higher rate of losses, and therefore have a higher interest rate.
The charges this quarter represent some cleanup of that portfolio that came with the acquisition.
Well that deep rooted credit quality in a couple of slides so let's move to slide eight which highlights our average balance sheet this quarter.
Average loans held for investment grew 1.4 billion driven by an increase in average warehouse loans and well balanced loan growth across our remaining it doesn't for loans held for investment portfolio.
We saw more opportunities in the quarter, but high quality loans in the portfolio, especially in the warehouse CDAI and non auto indirect portfolios.
It's one of those assets and margin the core deposits, while keeping the net interest margin flat to last quarter. The fact, there were over 500 million of additional warehouse lending opportunities in the quarter, we didnt take as we thought the spreads between era.
Both an average warehouse loans was a product of actions we took to grow net interest income by leveraging the lines, we acquire them in warehouses acquisition in early 2018, while also experiencing seasonally higher volume.
The non auto indirect loan growth reflects the continued growth of the business as average balances increased $154 million or 84% compared to the first quarter.
Also during the quarter, we managed the loans held for sale portfolio to a lower level than would be expected considering the increase in origination volume and we decreased the available for sale securities.
Both actions were taken to rotate into higher yielding assets.
To support this quarter's loan growth.
Average deposits increased $1.3 billion or 10% in the quarter driven by a higher custodial community banking deposits.
Average custodial deposits was $936 million or 37% from a higher level of loan prepayments underlying our servicing portfolio.
The growth of the number of accounts serviced and seasonally higher levels for Ts Grace.
Total retail deposits grew 332 million or 4% for the quarter.
Finally, our tangible book value per share increased $1.51 to $26.16 per share.
So, let's turn to asset quality on slide nine.
As noted earlier the quarter was significantly impacted by the live well loan that is partially charged off and placed on non accrual status during the quarter.
At June Thirtyth, the slowly been charged down to 37 million, reflecting our estimates of the value of the underlying collateral.
We expect to take possession of the collateral at some point during the third quarter and we are evaluating the most appropriate course of action.
Session.
Excluding the impact of live well credit quality in the loan portfolio remains strong.
Early stage delinquencies continue to be negligible.
Only 8 million of total loans were over 30 days delinquent and still accruing at June Thirtyth and improvements to the level of delinquencies last quarter.
At June Thirtyth, our allowance coverage was 0.9% of total held for investment loans.
I'd point out that this coverage reflects 23% of our loans held for investment in warehouse loans.
Our warehouse loan portfolio has little to no credit loss content as these loans are fully secured and we control collateral.
Excluding warehouse loans from the denominator given their relatively clean credit loss history, our allowance to loans held for investment covered ratio would stand at 1.2% in June Thirtyth.
Still relatively strong in the industry.
We continue to work toward implementing Cecil and intend to provide a more comprehensive update as we get closer to adoption.
With that being said, we don't believe the investment this quarter, including the reduction of our coverage ratio has impacted our overall view that we are set up as well as any mid sized bank for whatever seasonal impact might be.
Turning to slide 10 capital remains solid.
The total risk based capital ratio was 11.6% at June Thirtyth.
This represents a cushion of 226 million of total capital over the minimum level needed to be considered well capitalized.
Final capital simplification regulations, which take effect in Q2 of 2020 will increase this ratio by 30 basis points.
As I mentioned earlier, our risk based capital ratios declined as we had $1 billion warehouse loan growth during the quarter.
This factor alone reduced our total risk based capital ratio by 85 basis points.
Our target operating range the size of the strategic flexibility buffer and the stress buffer above well capitalized status.
Our all important wire stress tests.
Due to the very low level of losses that we would expect to have for the warehouse loan portfolio that even at adverse economic scenario.
Combined with our expectation in our warehouse loan balances declined seasonally in the second half of the year, we remain comfortable with our capital levels at June Thirtyth.
Our tier one leverage ratio was 8.0% at June Thirtyth.
