Flagstar Bancorp, Inc.
Q3 2014 Earnings Call Transcript

Published: 22 Oct 2014

[Operator:]

Good day, everyone and welcome to the Flagstar Bank Third Quarter Investor Relations Conference Call. Today's call is being recorded. At this time, I would like to turn the call over to Jim Ciroli. Please go ahead.

[James K. Ciroli:]

Thank you, Anna. Good morning. Welcome to the Flagstar third quarter 2014 earnings call. This is Jim Ciroli, Chief Financial Officer of Flagstar Bank. Before we begin, I’d like to remind you that the presentation today may contain forward-looking statements regarding both our financial condition and our financial and operating results. These statements involve certain risks that may cause actual results in the future to be different from our current expectations. For non-exhaustible list of such factors, please see our 2013 Form 10-K and our first quarter and second quarter Form 10-Qs as filed with the SEC, as well as the legal disclaimer on slide two of our third quarter 2014 earnings call slides that we have posted today on our Investor Relations site at flagstar.com. During the call, we may also discuss non-GAAP financial measures regarding our financial performance. A non-GAAP financial measure is a metric that is not presented in accordance with US GAAP. We believe that our use of these non-GAAP financial in addition to the GAAP results can provide investors with additional information that is useful in assessing the results of Flagstar’s operations on a run rate basis. In today’s presentation in the press release, we issued last evening and there are subsequent SEC filings, we identify these non-GAAP financial measures as core operating measures which adjust for significant items. We are providing a reconciliation of these measures to similar GAAP measures in the table to our press release which we issued last night or in the appendix to our earnings call slides. With that, I’d like to now turn the call over to Sandro DiNello, our President and Chief Executive Officer.

[Alessandro P. DiNello:]

Thank you, Jim, and thank you everyone for joining us today. First, let me officially welcome Jim. Jim has worked at a number of larger regional banks and brings 27 years of banking and finance experience to our team. Also with me today are Lee Smith, our Chief Operating Officer; Steve Figliuolo, our Chief Risk Officer and Mike Flynn, our General Counsel. We are changing the format of this call from previous quarters and I’d like to take a moment to describe the order of the call. First, I am going to highlight the key items and actions we undertook during the third quarter. After my comments Jim will review the consolidated quarterly financial performance. Lee will then provide a more detailed review of the results within each of our business segments. Following this, I will conclude with a view of our fourth quarter and then open the call for questions and answers. With that, let's begin. During the third quarter of 2014, we reported a net loss of $27.6 million or $0.61 per diluted share as compared to net income of $25.5 million or $0.33 per diluted share in the second quarter of 2014. Our third quarter results were materially impacted by our settlement with the CFPB which we announced on September 29th and which I will describe in greater detail momentarily. In addition to the $37.5 million which we paid the CFPB, we incurred legal and professional expenses related solely to this matter. Additionally, this quarter we paid certain indemnification claims related to FHA loans and increased our reps and warranties reserve to account for future FHA claims that may arise. I will provide additional detail on this as well. If you were to adjust our reported earnings to remove these significant items, we would have achieved a modest profit in a difficult mortgage market. This supports the confidence we have expressed in our efforts to mitigate risk and to prudently manage and grow our operations. Moving on to our continued focus on risk management. As we wrap up the third quarter, we believe that the Bank is in a much better risk position. As I have already mentioned in September, we reached an agreement to settle with the CFPB, while the economic consequences of this settlement are certainly difficult to stomach for all of us. We firmly believe that this resolution is in the best interest of our shareholders because it allows us to continue to focus on improving operations and delivering long-term growth and value creation to our shareholders. Also during the quarter, we paid indemnification claims on government insured loans of $3.4 million and reserve than additional $7 million for indemnifications and similar loans that maybe subject to future claims. One of my stated goals when becoming CEO was to continue to work through legacy issues and in effort to lower credit cost and this is consistent with that premise. This is a significant credit cost so, we have added it back to our calculation of core operating earnings. And while we are characterizing it as significant, we are certainly factoring this issue as well as a cost associated with our 2012 settlement with the DOJ on behalf of HUD into our thoughts about the profitability of the FHA originations business, as you have heard others discuss recently. Another area of significant improvement in our risk management efforts relates to asset quality on the balance sheet. Key highlights of continued improvement in our asset quality were reducing non-performing assets as a percentage of total assets to 1.40% compared to 1.54% in the previous quarter, which represents the lowest level of non-performing loans in over eight years. We do see now repurchase pipeline at the end of Q3 to $30.8 million which is the lowest level achieved in over six years and increasing the coverage of the allowance for loan losses to total loans held for investment to 7.6% from 7.4% at the end of the prior quarter. The increase in the coverage ratio was primarily due to a slight increase in the average loss rate as a result of loan sales executed this quarter. Finally, an important overall theme for our risk management efforts is that Flagstar is committed to maintaining our disciplined and our focus. We will not chase yield or volume especially in a difficult mortgage environment at the expense of taking on increased risk or jeopardizing our pricing and profitability standards. Now let's look at the results of the actions we took to grow in a safe and sound fashion and create value for our shareholders. Earning assets rose 5% to $8.8 billion which form the basis for an increase in net interest income of 3%. While net interest income increased 3%, net interest margin declined 7 basis points to 2.91% on a consolidated basis and core operating non-interest income increased 3% despite a slight decline in gain on loan sales. While Jim will provide further analysis of the income and balance sheet performance in his prepared remarks, I'd like to highlight that our average commercial loan portfolio increased 10% during the quarter. We are pleased to have funded this increase in earning assets with an 8% increase in average total deposits. This again demonstrates the success we have had and attracting seasoned relationship managers who recognize the value of Flagstar being Michigan's Bank. While Lee will provide a more detailed analysis of non-interest expense in his remarks, we believe we are tracking to the top end of the full year 2014 NIE guidance we provided on last quarter's call. We have previously demonstrated our discipline and ability to manage our expenses commensurate with our revenues and we remain committed to this level of discipline. We will be proactive in this regard and continue to invest were appropriate to grow the business and operate at acceptable efficiency levels. Before turning the call over to Jim for a detailed financial review, I would like to emphasize a few items. First, we will continue to manage risks to maintain and improve asset quality and the consistency of credit cost. Second, we remain committed to managing and controlling expenses to generate operating profits. Third, we continue to pursue prudent revenue growth. And lastly, we are confident in the future prospects for Flagstar as we continue to build a company that we believe will produce consistently strong earnings and grow shareholder value. As I said last quarter, we are deeply dedicated to the [task at hand]. With that, my colleagues will take you through a more detailed discussion of our financials and operations. I'd now like to turn the call over to Jim.

