Flagstar Bancorp's CEO Discusses Q1 2013 Results - Earnings Call Transcript

| About: Flagstar Bancorp, (FBC)

Flagstar Bancorp, Inc. (NYSE:FBC)

Q1 2013 Earnings Call

April 24, 2013 11:00 AM ET


Paul Borja – EVP and CFO

Michael Tierney – President and CEO

Matthew Kerin – EVP and President, Mortgage Banking Division

Alessandra DiNello – Chief Administrative Officer, EVP and President

Michael Flynn – General Counsel


Paul Miller – FBR

Kevin Barker – Compass Point

Marc Steinberg – Dawson James Securities

Robert Drenk – Optimum First

Jim Fowler – Harvest Capital

Bose George – KBW


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

Paul Borja

Thank you. Good morning everyone. I’d like to welcome you to our first quarter 2013 earnings call. My name is Paul Borja and I’m the Chief Financial Officer of Flagstar Bank.

Before we begin our comments today, I’d like to remind you that the presentation today may contain forward-looking statement 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 or regulatory requirements that may affect our business.

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 our Form 10-Q as well as a disclaimer on page two of our first quarter 2013 earnings call slides that we posted today on our investor relations page at flagstar.com.

During the call, we may also discuss non-GAAP measures regarding our financial performance. A reconciliation of these measures to similar GAAP measures is provided in the tables to our press release which we issued last night, as well as in the appendix to our earnings call’s slides.

With that, I’d like to now turn the call over to Mike Tierney, our Chief Executive Officer.

Michael Tierney

Thank you, Paul. Good morning, everyone. Thank you for joining us. I’d also like to welcome you to our first quarter 2013 earnings call. On the last conference call, we told you that we’re going to be refocusing our strategy in our national mortgage banking business and our Michigan base community bank model. We also mentioned that we’ll continue to improve risk management, strengthen compliance and quality control and strengthen the balance sheet.

Our results for the first quarter reflect the positive impact from these efforts which are highlighted by the strong improvements in many aspects of our business this quarter.

Total credit cost declined significantly for the lowest quarterly level since 2008. Total non-performing loans decreased by approximately 8% from the prior quarter, and now decreased by 785 million or approximately 70% from their peak level during the second quarter of 2010.

Our allowance coverage ratio increased to 78% of non-performing loans and our active repurchase pipeline decreased by about 17% from the prior quarter.

A representation and warranty reserve is now almost equal to our active repurchase pipeline.

We also continue to add deposit customers in Michigan where we experienced a 13% increase in core deposits from the prior quarter.

We are experiencing solid commercial and consumer loan growth. At the same time, we significantly strengthened our capital and liquidity rations and continued our efforts to reduce MSR concentrations as we prepared to meet the requirements of Basel III, and the regulatory prescribed stress test.

Along with the rest of the industry, we experienced a significant reduction in mortgage banking activity in the first quarter.

Flagstar’s business model is heavily dependent on mortgage production and our top line revenue was negatively impacted by decreased in gain on loan sales, reduced interest income from mortgage and warehouse loans, and lower loan fees from new mortgage originations.

We saw a reduced demand due to the upward movement of rates during the quarter. Margins also compressed due to the increased competition with excess capacity in the mortgage space. As a result, we lost some market share in the first quarter. In response to that, we’ve taken steps to gain market share back and improve our margins.

We feel positive about our national foot print and core penetration levels in our key markets and continue to believe we’re well positioned to grow market share. In addition, we saw positive signs during the end of the first quarter which will continue to end of April.

I’d now like to discuss some of the key drivers of our first quarter results. Matt Kerin, our Mortgage Banking President will then talk about the mortgage business.

After Matt, Sandro DiNello, our bank President will provide an update on our community banking areas. Paul Borja will then take us through the financial outlook, and finally, we’ll be available to answer your questions.

Let’s begin on slide five. As you can see, we reported first quarter net income of 22.2 million, or 0.33 per share. On an annualized basis, this represented a return on average assets of 0.65% and a return on average equity of 7.55%.

Turning to slide six, we provided a bridge from the fourth quarter of 2012 net loss to our first quarter 2013 net income. As you can see on the slide, our first quarter results were impacted by four key items.

First, legal and professional expense decreased by nearly 184.6 million, primarily driven by having increased reserves for pending and threaten litigation during the fourth quarter.

