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Flagstar Bancorp, Inc. (NYSE:FBC)

Q4 2012 Earnings Call

January 24, 2013 11:00 am ET

Executives

Paul D. Borja – Executive Vice President Chief Financial Officer

Michael J. Tierney – President Chief Executive Officer

Matthew A. Kerin –President-Mortgage Banking Division

Alessandro P. DiNello – Executive Vice President and Chief Administrative Officer, President-Flagstar Bank

Analysts

Paul J. Miller – FBR Capital Markets

Bose George – Keefe, Bruyette & Woods, Inc.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

Marc S. Steinberg – Dawson James Securities, Inc.

Andrew Luke – Jersey Micks

Dan Mazur – Harvest Capital

Operator

Good day everyone and welcome to the Flagstar Bank Fourth Quarter Investor Relations Conference Call. Today’s call is being recorded. At this time, I’d like to turn the conference over to Paul Borja. Please go ahead.

Paul D. Borja

Thank you. Good morning everyone, I’d like to welcome you to our Fourth Quarter 2012 Earnings Call. My name is Paul Borja and I’m the Chief Financial Officer of 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, the outcome of pending litigation, competitive pressures within the financial services industry and legislative of our regulatory requirements that may affect our businesses.

For additional factors we urge you to review the press release we issued last night. Our SEC documents, such as our most recent Form 10-K and Form 10-Q as well as the legal disclaimer on page two of our earnings call slides, that we have just posted on our investor relations page at flagstar.com.

In addition, pursuant to the existing consent order, we are in the process of finalizing our capital plans. And therefore, we will not be providing any guidance for the coming year at this time.

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 table 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 Mike Tierney, our Chief Executive Officer. Mike?

Michael J. Tierney

Thanks Paul and good morning everyone. Thank you for joining us, and welcome to our fourth quarter 2012 earnings call. We are focusing our national mortgage banking business in our Michigan-based community bank model. We also remain dedicated to enhancing our culture of compliance. We’re investing in our quality and risk management functions, as well as enhancing corporate governance, so we can continue to generate sustainable profitability and deliver shareholder value.

With these priorities in mind, during the fourth quarter we made several organizational changes that strengthen our corporate wide risk management in governance. First of all, our mortgage banking activities have been consolidated under one division, which Matt Kerin leads.

Second, the community banking activities including commercial banking, personal financial services, bank operations and technology are now operating under Sandro DiNello’s oversight. To help implement these organizational changes and further enhance our culture of compliance we made several additional personnel changes. First, we hired a new Chief Risk Officer; Hugh Boyle will take over the position from Todd McGowan.

Todd will be moving into a new and very important role as the Managing Director of Regulatory Affairs. We’ve also received OCC approval for John Lewis to serve as our chairman. We expect to finalize his appointment shortly once we have received approval from the Federal Reserve.

And now I’d like to discuss some of the key themes and drivers of the fourth quarter results. Matt Kerin, our Mortgage Banking President will talk about the mortgage business; after Matt, Sandro DiNello, our Bank President will provide an update of our community banking areas; Paul Borja will then take us through a more detailed financial review; and finally, would be available to answer your questions.

Please turn to slide four. We’re very happy to report fourth quarter net income to common stockholders of $66.8 million or $1.12 per diluted share representing our third consecutive quarter profitability. On an annualized basis, this represents a return on average assets of 1.8% and a return on average equity of 20.7%. For the full-year of 2012, we earned net income to common stockholders of $223.7 million or $3.74 per diluted share.

Looking at slide five, you can see that the majority of our key performance metrics improved from the prior year. Our 2012 return on average assets was 1.5%, and our 2012 return on average equity was 18.8%. We also increased our book value per common share to $18.97 at December 31, 2012, an increase of $4.17 per share or 28% from the prior year.

On slide six, we’ve broken down select items from our balance sheet. As you can see, our total assets are approximately $800 million less than they were at the end of the third quarter. This decrease is due to a variety of factors including lower mortgage loans held for sale, as loan sales outpaced originations during the quarter and a decline in commercial real estate loans originated prior to 2009.

Our fourth quarter financial performance was anchored by continued strong performance from our mortgage banking business. Gain on loan sale income for the fourth quarter 2012 was $239 million with a margin of 153 basis points.

Please note that this is different from our base production margin, which did not change materially from the third quarter to the fourth quarter. Matt Kerin will be speaking about the margin in a few minutes.

As you can see on slide seven, gain on loan sale income has outpaced credit cost in 2012, driving our strong financial performance. It represents the second highest level of gain on sale income from quarter in the bank’s history.

On slide eight, you’ll see the net interest income and margin both increased slightly from the prior quarter, as the reductions in interest expense driven by a lower cost of deposits, and improved mix of deposits outpaced a decline in interest income.

Turning to slide nine, our credit-related costs declined about 49% from the prior quarter, driven by a 75% linked quarter decrease in provisions related to the representation and warranty reserves. we also continue to strengthen and de-risk our balance sheet as reflected by $201 million decline in the repurchase pipeline, increased reserves for pending and threatened litigation, 100 basis point increase in Tier 1 capital and reductions in riskier asset classes amidst a flat level of non-performing loans.

On slide 10, you’ll see that our regulatory capital ratios increased significantly from prior levels, with the Tier 1 capital ratio of 10.41% at December 31, 2012. In addition, we carried approximately $1 billion in cash in interest earning deposits at quarter-end.