[James K. Ciroli:]

Thanks Sandro. Our core operating net income was $7.7 million or one penny per share in the third quarter. This compared to $14.4 million or $0.13 per share in the second quarter. Driving the overall decrease in core operating net income was the negative operating leverage for the quarter with 10% growth have been expenses partially offset by 3% growth in revenues. Slide seven provides a more detailed view of our third quarter operations. Our third quarter net interest income increased to $64.4 million as compared to $62.4 million for the second quarter 2014. The increase in net interest income was attributable to growth in earning assets of 5% to $8.8 billion partially offset by a 7 basis point decrease in the net interest margins to 2.91%. The higher level of earning assets was due to increases in commercial and consumer loans and higher security balances. Our success in opportunistically growing our commercial book continued. We continue to add experienced relationship managers from our larger non-Michigan based competitors. These relationship managers are finding traction with customers for whom being Michigan's Bank is an important distinction for us. The consumer increase thus from an expansion of our warehouse lending capability which while growing will also fluctuate with mortgage volumes. Average total deposits increased 8% from the prior quarter driven by higher retail savings and government deposits. At the end of the second quarter we began a promotional campaign to increase retail savings accounts. The third quarter provision for loan losses increased 1.9 million to 8.1 million for the quarter. This increase was attributable to charge-offs recorded when we sold jumbo and certain underperforming loans. Core operating non-interest income increased to 95.6 million for the third quarter as compared to 92.5 million during the second quarter. This included loan fees and charges, which increased 3.4 million or 22%, primarily due to an increase in loan originations. Other non-interest income which increased 1.8 million due to security sales and our rep and warranty provision are counter revenue item, which was 3.0 million lower than the prior quarter, this excluded the impact of expenses recognized for indemnifications and government insured loans. As Sandro mentioned, our repurchase pipeline is at a six year low. These positive developments in non-interest income were partially offset by our net gain on loan sales, which decreased 2.6 million to 52.2 million driven by a 6% quarterly decrease in mortgage lot volume. Our margin of 83 basis points, who will change from the second quarter and the net return on the mortgage servicing asset which declined 3.7 million. This decrease was attributable to a negative fair value adjustment from increased prepayments and a reduced hedge performance. Core operating non-interest expense increased to 10% to 140.8 million in the third quarter as compared to 128.5 million in the second quarter. This included other non-interest expenses which increased due primarily to increases in litigation costs, the normal accretion of our DOJ liability and a charge to establish a reserves for unfunded loan commitments consisted with our commercial loan growth and an increase in legal and professional fees of 3.3 million which was attributable to higher consulting fees. These were partially offset by asset resolution costs which decreased 4.3 million. Slide eight shows our key operating statistics. We've already talked about the profitability metrics and I'd like to focus on our operating leverage which was negative 7% as operating revenues grew at 3% yet expenses rose 10%. As Sandro indicated earlier, we are strong operators and have demonstrated our ability to right-size expenses relative to our revenues. As we move forward, we will continue to evaluate our businesses and as Sandro stated, we will remain committed to this level of discipline. Our asset quality statistics improved and I'll dive deeper into asset quality on a couple of slides as well as capital, where our ratios remained robust and well above peer meeting and ratios. Slide nine highlights our balance sheet. For the fourth consecutive quarter, we remained under 10 billion in assets. While this will provide certain financial benefits such as lowering our FDIC insurance costs and relief from Durbin. We do not intend to remain under this level for long, our capital and more importantly our infrastructure support a larger balance sheet and we expect to see growth in earning assets beginning in the fourth quarter. Turning to slide 10, our allowance coverage was 7.6% of total loans at the end of the third quarter as compared to 7.4% at the end of the second quarter. Taking a deeper look with respect to consumer loans, the allowance coverage was 9.0% at quarter end as compared to 8.6% at the end of the prior quarter. The increase in these coverage ratios during the quarter was primarily due to a small increase in the average of loss rates which was driven by charge-offs from our loans sales. We also established a reserve for unfunded loan commitments as previously mentioned which was charged to other non-interest expense. Non-performing loans were 106.9 million at the end of the third quarter as compared to 120.2 million at the end of the second quarter. This is the lowest level of NPLs carried by the Bank in more than eight years. Third quarter net charge-offs increased to 13.1 million or 136 basis points of associated loans compared to 7.2 million or 78 basis points in the second quarter. The increase in quarterly net charge-offs was due to 6.3 million of charge-offs incurred on loans sold during the quarter. Adjusting for these sales, third quarter net charge-offs in fact decreased. As we turn to slide 11, and look at the funding and liquidity Flagstar maintains an enviable liquidity position with 1.5 billion of total liquid assets that is cash and GSE issued securities and an additional 2.8 billion of FHLB borrowing capacity at the end of the third quarter. Our available liquidity to total assets was 43% while our wholesale funding ratio was 32% at the end of the third quarter. You can see that we are maintaining a strong funding mix with average total deposits for the quarter increasing to $7.0 billion of which, $4.9 billion were retail deposits, $1.4 billion were government and commercial deposits and $0.8 billion were company controlled deposits. It's also worth noting that gross loans held for investment equaled 58% of total deposits at quarter end. Turning to slide 12, we continue to maintain robust regulatory capital ratios. The tier 1 leverage ratio for the Bank was 12.4% for the third quarter compared to 12.5% for the second quarter. The tier 1 capital ratio for the Bank was 22.8% for the third quarter compared to 23.8% for the second quarter. And when I look forward to the fully phased in implementation of Basal III, our tier 1 leverage ratio would be 10.3% and our tier 1 common ratio would be 19.7% at quarter end. This 210 basis points impact to our tier 1 leverage ratio is mostly driven by the detrimental treatment that mortgage servicing rates received under Basal III. This impact comprises 140 basis points of the overall Basal III impact. We planned to continue MSR sales in the future to mitigate B III's impact to our capital. Also, if we look at excluding the benefit of TARP, our consolidated Bancorp tier 1 leverage and tier 1 common ratios under Basal I would be 9.6% and 12.7% respectively. We continue to evaluate all of our options with respect to TARP given the progress we continue to make executing on our plans of improving risk management, increasing our profitability and putting our legacy issues behind us. I will now turn to Lee for more insight into our businesses.

[Lee M. Smith:]

