Flagstar Bancorp, Inc.
Q1 2012 Earnings Call Transcript

Published: 1 May 2012

[Operator:]

Good morning. My name is Steve and I will be your conference operator today. At this time I would like to welcome everyone to the Flagstar Bank First Quarter earnings call. (Operator Instructions). I will now turn the call over to Paul Borja, Chief Financial Officer. Please go ahead.

[Paul Borja:]

Thank you. Good morning, everyone. I’d like to welcome you to our first quarter 2012 earnings call. My name is Paul Borja and I’m the Chief Financial Officer of Flagstar Bancorp and Flagstar Bank. Before we begin our comments, I’d like to remind you that the presentation today may contain forward-looking statements regarding both our financial condition and our financial results. These statements involve certain risks that may cause actual results in the future to be different from our current expectations. These factors include, among other things, changes in economic conditions, changes in interest rates and competitive pressures within the financial services industry, as well as legislative or regulatory requirements that may affect our businesses. For additional factors, we urge you to review the press release we issued last night, as well as our SEC documents, such as our recently filed form 10-K, and the legal disclaimer on page two of our earnings call slides that we have posted this morning on our investor relations page on flagstar.com. During the call, we may also discuss non-GAAP measures regarding our financial performance. A reconciliation of these measures to like-GAAP measures is provided in the tables to our press releases, to our press release, which was issued last night, as well as in the appendix to our earnings call slides. With that, I’d like to now turn the call over to Joseph Campanelli, our Chairman and Chief Executive Officer. Joe?

[Joseph Campanelli:]