41 basis points from last quarter.
Capital simplification will increase this ratio at 63 basis points, which will put us at the upper end of the target operating range of 8% to 9%.
I'll now turn to Lee for more insight into each of our businesses. Thanks, Jim and good morning, everyone. We're very pleased with how quickly we pivoted during the quarter, so maximizing revenue and earnings from our mortgage business given the lowest 10 year Treasury note right.
As we saw healthy increases in both fallout adjusted locks and gain on sale margin quarter over quarter.
Average, earning assets increased the commendable, 9% almost 1.5 billion.
As we experienced positive growth in all consumer and commercial lending channels.
The warehouse lending business, we acquired a little over year ago is paying dividends as we increased average warehouse balances, an impressive 70% or 822 million quarter over quarter.
Average deposits increased 1.3 billion or 10%.
I will now serve a single Subservicing, almost 1 million loans under the Bic largely self service in the country, which provides us with another source of stable earnings.
We're obviously disappointed with the lead well commercial long partial charge off a further $2 million during the quarter. After they abruptly unexpectedly ceased operations.
We are confident that the situation is not reflective of superior operation in our remaining commercial portfolio.
On the underlying collateral so these along with unique and not something we have elsewhere in that book.
We ended the quarter with almost 20 billion Xenapp rejects and have once again demonstrated the flexibility of our business model, where the different businesses Act as a natural hedge meaning we can generate stronger earnings in any interest rate environment.
I will now have launched some of the key operating metrics from each of our major business segments during the second quarter.
Please turn to slide 12.
Operating highlights for the community banking segment include.
Average commercial and industrial and commercial real estate loans increased $294 million or 8% during the quarter.
On the growth was evenly balanced between the two portfolios.
Average consumer loans held for investment increased $333 million or 8% during the quarter as we have in high quality non whats so indirect loans. He locks on first lien mortgages to our portfolio.
Average warehouse lending loans increased a remarkable $822 million or 70% during the quarter.
Due to the increased activity in the mortgage industry, but also helped by our acquisition of a warehouse lending business, which has helped bolster these growth.
Given our organic ability to originate loans, both consumer and commercial together without relationship based approach. We believe we will continue to originate high quality consumer commercial and warehouse loan balances going forward.
Average retail deposits increased 332 million or 4% during the quarter, while custodial and escrow deposits increased $136 million or 37% given the high number of loans self service on the low writing borrowman, increasing refinance activity and therefore, leading to higher principal and interest balances.
We're very satisfied with the performance of our community Bank as it continues to grow and further diversify the earnings power of the bank.
Please turn to slide 13 operating highlights for the mortgage origination fees to be seen clue.
Fallout adjusted locks volume increased 26% to 8.3 billion quarter over quarter, while the net gain on loan sale margin rose 17 basis points for 24% to icing on basis points.
As a result gain on sale revenues increased $26 million to 75 million in Q2 versus $49 million in Q1.
The increasing fallout adjusted locks volume quarter over quarter was due to both seasonally high volume on the lowest 10 year Treasury note right and we were able to maneuver quickly in order to expand capacity and optimize earnings from our mortgage business.
We also maintained that disciplined pricing approach to ensure we focused on generating based mentioned the most profitable channels.
It should be sufficiently that enabled us to increase our gain on sale margins, 24% to eight.
Basis points quarter over quarter.
We will continue to take advantage of this low rate environment and remain disciplined pricing and capacity management in order to Maximise earnings from the mortgage business, while providing excellent service to our customers.
Moving to servicing quarterly operating highlights for the mortgage servicing segment on slide 14 include.
We service or Subservice, approximately 983000 loans of which over 816000 or 83 cents a sub service for others, making this the fifth largest sub servicer in the country as of March 31st per inside mortgage finance.
We've increased the number of long service will sub service, plus 440000 or 81% in the last 12 months and of being one of the fastest growing sub services in the industry during that period.