Thanks Jim and good morning everyone. As we start to focus more keenly on growth strategies across our three business line verticals, I want to start by outlining some of the key operating metrics from each segment during the quarter. We also continued to execute on our balance sheet derisking and cost optimization initiatives in order to create the foundations to grow in a prudent and effective manner. Please turn to slide 14. Third quarter operating highlights for the mortgage origination business include fall out of just the gain on sale margin which is what we use when reporting gain on loan sale increased slightly to 83 basis points in the third quarter as compared to 82 basis points in the second quarter. Although lot volume decreased to $6.3 billion from $6.7 billion during the same period in a challenging production environment. Approximately 74% of mortgage production volumes were originated through correspondence during the quarter which is consistent with the prior period. Purchase mortgages accounted for slightly more than 62% of origination volume in the third quarter as compared to just under 65% of origination volume in the second quarter and we successfully utilize a new underwriting flexible capacity model with outsourcing to improve turn times and enhance the customer experience during the period. This in part help closings increase from $5.9 billion in Q2 to $7.2 billion in Q3. Moving to servicing, quarterly operating highlights for the mortgage servicing segment on slide 15 include, we executed on the sale of $4.9 billion in aggregate UPB or 31,000 loans of residential MSRs where we will act to sub servicer. The Bank's MSR to tier 1 capital ratio increased slightly to 25.2% compared to 24.3% in the prior period. Despite MSR sales during the period, the quarter's net loss driven predominantly by our settlement with the CFPB led to an increase in the concentration ratio. As you can see on slide 16, by the end of the quarter, the repurchase pipeline had decreased to a six year low of $30.8 million with only 15.7% of demands, a 180 plus days old compared to $53.7 million and 42.3% of demands being 180 plus days old in the second quarter. As Sandro noted, we did pay indemnification clients on government insured loans of $3.4 million during the quarter and reserve an additional $7 million for indemnifications on similar loans that maybe subject to future claims. And of course, we also reached a settlement with the CFPB regarding certain default servicing and loss mitigation practices going back to 2011. Servicing performing loans is very much part of our core strategy and the business we believe we can be very successfully at. We continue to estimate for every 100,000 loans that we bring onto the platform, it will generate between 5 million and 7 million of incremental pretax operating profit. We're currently servicing approximately 393,000 loans of which 238,000 are sub-service for others on a 145,000 are either owned by us or we own the mortgage servicing asset. Furthermore 96% of all the loans we service are performing loans which means approximately 15,000 or less than 4% of our total portfolio of 60 plus days delinquent. We are always looking at ways to reduce the number of default and delinquent loans in our portfolio given the servicing on working out delinquent loans is not part of our core growth strategy. Please turn to slide 17, quarterly operating highlights for the community banking segment include average consumer loans rose 3% in Q3 driven primarily by a $130 million increase in average warehouse balances quarter-over-quarter. Average commercial loans increased 10% to 903 million for the third quarter as compared to 819 million for the second quarter. The portfolio remained balanced among both industry tied and collateral with 83% of the borrowers in our backyard here in Michigan. Where the borrower all properties not in Michigan it is typically because we have followed the strong Michigan based customer. New commercial loan originations in the third quarter were $55.4 million, commercial loan commitments grew 5% quarter-over-quarter to $1.64 billion. During the first nine months of this year, we have grown C&I lending by $134 million, CRE lending by $184 million and warehouse lending by $171 million, for a net increase in new loans of $488 million. Average interest-bearing deposits increased by 6% in the period driven by an increase in government and retail savings deposits. It is our intention to continue to grow at commercial and warehouse businesses in a controlled, safe and sound manner, as we have been doing to-date. We continue to focus on the Michigan market while optimizing our warehouse offering nationwide and we are also looking at new products that leverage existing skill sets within the Bank. Pertinent to our held for investment book, we sold approximately $48.2 million unpaid principal balance