Second, total credit related cost decreased by about 43.2 million including a 29.9 million decrease in provision for loan losses a 7.8 million in representation and warranty reserve, change in estimate expense, and a 4.8 million reduction in asset resolution expenses.

Third, gain on loan sales decreased by 101.4 million. From a rate volume perspective, this decrease was driven equally by a decrease in the volume of mortgage rate lock commitments and lower gain on sale margin. Matt will discuss this later in the call.

Lastly, interest income decreased by 20.4 million driven primarily by lower average balances of residential first mortgage loans held for sale, and warehouse loans. Both attributable to the reduced mortgage banking activity during the quarter.

It also reflects the impact of the sale of our New England base CNI and commercial real estate loans originated by former lending group during the last quarter.

On slide seven, we’ve broken down select items from our balance sheet. As you can see, total assets decreased by almost 1 billion from the prior quarter. This decrease was driven largely by an $859 million reduction in commercial loans held for sale attributable to the closing of our two sales of north east based lending groups commercial loans referenced earlier.

In addition, our mortgage loans held for sale on warehouse loan decreased during the quarter. These decreased were partially offset by an increase in cash and interest earning deposit resulting from both the proceeds of the commercial loan sales, and a reduced level of funding needed for the mortgage business.

We expect the excess liquidity to decline through the remainder of the year as mortgage funding needs increase and we experienced further reductions in high cost liabilities.

Please turn to slide eight. Like the majority of the banks in the industry, we continue to significantly increase regulatory capital ratios. At March 31, 2013, the tier one leverage capital ratio was 10.14% the highest level in the recent history in 88 basis points – in an 88 basis point increase from the prior quarter.

Turning to slide nine, you can see a break out of our non-interest expense. In total, non-interest expense decreased by 196.6 million from the prior quarter.

As I mentioned, the majority of this decrease was related to us increasing the reserves for pending, and threaten litigation during the fourth quarter of 2012.

Nonetheless, we are actively evaluating our cost structure seeking opportunities to reduce expenses while implementing initiatives to improve our operating efficiency consistent with what I’m sure what you’re hearing from others in the financial services industry.

As we noted in our earnings release, during the first quarter, the U.S. Treasury announced that it sold our TARP preferred stock private investors. This amount will continue to qualify as tier one capital and will continue to accumulate dividends quarterly at a rate of 5% per annum.

We continue to emphasize a culture built around exceptional customer service. In April, J.D. Power and Associates ranked Flagstar Bank, second highest in customer satisfaction for the north central region which includes Michigan, Indiana, Ohio, Kentucky and West Virginia.

The J.D. Power survey measures retail customer satisfaction based on county activities, county occupation, banking facilities, fees, problem resolution and product offerings. Our overall score of 807 rank 44 points above the national average.

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

Matthew Kerin

Thank you, Mike. Good morning everyone.

And as Mike mentioned, both the industry and Flagstar experienced a slowdown in mortgage banking activity during the quarter, which reduced demand and create a tighter margins due to increased computation and the results in excess capacity.

If you turn to slide 10, you can see that net gain and loan sales decreased significant from both the prior quarter and from the same quarter in 2012. This was driven by a decrease in both rate lock commitments and margin, both of which we highlight on the bottom chart on page 10.

For the first quarter of 2013, fallout adjusted locks came in at $9.8 billion as compared to $12.6 billion in the prior quarter. This decrease as compared to the prior quarter was driven by a number of factors, including seasonality and upward movement of rates and increased competition for mortgage lending with new entrance to the top 30 and several of the top lenders buying up market share.

Gain and sale margin which we measure based on fallout adjusted rate locks, decreased to 140 basis points in the first quarter as compared to 190 basis points in the fourth quarter of 2012. As we know, gain and sales margin stayed at historically high level throughout much of 2012 and we alone and the industry had anticipated it would come down.

Our gain on sale margin declined due to a number of factors including the impact to GC increases, seasonality, increases in the buy up and buy down fees and a conservative approach we took to capitalizing our new mortgage servicing rights that was generated in the quarter.

If you look at where the quarter ended, with the increase in registrations we’re saying the GC increases now being well-incorporated into our pricing and changes in the primary and secondary spread together with recent information suggesting increase in the evaluations. We believe we’ll be seeing improved margins in the second quarter.

As we look at the business today and while we clearly have come down from the peak of 2012, we believe we’re now back to a level that’s not far away from the longer term run rate and we’re optimistic for the future.