Today, we have the capacity to service will sub service 2 million loans as well as provide ancillary offerings such as recapture services I'm, calling on seem solutions to MSR arguments.
We recently announced that we would be acquiring the default servicing operation in Jacksonville, Florida exclusively supporting gas seriously delinquent mortgage loans, which is currently managed by third party.
The transaction is scheduled to close at the end of September .
With the rapid growth of our sub servicing portfolio. It makes sense to strengthen our capabilities on the default side and bring the operation back in house.
This acquisition further leveraging our industry, leading oversight and monitoring while providing clients the risk and compliance infrastructure benefits flagstar has to walk up.
The custodial deposits. These launch generate also help us fund that loan growth, we held $3.5 billion of average custodial deposits throughout the quarter, an increase of $936 million or 37% quarter over quarter.
We're very pleased with how we've grown our subservicing business felt about last night's a months I believe you will continue to see flourish as we move forward.
Moving on to expenses on slide 15, our non interest expenses increased 12% for 23 million to 214 million quarter over quarter, while revenues increased 20% or $46 million during the same period, excluding with the o'shea benefit.
This led to positive operating leverage of 8% Q2, as our variable cost structure and dynamic business model allowed us to take advantage of market opportunities, particularly in the mortgage business.
The majority of the increase in non interest expense was due to the increasing mortgage activity with 87% or $20 million of the 23 million increase quarter over quarter being because of higher mortgage production.
Our adjusted efficiency ratio, excluding the DLJ benefit was 76% for the second quarter, which was an improvement of 5% from the prior quarter.
If you break it down further.
Gain on sale revenues on loan fees and charges increased 33 million in the quarter, while costs related to the space mix increased $20 million.
Meaning revenues from other piece me slowing decreased $13 million and associate costs increased $3 million. The point being we have made thoughtful and deliberate cost investment decisions that have benefited the earnings of the bank and creating shareholder value.
We estimate non interest expense will be between 220 and $225 million during the third quarter.
The slight increase in expenses was all related to increased mortgage production volume.
It's been a solid three months, we pivot quickly and efficiently to take advantage of the low rate environment, particularly with our mortgage business, we saw excellent commercial and consumer loan growth together with strong deposit growth.
And our Subservicing business continues to prosper printing consistent non interest fee income to our earnings.
Given as diversified as flexible business model supported by our robust risk and compliance infrastructure. We believe were well positioned to continue to add value for our shareholders as we move forward.
With that I'll hand, it back to Sandra.
Thank you Lee Im going to close after prepared remarks with some guidance with Q3, and then open the call for questions and answers. Please turn to slide 17.
We expect net interest income to improve approximately 5%, while net interest margin will be flat or decline slightly.
We anticipate gain on loan sale income will increase 15% 20%.
We expect the return on the MSR to decline slightly.
All other non interest income is expected to decline by 10%.
As Lee noted, we anticipate non interest expenses to be between 220 $225 million and we expect the effective tax rate for the 18%.
This concludes our prepared remarks, we'll now open the call some questions from our listeners.
Alternative overview Paula.
Thank you Mr signal for a question. Please press star one on your Touchtone telephone also if you are using a speaker phone. Please make sure that your mute function is turned off to allow your signal to reach our equipment.
Once again it is star one at this time, if you do have a question one I will pause for just a moment to give everyone the opportunity to signal.
We'll take our first question from Scott Siefers with Sandler O'neill.
Good morning, Scott.
Hi, Thanks for taking my question.
I guess first question is just on the gain on sale margins I mean really really strong improvement this quarter and I. Appreciate the context, you put it in about the or regarding the <unk>.
Improved.
Basically by the just curious if you could talk a little about how much is left if you continue to enrich the mix of originations and then just on sort of a steady state in other words, if you had not improved.
The mix of originations what kind of trends are you seeing.
By channel on gain on sale margin.
I'll give christine.
Second to think about that but my reaction Scott is I think we've seen improvement in our margin in all areas of some more than others and I think that is because as we said in our prepared comments that we have really focused on optimizing the production as opposed to just optimizing volume.