We also added approximately $16 million in additional reserves for pending and threatened litigations, bringing the total legal reserves, including amounts paid in anticipation of future settlement to approximately $83 million. As part of our continued efforts to reduce the concentration of mortgage servicing rights, we sold mortgage servicing rights related to $13.8 billion in underlying mortgage loans, on the book sale basis during the fourth quarter. We’ll continue to look for opportunities to reduce the overall level of our mortgage servicing asset. We believe the market for mortgage servicing is becoming stronger as non-bank participants enter the market.

Turning to slide 11, you’ll find a summary of agreement we made in the fourth quarter to sell $785 million in Northeast-based commercial loans for $779 million. We expect the transaction to be capital accretive and as a majority of these assets will be transferred to CIT during the first quarter of 2013.

As you can see the transaction is expected to be capital accretive by about 61 basis points and we believe this is an important step in de-risking the balance sheet, and strengthening the focus on our core markets. Although we intend to complete our exit from the New England commercial market, we remain very dedicated to the commercial banking market in Michigan.

Turning to slide 12, you see further details on our representation and warranty reserve. The total reserve would have increased by $2 million from the prior quarter after adjusting for $11 million reclassification of reserves associated with loans insured by the MBIA Insurance Corporation. This reclassification of the reserves was done concurrently with the establishment of additional reserves related to the litigation filed by MBIA. Provisions related to the representation in warranty reserve decreased by approximately $100 million from the prior quarter, primarily driven by a decrease in net charge-offs of loan repurchases.

At December 31, 2012, the total repurchase pipeline decreased to $224 million as compared to $426 million at September 30, 2012 as we continue to work through the existing population of repurchase requests. New order file requests increased by 12.7% from the prior quarter, which we believe is a reflection of the GSEs continuing their reviews as they transition to a new review process.

Turning to slide 13, allowance for loan losses was unchanged from the prior quarter, at December 31, 2012 our ratio of allowance to non-performing loans was 76%, the same as the third quarter, but increased from December 31, 2011 level of 65%.

On slide 14 and 15, you can see non-performing loans in total were essentially unchanged from the prior quarter. Consumer non-preforming loans increased by approximately 13% from the prior quarter, but decreased by 19% from a year-ago. The increase from the prior quarter was driven primarily by $25 million increase in performing non-accrual TDRs as the result of the implementation of the OCC guidance on bankruptcies.

This is highlighted on slide 16, which shows a break-out of our three categories of TDRs. Remainder of the increase came from the re-purchases of loans from the GSEs resulting from our continued successful efforts to reduce the loan re-purchase pipeline. Commercial non-performing loans decreased by 29% from the prior quarter, and 14% from the same period a year-ago. These decreases are primarily driven by continued workouts in individual note sales within the portfolio.

On slide 17, net charge-offs on consumer loans increased from the prior quarter, as we continue to work through non-performing loans associated with our HFI residential first mortgage loan portfolio. A portion of the increase from the prior quarter was related to the implementation of the OCC guidance on bankruptcies I just mentioned.

One other item worth mentioning, on December 18, 2012 the U.S. Treasury announced that they were planning to conduct periodic individual auctions of its TARP preferred stock for 53 of the remaining 218 institutions. Flagstar was included in those 53 institutions, and once we have further information to share we will did so.

Before I turn the call over to Matt, I want to take a moment and thank all of our employees for their hard work and dedication. Our sustain profitability and the achievements over the last year are truly amazing, and they are testament to the ongoing commitment of our team.

With that I’d like to turn the presentation over to Matt Kerin for more detail on our mortgage banking operations.

Matthew A. Kerin

Thanks Mike, good morning everyone. As Mike mentioned, we continued to generate strong revenues from our mortgage banking operations. Mortgage banking currently represents the majority of our overall revenues and consists of four primary drivers, a gain on loan sale income, interest income and residential first and second new mortgages, income from loan fees, which is accounted for separately from the gain on sale component and income from servicing of mortgage loans.

During the fourth quarter 2012, we earned $235 million in gain on loan sale income, with the margin of 153 basis points. This base margin has been consistent throughout the year prior quarters. Net gain on loan sale income decreased finally as compared to the prior quarter, but remains higher than historical levels as outlined on slide 18. The change from last quarter’s record levels as reflected and declined in loan against your margin and a lower level of mortgage rate lock commitments.

The fourth quarter gain on loan sale margin decreased by approximately 90 basis points from the prior quarter. This decline reflects a calculation from margin, accounting purposes, partly which is determine using loan sales revenue, then loan loss as the denominator. As such in a period declining gain, but increasing loan sales as was the case during the fourth quarter. The gain on loan sale margin would be more compressed; this had material impact during the fourth quarter. The decline also reflects in part a change in mix, and the increasing yields we experienced during the fourth quarter roughly 18 basis points. A number of other anomalies that impacted or items that impacted the quarterly results, we implemented the GP increase for Fannie, we experienced that into our pricing. it took effect and tampered some of the wider margins we have been available to us earlier in the year. And there are other specified pooling opportunities that changes the result of the mix.

Overall our gain on loan sale margins remains strong relative to historical perspective, reflective of the strong consumer demand from the refinancing of residential mortgage. Our residential rate lock is also declined towards the end of the quarter, as you can see on slide 19, in part due to the increase in yields, I mentioned previously, and also due to normal cyclical mortgage origination patterns.

If you turn to slide 20, you will see the residential mortgage originations increased in the prior quarter, which grow higher loan fees, as you can see it from the slide, refinancing has continued to make up by 80% as the overall residential mortgage origination volume.

