Flagstar Bancorp, Inc. (NYSE:FBC)
Q1 2009 Earnings Call Transcript
April 22, 2009 11:00 am ET
Mark Hammond – Vice Chairman, CEO and President
Thomas Hammond – Chairman
Paul Borja – EVP and CFO
Terry McEvoy – Oppenheimer
Bose George – KBW
Good morning. My name is Leslie, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Q1 2009 investor relations conference call.
(Operator instructions) Thank you. Mr. Hammond, you may begin your conference.
Thank you. Good morning everyone. Welcome to Flagstar’s first quarter earnings conference call. My name is Mark Hammond, and I am the Chief Executive Officer of Flagstar. Please note that we will be using a PowerPoint presentation during this call. We recommend that you refer to it as we reference it throughout the call. This presentation, as well as our earnings press release that we issued last evening, which contains detailed financial tables, is posted on our Web site in the Investor Relations section at www.flagstar.com.
I’m here today with Thomas Hammond, our Chairman of the Board; and Paul Borja, our Chief Financial Officer. Tom will provide prepared remarks. Then I will talk about our 2009 outlook. Paul and I will then answer questions. Please note that we will be addressing the questions that we receive by email or that have been frequently asked. Before we get started, please first direct your attention to the legal disclaimer on the second page in the presentation. The content of our call today will be governed by that language.
With that, I will turn the call over to our Chairman, Tom Hammond.
Good morning everyone. Thank you for joining us. Please turn to page 3 of the presentation. During our last conference call we announced that our capital plan called us to raise an aggregate of $621 million. During the first quarter, we completed three of the four tranches of these investments. In January, we closed on a $250 million infusion from MP Thrift Investments as well as $266.6 million pursuant to the TARP capital purchase program.
In February, we received an additional $50 million from MP Thrift Investments; and during the second quarter, we expect to raise the final tranche of $50 million in capital from MP Thrift Investments. To our knowledge, no other thrift has successfully raised private capital in this difficult market.
We believe that these investments were made possible by the strength of our mortgage origination and banking franchise, as well as our ability to generate income to offset increasing credit costs without having to add loans to our balance sheet.
Let's discuss how we have utilized the investment proceeds. In the normal course of our business, we have already used these funds to increase our originations of residential first mortgage loans for sale through our existing Fannie Mae, Freddie Mac and Ginnie Mae lending channels and through our residential warehouse leading business. These loans have since been sold and we used the proceeds to make additional residential mortgage loans. The capital we have received has allowed us to meet the growing demand of consumers for affordable, single-family residential mortgage loans either to lower their payments on existing loans or to purchase a home during this period where interest rates are at historically low levels and home values declines have made housing more affordable.
It has also allowed us to continue to expand our residential warehouse lending business, which we view as a natural complement to our mortgage business.
Finally, these investments have increased our capital to levels which are higher than we have historically operated. We will talk in more detail about loan production and capital levels in a few moments.
Please turn to page 4. Last evening we announced our financial results for the first quarter of 2009. During the quarter, we lost $67.4 million, which was significantly less than the $218.5 million loss we experienced in the fourth quarter of 2008. The difficult market environment we faced in the fourth quarter last year carried into the first quarter of this year. We continue to experience deteriorating macroeconomic conditions and plummeting residential home values. The conditions led to continued high credit costs; however, we experienced significant improvement in core earnings from operations.
During the quarter, we had historically high gains on the origination and sale of loans, stronger loan production, and lower finding costs which resulted in improved net interest margins all of which combined to contribute to a pretax pre-credit profit of $144.6 million, which is outlined on page 5. On page 5, you see that in addition to our loan loss provision we incurred a number of other credit related expenses. In the aggregate, credit costs totaled $237.8 million in pretax costs for the quarter.
Let's go through those items individually. Item 1; in the first quarter, we had a provision for loan losses of $158.2 million, of which $68.2 million were in charge-off net of recoveries with the remaining $90 million being used to increase our allowance for loan losses. Our total allowance for loan losses is $466 million as of March 31, 2009. Item 2; we had $24.9 million in assets resolution costs related to valuation adjustments on our real estate owned portfolio which flows through our non-interest expense. Item 3; we had a $17.2 million other than temporary impairment related to several of our available for sale non-agency collateralized mortgage obligations. Item 4; we had a $14.6 million provision for a secondary marketing reserve, which covers expected losses when we repurchase loans or reimburse the purchaser. Item 5; we had a $12.5 million write-down on interest which recorded as unrealized losses on trading security. Item number 6; we had a $10.4 million reserve for anticipated mortgage insurance losses in our captive reinsurance subsidiary, which also flows through our non-interest expense.