Please turn to slide 11, which provides additional stratifications on our residential first mortgage originations. As you can see from the chart on the bottom right, both purchase and refinance originations declined from the prior quarter levels but increases compared to the same period a year ago.

We continue to expect refinance activity to remain strong during 2013 and we expect to continue to be a major player in that space. However, growing the purchase business continues to be a key component of our strategy going forward. As all of the industry estimates contemplate the percentage of purchase share to more than double by the end of 2013 and continue that increase through 2014 as a percentage of the total production.

In addition during the quarter, we added 10 retail home lending centers as part of our purchase acquisition strategy on the home lending side of the business.

If you turn to the chart on the top of slide 11, you can see our HARP 2.0 originations decreased in total but continue to hang around the 9% level of total production. We’ve been successful in refinancing HARP eligible loans, especially our originations relative to the size of our overall servicing loan.

With the recently announced extension of the HARP 2.0 program and with the recent rally in the 10-year, we see a greater opportunity for a stronger refinance market coupling that with the fact that as housing buyers go up, there’ll be more customers that could take advantage of a refinance. We see a good opportunity to continued success on the HARP space.

Further, HARP opportunity do not laminate to our servicing book and we’ve routinely HARP loans last year and prior from other servicing books. We would expect that to continue.

If you turn to slide 12 please, the net servicing revenue, which is a combination of our net loan admin income including the off-balance in hedges or the MSR, so mortgage servicing rights, and the gain on trading securities, which in this case the unbalance sheet hedges of mortgage servicing rights decreased to 20.4 million as compared to 25 million in the prior quarter. This decrease from the prior quarter was primarily attributable to challenging hedges or hedging challenges, I say, associated with interest rate volatility that we experienced during the quarter.

I’d now like to turn to credit quality. If you look at slide 13, you can see our total credit cost, created related cost declined by about 43 million from the prior quarter which presents the lowest level since 2008.

This decrease was driven by significant reduction in each of our three major categories of credit cost, representation and warranty reserve are changing estimated expense provision for long losses and asset resolution.

On slide 14, expense is related to the warranty reserve decreased by $7.8 million in the prior quarter. This decrease was largely driven by two factors; first is as you can see on the chart, there was a $37 million deduction in the total active repurchased pipeline as we continue to work through the existing population if you purchase request. Second, loss rates improved from the prior quarter resulting from two consecutive quarters of declining levels of net charged us from loan repurchases.

As you look at the bottom two charts in the page, both new audit file review request and repurchase demands increased from the prior quarter yet continue to remain below peak levels. We believe this is a reflection of heightened scrutiny from the GECs as they transition to their new review process focusing from the 2009 vintages toward more current originations. While both the level of file pulls a new demand of increase, we anticipate continuing improvement.

Turning to slide 15, our allowance for loan losses decreased from the prior quarter largely driven by a release of reserve associated with the commercial loans we sold in the northeast. But also due to an improvement in the overall loss rate associated with the consumer loan portfolio. Despite the decrease in reserves, our ratio of allowance in that performing loans improved to 78% as compared to 73.6% in the prior quarter.

If you turn to slide 16, you’ll see that our net charge-offs of consumer loans decreased by about $15 million in the previous quarter as we continue to work diligently to a non-performing loan associated with our HFI residential first loan portfolio. As a result to the decrease in net charge-offs, we saw a decrease in provision for long loses from the prior quarter.

Slide 17 to 19 provides a breakout of our non-performing loan in TDR portfolios. As you can see on slide 17, total non-performing loans decreased by 7.6% from the prior quarter. While the absolute level of non-performing loans declined, the ratio of non-performing loans to total loans actually increased from the prior quarter.

It’s important to note that this has occurred primarily because there was $700 decrease in the investment loan portfolio at the same time which negated much of the effect of the lower level of non-performing loans.

Loans past due 30 to 59 days, which are leading indicator for us of non-performing loans also decreased about $14 million or roughly from the prior quarter. Finally, asset resolution expense which includes expenses associated with foreclosed properties, decreased a $16.4 million in the first quarter as compared to 21.2 million for the fourth quarter of 2012. This decrease is primarily attributable to the realization of gains on the sales of repossessed assets due to an improvement in home prices.

I would now like to turn the presentation over to our bank president Alessandro DiNello.

Alessandra DiNello

Thanks, Matthew. Good morning everyone.