And I think that has proven to work very well for us as I've said, we increased our mortgage revenue by 45% quarter over quarter.
I think that compares pretty favorably to other large mortgage originators.
Yes, Scott what I would add is the big story in the mix really came in bulk and so the way you saw the volume coming in.
Bulk we are seeing easily 1.4 billion a day and we just maintain the discipline there where the margin.
We're in terms of Volte channel choosing to do more in the retail originations as we said in our prepared remarks so.
The volume certainly is there it was the discipline around where we wanted to maximize that and take margin not just take the volume for volume sake.
Scott Lastly, I'll just I'll just add if you actually just look at Q1 over Q2, and this is going back to Sandro point the volume growth, we saw in multiple channels, particularly correspondent non doubt broker and retail and Thats, where we saw the margin expansion because those are the higher margin channels and we focused on getting the business for most channels, which is why.
The margin increase so much quarter over quarter.
But the real important point really more than volume or margin is revenue and thats. What we are focused on and the revenue growth is what I was most pleased with.
Yes, that's perfect. Thank you guys for the color.
Maybe to switch gears to the.
The live well situation.
Maybe just a comment or two about.
What's left and I guess, what gives you comfort.
That it's well secured I know there was.
Some questions on the collateral valuation that at the beginning so just maybe a little more color on.
If what's left if there's.
Any question or additional risk to it or do you feel like this with that.
Good very conservative.
Yeah, so to speak.
Yeah, we feel extremely comfortable with where weve valued the collateral and so.
No I can't say anything for sure of course, but we're confident that the ultimate resolution will be.
Similar to where we've marked the asset and then as we go through the lead legal process, perhaps there is other opportunities for recovery.
Okay perfect. Thank you guys very much.
You're welcome.
Moving on we'll go to.
Bose George certainly is.
KBW.
Hi, guys good morning.
Just a follow up on the gain on sale is the guidance for next quarter for the increase driven by volumes or margins or both.
Probably a little bit of both but I think more so on the margin than on volume.
But you never know Whos right. It's hard it's hard to know what's going to happen tomorrow, let alone over the next three months.
I think.
No what I'd like to emphasize is we'll adjust to where the opportunity is and so.
If theres more opportunity for volume at a narrow margin, but we think that brings us more net revenue. That's what we'll do and I think we've been able to show quarter over quarter that we can make good and swift.
Decisions on where the best opportunity is.
Okay, great. Thanks, and then actually switching to the guidance on the net interest margin.
Can you just talk about the drivers there and.
Are you incorporating the rate to rate cuts surge how does that work.
Well you know I.
Let's look at yields and then call it straight on the yield side as.
We noted in our prepared comments, we've definitely seen pressure on the yield side on the commercial book and so we're concerned about.
So how that is going to react not only from the pressure from competition, but then of course, if you get a 25 basis point decline in the fed funds rate next week, then you're going to see all of the adjustable loans adjust pretty quickly and.
You never know for sure just how quickly you can adjust the deposit costs to match up with that decline so.
We're a little cautious on that and so I think thats the.
Well, how does that answer your question, Jim you want to add yes.
The guidance, we've given for the quarter reflects what you see in the curve right now which is almost a certainty Saunders said it but we cut next week.
A small chance of a 50 basis point cut but we just go with what the market tells us when you focus then on the short term. The short end of the curve, we are slightly asset sensitive and I think Sandro said, it well that that slight asset sensitivity defines what our goal is in terms of managing our deposit costs, so well get out and we'll manage those deposit costs in a very thoughtful and deliberate way and we know we have to do to maintain that flat to down guide on NIM.
Yes, I'd say add the goals that I was very pleased that we only saw a one basis point narrowing of our margin this past quarter given all the pressures that we're in the business and the way the interest rate.
Interest rates, we acted over the last few months, so I'm pretty calm confidence that we can manage the margin reasonably well.