Turning to page 6. We had $195.7 million in loan gain sales and our margin on gain on origination and sale of loans increased to 254 basis points as compared to 29 basis points in the fourth quarter of 2008 and 89 basis points in the first quarter of 2008. The margin for loan sale gains was positively impacted by our adoption beginning in 2009 of fair value method of accounting, for the available for sale portfolio of residential mortgage loans that we originate after 2008.
Under the fair value method, we recognize gains or losses on available for sale loans while they are in our portfolio as well as at the time of sale. This resulted in a one-time increase of $22 million in our first quarter 2009 loan sale gains upon adoption of fair value on January 1, 2009 relative to what gain on sales would have been if it had been accounted for under the historical method. Without the effect of the change to fair value accounting, our gain on sale would still have been $173 million for the quarter or 225 basis points. By adopted fair value accounting on our closed loan inventory, we were able to mitigate the accounting lag associated with the gain on sale of loans previously held at lower of cost or market.
Notwithstanding the positive effect in the accounting change, our first quarter 2009 margins on the gain on origination and sale of loans were the highest we have experienced. Throughout the remainder of 2009 we expect these margins will continue to be strong. However, we do not anticipate them to continue at their current levels as we expect there to be more competition as financial institutions return to stability.
Turning to banking. For the first quarter, our bank net interest margin increased to 167 basis points from 161 basis points in the fourth quarter of 2008. With loan production growing in the first quarter, we saw an increased available for sale loan balance, which resulted in higher interest income. We also witnessed a decrease in funding costs although we significantly increased the amount of our retail deposits and our customer base. In addition, we leveraged our large cash position which had negatively impacted our margin in the previous period, through investments at agency mortgage-backed securities. On the other hand, the increase in non-performing assets had a negative effect on the net interest margin.
Now let's talk about loan production. Turning to page 7. We continue to increase our residential first mortgage loan production including FHA production. Turning to page 8, you see in the first quarter we originated $9.5 billion of residential first mortgages as compared to $5.4 billion in the fourth quarter 2008 and $7.8 billion in the first quarter of 2008.
Turning to page 9, you see that at January 2009 loan underwriting volume was the highest monthly level in five years. Page 10 shows our historical loan lock rate commitments. In March 2009, we locked $5.1 billion in loans, the second-highest level in five years only behind December 2008. On page 11, you can see that the loans we closed during the first quarter of 2009 are at the highest quarterly level since 2004.
Page 12 outlines some industry origination rankings. As of the fourth quarter 2008, Flagstar was the ninth largest overall mortgage originator in the nation. We expect to continue to gain market share given our increased originations and also because of competitors exiting the business. Loan administration income reflected a loss of $31.8 million as compared to a loss of $46.2 million for the fourth quarter of 2008. The loan administration fee amount of $40 million earned in the first quarter 2009 for servicing loans was substantially the same as was earned in the fourth quarter 2008.
We experienced a smaller write-down of mortgage servicing rights net of hedging gains of $69.6 million for the first quarter 2009 as compared to $87.5 million net write down during the fourth quarter of 2008. Additionally, we recorded a gain of approximately $24 million on trading securities that were used to hedge the MSR portfolio. Overhead expenses increased by $52.7 million to $182.7 million in the first quarter of 2009, as we focused on underwriting, the increased loan volume, and added collection and workout staff to mitigate delinquent loans. Included in the increase are $41 million of credit and mortgage related costs flowing through our non-interest expense. Also included are $51 million in expense related to the warrants we issued in January 2009 to certain private investors and to the US Treasury as part of our capital raising activities in 2008 and 2009. These warrants must be treated as liabilities rather than equity on our books and so must be marked to market each month.
The US Treasury warrant will be treated as equity once stockholders authorize more shares of common equity which is expected to occur at our annual meeting in May, next month. However, the warrants issued to our investors will remain liabilities that will be marked to market each quarter until exercised.