of jumbo loans during the quarter for a gain $2.6 million. We also sold approximately $27 million unpaid principal balance of NPLs and CDRs during the quarter for a gain of $2.2 million and improving our ALLL to NPL coverage ratio to 295%. We've now sold approximately $570 million in UPB of NPLs and CDRs during the last 15 months, as part of a consorted effort to derisk our balance sheet. We also sold $5.7 million unpaid principal balance of scratch and dent loans during the period for a small gain. Moving now to expenses on slide 18. Our core operating expense during the third quarter was $140.8 million. This compares to $128.5 million for the second quarter after adding back for the CFPB settlement and associated cost under Department of Justice fair value adjustment. Excluding one-time items at current non-interest expense quarterly run rate is approximately $135 million to $140 million which on a quarterly run rate basis is $45 million to $50 million less than where we were in the first half of 2013. I want to emphasize that our expenses this quarter were in line with our guidance. We guided to $520 million to $540 million for the year last quarter and if you take the non-interest expenses results through Q3 and add to that what we are guiding for, for Q4 excluding the CFPB fine, you will see that we are within the range we always expected to be. Managing at cost structure aggressively, we'll continue to remain a focus for the organization given the decrease in mortgage origination volumes and margins over the last 12 months. Our adjusted efficiency ratio for the quarter was 86.8% versus 80.2% last quarter as for adjusting for the CFPB settlement and related cost this quarter of $38.6 million and $17.1 million in pretax significant items last quarter. The decrease in efficiency is the result of the $12 million quarter-over-quarter increase in non-interest expense after excluding the CFPB settlement. We continue to work diligently on various initiatives to further optimize at cost base and make ourselves more efficient across the entire organization and expect such initiatives to start showing in our reported results through the first half of 2015. Consistent with the last call, I will now provide detail on the IO portfolio. If you turn to slide 19, you will see that we have $741 million of interest-only loans on our balance sheet that are yet to reset. Of this, $72 million are due to reset during the remainder of the year. The anticipated payment short associated with these resets versus current payments is approximately 98%. If you turn to slide 20, you will see that since January 1, 2013 and through September 30, 2014 we have experienced 846 IO resets. Of this 846, 25.5% unpaid principal balance or 196 loans have paid in full. 19.5% UPB or 148 loans have been sold or modified. 6.7 UPB or 57 loans have been charged-off or for closed on and on this, 54 defaulted prior to the reset and only three defaulted post reset. 3.5% UPB or 29 loans are delinquent and have been referred to default servicing. 41.5% UPB or 378 loans are cash flowing resets of which 375 have been paying for three months or more and 265 of those have been paying for six months or more. 3.4% UPB or 38 loans are in the process of being resolved, the majority of which we anticipate will be cash flowing resets. As I've previously mentioned, we have a dedicated team working hard without borrowers to get ahead of these resets and be proactive in refinancing or modifying such loans if that something our borrowers are interested in doing. Another key metric is the right party contact rate which measures how often our team is getting in touch with the borrower directly. The Q3 we had a right party contact rate of 100%. We currently at 96.3%, the Q4 where we have 438 IOs resetting and 71.6% of the Q1 where we have 412 IOs resetting. Here's what else we're tracking and noticing. If you turn to slide 21, you will see the 47% of our IO portfolio, a loans on properties in either California or Florida, two of the top six states of the house price appreciation over the last 12 months. Slide 22 shows the aging of all cash flowing resets and as you can see 99% of all cash flowing resets have been paying for three months or more which includes 70% that have been paying for six months or more. With respect to overall quality slide 23 shows that 83% of all remaining IOs have -- FICA scores greater than 660 and 85% of those same loans have LTVs less than a 100%. The rolling 12 month average loss severity on the IO portfolio continues to be lower than on the non-IO portfolio through September 30, 2014 based on historical data. As you can see it's been a busy quarter as we continue to clean up legacy issues, but in the long run, we believe we've created the platform from which we can push on and grow in our three major business line verticals. With that, I'll hand it back to Sandro.