Please turn to slide 20. As Mike mentioned, our net interest income in March decreased significantly from the prior quarter. In interest income decreased from 75.6 million in the fourth quarter of 2000 to 57.3 million in the first quarter 2013.

That interest margin at the bank also decreased to 1.89 percent as compared to 2.26% in the prior quarter. These declines are primarily attributable to lower average balances of our mortgage related portfolios both residential first mortgage loans held-for-sale and warehouse loans. Both of these lower bounces were attributed to a slowdown in mortgage volumes during the quarter.

The decrease was also related to a decline in commercial and commercial real estate loans related to loans we sold in the northeast. Both of these contributed to $20.4 million decrease in net interest income.

Looking at slide 21, you can see our overall balance sheet shrunk driven by a conversion of higher yielding assets to cash. The decrease in interest income was partially offset by $2.2 million decrease in interest expense as compared to the prior quarter.

This is primarily due to lower average balances of retail certificates of deposits and wholesale deposits as well as the lower average cost of the process. And you can see on slide 22, our average cost of funds improved by 6 basis points from the prior quarter.

This improvement was driven primarily by two factors. One, our mix of funding sources continue to improve as we reduced the balance of higher cost in liabilities. And two, the average cost of our retail deposits also fell by 6 basis points versus the fourth quarter, driven primarily by 12 basis point decline in the average rate paid and retail certificates of deposit.

Turning to slide 23, which presents point in time balance as the quarter end, you can see the total deposits decrease by about $500 million from the level December 31, 2012.

The decrease from the prior quarter was primarily driven by decreased in company controlled custodial deposits, and certificates of deposit as we continue our efforts to reduce the level of wholesale funding sources.

These reductions were partially offset by increases in demand and savings deposits as we continue to add core customers in Michigan.

In that regard, on slide 24, you can see that we continue to add core deposits and improve the ratio of core deposits which we defined as checking, savings and money market accounts to retail deposits.

We added approximately $400 million in core deposits during the quarter, a 13% increase from the same period last quarter. As a result, our percentage of core deposits improved from 50.1% at December 31, 2011, to 58% in March 31, 2013.

With that, I’ll turn it back to Paul Borja.

Paul Borja

Thank you, Sandro. Good morning again, everyone. As we talked about on prior calls, we focused on three key areas of our operating results. Revenue generation, expense management and credit cost.

Starting with revenue generation, as Mike mentioned, the majority of our revenues are tied to the mortgage business. Gain on loan sale income is reflective of the volume of fall out adjusted mortgage rate lock commitments which we now provide for you.

It is also impacted by gain on sale margin which is calculated based on the level of fall out adjusted locks. Loan fees are primarily based on a level of residential mortgage originations.

The majority of our interest income is also based on a mortgage business with mortgage loans held for sale and warehouse loans being driven by the level of residential mortgage originations.

Within the remainder of our investments loan portfolio, we expect the residential first mortgage portfolio to continue to run off.

We will try to offset a portion of that run off with growth in the commercial and industrial, as well as commercial real estate portfolios, and to a lesser extent, consumer loans.

The most current industry projections from Fannie Mae, Freddie Mac and the Mortgage Bankers Association estimate the total mortgage reduction industry wide for the second quarter of 2013 will be between $400 billion and $500 billion,

The percentage of total mortgage originations which are refinances, are estimated to remain between 60% and 70%.

As we’ve discussed earlier for a number of reasons we discussed, we lost market share during the first quarter.

As the quarter progressed however, we saw a healthy increase in registrations and strong pull through. And we believe that we can gain back mortgage market share going forward.

We have seen a pickup in our purchase volume and expect that to actively increase over the course of the year.

Our mix of refinancing versus purchase mortgages that we originate during the second quarter of 2013, should mirror that with the industry estimates as has been historically been the case with us.

Also as Matt indicated, we believe that our base margin declined in the quarter due to the factors Matt outlined earlier. At the same time, we’re experiencing a number of positive trends including an improving market place for more profitable servicing transactions.

As the approximately 2.1 trillion in mortgage serving right in the banking industry, moves from the regulated banking space to the non-regulated space during this year.

Recent information suggested MSR valuations are increasing. And as a result, we believe that we will see improved margins in the second quarter.

Net [ph] serving revenue is a function of interest rates, our hedge effectiveness and the impact of mortgage serving rights as well. We expect hedging challenges that occurred with respect to our MSR during the first quarter to continue although to a much lesser extent.