Thank you, Paul, and good morning everyone. I’d also like to welcome you to our first quarter 2012 earnings call. I’ll begin today with some high-level thoughts on our first quarter. After I finish my remarks, I’ll turn it back over to Paul, who will take us through a more detailed financial review, including the business driver outlook. Afterwards, Paul and I, along with the rest of the executive team, will be available to answer any questions you may have. During the first quarter, we continued to experience significant improvement across each of our business lines, specifically within the mortgage banking business, where we generated record revenues and anticipate gaining market share. Consistent with our business plan, we continue to use strong mortgage banking revenues to help fuel the growth in other lines of business, thus diversifying and lessening the volatility of our revenue streams over time. Our first quarter pre-tax, pre-credit cost revenue was $206.3 million or $.36 per share. As you can see on slide five, this is more than double the prior quarter level, and significantly higher than any other quarterly level in previous quarters. This revenue, however, was offset primarily by continued legacy credit costs, contributing to a net loss of $.02 per share for the quarter. Although we incurred substantial credit costs during the quarter, which I’ll provide more color on in just a moment, we remained well-capitalized with significant (inaudible) at the end of the period. We also experienced significant improvement in delinquent loan trends, as we continue our emphasis on putting challenges associated with the pre-2009 origination portfolio behind us. We believe our core business drivers are all moving in the right direction, with our continued emphasis on enhanced risk management and controlling credit costs, as well as the favorable underlying credit trends we experienced during the quarter. We still believe that we are on pace to return to profitability during 2012. This assumes that no material adverse changes in our expectations of economic and business trends. Before I get into each of the business lines, I’d like to first discuss credit quality. For the quarter, credit-related costs totaled $213.6 million, as compared to $173.2 million in the fourth quarter. This increase was driven primarily by a $51.2 million increase in loan loss provision expense. Let’s first discuss the loan loss provision. The increase in provision expense from the prior quarter was driven by three key items. First, on our fourth quarter earnings call, we mentioned we would continue to enhance our loan loss model by incorporating more granular and segmented data. During the first quarter, we made refinements to both our allowance for loan losses and representation and warranty reserve models, inclusive of improved risk segmentation and quantitative analysis and modeling of the qualitative risk factors. We believe these are consistent with our ongoing risk assessment process, focused on the impacts of the current economic environment and related borrow repayment behavior on our credit performance, back testing and validation of the results of our qualitative modeling of the risk, in efforts to use better quality information. Such is consistent with the expectations of the bank’s primary regulator, in a continuing evolution of the performance dynamics within the mortgage banking industry. Part of the first quarter provision expenses are related to these refinements. Second, during the first quarter, we also eliminated our specific valuation allowance practice, to conform to regulatory guidance as we are now required to file an OCC quality report on a quarterly basis, beginning with the quarter ended March 31st, 2012. Those specific reserves were charged off during the quarter, contributing in part to an increased provision expense. We expect that a portion of the first quarter provision relating to these items should not impact future quarters. Paul will address this further in his review of our outlook for our second quarter. Third, our first quarter loan loss provision expense includes the impact of increased loan modification and other loss mitigation activities. This increased activity is the result of strategic initiatives we implemented in the fourth quarter of 2011, which are designed to put legacy portfolio challenges behind us. We believe these strategies are working, as evidenced by first, about $445 million reduction in our residential first mortgage held-for-investment portfolio, an 18.7% decline of residential first mortgage delinquent loans, an 18.1% decline in residential first mortgage non-performing loans and lastly, the satisfactory resolution of $147 million in residential held-for-investment loans to financially distressed customers. Through either modifications or other loss mitigation options, including short sales or deed in lieu of foreclosure. At March 31st, 2012, our overall allowance for loan losses was $281 million, as compared to $318 million at December 31st, 2011, to decrease the allowance of loan losses reflection, increased level of charge-offs, due to the write-off of specific valuation allowances to conform with regulatory guidance. Our allowance-to-non-performing-loan ratio increased to 69% at March 31st, 2012, as compared to 65% at December 31st, 2011. Net charge-offs related to first mortgages comprised $94.6 million of the first quarter total, as compared to 18.6 in the first quarter of 2011. Net charge-offs related to commercial real estate loans also increased to $43 million in the first quarter of 2012, as compared to 1.7 million in the fourth quarter of 2011. These increases from the prior quarter were driven primarily by the elimination of the specific valuation allowances. During the quarter, we experienced positive credit trends in the overall level of delinquent loans, as well as the 90-day-plus non-performing category, which is a leading indicator of future charge-offs. We believe these improvements were driven in large part by the significant investment in our mortgage servicing platform, including single point-of-contact strategy, along with an economy that is showing some signs of stabilization in employment trends and changes in housing prices. Total delinquent loans, those loans that are 30 days or more past due, also decreased