[Alessandro P. DiNello:]

Thanks Lee. I'm now going to close our prepared remarks with some guidance for the fourth quarter and then open the call for question-and-answers. Please turn to slide 25 where we've itemized our guidance parameters for the fourth quarter. We expect net interest income to increase slightly as we continue to grow earning assets. Net interest margin is expected to be relatively stable while we expect mortgage locks to decline with normal seasonal fluctuations we have seen strong October volumes so far and believe that the favorable rate environment could continue to induce higher volumes. We are obviously interested in Director Lot’s recent comments and the FHAs apparent desire to expand credit availability. This could be positive for originations but details are needed before we can evaluate this potential benefit. We expect a modest improvement in gain on loan sale margin. We expect loan administration income and the net return on the mortgage servicing asset to be consistent with third quarter performance. We expect to continue sales of the MSR asset in the normal course to retain sub-servicing where it makes economic sense to do so, and we expect the ratio of our MSR to tier 1 capital to be slightly below current levels. We expect our total credit cost including provision for loan losses, representation and warranty and asset resolution to be between $20 million and 25 million for the fourth quarter and as we noted, we expect non-interest expenses to total between $135 million and $140 million for the fourth quarter. This concludes our prepared remarks and we will now open the call to questions from our listeners. Ann please proceed with questions.

[Operator:]

Thank you very much. (Operator Instructions). We will take our first question from Bose George from KBW.

[Bose George:]

Hey, guys good morning. First, just in terms of mortgage volumes in the fourth quarter. Can you just talk about how much mortgage applications have increased just over the last few days? And also just in terms of the gain on sale margin guidance, is that based at all on increased demand you are seeing or would you have expected gain on sale to be up even if you saw the normal seasonality where volumes are going down in the fourth quarter?