However, we expect to maintain at least our minimum 3% target level for total return on net asset. At the same time, we’re working to increase our warehouse loan balances from the first quarter 2013 level, although like the rest of the industry, we do not expect to return to the fourth quarter 2012 levels.

We also plan to redeploy the excess cash we currently have, debt interest running asset and reduce higher costing liabilities.

These actions are consistent with our short term goal of increasing our NEM [ph] over first quarter levels, as we target gradually moving back towards levels experienced in 2012 by the end of 2013.

Turning to non-interest expense, we’re working towards managing quarterly expenses at or below first quarter 2013 levels for the rest of the year and we’re optimistic we can reduce the overall level of quarter level of non-interest expense by about 5% by the end of this year.

And looking at credit costs, we identified the primary three as our provision for loan losses, our reps and warrants [ph] expense and our asset resolution expense.

We remain cautious about regarding losses embedded in our loan portfolio as we continue evaluation loans with potential payment shock characteristics.

As such, taken together, we expect credit cost for the next quarter to remain the key challenge at current or slightly higher levels.

With that, I’ll turn it back to Mike Tierney, our CEO for the question and answer session.

Michael Tierney

Great. We’re happy to entertain questions.

Question-and-Answer Session


(Operator instructions) And we do have a question from Paul Miller from FBR.

Paul Miller – FBR

Yes, that you very much. Paul, on the expense side, that’s one of the areas that I think we were a little under, relatively speaking. And I think it’s mainly on to the legal cost. You talked about the expenses being down 5%. Can you give some color to what you think the legal cost shake out over the next couple of quarter?

Paul Borja

This is Paul. Thanks Paul Miller. With respect to the overall legal cost, we’re continuing to evaluate the litigation. I think that in the context of legal and expenses, I think folks are aware that we had a higher level of legal expenses in Q4 and Q1 of 2011 and 2012 respectively with respect to the Department of Justice analysis.

We’ve also experienced higher level of legal cost we discussed earlier in Q4 of 2012 as well as Q1 based upon publicly available information regarding our ongoing litigation.

At this point, we’re modeling, we’re looking towards legal expenses as I presume the same level. We’ve not in the position now to discuss the level extent either in total or by type of litigation although we do acknowledge that we have incurred quite a bit in the past, it might seem a little out size

Paul Miller – FBR

So I mean just to not to put word in your mouth, so expect the same level for the next couple of quarters until things kind of calm down?

Michael Flynn

This is Mike Flynn, the General Counsel. We cannot project out to the future all legal fees involved in the litigation which is the biggest driver of our legal fees at the present time.

We are presently involved in several large pieces of litigation which have been publicly reported and are ongoing. And we are incurring expense in those cases, but those expenses obviously vary from month to month depending upon the activity in the case.

Paul Miller – FBR

Okay. And then moving on and I missed the first five, 10 minutes of the call, I was in a meeting. Can you talk a little bit about your gain on sale margins and where things are improving? With the 10 years down like 30 dips [ph] over the last month, which usually means that’s beneficial for gain on sale.

Can you talk a little bit about your gain on sale this quarter?

Paul Borja

As you know, the industry was down overall, and were down probably a little bit more than the industry in part because of seasonality and part because of the upward movement in the 10 year which cost the slowdown which further compresses margin specially when there was – they were increasing them, they’re buying into the market share which we chose not to do. But the recent improvement in the 10 year, we seen a significant uptick in our registration which we’ve been seeing, experiencing over the course of the quarter as well as our ability to price through some of the anomalies that we took place in the first quarter with respect to some of the secondary activities and the implementation of the GP.

So I think that we’re very optimistic. While we’re not pleased with necessarily the performance in the first quarter, we see a number of positive trends as we enter into the second quarter including increased registration, strong margins that we believe will put us back on track to where I think people will be comfortable.

Paul Miller – FBR

Thank you very much gentlemen.


Next, we’ll go to Kevin Barker with Compass Point.

Kevin Barker – Compass Point

Good morning.

Paul Borja

Good morning.

Kevin Barker – Compass Point

Your provisions for reps and warrants came down to 17 million from 25 million, and you released $8 million for the reserves while the pipelines come down. However repurchase demand have increased roughly 20%. Could you help us understand why there would be a reserve lease as demands are increasing?

And you mentioned the change in the GSC review process the last couple of quarters. Can you help us understand how the review process has changed and what your expectations for losses are going forward?