Please turn to slide 21. Net servicing revenue, which is a combination of net loan admin income, which includes the off balance sheet hedges of the mortgage servicing rights, and the gain on trading securities, in this case, the on-balance sheet hedges of mortgage servicing rights. this amount increased by $13.7 million to $25 million for the fourth quarter. This increase in the prior quarter was primarily attributable to effective hedge positioning despite significant rate volatility to quarter.

I would now like to turn the presentation over to Sandro DiNello, President of our Bank.

Alessandro P. DiNello

Thanks, Matt. Good morning everyone. As Mike mentioned, our net interest income and margins increased slightly from the prior quarter. These increases were driven by improvements in our funding costs, which more than offset a decline in the yield on interest turning assets.

As you’ll see on slide 22, our average cost of funds improved by 13 basis points from the prior quarter, this improvement was driven primarily by two factors. First, a mix of funding sources continued to improve as we reduce balances in wholesale broker CDs and longer-term borrowings, both of which represent higher cost funding sources.

The decreases in these balances were offset by an increase in lower cost deposits, and by total assets. Secondly, the average cost of our retail deposits fell by about 10 basis points versus the third quarter, driven by a decrease of 19 basis points in the average rate paid and retail certificates of deposits. This improvement continues an ongoing trend as the cost of our retail CDs fell 50 basis points compared to the fourth quarter of 2011.

Turning to slide 23, which represents point in time balances at quarter-end, you can see the total deposits decreased $1.2 billion from September 30 to December 31, tracking the overall decrease in total asset. This decrease was primarily attributable to $1.2 billion of reduction in principal and interest custodian accounts serviced for the GSEs. While these accounts were non-interest bearing, the balances were also highly volatile and the reduction was held smooth out our deposit levels, and so facilitate easier balance sheet management.

On slide 24, you can see that we continue to add core deposits and improved the ratio of core deposits, which we defined as checking savings in money market accounts to retail deposits. We added approximately $400 million in core deposits during the quarter and has grown our core deposits by $670 million just the same period a year ago, the increase in our percentage of core deposits from 45.9% at December 31, 2011 to 50.1% at December 31, 2012. The growth of programs, deposits will continue to represent a primary focus for us in 2013.

I’d also like to add that I’m very bullish about our prospects for growing our retail business here within Michigan. We got a largest bank headquartered in Michigan, and are successfully leveraging our position. We have some very strong bankers in place, and our product sweep rivals ahead of any bank in our market. The exiting of our New England commercial line of business now allows us to focus all of our efforts right here in our home state of Michigan and our community banking team is very excited about that.

I’ll now turn it back to Paul Borja.

Paul D. Borja

Thank you, Sandro and good morning again, everyone. As my colleagues have discussed and as we have mentioned in our recent public filings, we have refocused Flagstar’s strategy to emphasize our National Mortgage Banking business, and our Michigan-based community bank model. To execute on this strategy, we have materially changed the composition of our balance sheet and made significant organizational changes that strengthen our risk management and governance.

We will continue to work closely with our regulators and our Board of Directors to achieve compliance with our consent order, including the submission of a three-year capital plan. as a result and as I indicated earlier, we will not be providing guidance for 2013 at this time.

As mentioned, our net income for the fourth quarter was $66.8 million or $1.12 per share on a fully diluted basis. This is our third profitable quarter in a row. Our fourth quarter earnings reflected a relatively flat net interest income after provision for loan losses, a decline in the gain on loan sales that was offset by the decline in the representation and warranty expense and resulted in an overall net increase in non-interest income and relatively flat non-interest expense total.

with the tax quarter, that was not repeated during the fourth quarter. We have in prior calls focused on three key areas of our operating results: revenue generation, expense management, and credit costs.

From a revenue generation perspective, our fourth quarter results arose principally from mortgage banking revenue including the second highest level of gain on loan sales in a single quarter in the bank’s history, and a steady level of net interest income even before the provision for loan losses.

With respect to net interest income, it increased slightly to $73.9 million from $73.1 million in the third quarter. At the same time, the bank’s net interest margin increased 2.26% from 2.21% in the third quarter.

On a company-wide basis, the yield on our interest earning assets declined by 10 basis points due to lower yields on our mortgage loans held for sale, which are short-term assets and that’s more sensitive to interest rate movement on our securities available for sale, reflecting the sale during the third quarter of our CMO securities, and on our residential mortgage loans as higher rate loans refinanced.

The cost of our liabilities during the fourth quarter declined by 13 basis points, this decline resulted in large part from a 16 basis point decline in overall deposit costs, which is significant driver was a 10 basis point reduction in the cost of retail deposits, as Sandro mentioned earlier, covering demand deposits, savings accounts, money market accounts, and retail certificates of deposits.

As a result, the decline in the yield, we earned in our assets was more than offset by the decline of the cost of our funds, resulting in an increase in the overall spread earned on our consolidated assets to 1.84% from 1.81% during the third quarter.

The decline in yields reflects the overall low interest rate environment during the fourth quarter, although there was significant inter-period volatility of these rates. For instance, the 10 year U.S. treasury rate was at 1.64% at the beginning of the fourth quarter, and 1.78% at the end of the quarter. During the quarter, rose as high as 1.86% and decline to as low as 1.58%. These historically lower yields facilitated continuation of the current refinancing environment with higher yielding residential mortgage loans that we hold for investment, refinancing the lower rates are paying off in both cases, reducing the yield, we are on those asset classes.

also the significant downward fluctuations both in the fourth quarter and the prior quarter resulted in a decline in the overall yield we were able to earn on the residential mortgage loans we originated during those periods and which we hold for sale for periods of 25 to 45 days.