We continue to monitor overhead and have taken steps to manage compensation expenses, including a current freeze on salaries and bonuses for nearly all employees. In addition, we have reduced executive compensation by suspending bonuses and performance-based pay. Currently, we are reviewing all compensation practices. We are currently finalizing plans to further reduce significant operating overhead during the second quarter. We have gone through an extensive review of our operation, business units and budgets, are in the process of implementing a number of changes. We intend to provide more details in the next quarter of our anticipated cost savings resulting from these initiatives.
Now let's turn to liquidity. Please turn to page 13. During the first quarter, our retail deposits increased to $6.2 billion from $5.4 billion in the fourth quarter of 2008, an increase of 15%. We believe that we were able to increase these retail deposits in a difficult market by maintaining our focus on customer service. While increasing our retail deposit portfolio, we continued to lower our funding costs. Our retail deposit funding cost decreased to 313 basis points at March 31 from 340 basis points at December 31. Additionally, as the interest rates paid on municipal deposits decreased, we saw funding costs on our total deposit portfolio decrease to 283 basis points at March 31 from 330 basis points at December 31.
During the first quarter, we opened two new banking centers bringing our total to 177 at March 31, 2009. Of these, one was in Michigan and one was in Georgia. At this time, we remain focused on managing overhead, and as such we intend on only opening one additional banking center for the remainder of 2009. We have additional sites available to develop but have postponed future expansion until we observe an improvement in the economy. In the first quarter, we opened over 4,300 net new checking accounts. We opened over 1,200 net new savings accounts, and opened over 8,600 net new certificate of deposit accounts. We anticipate that we will be able to continue adding retail customers, while we intend to decrease our reliance on wholesale funding and borrowings.
Now let's talk about our assets. Please turn to page 14. For the quarter our balance sheet increased by $2.6 billion, with total assets of $16.8 billion at March 31, 2009 from $14.2 billion at December 31, 2008. Majority of that increase came from our available for sale loan portfolio, which increased to $3.7 billion at March 31 from $1.5 billion at December 31. Our held-for-investment loan portfolio decreased slightly to $8.9 billion at March 31. This came from normal loan run off.
Slides 15 through 18 provide further analysis of our residential first mortgage portfolio by state, loan-to-value, original FICO scores, and vintage year. Of the loans with an original 80% LTV or higher, virtually all are covered by mortgage insurance.
Let's talk about our non-agency investment securities. Please turn to page 19. During the first quarter 2009, a new accounting standard became effective which requires a company to record a decline in market value on its securities only to the extent that the decline is attributable to a credit loss and the company plans to hold the security. During the first quarter, we had OTTI credit marks of $17.2 million on our non-agency securities available for sale portfolio, which resulted from several of the securities receiving ratings downgrades.
Now let's discuss asset quality. Page 20 identifies our key asset quality ratios. We continue to add significant reserves, increasing our allowance for loan losses to $466 million at the end of the period. Our first quarter provision included net charge-offs of $68.2 million and a $90 million increase in reserves. For the quarter, $25.1 million of net charge-offs were related to first mortgages, $22.6 million was related to commercial real estate, and $18.2 million was related to second mortgages and HELOCs.
Our asset quality by loan type, including a breakout of general and specific reserves is set out on page 21. As you can see, the majority of the specific reserves are related to our commercial real estate portfolio. We also increased our secondary marketing reserve for losses on repurchased loans by $6.4 million compared to a total of $48.9 million at March 31, 2009.
Turning to page 22, you see that the real estate owned net of any FHA insured assets decreased to $106.5 million at March 31 from $109.3 million at December 31, and $136.5 million at March 31, 2008. Repurchased assets were $14.8 million at March 31 as compared to $16.5 million at December 31, and $9.6 million at March 31, 2008.
On page 23, you see our 30, 60, and 90-day-plus delinquency rates. The 90-day-plus delinquency rates still continue to rise. However, the residential and consumer – excluding commercial – 30 and 60-day delinquencies are static, which indicates that the migration rates from the 30 to the 90-day is high. We did not notice a decline in the 30 and 60-day trends through the end of the quarter – we did notice a decline, a slight decline. Although we anticipate further credit losses, we have observed in recent months that the rate of increase in delinquencies in our portfolio has slowed. In the appendix we provide a variety of additional asset quality metrics, both in our residential first mortgage and commercial real estate portfolios.