by 15.8% during the quarter, to $533.4 million, as compared to 633.5 million at December 31st, 2011. Overall, 90-day-plus non-performing loans decreased by 16.7 million, to 406.6 million at the end of the quarter, as compared to 488.4 million at December 31st, 2011. This improvement was driven primarily by decreases of 69.7 million in non-performing residential first mortgage loans, and 7.1 million in commercial real estate loans. Our ratio of non-performing assets to Tier 1 capital and allowance for loan losses, commonly referred to as the Texas ratio, also improved to 34.6%, as compared to 39.3% at 12/31/2011. Turning to loan repurchases, we also experienced continued hikes in provisions related to our representation warranty reserve, reflecting both increased charge-off of loans previously sold, and expectations for continued levels of repurchase requests from GSEs. We remain committed to maintaining our long-term partnership with Fannie Mae and Freddie Mac, and will work to make sure those relationships are mutually beneficial. However, we continue to have ongoing discussions with the GSEs over their anticipated levels of future repurchase requests. At March 31st, 2012, our representation and warranty reserve increased to 142 million, an 18.3% increase compared to 120 million at December 31st, 2011. I’d like to now discuss our business line, starting with mortgage banking. The strength of our distribution channels, our industry-leading position as a conforming residential mortgage originator, and the strategic initiatives we implemented, as well as the current dislocation in the market, have well positioned us to gain additional market share, which we believe we have been able to accomplish. The results of these efforts in the strong refinance market drove a record level of mortgage banking revenues in the first quarter. Gain on loan sales income for the first quarter increased by about 92% from the prior quarter, to 204.9 million, with a margin of 189 basis points. This was a result of the strong margin due to decreased competition, efficient origination and sale execution and increases in the overall level of residential first mortgage volume. Residential first mortgage originations increased to 11.2 billion in the first quarter, as compared to 10.2 billion in the fourth quarter of 2011. In addition, first quarter residential mortgage rate locks also increased approximately 32%, to 14.9 billion. Some of you may be wondering about HARP 2. While the enhanced Making Home Affordable Program is still in its relative infancy, as you may imagine, we are actively working with borrowers nationally on refinancing options to help keep them in their homes and stabilize the housing market. I would have to say it’s been an early success, and level of locks and closings are falling right in line with expectations as the new program gains an operational efficiency and consumer awareness grows throughout the market. We have built our mortgage banking loan origination model around efficiency, which is why we have not had to add significant staff and dramatically increase non-interest expense to handle increased mortgage volumes. Our first quarter credit-adjusted efficiency ratio improved to 42.6%, as compared to 65.8% in the fourth quarter of 2011. At the same time, both loan fees and charges and net servicing revenue from our mortgage servicing rights, increased from the prior quarter. Turning to commercial banking, our commercial and specialty banking groups continue to execute on the strategic plan we laid out in 2010. Since that time, we’ve made significant investments in infrastructure, developed a competitive suite of lending and treasury management products and services and added experienced relationship managers and credit and support staff. Since starting essentially from ground zero in the first quarter of 2011, we’ve been able to achieve all of our loan fee, deposit and asset quality goals consistent with our forecast. Our current pipeline is strong, and we continue to add new customers and cross-sell opportunities in a thoughtful and controlled manner. Management is focused on building a high-quality, diversified portfolio of commercial, specialty and small business relationships. Turning now to personal financial services, which we formerly referred to as retail banking, we continue to be successful in improving deposit mix and reducing funding costs. We increased retail core deposits by approximately $352.5 million from the prior quarter, with an improved retail core deposit ratio of about 48% at March 31st, 2012. The improvement in core deposits led to a reduction in overall funding costs, with the first quarter average cost of funds declining to 1.76%, as compared to 1.81% in the fourth quarter of 2011. This improvement in funding cost partially offset declines in yields and balances of average earning assets. Overall, first quarter net interest margin remained flat at 2.41%, as compared to 2.43% in the fourth quarter of 2011. Personal financial services continue to successfully grow deposits, primarily through its branch and business banking network. It’s savings account promotion continues to be very successful, both in terms of acquiring new customers and new deposits, and also in retaining those dollars past the initial four-month promotional period. PFS continues to focus on acquiring new personal and business checking customers, then cross-selling those customers the full range of financial products and services offered. PFS has completely replaced the deposits sold from the Indiana and Georgia Branch Divestiture. Michigan deposits grew by $925 million between September 30th, 2011 and March 31st, 2012; 744 of that growth is centered in our branch banking, which more than replaced the total amount of deposits sold in the two divestitures. At March 31st, 2012, we remained well-capitalized, with a Tier 1 ratio of 8.64%, a Tier 1 common-to-risk-weighted assets of 8.85%, and a total risk-based capital ratio of 16.06%. We also maintained significant liquidity to fund ongoing business, with approximately 758 million in cash and interest-earning deposits, in addition to approximately 670 million in collateralized borrowings at the FHLB and approximately 270 million in unencumbered marketable securities. I’d like to now turn over the press station to Paul