[Alessandro P. DiNello:]

Bose, this is Alessandro. So with respect to the uptick that I referred to in my comments so far this quarter I can't be specific or I won't be specific in that regard but clearly with the 10 year getting down under 2% last week, we saw an increase in refinance volume. Relative to our view of the margin in Q4 given the fact that the demand is a bit stronger, we believe that based on what we've seen thus far this quarter that overall the margin maybe a little bit larger but we're not estimating the bet to be a significant increase.

[Bose George:]

Okay, great. And then just actually switching to the indemnifications this quarter. I am just curious what drove them and also the vintage of these loans were they older loans or newer loans?

[Alessandro P. DiNello:]

Well I can’t I guess I can’t really speak to what drove them I mean those are presented to us so I can tell you is that the activity did increase during the quarter relative to vintage there isn’t anything specific about the vintage, it’s pretty wide spread across past years.

[James K. Ciroli:]

Hey Bose, this is Jim. As we looked at the claims that we did pay, there was really no discernible trend or characteristic of what we received as Sandro mentioned it's across a large number of geographies in large number of years.

[Bose George:]

Okay, great. And then just a related question on your comments about the FHA. I mean do you think, I mean lenders just need to raise rates more to protect against that risk we're dealing with the FHA or overlays into increase or is the FHA kind of trying to work with people a little bit to make, provide more transparency on this issue?

[Alessandro P. DiNello:]

Well, here is what I think Bose. I think that in order to be comfortable that we're getting paid for the risk that we are taking in the government lending business there needs to be more clarity in terms of how the government is going to handle indemnifications and things of that nature so, for us we're going to just be very careful and I think it’s a time of transition potentially in that regard, so we're going to watch it very closely.

[Bose George:]

Okay, great. Thanks.

[Operator:]

We'll take our next question from Kevin Barker from Compass Point Research and Tradings.

[Kevin Barker:]

Good morning.

[Alessandro P. DiNello:]

Hi, Kevin.

[James K. Ciroli:]

Hi, Kevin.

[Kevin Barker:]

Hi. Given the sale of the jumbos and the non-performing loans and you took a gain. Do you expect to continue to sell jumbos and NPLs in the market in the coming quarters and do you expect that to be, is there a significant pipeline of sales over the next several quarters?

[Lee M. Smith:]

Hi, Kevin its Lee. I won't say there is a significant pipeline but if there is an opportunity to sell our assets to further derisk the balance sheet and generating appropriate return, we will consider such sales.

[Kevin Barker:]

So do you see there is a more an off of that because there is an opportunity that presenting itself or something that's going to be a regular program?

[Lee M. Smith:]

Well I think in terms of the jumbo and NPL sales, I wouldn't say they are regular. As I mentioned in my prepared remarks, we have sold $570 million of NPLs and CDRs over the last 15 months as a result were down to about $107 million which is the lowest level we've been for some time and if the opportunity presents itself we'll take it. But I wouldn't say that we're going to be a regular seller of NPLs every quarter, it's just as and when it makes economic sense now what I would say as it relates to MSR sales given that we are looking to manage the concentration risk of MSR to tier 1, you can't expect more regular MSR sales and as Sandro noted where it makes economic sense to do so, we will try and retain the sub-servicing of such sales.

[Kevin Barker:]

Okay. And then in regards to the Series C preferred stock that's outstanding still. Can you give us an update on new timing of repayment and how that's going to look and what are you expecting regarding the repayment of the Series C Preferred?

[James K. Ciroli:]

Yeah Kevin, this is Jim. So really I don't think I can give you additional color on some of the things you are asking for and we continued to evaluate all of our options with respect to TARP and look for the right timing considering as I mentioned in my prepared remarks. What our progress is on risk management, improving the operating earnings of the Bank and getting some of the legacy issues behind us.

[Kevin Barker:]

So do you see a delay in the repayment of Series C Preferred related to the recent settlements that you've done or is this something that's a -- is it capital or regulatory process?

[Alessandro P. DiNello:]

This is Sandro, Kevin. I don't think there is any delay I mean we've been saying that we're evaluating it, we're getting more serious about where we go with that at this point. But it's just a little early for us to be very definitive but exactly what we think is going to happen.

[Kevin Barker:]

Okay. And then if you were to repay them today or future period, what would the amount of charges you would need to take in regards to the deferred dividends?

[James K. Ciroli:]

This is Jim. So there is deferred dividends on the TARP with about $49 million and on the troughs of about $19 million.

[Kevin Barker:]

Okay. Thank you for taking my questions.

[Alessandro P. DiNello:]

Thanks, Kevin.

[Operator:]

We'll go next to Paul Miller from FBR.

[Alessandro P. DiNello:]

Good morning, Paul.