Now let’s turn to capital. Please turn to page 24. As I mentioned earlier, we received a total of $571.9 million in capital during the quarter. Of that, $525 million was invested in the Flagstar Bank, improving bank regulatory capital levels significantly. In addition, we received a capital credit of $32.9 million because we were able to reverse a portion of the OTTI taken in the fourth quarter 2008 due to the new accounting standards. At March 31, 2009, our Tier 1 core capital ratio was 7.22% and our risk-based capital ratio was 13.58%.
With that, let me turn things over to Mark.
Thanks, Tom. On page 25 of the presentation, we provide an outlook for 2009 for each of those drivers [ph]. Please note we have refined the list from previous quarters. Target asset size. In our previous outlook, we provided a year-end total asset range between $17 billion and $18.5 billion. We are revising this range to between $14.1 billion and $15.5 billion to reflect our continuing emphasis on maintaining higher regulatory capital levels and also because we will be selling all of our residential mortgage loan production rather than growing the balance sheet.
At March 31, 2009, our total assets were $16.8 billion. As we are not intentionally adding any new loans to our investment portfolio, we plan to shrink the assets through normal loan payouts. Loan runoff is projected to be between $100 million and $200 million per month. In addition, we also intend on reducing our wholesale deposits and our Federal Home Loan Bank borrowings to shrink the liability side of our balance sheet. Our goal is to shrink the balance sheet to run at a higher bank regulatory capital level and we will not look to relever until there is more economic certainty in the marketplace. Although we anticipate shrinking the balance sheet, we anticipate originating more loans in 2009 than we did last year.
Residential mortgage originations. We are slightly raising our prior estimates from a range of $36 billion to $44 billion to a new range of $38 million to $46 million. In the first quarter, we originated $9.5 billion in residential first mortgages even though January, February, and March are historically low origination months. Year to date, we have locked $12.6 billion of residential mortgages and expect those trends to continue throughout 2009.
Loan sales. We still intend to sell virtually all of our production in 2009. Therefore our loan sales for 2009 have been increased to a range of $37 billion to $44 billion. In the first quarter, we originated $9.5 billion of loans, but had loan sales of $8.2 billion. The difference is a result of the timing lag between origination and sale.
Margin on the origination and sale of loans. We are significantly increasing our estimate for margin on the origination and sale of loans to 132 basis points to 142 basis points as we continue to see historically high spreads. Gain on loan sale margin during the first quarter was 254 basis points. We do not anticipate that we will be able to hold these margins, but do think that 2009 will be the best year for mortgage origination profitability in our history.
Net interest margin at the bank level. We are decreasing the estimated range of our bank net interest margin for 2009 from a range of 240 basis points to 270 basis points to a new range of 186 basis points to 196 basis points. Although borrowing costs and deposit costs continue to fall, we are not putting new loans in our investment portfolio, and the rising defaults in the loan portfolio will continue to deteriorate the average yield in our interest earning assets putting pressure on our net interest margin.
Provision expense. We are adding a new driver to our outlook, provision expense. We have completed an extensive cumulative loss projection. We are modeling continued declines in real estate values and worsening unemployment, in line with a bearish market sentiment given that we anticipate provision expenses of a range of 382 million to 422 million in 2009. In the first quarter we have provision expense of $158.2 million, which included replenishment of $68.2 million in charge-offs. Although we anticipate significant continued credit cost throughout the year, we are optimistic for a number of reasons. First, we have a static, seasoned loan portfolio where we feel that our credit costs are manageable, measurable, and predictable. Second, we anticipate that we will have our most profitable mortgage banking origination year ever. Finally, we should continue to see benefits from lower deposit costs, overhead reductions, and from new government programs as they go into widespread utilization.
With that said, let me turn the discussion over to our CFO, Paul Borja, for the question-and-answer session.
Thanks, Mark. We are going to go over some questions we received via e-mail today. Either Mark or I will address them.
Our first questions are from Terry McEvoy of Oppenheimer. Why is there a decline in the number of loan officers and account executives, given the increased mortgage volume that you and the industry are seeing? Mark?