[Paul Borja:]

Thank you, Joe. Good morning again, everyone. As indicated in our earnings release, we had an $8.7 million loss during the first quarter, or about $.02 per share, which was primarily attributable to an increase in loan loss provision expense of $51.2 million. This is our smallest quarterly loss in over three years, and reflects a strong core revenue generation capability of the company this quarter. We have in prior calls focused on three key areas of our operating results

[Joseph Campanelli:]

Thank you, Paul. Now I’d ask Steve, our operator, to open it up for questions. Myself, Paul and the members of the executive management team are all here, available to address any questions that people may have if they’re on the line.

[Operator:]

(Operator Instructions). Your first question comes from the line of Paul Miller with FBR. Your line is open

[Paul Miller:]

Thanks you very much, gentlemen. On the reps and warrants slide, page 20, you talk about the 36 million from ’09, ‘11 vintage. This is somewhat brand new and you don’t expect the incur any losses on that. Can you just add some color to that?

[Mike Maher:]

Yes, sure, Paul, this is Mike Maher. How are you?

[Paul Miller:]

How are you doing.

[Mike Maher:]

Good. We indicated in a short little footnote there that vast majority of the increased demands related to the 2009 to 2011 vintage represent primarily Freddie Mac documentation request for which we have typically been very successful in supplying the necessary info. And as such, we expect to have very little exposure to loss, if any. In essence, it represents a change in practice by Freddie Mac compared to how they’ve been operating in the past. It does not indicate any further exposure to us, just frankly a little bit more work on our end to provide the information that we have always been successful in providing.

[Paul Miller:]

And just back-of-the-envelope calculations, it appears that you worked through – correct me if I’m wrong – you worked through about $190 million in requests? Is that about right? That you took $44 million loss on that?

[Mike Maher:]

I hadn’t done the math. Certainly we took $44 million of loss, 190 would be the changed in new to the end – I don’t know where you get 190 from, Paul.

[Paul Miller:]

Well I’m just taking – you have the 343 and the 357, which is a $13 million difference and I’m backing out the 36, I guess, for the 239 so 203 came in right – I forgot how I did it now. But I guess the loss rate is about 44%, am I correct on those reps and warrant that you do buyback?

[Mike Maher:]

Our loss severity on the bottom right table is 36%.

[Paul Miller:]

36%

[Mike Maher:]

Right and if you look at – I’m not sure how you did your math, but if you look at the chart at the end of the year we had pending demands of 343 million, we received additional demands during the quarter and ended up at 357. You know, I don’t necessarily have the nominal amount of demands, you’ve got the increase of 239. So if we went from 343 and added 239 and only went up 16 we would’ve indeed resolved about 220 million of demands given that our total inventory only went up by 14 million.

[Paul Miller:]

And is that a good run rate going forward, I mean, moving through this?

[Mike Maher:]

Right. Yes I would suggest that the – our volume – our capacity to resolve requests in whatever you calculate in terms of the quarterly run rates is indicative of what we have been able to accomplish. If anything, we have been able to resolve more in the recent quarters then what our previous run rates have been.

[Paul Miller:]

And then on slide 33 in the appendix, you know it’s a really good slide backing out all of your different add-backs or environmental costs I would say. And I think you mentioned your reps and warrants reserves should drop by anywhere from 2/3 to 3/4s, and I missed the asset and resolution. What should that – should that start to move down or is that going to remain relatively constant?

[Paul D. Borja:]

This is Paul. The asset resolution expands we expect would start to decline quarter over quarter towards the end of the year, slight declines but definitely a trend downward.

[Paul Miller:]

Okay and then in the provision, I mean, that was a big provision and you talked about it but where should that go back to?

[Paul D. Borja:]

You mean our provision expense for second quarter? We’re expecting that to move back down to 1/2 to 2/3s in Q2 and in Q3 and Q4 we expect that to be moderating down further. I think part of it, Paul Miller, is that we need to as we go through Q3 and Q4 combine some our loss mitigation activities and the impact as, for instance modifications have on the overall loss rates, because as we do modifications with TDRs as we have to be mindful of redefault rate. As we start to see redefault rates we have provide a redefault loss curve built within those TDRs, the performing TDRs and so that has its impact on an all of our loan loss provision. But if all things being equal, you’d expect given it’s a static portfolio, that you would expect to see loan loss provision for the residential side to continue to move downward.

[Paul Miller:]

Okay and one last question on HARP. Have you been – I know a lot of guys, but most of the stuff in the first quarter was done by minding your own portfolio for HARP-eligible loans. Have you seen applications coming or have you been actively seeking other servicing portfolio HARP product yet?

[Matt Kerin:]

This is Matt Kerin. The answer is yes, we are running at about year-to-date probably four to one other service to Flagstar.

[Paul Miller:]

So four to one?