Okay. Thanks, and just one more just on the servicing fee. Your average servicing fee has gone up quite a bit over the last year.
I'm just curious are you getting better execution, just holding more excess servicing or mix shift or is anything else going on there.
Yes on the MSR, we're definitely holding more genie and that's having a positive impact on the carry and then we're holding to be drastic thats what you see.
Yes, both Jim.
In his comments talking about how how well our team manage that investment.
As you know, we do a lot of warehouse lending. So we see a lot of other companies and of course, the non more non bank mortgage companies don't.
Hedge their MSR and this environment were out in the last month to see only a million dollar deterioration and the value of our MSR is pretty remarkable.
And I think that shows.
How strong our team is in managing that in the side, David as leases that we've been able to keep that pretty much unchanged, despite increasing or decreasing interest rates I would add to that that track record goes back to.
For the team because back to 2016.
Okay, great. Thanks.
You're welcome.
Up next we have Steve <unk> with B. Riley FBR.
Good morning, good morning.
I guess just following up on the live while asset here just wondering what are your thoughts with regard to whether you retain the asset or liquidated.
Well I can I don't know I can't speculate.
Depends on what the market.
Opportunity is.
We don't have a desire to own the collateral long term necessarily but if that is the best.
That's the most efficient way to go that's what we'll do.
But as I said and to the earlier question.
I'm not too concerned about where we havent Mark I think we're in a good place with it and I think that we're going to be able to work through it reasonably well Jim.
What I would add to that is we did bring some consultants in to help us evaluate the collateral evaluate what our strategies in pricing was of collateral. So I'd say that that Sundress comments were really informed by.
What that consultant was able to.
Inform us about.
Respective collateral the pricing.
Okay, and then I guess just.
Digging a little further on funding costs and in particular deposit costs here, if we do see 50 basis points this quarter.
What do you expect for your deposit pricing.
Well as you May know, Steve I've been.
Mab generate did manage the.
Deposit base here for many many years and my philosophy has always been that on the way down.
I'll wait for others to move you move and so we will be aggressive and our adjustment of deposit rate that's been our history.
At a balance that against our need for funding so I.
I can tell you that.
Reduce deposit rates by 25 basis points at the fed drops 25, but but we're not going to be.
Overly cautious about it either I think.
Managing the deposit costs going to be important to extremely important and managing the margin and as Jim said were a touch asset sensitive and so the way to deal with added by being more aggressive on the deposit side, we're not going to be afraid to do that I think when you. When you look at our balance sheet, Steve you'll see all of the it's easy to see the assets that are going to reprice down.
Commercial loan portfolio. If you look at the FHLB looked at the interest we pay where were the sub servicer on custodial deposits.
You look at the trust preferred there's a whole host of liabilities will also priced sales so that liability.
As the liability sensitivity that shortly herb is really something that we feel was within our our ability to manage to whatever degree we have to manage it typically what we see in terms of the outbreak of that.
Jim on those sort of deposits was actually my next question.
The interest there is.
<unk> is an offset to a loan administration income just kind of thinking.
How do we think about that line item.
How index or those deposits, if you will and perhaps how going to translate into fee income for you guys.
Well Weve given you a up page to page two of the deck, it's actually slide 37 in the appendix.
That will I think give you a lot more information than we've ever done before and I'll turn it over to lead to elaborate yes, I think you're exactly right. Steve lung that mean income includes servicing and sub servicing fees lets the amounts paid to MSR.
Who knows so the interest on those escrow deposits and remember with Subservicing, 84% of the overall portfolio. The benefit flagstar received from those deposits shown an interest income.
So we does it doesn't match so under GAAP rules, which is why to Jim's point. If you look at page 37 of the deck, which is a new slavery.
We've included these non-GAAP services servicing profitability slowly, where we do Max interest income and interest expense from escrow deposits and as you can see from that just from a servicing profitability point of view.
We are achieving the $4 million to $6 million of operating profit pretax for every 100000 miles we app.