Paul Borja

Sure, this is Paul Borja. With respect to the second part, we’ve had increased demands and power polls as we’ve indicated on the chart. I believe it was one of the earlier charts within the slides, 14. And with respect to that, we see that the increase we talked about heightened scrutiny from the GFCs as they transition to the recent process.

You may recall back in September of 2012, the GFCs announced that they would be implementing a new review process effective January of 2013. That continues to be a process that they’re implementing. At the same time, we understand as others do we deal with GFCs that there are going to be increased demand as they go through their process. So we’re working through our existing population and repurchase request.

We have $37 million incline, Kevin, as you see in the chart in total repurchased pipeline. We think we put good process improvements in place. As we’ve indicated in our earlier conversations, earlier conference calls. And with the process improvements, we think we can through this influx of new demand in a timely basis. We’ll remain in compliance with the agreements.

As far as overall, mortgage put backs. As far as overall mortgage put-backs, we’ve seen audit files, pulls at an elevated level. That’s what you’re looking at for the past two quarters. But that has yet, in our view to systematically translate it to higher demands.

We did see a surging demand in mid-March, but however since then at least through mid-April, Kevin. The rate of demand put back is normalized back to level and seen prior to March in addition to demands from Fannie in March where 56% of May versus below 20% that we typically see.

We experience a higher loss and make demands versus repurchased demands. So in the interim, we’re expecting slightly higher net charge-offs. We’re working through this mix in our current pipeline.

April so far is trended back to normal levels with make whole demands making up roughly 23% of total demands, and so a significant drop off. And so we’re expecting net charge-off to stabilize a few months out as we clear out our existing pipeline.

Kevin Barker – Compass Point

But do you see an endpoint eventually down the road? Do you see the light of the end of the tunnel for reps and warranties?

Paul Borja

Yes, I think that we’re not prepared to do sort of a first to rise in statement and says, "We’ve got everything in the right thing as pretty much as everybody else has said during the course of their call this season.

We’re carefully monitoring the progress and addressing it. And what we want to do in the meantime is be as transparent as possible, which is why we’ve increased the amount of information within our slides and within these calls.

Kevin Barker – Compass Point

Okay. Thank you. And then concerning capital, you submitted a capital plan to the OCC this past quarter, can you just give us some color around that and when you expect to hear back from the OCC and what that process entails and just some color around the OCC capital plan?

Alessandro DiNello

Yes. This is Alessandro DiNello. Yes, we’ve submitted the capital plan kind of the first version of it. And at this point, we’re working through discussions with the OCC and getting their feedback. But we’re very, very satisfied with what we’ve been able to accomplish there with our discussions with the regulators, and we think we’re in good shape on that front.

Kevin Barker – Compass Point

Do you expect to hear back soon or is that something that’s like a work in process?

Alessandro DiNello

Oh, yes. Yes, it’s clearly a work in process. There’s no timetable to these things but there’s ongoing dialogue with the regulators and we feel very positive about the relationship that the new management team has put together with the OCC, the CFPPM, the FCIC, we’ve worked very hard at making sure that they’re partners with us and we feel real good about that relationship.

Kevin Barker – Compass Point

Okay. And do you have any thoughts or plans around TARP repayment given the coupon step up beginning next year? Is there anything you provide there, what’s your plans are for TARP?

Paul Borja

This is Paul Borja. As you know, the preferred stock that was previously held by the U.S. Treasury as part of the TARP program was successfully auctioned off in the course of March. As you know, the treasury issued a press release announcing all of that.

And so going forward, the preferred stock is now in hands of private investors, and therefore out of the TARP program, we do still have that preferred stock and we do consider that we are considering that, Kevin, as part of our overall capital plan Alessandro was referring. So we’re still looking at that and we’ll probably have some more information down the road.

Kevin Barker – Compass Point

Okay. Thank you very much.


And we’ll now go to Marc Steinberg with Dawson James Securities.

Marc Steinberg – Dawson James Securities

Good morning. I heard a few times mentioned about trying to pick up market share. But I don’t really think I heard anything specifically as to how the company expects to pick up market share. And if you can go into a little bit of detail about that, I’d appreciate it.


Matthew Kerin

Oh, sure. Yes, absolutely. This is Matt Kerin.

We have always been fairly successful in increasing our market share over the last several years. And while we had a downturn in the first quarter, there were a number of factors that we’ve referenced earlier. But we have taken a number of steps throughout the quarter that are starting to demonstrate some results at least based on the early indications of April.