Yes, Paul, the primary reason is we are focusing on trying to do more with less. And we are focused on eliminating fixed cost and trying to do more business with high producing variable costs.
The next questions. Taking into account the adoption of the fair value method of accounting for residential mortgage loans, what was the net impact to Q1 ’09 results? Or said another way, if this was not adopted, what would earnings have been in the quarter?
We discussed this briefly in the speech and mentioned that we estimate about $22 million pretax was the effect of the fair value adjustment.
The next question also from Terry, was any of the upside to revenue one-time in nature?
We’ve discussed the fair value adjustment. There were no other non-recurring revenue items. There are a couple of new items in the expense side. We did have expenses related to our capital offerings, but they are capitalized as part of the overall net proceeds. We did also have, as we mentioned in the speech, new expenses related to the warrants that we issued as part of the capital offerings. Those warrants put off $11 million in expense for Q1, and we expect them to have expenses through the Treasury – we expect the Treasury to have an expense through the time that shares are approved at the stockholders meeting to allow the Treasury warrant to be exercised, and that the warrant issued to the other investors will continue as a liability.
Our next set of questions are from Bose George of KBW. His first question. Even if we pull out your $21.9 million of fair value adjustment, we estimate that you recorded a gain on sale margin of 206 basis points. Is that number correct.
His next question. Can you discuss where that number is trending in second quarter? With that I will turn it to Mark.
Yes, we still anticipate stronger gain on sales than we’ve historically experienced as we indicated in the drivers. However, we do not anticipate that we will be able to hold a 225 gain on sale margin. We expressed that we will be able to do what we said in the drivers, which that will take in the 225 in the average for the year.
Next question from Bose George. Can you talk about where volume are trending in second quarter versus first quarter ’09? Mark?
Yes, for the industry as well as for us mortgage volumes are trending higher. However, we are going to be managing our business to approximately do no more than $4 billion a month in production. We could potentially do substantially more, but instead we'll allow for pricing power and try to reflect the ability to do more volume instead in margin and gain on sale. The strategic reason to manage the volume and not to more than $4 billion is, one, so we could manage balance sheet growth. Two, so we could manage the growth of MSRs. And three, so we don't have to balloon our staffing levels to later have to take them down.
The next question from Bose. How much of a benefit are you seeing from the Home Affordable Refinance program that allows conforming borrowers with high LTVs to refinance?
That program is just getting started. We are seeing a lot of activity on it. However, we have an unclarified situation on a large portion of our Fannie and Freddie servicing book. It gets fairly technical, but over the years we had entered into tri-party credit agreements with mortgage insurance companies and Fannie and Freddie Mac to minimize credit exposure. In doing so, we entered into what's referred to as SMC and pool structures. And currently, Fannie and Freddie’s Home Affordable Refinance program is not allowing SMC or pool structures in. So a good portion of our book is not eligible at this time. For the portion of book that is eligible, it's a lot of business with a situation that a lot of borrowers who are unable to refinance their home before, particularly due to declining property values, are now able to do so. If Fannie and Freddie are unable to resolve the current issue with finding a way to include loans that have SMC and pool in the Home Affordable Refinance program, the result will be less refinance opportunity. But the positive side will be – that will be a positive for our existing MSR valuation, in as much as the speeds on the runoff won't be as much a concern and the MSR won't have as much potential for write down or impairment.
As a follow-on to that last question Bose asked, has this materially changed your pull-through rate?
No, it has not had a material effect on pullthrough.
And our last question from Bose. Can you quantify the financial benefits you could get as a servicer from the government's loan modification program that was announced in early March?
Not at this time. But we don't feel that it will be material on our Fannie/Freddie servicing because the government fees will offset some of the operating expense service. On our own portfolio, the economics will be hard to determine. A lot will depend on what the net improvement in the re-default rate is, versus or relative to the increased principal and interest write down that we would take on those loans. So only time will tell and it's a little too early to analyze and determine if the government subsidy and the improvement in the re-default rate will offset any concessions that are made to borrowers and writing principal or interest down.
This concludes our questions for today. With that, I will turn things back to Mark Hammond.
Thank you for all joining today and have a good day, everyone. Bye.
Thank you and this concludes today's conference call. You may now disconnect.
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