So Steve I think if you look at that page, it's interesting to look how the interest expense has grown quarter over quarter related to the ASCO the deposit.
It was noted in the prepared comments custodial deposits in credit availability no $1 billion last quarter. So there's a lot of impart firstly, the large part because of the prepayment of loans because the number of loans that we service really didn't change much quarter over quarter. So that billing of deposit that's all tied the LIBOR that ranges from LIBOR, plus a little LIBOR minus of something but it's all tied to LIBOR ours with the important point is so as alive, where declines the cost of those deposits declined immediately and Thats really really.
Missions for form of funding.
Alright, well, thank you very much for that.
You're welcome.
Moving on we'll go to Kevin Barker with Piper Jaffray.
Hi, good morning.
Good morning.
Justin.
Going back to some of the comments that Jim made on capital and the share buybacks, if acute August or pull back very little in the second quarter and then.
How the parties going forward.
Given where your capital ratio stands today and.
The amount of growth that you put on the balance sheet, especially in second quarter.
Well, let's just come back to the share buybacks. If you recall buyback we executed beginning of February and January was an accelerated share repurchase.
And the way that works is that we work with another we've worked with this investment bank.
And we execute.
Immediate buyback and then Theres a several up transaction later, which happened for us kind of mid second quarter. So really the way we think about it from a share buyback we've done in February with a small settle up.
He had that's what you're seeing come through Q2.
So we used our total 50 million of.
Of authorization.
But I go back to my prepared remarks, when we look at.
The capital ratios at the end of the quarter.
And you think about meeting.
Capital for the risk of possible loss.
I just don't when you look at the billion dollars worth of balance sheet inflation that we have which will also come down through the second half of the year from that warehouse loan increase.
It is not something that that.
Bothers us that concerns us and as the balance sheet deflate, you'll see the capital ratios come back up because of that and also because of the.
No just the earnings accumulation will experience over the next couple of quarters and not to mention kept both implications you hope that next year. So.
But to your point, Kevin we're managing capital very closely and making sure that the assets we put on the books.
Bring us the return that makes sense given the use of the capital and that's why you heard a couple of say in our prepared remarks.
We passed on quite a bit.
Quite a few opportunities that we were comfortable with from a credit point of view, but we couldn't get to hurdle from.
Earnings from Needham.
Okay.
And then.
Obviously were finally getting no credit and your loans held for investment pick up quite a bit here in second quarter.
And you gave guidance for the third quarter, but as you look into the slower or seasonal months in the fourth and first quarter.
What do you expect as far as.
No an average balance or do you feel like you can sustain.
Your current loan balances as we move through those quarters given.
The seasonality of the balance sheet at this point.
Well only speaking.
To the third quarter right and if you look at our guidance and we said that we think that net interest income is going to grow about 5%. So that would suggest that there isn't a significant growth in the balance sheet projected over the next quarter. So while we might see some growth here, we might see some decline there and in the past that and I couldn't comment.
So would you expect.
To be able to sustain that eni going into the fourth and first quarter, especially given that the shape of the yield curve.
Again, I don't want to I don't want to speculate on anything farther out if you look historically.
At our net interest income performance.
You can come to your own conclusions.
Soon.
Well, how we're able to perform in the fourth and first quarter.
I'd, rather not comment on that.
Okay.
All right. Thanks for taking my question.
Yes.
Henry Coffey with Wedbush has our next question.
Yes, good morning, everyone and good morning.
Okay.
Thank you for taking my question, it's interesting to see how quickly you can kind of turn on the mortgage machine.
Take advantages of the rate decline.
When we look at the.
When we when we look at the collateral behind behind by your mortgage warehouse loan that you're having issues with.
The press says.
Henry Let me correct, you just yet but that is not a warehouse loan.
We did have a warehouse well let me just explain we have two loans with level. One was of warehouse loan. The warehouse loan is completely paid off without any loss or charge offs.
The other long, which is secured by marketable securities is where the issue lies.