[Matt Kerin:]

Yes, roughly, the Flagstar service is about 25%, and part of that is, if you think about the market place and our distribution, you know, we don’t service a significant percentage of the total servicing of loans out in the marketplace. We’ve been a pretty active seller of servicing. [inaudible] in particular a lot of the vintages were talking about. So what we’re continuing through our retail channel and through our existing customer for life clients focusing on the Flagstar service loans, but an addition we are doing other servicing.

[Paul Miller:]

Okay. Hey, gentlemen, thank you very much.

[Operator:]

Your next question come from the line of Mark Steinberg with Dawson James Securities, please go ahead.

[Mark Steinberg:]

Good morning. I was wondering what options and/or actions is the company considering to deal with the de-listing issue that you know is hanging over their head?

[Paul D. Borja:]

Hi. This is Paul Borja. I think there’s several things. First of all, it’s a question that’s been raised before. We still have – we did have initially a timeframe until February 18, that timeframe was extended for us to be able to consider the annual meeting but the Board of Directors has not yet scheduled the annual meeting but intends to consider that, I believe, very shortly.

[Mark Steinberg:]

I’m sorry, so you said you were talking about the annual meeting, but my question was you know, what particular options or actions are on the table? Or at least being discussed to deal with the issue?

[Joseph P. Campanelli:]

One is to secure our business plan to restore the company in profitability. By doing so we believe we’ll be trading close to the book value then at the significant discount we have now. As of the end of the quarter, I believe our book value per share was 1.49, so a significant difference between our current trading level. We also have options available relative to reverse splits in other mechanical type things that would restore us to NYSC trading guidelines. So we have up until our annual meeting to put that to a vote and resolve the issue.

[Mark Steinberg:]

On the last conference call, it was stated that a reverse split was something that the company at that point was really not considering. Is that still an accurate statement?

[Joseph P. Campanelli:]

It would be, it’s an option we have available, which I believe was part of your question, it’s clearly not our preferred option. Our preferred option is to have the value of the company reflected – truly reflected in the market cap and the steps we’re taking to execute our business plan, I think, will move us forward along that path sooner. But it’s clearly an option that’s there.

[Mark Steinberg:]

Understood, well thank you

[Operator:]

(Operator Instructions). Your next question comes from the line of Bose George from KBW, your line is open.

[Bose George:]

Good morning I was just wondering do you have the number of – or the percentage of harp loans as the percentage of total volume in the first quarter?

[Joseph P. Campanelli:]

Yes we’re running at about for the first quarter, we’re running at about 15% of our closing – of our locks, excuse me, it’s up much less in percentage in closing because they haven’t closed yet, it’s about 11% I think.

[Bose George:]

Okay and do you think that number trends up or is that fairly stable or –?

[Joseph P. Campanelli:]

There’s a steady increase month over month, which we anticipated as the program gets rolled out. There’s been so many refinements, there’s still some issues with Freddy that will have some impact as they straighten those out you know in the first month the AUS programs weren’t available until March, so we were basically only using the manual through our retail channel at the time because we’ve been doing that for a long time. I did want to clarify an earlier comment, the four to one was our current run rate for the month of April, it’s actually about three to one year to date.

[Bose George:]

Okay great and then if you’re switching – pull up on the rep and warranty slide – the 2008 vintage had a little pop up as well and I was just curious what drove that. Yes, the increase in the 2008 vintage to I guess 63 million from 45 million last quarter.

[Mike Maher:]

I would attribute the increase in 2008 to again largely would be related to either Freddy Mac or Fannie Mae increase requests largely due to documentation. It’s not indicative to any sort of adverse trend for the company.

[Bose George:]

Okay, great, thank you.

[Operator:]

I’m showing there are no further questions at this time. I’ll turn it back to Joe Campanelli for any closing comments.

[Joseph P. Campanelli:]

Thank you, Steve, and I want to thank everyone for taking the time out of what I’m sure is a busy schedule to share our discussion this morning and we look forward to chatting with all of you in the near future. Have a great day. Thank you.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.