The overall average balance of our interest earning assets is relatively unchanged during the fourth quarter; an increase in the average balance of mortgage loans available for sale is offset by declining the average balance of higher yielding investment securities available for sale following the sale of such securities during the third quarter.

There are also declines in the average balance is a commercial real estate loans as they paid off or paid down, and warehouse loans that we provide to correspondents and brokers for their origination of residential mortgage loans. With these and other declines in average balances and yields, the bank’s interest income for the fourth quarter declined slightly to $115 million from $119 million during the third quarter.

At the same time, during the fourth quarter, we were able to continue to reduce our funding costs. We see opportunities for further reductions as we continue to execute on our strategy for a liability structure, comprised substantially of retail deposit products. For the fourth quarter, the average cost of our retail deposits declined to 82 basis points or 0.82% from 0.92% in the third quarter.

We continue to see declines in the cost of our certificates of deposit with a lower rate structure of our retail certificates of deposits, continuing to replace maturing higher cost retail CDs and wholesale CDs in our funding structure. During the fourth quarter, our overall funding expense declined to $41 million from $47 million in the third quarter, and the cost of such funding decreased to 1.60% overall from 1.73% in the third quarter.

Turning to gain on loan sales, the bank’s mortgage business during the fourth quarter generated $239 million in gain on loan sales, as compared to $334 million during the third quarter. The fourth quarter gain on loan sales was the second highest level of quarterly gain on loan sales in the bank’s history.

During the fourth quarter, the bank continued to originate loans through refinancings of residential mortgage loans, including participation in the HARP 2 program and origination of FHA and VA loans. The gain on loan sales for the fourth quarter 2012 reflects a decline in overall loss volume as compared to the third quarter with an increase in originations and an increase in sales.

Another driver of mortgage banking revenue is our net servicing revenue, which is a combination of income we earned from servicing the loans and the net effect of the hedges on the mortgage servicing rights on our balance sheet. During the fourth quarter, we’ve continued to earn the income from our mortgage serving assets, during the quarter in which as we discussed earlier. There was significant interest rate volatility in the marketplace.

In total, our net servicing revenue was $25 million for the fourth quarter, an increase of $11 million in the third quarter of 2012. This reflects the refinancing experienced during the fourth quarter as well as the hedging challenges experienced during the third quarter with a volatile interest rate environment given the better reserves QE3 announcements and the European marketplace impact during the third quarter on the U.S. treasury market.

Overall, our mortgage servicing asset increased during the fourth quarter to $711 million from $687 million at the end of the third quarter. At December 31, 2012, the asset reflected approximately $77 billion of loans we are servicing for others primarily GSEs.

Non-interest expense excluding asset resolution was $216 million in the fourth quarter as compared to $221 million in the third quarter, reflecting slightly higher commission expense due to the higher level of loan originations during the quarter, as well as warranty expense, which reflects the increase during the quarter on our stock price. and this was offset by the absence during the fourth quarter of our prepayment fee that we made during the third quarter to the Federal Home Loan Bank of Indianapolis as we prepaid several advances.

Turing to our credit costs, loan loss provision expense declined slightly to $50 million for the fourth quarter, as compared to $53 million for the third quarter. At the same time, we maintained a level of our reserve at $305 million as of December 31, 2012, even though the balance of our loans held-for-investment investment declined by approximately $1 billion from September 30 to December 31.

This reflects our efforts during the fourth quarter to provide reserves for the potential re-defaults of modified loans, also known as Troubled Debt Restructurings or TDRs. We also worked to provide further loss reserves against the balances of residential mortgage loans on our books that are currently performing, but which have interest rates that are expected to reset in the near future. We continue to review these areas and additional risk metrics, as we monitored the level of our loan loss reserves.

Our representation and warranty expense for the fourth quarter declined as our charge-offs declined, although our reserve level actually increased when taking into account the reclassification of a portion of the reserves, the litigation reserve during the fourth quarter.

For the fourth quarter, our reserves changed from $202 million at September 30, 2012 to $193 million at December 31, as we reclassified $11 million of the reserves to our litigation reserves in response to the MBIA litigation. That amount had initially been set aside in our representation and warranty reserve, based on our expectation that we would resolve MBIA related loan purchase demands on a loan-by-loan basis in a manner similar to the practice followed by the GSEs with us.

During the fourth quarter, we remediated loan purchase request in our pipeline, reducing the population of outstanding request loans by 47% as compared to the end of the third quarter. at the same time, however we experienced an increase of almost 13% in requisition the GSEs for loan policy review for a possible repurchase.

Finally asset resolution expense increased to $21 million from $12 million in the third quarter. This increase reflects that there was a $7.8 million benefit we’ve realized in the third quarter from the high coordinated market option of our loans.

With that I will turn it back to Mike Tierney for questions and answers. Mike?

Michael J. Tierney

All right thanks Paul. Operator, we’re going to open it up for questions.

Question-and-Answer Session

Operator

Very good (Operator Instructions) We’ll take our first question from Paul Miller, with FBR.