Okay, Yes, no. Thanks for clarifying that when you look at live well.
The press says that the problem was that you had ginnie Mae Io collateral.
That you and others that were exposed to that credit. We're we're counting on on GDB Io collateral, which obviously is a pretty volatile item I'm going to assume that's correct.
I would take from so I would take it from some of the remarks you made on the call that you don't have other loans. So collateralized is that accurate or.
Yes, that's accurate, but I also want to I want to say one other thing.
Maybe just.
A clarification.
From what something you just said.
The we do not believe that the collateral issue is related to market conditions I want to be very clear about that.
Theres a different problem that we're researching it's why I made reference to the law enforcement and the FCC investigation. We don't have all the answers to that I can't really comment on it any further but I just want to be clear that we do not believe that the collateral issue that we experienced and the charge off associated with that anything anything to do with market conditions.
So there's no you're not looking at your overall approach to the business as saying Oh, we need a better telescope here, you're happy with your telescope so to speak.
Yes, given the uniqueness of this particular credit credit absolutely now that doesn't mean, we don't.
Farm ourselves and.
Look deep into our operations to make sure that it couldnt be something similar but we've done that and I'm comfortable answering your question the way that the.
Great. Thank you the other thing kind of from a broader look.
A couple of banks have been talking about issues in there a C and D acquisition and development portion of their portfolio, which obviously includes both commercial and residential activity you have a pretty broad scope on that have you on that market are you seeing weakness in the CD business.
Strengths in the CD business because of where the mortgage market is what are you what are your thoughts on the overall tone of that sub portion of the lending market.
Okay, I'll, let drew a comment I'll just say so begin that we haven't seen any weakness whatsoever from a credit perspective. So we don't have delinquencies at any level and the ATM deal, but that drew I know you probably want to chime in yes.
Yeah, I mean, we're really happy with the way we've grown that book of business, it's very well diversified.
Bank seven of the top 10, we bank 51 of the top 103 are really tight concentration policies around what we take as collateral that mix of that collateral and how we monitor that collateral. So it suggests that we have.
Any any concerns today with that book of business. I think you know affordability is still an issue out there, but I think.
Price appreciation is slowing so we think there is ample room for us to continue to grow that book of business.
The opportunities are coming almost every week on our inner alone maybe we're seeing new opportunities in the space.
What are the are the the builders at the very low end of the spectrum, maybe that's not even the top 100.
The five trucks 20 homes, a year is that builder, having access to credit or is that builder in your view credit story.
I mean, I do think that I do think the market overall is still constrained by available credit we don't happen to bank builders like that we only bank large regional.
Builders do significantly more than.
20 houses and five trucks.
Great. Thank you very much.
Youre welcome.
Next we'll go to Chris Gamaitoni with Compass point.
Hi, Chris.
Hi, everyone.
I wanted to clarify one of the guidance points on the all other non interest income down 5% to 10% is that inclusive or exclusive of the D. J fair value change.
With that Neal Jay is completely excluded from any comments that we've made.
Okay.
That's helpful.
And then thinking about the.
Hfive growth, 5% to 10% quarter over quarter.
Is there any thoughts on kind of the composition of that is that strength in core commercial is is it homebuilder loans is it greater warehouse balances just wondering to kind of get a.
A better understanding of what's going on in the business to drive them.
And the best in the past partners, we continue to go forward guidance.
No the future guidance.
Yes, I think it's going to be very similar to what we saw in Q2 and honestly. That's what you see in just about every quarter for flagstar is that doesnt typically come in any one area Q2 as unique.
In that we had such a big increase in the warehouse business.
And there is a lot of reasons for that and touched upon it in our prepared comments number one.
Joe and his team did a really good job of maximizing the utilization rate so jumping on top of the opportunities that presented itself once the rates.
It is a little bit of a.
Room and refinance area.
Reacting quickly to overlying requests and things of that nature that allowed us to grow that.
That business that is really good.