[Unidentified Analyst:]

Good morning guys. This is actually Thomson on behalf of Paul. One quick question to follow-up on Bose's question on indemnification, the $3 million you took for this quarter, the $7 million you took for sort of future expectations. How many loans was that or UPB or can you provide a color there.

[Lee M. Smith:]

Yeah, it was approximately 21 loans.

[Unidentified Analyst:]

21 loans, okay. And on the interest-only portfolio, we've now sort of had a couple quarters of reset data and the charge-offs 2Q to 3Q were pretty stable right around 6.7% I'm thinking. Is there anything that you think could drastically change the sort of existing pays to charge-offs you were seeing in that portfolio or do you guys feel pretty comfortable that that sort of what the going forward rate could be.

[Lee M. Smith:]

I think that we are strong, we feel pretty comfortable, I mean we're pleased with the performance and how we're dealing with these portfolio, we've been proactive in managing it and as you mentioned if you look at the performance quarter-over-quarter it's been pretty consistent now. I think the next two quarters are going to be key because in Q4 we have 438 IOs resetting, then 412 in Q1. So we are going to have... we are going to basically double the amount of resets that we've currently seen in the next two quarters. So, I think the next six months are going to be interesting. But again given the robust process that we have in place, we feel pleased and good about what we're seeing.

[Unidentified Analyst:]

Okay, great. Thank you guys.

[Alessandro P. DiNello:]

You're welcome.

[Operator:]

We'll go next to Scott Siefers from Sandler O'Neill and Partners.

[Alessandro P. DiNello:]

Good morning Scott.

[Scott Siefers:]

Good morning I was just hoping you could give a little more thought on just overall profitability look as you look specifically into the fourth quarter and then next year. So I think just as I look at the guidance for the fourth quarter depending on how couple of things are interpreted. It looks like it could come in right around breakeven. So I mean one, are you guys expecting to be profitable in the fourth quarter and then just as you look into next year I imagine for the time being probably the mortgage market or housing market more broadly would be the main revenue driver at least. Lee maybe you could speak in a bit more detail on some of the conversations or opportunities you're talking about that hopefully would hit in the first half of next year. And what kind of additional flexibility is there on the cost side in light of all that you guys have already done over the past couple of years.

[Alessandro P. DiNello:]

Alright. I think you got a few things there Scott so all the guys are making sure we got all the questions identified here. Let me start with overall, so I'm not going to be specific about what we think profitability is going to be for Q4 or for 2015, but here is what I'll tell you and it's probably nothing that I haven't already said. First of all as it relate to the mortgage business, we've structured this business to get the cost structure it in a way that assures us that we can be profitable even with the level of originations that we currently have. The key is whether there is revenues sufficient there to cover other cost of the organization as we continue to build our other businesses. So we try to give you as much color as we can relative to what we think will happen in our community banking business while we've been very pleased with the overall results and growth of our earning assets and of our deposits. So if we can continue to grow that business that will be very helpful obviously to the overall profitability of the company and then additionally the servicing business, I think Lee has been pretty specific about what he thinks the opportunity is in the servicing business. So I mean everybody is going to have to make their own estimates and guesses on where all those things can go, we obviously have our own view of that and we're working hard to be certain that will be profitable on a regular basis. It's just not going to be any more specifics than we already were with the guidance we gave relative to the fourth quarter and of course we haven't given any guidance yet relative to 2015. Anything Lee?

[Lee M. Smith:]

Yes sure. I mean I think Sandro and Scott I would just add in terms of where the potential cost reduction opportunities as we move forward here and again not getting into any specific guidance of 2015 we have given you guidance just to how we look at Q4, but I think as we do move into '15 we would be looking at asset resolution, legal and professional and other vendor management savings where we can further improve the cost base of the organization.

[Scott Siefers:]

Okay. I appreciate that. And then separately just maybe Sandro just on the kind of the notion of legacy issues. Could you just sort of speak broadly where you think you are in resolving in other words are there other things that are left to be done. So I think one of the concerns, it certainly gets incorporated into evaluation is this, this notion that the intangible book value for example is not what is stated in other words there is kind of a vague concern that there could be additional charges that deteriorate that tangible book. Where are you broadly? Are there any other kind of big picture items that you would hope to resolve going forward, are we pretty much done with all the legacy stuff?