Paul J. Miller – FBR Capital Markets

Yeah thank you very much. Hey guys there is a lot of confusion out there, and I think it’s driving the stock price today on your gain on sale margins. Now, I think the confusion, it doesn’t necessarily lie under 153, but it’s really going back to the gain on sale margins of last quarter, what exactly drove that 244 to be so high, and can you add some color to that. And then also can you add any color on what you are seeing right now, is there interest rate locks up today, it seems like December was abnormally spike down?

Michael J. Tierney

Paul, it’s Mike Tierney, how are you?

Paul J. Miller – FBR Capital Markets

How are you doing?

Michael J. Tierney

Great, I mean look, if I went back on it, as we all know the industry benefited in the second and third quarter as mortgage yields had a pretty steady decline on a 100 basis points or so, and we all had the opportunity to enjoy higher margins, and then pretty strong volumes. In the fourth quarter obviously yields increase in a roughly 18-20 bps and that did have some impact on our overall margin.

Some of the factors that impacted the fourth quarter, I think you saw, our lot of volume was down, and that was consciously done as we look at where originations and kind of focusing on where our production was coming from and some tweaking or just some pause, if you will to assess and confirm and validate to our board and others, where our business and the type of business we are doing.

There are a number of other things that impacted the margins and December in particular we had the December Fannie GP increase, it took effect and that had a tempering influence on some of the wider margins that has been available for our said GP increase. Part of our origination, development activities, we had benefited from some previous high balanced full transactions, that had some spread widening impact in the mid November at the loans and the yields, and impacted our execution in that space in December.

Overall December was a little bit of reduced supply of premium coupon spec tools and that impacted some of our ability to make volatility, get higher pay ups and yields, let’s say flattened out. We also had a loan different mix in our production volume, as you know the FHA introduced their insurance premium increase, and that just closed out of the market, and we’re a big FHA player, so they were just a number of things that impacted that overall execution premium that we are contributing as well as our own kind of predetermined pooling activities based on the originations that we were developing.

I do want to reiterate that our based production margin as we remained steady, and pretty strong over the course of time, obviously impacted by the…

Paul J. Miller – FBR Capital Markets

Because I’m not so sure, now you went through a lot of point, but I’m not so sure most people followed any of it, right and so I guess in layman terms because we’re not mortgage bankers out here, where we follow stocks, and we try to address the profitability of banks, and so what a lot of people are saying is, this is a sure sign (inaudible) boomers over, to a sure sign that is a steep decline coming and gain on sale margins, so when you talk about your base production margin, could you talk about that and what exactly that is?

Michael J. Tierney

Absolutely, our base production margin is – I will try to make this as clean as I can. It’s the average spread between our point combination on our rate sheets right, and then the final price we intend from the expected loan sales proceeds at the time of funding, and then we obviously use our secondary capabilities to affect specified poolings that may provide higher pay ups for particular loan classes, as you know we are national lending, so we do have some high balance pools, I don’t call jumbo pools, that we’re able to have high balance specific pools that we’re certainly at one point had narrower spreads than they did in mid-December or as they widened in mid-November. The December Fannie GP increase basically that took effect in December, and that had some tempering effect on the margins that we had been. . .

Paul J. Miller – FBR Capital Markets

But this base margin right? Getting to the core of the profitability, so this base margin remains relative constant over the last couple of quarters?

Michael J. Tierney

Yeah, I mean it was down modestly in December obviously as a result of deals moving, but no it’s been very consistent. We were above 145 for the year, I guess and probably slightly higher than that for the fourth quarter, and slightly higher than that for the third quarter.

Paul J. Miller – FBR Capital Markets

And what about today, like in the first couple of weeks of 2013, is that base margin holding in there pretty solidly.

Michael J. Tierney

Let me say this without making any forward-looking comments, I think that we’ve been consistently pretty good indicated where the market is, and I would suggest that that’s still true.

Paul J. Miller – FBR Capital Markets

So, you are looking at, if you’re pulling up Bloomberg, and you’re seeing a primary secondary markets spread, that’s relatively flat down slightly that’s a good indication of what’s going on with your base margin.

Michael J. Tierney

I would say we are pretty consistent with what you could look, what’s going out on the industry and the markets specifically.

Paul J. Miller – FBR Capital Markets

Okay. And then the other issue is what percentage of HARP, did you guys do?

Michael J. Tierney

That wasn’t impact as well, because of our HARP volumes were down, I think like a lot of folks, we were not a big servicer of refi opportunities, so we had an outside share of that, and like a lot of folks, I think, we probably peaked at about 15%, which was an outside number for us, when you think about our 2% service of market share, and that’s dropped off to probably south of 10, I haven’t looked at it in recent times, because we kind of busy with year-end, and a lot of the organizational changes, but that certainly had an impact from the margin perspective, that’s part of the mix.

Paul J. Miller – FBR Capital Markets

And then do you guys, I don’t know, if you guys disclose it, some people do, but given your book, right which is not relatively a new book, what do you think your book has a instead of the refi, I mean given where rates are today, what are your things out there on the pipeline for production.

Matthew A. Kerin

Well, I think if you look at the industry forecast, we’re all calling for modestly down environment, but I think we’re talking about a 1.7 trillion market for 2012, and somewhere around 1.3 trillion, and if you really look out into the fourth quarter, you’re still talking about 60% refinance share, so why we’re focusing on the purchase market as an opportunity for future, we are mindful of the fact that the refinance market is going to be a consistent feature, that in and obviously that is a big part of our production today.