We have continued to improve our customer service levels and maintain current staffing levels, unlike some of our peers so that our turn times were competitive or super competitive because it’s one of our value-added propositions.

We continue to focus on our core markets like California which is an area that are strong HBI growth regions that will help us as we migrate to more purchase-focus environment. We have held a consistent pricing strategy and we believe that will help us regain shares, others ease their pricing from the approach that they took in the first quarter.

In addition, we continue to prudently expand our home lending business activities which is heavily purchased market focus and in the first quarter we opened up 10 new home lending centers in the dominant wholesale markets for us.

Marc Steinberg – Dawson James Securities

And do you expect to see the California market make a significant difference for you?

Matthew Kerin

Well, we’ve always been a strong presence in California in part because of our season sales force and our longstanding customer base. And we believe that will continue to be a significant part of our efforts.

Marc Steinberg – Dawson James Securities

Hey, thank you.


(Operator instructions) Our next question will come from Robert Drenk from Optimum First Mortgage.

Robert Drenk – Optimum First

Hello guys, this is Robert Drenk. I’m with Optimum First. As you said, which I believe were the top broker and relationship to flex our bank and we’re based in California.

This was more of a response to the gentleman’s last question you just had in the California market. In regards to purchases with Flagstar, what are you guys doing? Hey, Flagstar, what are you guys doing to increase the market share in California in purchases as soon as it gets really big opportunity for Flagstar? And then I’ll go on with my comment.

Matthew Kerin

This is Matt Kerin. I think that what we’re doing is really trying to put a forward-looking attitude in the entire company so that we are, one, streamlining the turn times on our purchased activity. We’ve always prioritized our purchased business.

We are putting more of a focus on prioritizing our purchased business. We are ensuring that we have AMCs and appraisers that are in-tuned with the markets so that they could be responsive to the needs of the customers and we’re constantly looking at the strengths in particular market and working with our underwriting and processing teams to eliminate some of the inefficiencies that developed or timed as we were processing a significant amount of refinanced volume.

So I think it’s a combination of processing efficiencies, good strong customer service, problem resolution in terms of areas where a loan may get off the tracks, if you will, so that we can restore confidence in the marketplace that there is a certainty of execution when they come to Flagstar.

Robert Drenk – Optimum First

Got you. And are those released financial rate, I mean, obviously the rate is ticking up at a (inaudible) even in our business. We seem to have a 30%, 40% falloff. But in regards to you guys, Flagstar Bank has done a great job. It’s definitely a go-to bank. You guys do a great job of making sure you’re leading from the best interest rate job, to the best assistance, the best customer service.

As you guys are seeing a big uptake in volume right now compared to last quarter as well. So keep up the good work and thank you.

Matthew Kerin

Thank you. We’re going to continue investing and thank you for your business.


And now we’ll take the question from Jim Fowler from Harvest Capital.

Jim Fowler – Harvest Capital

Good morning. Thank you for taking the question. One clarification, I guess just ironing up my understanding. What you referenced to the impact on guarantee fees, my understanding is that increases in guarantee fee announcements are made and got in effect 90 days hence and a lender is protected on their current pipeline.

So I guess I’m a little lacking in understanding why they increased the guarantee fee would have an impact on sale margins unless you were not able to push that through in price 90 days forward and given the protection you’d have on you pipeline. The reason why I asked the question is to get some view on what the impact might be in the impending 20 basis point guarantee fee that we continue to hear about that – my understanding is that’s being discussed with lenders right now, that will be announced at some point in the near term and we’ll have again, a lagged impact.

If the last one cause a disruption on your margin as you stated, I’m wondering if it might similarly you know, the next one might have an equal impact in last second quarter, early third quarter to margins. Just any thoughts there would be helpful and then I have one more question.

Matthew Kerin

Yes, this is Matt Kerin again. One, we’re not in the position to talk about discussions with the GSCs on the potential future GP increases, but relative to your question on the first quarter, we did not have the pricing protection in place at the time.

We are since in the process of looking at that as an option so that we can avoid what I would call a onetime interest rate impact on our pipeline. Nonetheless, because we introduced our GP increases sooner than others that had the protection, so therefore, we were early on and that impacted our margin and our production.

So we were kind of hit twice with that, we do not anticipate that happening going forward.