In term perspective quickly, but otherwise it's very balanced against.
The CRB and inside of CRT with.
Builder Finance and then we'll see an eye and then also the continual growth of our consumer loan book than the non auto indirect has performed really well here in this year. So.
I wouldn't expect it to be much different June no I think that's exactly right. I mean, I think we have a really good mix of commercial and consumer and warehouse and I think we've been able to take advantage. We're in advantages presented themselves and this this quarter, we had an outsized advantage with warehouse, we jumped on and we have a great book, even within warehouse over 300 customers. So it's not like it's hyper concentrated in any one name and frankly the acquisition that we had last year. This has helped bolster those results but.
The Sienna is very well diversified in terms of your local core businesses a national platforms that we service CRB very very much. The same thing and then you can see the continued diversification and the consumer book of business, including the non auto and direct.
Perfect. Thank you so much.
Our next question will come from Daniel to mail with Raymond James.
Hey, good morning, guys.
Danny.
So this is kind of a.
Longer term question on the asset growth, you've obviously had very strong asset growth and deposit growth in the last several years.
Even excluding the wells branches I think you've talked in the past about kind of a $3 billion to $5 billion number over two to three years on an organic basis is that still something you think is achievable going forward here or how do you think how are you thinking about kind of long term balance sheet growth now.
Well growing growing the company is important and growing earnings for sure, but I think that we're at today given capital levels and the growth that we have achieved we've got to be careful that the growth that we have going forward.
He is meeting higher return levels and so we're very very focused on that and the opportunities are going to be there because we have lots of good people that have come to work at flagstar that have great relationships not only here in southeast, Michigan, but across the country and so we know that we're going to get the opportunities.
What we don't know as what are the opportunities will world.
To this a return that will be satisfactory to support the use of our capital so.
We're probably going to be a little bit more.
Cautious about that going forward, but only because of capital levels, but you know as we've done in the past we will take advantage of the opportunities that present the.
Themselves to us and we'll execute on them in a positive way.
And then.
How does the.
Kind of held for investment loan to deposit ratio, which has crept over 80% here factor into that or as far as capital still the the kind of the defining a threshold for how you're thinking about loan growth.
Well I think capital is defining threshold not to say that hfive or the ratio that you're referring to.
It's not considered but clearly I think capital Jim the degree, yes, and I think I understand it well, it's not that we ignore the modified loan deposit ratio, where we're cognizant of what our runway is from a liquidity standpoint, but as we look at it right now we have invested the capital that we have.
Improving the.
The outlook and the stability of the company now have the ability to buy back stock we initiated the dividend earlier. This year. So we have the capital management tools.
That enable us if we don't like the returns that we're seeing what's presented to US we can always sit back on the capital or maybe even by some of it back. If we think that's the right thing to do so we've got more tools available to us to manage that return on equity of mix as we as we go forward.
That said I appreciate it guys. Thank you.
Youre welcome.
And we do have a follow up from Kevin Barker with Piper Jaffray.
My question has been answered thank you.
Thanks, Kevin.
Thank you and now I'll turn it back to Mr. Sandro Dinello for any additional or closing comments.
Thanks, Paul offset it was a good quarter with solid contributions across the board from retail banking commercial and mortgage including servicing they all came through with strong results and this quarter in particular, we can see the payoff of our acquisitions Wells Fargo and DCB in the deposits that efficiently fund our loan growth focus and the strong performance of our retail mortgage channel and Santander and the huge upswing in warehouse lending plus the new businesses. We started such as our indirect nine auto lending are emerging as important contributors when you put it all together you get the profile of a unique bank with many diverse pieces work together and complement each other to deliver consistent earnings and long term growth and shareholder value.
In closing thanks again to the Flagstar family, we are outstanding performance, thanks to our shareholders for your support.
And thank you again for taking the time to listen in today I look forward to reporting third quarter results in October .
And that does conclude today's conference we'd like to thank everyone for their participation you may now disconnect.