Paul J. Miller – FBR Capital Markets

But you guys talked about it our conference that you guys want it to be closed to 5% market share, so could you grow in a market that is declining, I mean we haven’t seen any decline, so I know a lot of people say in $1.3 trillion, but these same people said $700 billion last year, and they were completely wrong, so I don’t really follow the industry experts, but given the fact that you said you want to be a top five player, which gives you over 5%, would you be able to grow even if the markets are to shrink a little bit.

Matthew A. Kerin

Hey Paul, Matt Kerin, when we were at your conference we made some aspirational comments about, what you want to be over the next five years, very long-term, like (inaudible) thing, so I want to be sure that we got the in the right context.

Paul J. Miller – FBR Capital Markets

Okay.

Matthew A. Kerin

And to your point, Paul, this is Matt, I mean our mantra, and it will continue to be two business with good quality customers, to develop good quality product, and that is first and foremost for us, we believe we have a very strong distribution network, and that we are well position in the marketplace, and we’re going to manage our business appropriate to the capacity, and it controls it on (inaudible)

Paul J. Miller – FBR Capital Markets

Okay, hey guys thank you very much.

Michael J. Tierney

Thanks Paul.

Operator

We’ll take our next question from Bose George with KBW.

Bose George – Keefe, Bruyette & Woods, Inc.

Hi guys good morning, it’s a just one follow-up on the gain on sale question, was there much of change in the mix in terms of channel like did your correspondent increase or anything there that was affecting the gain on sale margin.

Michael J. Tierney

Not significantly obviously with well (inaudible) earlier in the year our broker per share picked up not particularly.

Bose George – Keefe, Bruyette & Woods, Inc.

Okay, great. And then just in terms of the hard percentage you noted that it was down, is that something that could come back up or is that this probably going to continued to be single digit percentage.

Michael J. Tierney

As you know we want to participated in the Freddie Mac Refi Plus program that’s something that we are looking at now reductions fixed and we’ll continue to be an appropriate player in that marketplace, and I think it has been, we’ve done a pretty adorable job of playing in that space given that relatively small servicing share.

Bose George – Keefe, Bruyette & Woods, Inc.

Okay, great. And then just switching to a couple of other things, you guys sold some servicing almost $14 billion, was that mainly older more delinquent stuff or you opened to get a selling and older and newer service thing?

Matthew A. Kerin

Yeah. I mean obviously, we look at opportunities to sell servicing as appropriate to the company, both from the capital perspective and just from a concentration perspective, we’ve been a consistent seller of servicing in the near three and a half years, I have been here and I would expect that to continue, if the opportunity presents itself.

Bose George – Keefe, Bruyette & Woods, Inc.

Okay. And then lastly just on the rep and warranty, obviously came down pretty meaningfully this quarter. If all things being equal, if nothing changes, is that kind of a reasonable run rate for rep and warranty charges going forward?

Paul D. Borja

Hi, this is Paul Borja. One of the things that we don’t want to be doing is providing guidance for 2013, we believe that the reserve that we’ve established at the end of the year is appropriate, and we provided the additional slides, the additional information on in the earnings slides to provide you with the information, I believe it’s slide 12.

Bose George – Keefe, Bruyette & Woods, Inc.

Okay, great. Thanks a lot.

Paul D. Borja

Thank you.

Operator

We’ll take our next question from (inaudible).

Unidentified Analyst

(inaudible) just quick question on the rate lock impact on the margin, is there a way to break that out, just so I appreciate the comments on Paul’s questions about today’s margin, but is there a way to quantify the impact of the rate lock impact on the margin in the fourth quarter?

Paul D. Borja

Hi. This is Paul Borja, help me to understand the questions a little bit more if you could please.

Unidentified Analyst

So the 90 basis point margin decline, you said maybe kind of 18 basis points of it was due to kind of maybe mixed shift and then you also discussed a little bit about the change in the use of rate locks. Can you maybe discuss what that did to the margin to also kind of squeeze it a little bit?

Matthew A. Kerin

This is Matt Kerin. I think what we were saying is just kind of a dual combination impact to how this reads when you look at the margin. The part is the account achievement as we use the closings as the numerator, I mean as a denominator in the calculation as opposed to just, staying on sales (inaudible). But in terms of the overall execution in the margin compression, it was a combination of rates, yields moving up in the month, change in mix, because obviously different products have different margins associated with that. So those were really the two primary drivers in then some of it is special pooling in execution as a secondary side.

Unidentified Analyst

Oh my God!

Matthew A. Kerin

Sorry.

Unidentified Analyst

Thank you, guys.

Operator

We’ll take our next question from Jordan Hymowitz from Philadelphia Financial.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

Thanks for taking my call, guys. A couple of things; you said that December was when the Fannie Mae raised the GC?

Matthew A. Kerin

No. It was raised – that’s when it was put into effect and it’s with us..

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

So, if you look at December alone versus November and October, how much negative impact on gain on sales that just the GC has in December?

Matthew A. Kerin

I mean, I haven’t really looked at it specifically going by month to be honest with you. So – but the…

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

All right. Then, are we talking 20 basis points or we’re taking 50? What is the sense of exactly the GSE in isolation or what it would be because it was only in effect for one month and this time, it will be an effect on quarter?

Matthew A. Kerin

No, I mean it’s a one-time adjustment. We’ll pickup some benefit from it. It has to do with how you price the GSE into your transaction.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

So but there you paid 10 basis points higher on GSE, is it going forward?

Matthew A. Kerin

That’s reflected in our margin now. It’s really – what happened was before, that actually we came and put into effect. You had buyer-supplier spreads available to you. And when the 10 basis points came in, that was an absolute narrowing in the hedge at the time.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

So in other words, the margin was at low in December because of the GC.