[Alessandro P. DiNello:]

Well we think we've addressed everything, everything we know about we certainly feel that we've appropriately addressed and we think that what we've done and communicated to all of you is pretty transparent. So there is nothing that I know about that gives me concern relative to legacy issues again other than what we've already expressed to you. So when you look at where are the risk and risks in the company it's, they held for investment loan portfolio we have and I think Lee has done a tremendous job of articulating the work we've done on the IOs and putting a fence around that risk. And I think when you look at our allowance for loan losses, we've taken some pretty aggressive action there and we feel very comfortable of what we stand in that regard I think this last piece that you saw this quarter relative to indemnifications, I was just responding to a change in behavior that we saw and so therefore we looked at what we needed to do in order to be in the right place going forward so I think we've done everything we can relative to legacy issues I mean even if you look at the commercial book we have virtually nothing left in the SAG portfolio I think it might even all gone at this point. So you know we're pretty pleased with the amount of progress we've made on all those things over the last year and a half but I can’t sit here and tell you it’s impossible for something else to come up, I just don’t what else might come up but everything that I know about I feel pretty good about.

[Scott Siefers:]

Okay. Alright, perfect guys. I appreciate that color. And then maybe Jim just one kind of final question sort of follow-up from the TARP related question a couple earlier but you've got the -- I guess if all of equal there would be roughly 70 million or so of kind of catch-up dividends between TARPs and troughs. Can you just clarify because there is obviously the noise that gets embedded in your diluted EPS calculation but if you were to pay those, pay off those instruments does any of that then go through your equity or because you have been doing the catch-up accounting in diluted EPS will there be no equity impact, how does that work?

[Alessandro P. DiNello:]

Scott I prefer to check that before I answer you so I can give you that answer later.

[Scott Siefers:]

Okay, alright. Thanks a lot.

[Alessandro P. DiNello:]

Why don't we do this with Scott we'll make sure that we give more color on that in the 10-Q.

[Scott Siefers:]

Okay, that’s perfect. Thank you.

[Operator:]

We'll take a follow-up question from Kevin Barker from Compass Point Research and Tradings.

[Alessandro P. DiNello:]

Hey, Kevin. You might be on mute.

[Kevin Barker:]

Sorry. In regards to the legacy issues you just addressed you just completed a settlement with the CFPB is there any investigation or that you are seeing from state in general you know we've seen several banks to be partied to the national mortgage settlement do you see that as a risk?

[Alessandro P. DiNello:]

Let me let our General Counsel, Mike Flynn answer that question.

[Michael C. Flynn:]

General policy we don’t comment and we cannot comment on specific communications with regulators but of course we will continue to advise investors of all material events that materialize as we did with the CFPB negotiations.

[Kevin Barker:]

Okay, thank you. And then in regards to the servicing operation given a lot of turmoil that’s going on special services and our scrutiny there. Do you see yourself as a potential beneficiary to acquire servicing given what is going on that side of the business?

[Alessandro P. DiNello:]

I’ll let Lee answer but just a quick thought before he does. I think relative to acquiring servicing if you're talking about acquiring the asset no we don’t have any intention of acquiring mortgage servicing assets from anyone else but when it comes to sub-servicing I think there could be opportunities there as I think Lee has talked about in the past specifically with the - Fannie Mae contingent sub-servicing agreement we entered into. But let me let him put some more color on that.

[Lee M. Smith:]

Yes sure thanks Sandro. And I agree I mean we are not going to be an acquirer or buyer of MSRs we are seller of MSRs given the concentration risk but we do want to sub-service the loans we sell and we do want to make our platform available, the people who want loan service where we haven’t originated those loans. As I have said before our focus is on servicing performing loans that’s what we are very good at and as I mentioned in the prepared remarks 96% of what we service today the 383,000 loans are performing loans as it relates to potential fallout Kevin as you mentioned I mean look we certainly believe that our retailed servicing platform and the fact where a bank provide certain competitive advantages as a bank we already have a robust infrastructure in place to address risk components on the regulatory environment in which we operate daily. So we do believe that provide certain competitive advantages and we want to use that plus the platform that we have in place to drive performing servicing businesses as we move forward.

[Kevin Barker:]

Okay. I appreciate it. Thanks for answering my questions.

[Alessandro P. DiNello:]

Thanks.

[Operator:]

And at this time, I would like to turn the call back over to management for any additional or closing remarks.

[Alessandro P. DiNello:]

Thank you Ann. I'd like to close with just a few comments. First of all, I'd like to thank all of you for your interest in Flagstar. This management team and the Board and the entire Flagstar family are together working very hard to build a great company. We continue to make good progress and the third quarter took us a little closer to where we want to be. There is still much work ahead and we look forward to reporting further progress to you in the future. Thank you and have a great day.

[Operator:]

This does conclude today's conference. We thank you for your participation.