Matthew A. Kerin

It was lower than we had experienced in the prior months because of the impact of the GC increase, yes.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

But that’s a one time thing going forward. March – January through March will not be reflective of that lower rate because of the GC by itself.

Matthew A. Kerin

I’m really not in a position to make any forward looking comments.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

It’s a simple question. Does the GC lower your gain on so much now that it has been raised or no?

Paul D. Borja

This is Paul. I think what we were saying was that the GC that took effect in December is being backed into the pricing, so that it doesn’t have an adverse impact as it did in December.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

Okay. So you’re saying that the pricing is now being raised to make up for it.

Paul D. Borja

Right.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

If the pricing was not raised to make for it on an apples-to-apples basis, how much does the GC impact the profitability?

Paul D. Borja

That – we’d have to get back to you on it because I think there’s a couple of things. One is we want to make sure that we get that kind of granularity you’re asking for. And second, we would definitely want to find a way to provide it in an appropriate manner.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

Okay. But it is 10 basis points by itself, right?

Paul D. Borja

I believe that was the demand increase.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

And it’s an average of about a four year life?

Paul D. Borja

I believe that in the industry, it’s about a four year life, right.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

Okay. And then, what was the price you sold servicing for?

Paul D. Borja

This is Paul Borja. When we self servicing which is part of a normal opt. So what we normally do is we’ll provide information regarding the amount of the underlying UPV and we also provide a gain loss and we include within the more detailed 10-Q and 10-K. I think a discussion within the income statement of the valuation changes, but we don’t reveal specific prices.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

Would it be fair to say, you’re more excited to sell servicing today, because of the very high prices people willing to pay it for?

Michael J. Tierney

If there are very higher prices, folks would want to pay for it, then we’re always happy to look for that opportunity.

Jordan N. Hymowitz – Philadelphia Financial Management of San Francisco LLC

Okay, thank you.

Michael J. Tierney

You’re welcome.

Operator

We’ll take our next question from Marc Steinberg with Dawson James Securities.

Marc S. Steinberg – Dawson James Securities, Inc.

Good morning. I have two quick questions for you. I know that you said that litigation reserves and now at about $83 million, an increase of $16 million for the quarter. Can you anticipate having to add more for litigation reserves and if yes, how much? And my second question is maybe, I missed this, I heard you say you’re not providing guidance for 2013 and I was wondering why?

Paul D. Borja

This is Paul Borja. As to the second question, we said we’re providing guidance for 2013 at this time. We first want to finalize the capital plan that’s described in the consent order, complete that process before we provide guidance to the street. As to the first of the questions, which is whether we intend to increase the litigation reserve, standard policy here and I think a number of corporations not to comment on pending litigation or the accounting effects of that.

Marc S. Steinberg – Dawson James Securities, Inc.

Okay. Now I know that with regards to assured guarantee, there is supposed to be a decision sometime this month. Is that still on point?

Unidentified Company Representative

This is (inaudible) the acting Deputy General Counsel of Litigation. We have received no indication from the court as to the timing of the opinion other than what federate corp said to us in open court on the last day of trial. So we’re still operating half of those comments and…

Marc S. Steinberg – Dawson James Securities, Inc.

Were those comments on the last day, any difference in what I’ve just asked I mean, did he say sometime towards the end of January or did I misinterpret?

Unidentified Company Representative

No sir. You got it right, it’s late January. That’s about all we know at this time.

Marc S. Steinberg – Dawson James Securities, Inc.

Okay, all right. Thank you.

Operator

(Operator Instructions) We’ll take our next question from Andrew Luke from Jersey Micks.

Andrew Luke – Jersey Micks

Hello, good morning. Just want to add my congratulations about another great earnings report.

Michael J. Tierney

Thank you.

Andrew Luke – Jersey Micks

And my first question, I mentioned if it’s kind of fewer forward speculation in that, but I know Flagstar currently owns and operates a 111 banking centers in Michigan. But they used to operate about 169 banking centers across the U.S., which is 58 more than now and I was wondering if you are currently thinking of re-expanding throughout the Midwest and the rest U.S., and if there is a timeline. And how many total locations you guys looking to think?

Alessandro P. DiNello

Hi, this is Sandro DiNello. with respect to bank franchise, you’re right on your numbers we did sell or divest ourselves of our Indiana and our Georgia banking centers about a year ago. But in keeping with the comments that we’ve been making relative to forward-looking statements that it’s not something that I can comment on at this time.

Andrew Luke – Jersey Micks

And there’s some point, where you’re willing in kind of the next year or is there no like comment and all?

Alessandro P. DiNello

Well, at this time, we’re really just going to comment on that.

Andrew Luke – Jersey Micks

All right. Next question is, I was wondering in 2013, what’s your guys’ primary focus for key profits continuing and base of the keeping bad loans down.

Alessandro P. DiNello

Well, our primarily focus at the bank is to come into full compliance with our consent order, we want to improve our operations inside the bank. And we want all of that to result in sustained profitability for the company.

Andrew Luke – Jersey Micks

Okay. And back to the – about the sell off of – what was the primary reason for the sell offs of the 58 locations in Indiana and throughout the U.S? Was it something like you’re gaining capital or was it for another reason?

Alessandro P. DiNello

Yeah, this is Alessandro DiNello. Again, it was a number of different reasons that was strategic in connection with that. We made a decision that we wanted to focus on our Michigan operations as we’ve been talking about throughout the call today. The primary driving reason is to be able to focus all of our efforts here at Michigan, where we’re the largest bank headquarter here. And we think that enhances our ability in the future to have an impact on improving the profitability of the banking part of the company.

And so at that point both transactions, we felt that the economics made sense and as I said we’ll be reevaluating further expansion as time goes forward.

Andrew Luke – Jersey Micks

Was that a large part to the profitability in the last few quarters due to the sell off or was that more for other reasons or do you think that was partly may be probably because of the sell off and – obviously making good loans, et cetera?

Alessandro P. DiNello

I’m not sure I understand the question. Let me ask, were you asking if the divestiture of those branches impacted the profitability of the bank over the last year?

Andrew Luke – Jersey Micks

Yes sir.

Alessandro P. DiNello

Well, we haven’t provided specific information in terms of what portion of the profitability was specifically related to those sales. Certainly, there was an impact on the operation relative to being able to reduce some operating expenses in such and as I said, to concentrate our efforts here in Michigan.

Andrew Luke – Jersey Micks

Okay, perfect. Thank you so much. Have a good day.

Alessandro P. DiNello

You’re welcome.

Operator

We will go next to Dan Mazur with Harvest Capital.

Dan Mazur – Harvest Capital

Good morning. Thanks for taking my question. It looks like and just looking to the components of gain on sale, you took a $143 million loss related to the value of interest rate locks. Is that partly due to the GC impact that you discussed earlier?

Paul D. Borja

Hi, this is Paul Borja. No, the interest rate locks and the forward sales are hedges against the share value of the portfolio itself. So you would generally expect to see as you’ve seen in the prior quarters that are displayed as well, offsets between the two.

Dan Mazur – Harvest Capital

Okay. And so it was a net more of a drag between the forward sales this quarter, so that the GC didn’t impact the net of the forward sales and interest rate locks?

Paul D. Borja

Right.

Dan Mazur – Harvest Capital

Okay. So about the catch up on the GC that you referenced earlier, was that on the interest rate locks and for a go forward basis or on a look back basis?

Paul D. Borja

It is going to be a go forward basis.

Dan Mazur – Harvest Capital

And where is that reflected? What part of the – I mean, I think you break out five or six parts of your gain on sale?

Paul D. Borja

Why don’t we do this? You’re asking me a question and generally what happens is – this is Paul Borja. In our chart that we provide, we indicate the two key parts of the gain on loan sale value, analysis from the accounting side. The top half is really the share value analysis and the bottom half is really the operational effect of selling loans and the requirement to recognize different expenses as we do that. What might make sense is for us to take a step back since this is an issue that’s raised now by two colors and look for a better way to display that within the presentation, and then perhaps present it again publicly that way.

Dan Mazur – Harvest Capital

Okay. And Paul do you have an estimate when you’ll set the capital plan, and after that do you expect to provide more color on ‘13 or first quarter?

Paul D. Borja

I think from the capital plan perspective, we are continuing to work on that; we work with the Board of Directors, and with our regulators. And so, we’re not at the point prepared to provide a timeline, we work within the construct of the capital or the consent order. But our expectation, our hope is that, once we finalize that, that we will be able to provide guidance to the public.

Dan Mazur – Harvest Capital

Okay. And can you give a – just an estimate, what the valuation allowance was at year end, and is there any way to kind of think about or what we should handicap on a go-forward basis or rule of thumb on discussion with auditors and when that might come back?

Paul D. Borja

Sure. The valuation allowance you’re referring to is a deferred tax asset valuation allowance?

Dan Mazur – Harvest Capital

Yes correct.

Paul D. Borja

I believe it’s about, we will confirm this; I believe it’s about $285 million. That from a reversal perspective, generally we’ve seen as few as five or six quarters as long as 12 quarters. It’s a function of being able to demonstrate sustained profitability, as well as reliable forecasting.

We know that in the last week to 10 days, at least one or two banks have indicated they fully reversed their deferred tax asset valuation allowance, and placed the asset back on their books.

We have had three quarters of profitability, and so we continue to watch it, but it might be preliminary for us to be engaging in these kind of discussions at this point with the auditors. But we do keep close – close touch with our auditors, and keep an eye on what the current industry trend is.

Dan Mazur – Harvest Capital

Okay. Thanks.

Operator

And we’ll take a follow up from Bose George with KBW.

Bose George – Keefe, Bruyette & Woods, Inc.

Hey guys, just had a quick question. Actually can you give us sort of a ballpark of the difference between gain on sale margin on HARP loans versus non-HARP loans?

Paul D. Borja

And obviously the margin on the HARP loans historically has been higher than non-HARP production in large part, I presume because people would use our prepayments fee have an impact on their estimate of value.

Bose George – Keefe, Bruyette & Woods, Inc.

And just going back to the gain on sale margin decline, and if there is one factor that you would highlight is being sort of the predominant driver of the decline. I mean, is there one factor you can pin down, I mean would HARP be the biggest factor?

Paul D. Borja

Mix. Mix would be a big factor, which would include the shifts in HARP as well.

Bose George – Keefe, Bruyette & Woods, Inc.

Okay. Great, thanks.

Operator

And no further questions in the queue. I would like to turn the call back to Mike Tierney for any additional or closing remarks.

Michael J. Tierney

Well, I’d like to thank you all for your time today, and we look forward to talking to you again in another 90 days.

Operator

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

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