Jim Fowler – Harvest Capital

Okay. And then one question on your, on pulling out your home lending center infrastructure, assuming that now that refis at some point will wane a bit and everybody, you know, the larger lenders, the more efficient lenders and also the smaller lenders that want to you know, kind of remain some level of vibrancy become more competitive in terms of pricing, why do you think this is the right time to be putting in place a broad infrastructure to originate purpose mortgages if some of the larger you know, lower cost of capital originators will be – started to focus on that and some of the smaller guys that wanted to stay in business and will you know, cut price into the bare bones to do so will also.

I mean how does a mid size lender compete you know, with competition coming from both ends and you know, how long are you willing to maintain the fixed cost structure in that environment?

Matthew Kerin

Sure. This is Matt Kerin again. Let me offer a couple of comments. One, respectfully, I wouldn’t suggest that we’re a mid size lender. We’re a major lender in the industry from a share perspective and that’s a function of our capacity to produce loans.

With respect to the homed lending initiative, this is something we embarked on close to almost four years ago when I first arrived to strategically expand upon our existing home lending centers and areas of strong, today’s environment, strong employment prospects and good HBI indicators in markets we were under represented in the wholesale PPL space.

The difference for us is that we do not have a brick and mortal expense associated that others may see in terms of branch banking and organizations.

So for us, it’s really a very quick return on investment. It’s in fact it’s as good a return on investment as probably anything you could probably put your money into from a capital investment.

The cost of entry for us is de minimis, we have the platforms, we have the technology, it’s a function of bringing people on that want to come to Flagstar because we are known in the market place, we have a good reputation for being nimble, and for basically providing certainty of execution which really drives the purchase business.

And we see the purchase opportunity is something that’s going to continue to grow as the refinance activity begins to slow whether it’s this year or next year.

Jim Fowler – Harvest Capital

Okay. Thanks Matt. I appreciate it.


And now, we’ll go to a question from Bose George from KBW.

Bose George – KBW

Hey guys, good morning. So when I looked at that slide 14 again, on the rep and warrant, was the increase there driven by new loans and if the GSCs are auditing kind of on the front end or is it still kind of the older books that are driving them?

Paul Borja

Hi, this is Paul Borja. So when we take a look at the polls, we’re taking a look on ‘14 at the...

Bose George – KBW

At the polls, yes.

Paul Borja

Right. So the fall polls, we’re looking at are going to prior vintages, not the most recent vintages and they continue to go to the older books. And so a lot of these are, I know Matt Kerin is also working directly with this so he’ll comment as well, but a lot of these Bose, are going to be files that we’re seeing they’ve already looked at in the past.

Matthew Kerin

Yes Bose, this is Matt. I mean we’re seeing a combination. The vast majority of the increase in the polls are the lack of a better way to describe it, I think you know, bona fide effort from the GSCs to take on final look at a legacy book or a more comprehensive look largely focusing on a modified loan space.

But we still continue to see a review of the current book or post 2009 book if you will on a regular basis, although it’s not a meaningful part of the percentage.

I think if you read the verbiage that’s been published out there to the FHFA and from the GSCs themselves, the intent is to move forward at some point probably towards the end of this year or early next year towards the new model which would be a heavy focus on the current origination so that the industry doesn’t get stuck in the quad [ph] market that we’ve experienced the last couple of years about looking at loans that are seven years old.

So we’re still seeing a heightened level of pre 2009 books, but we would expect that to continue to move in the opposite direction as they implement the new model.

Bose George – KBW

Okay. And then did you say that sort of the conversion rate from a poll to repurchase demand is kind of lower on the recent ones?

Michael Tierney

Well I mean clearly, you know, you have more success with the more current vintages in terms of where you’re going. So we think that that should continue as a trend. The other issue is your severity of loss should come down as well if the economy is improving and you main goals [ph] are lessen and your actual losses on your repurchases.

From a perspective of the performing books, we’ve had, and if you look at our 2010 post vintages, it’s a really insignificant number of repurchases and other than a misquoting in a program, it’s largely the performing loans.

Bose George – KBW

Okay. And then on the servicing revenue, the comment you made about the hedging challenges, I was just curious if you could quantify the impact there.

Michael Tierney

I think it was about a $5 million quarter over quarter delta in the actual return on the hedge. And obviously, the return on the hedging activity from the servicing asset.

I think it just had to do with some of the volatility that we experienced, you know, we did have a pretty rapid uptick in the 10 year that I think probably in the middle of February, early February that you know, happen pretty quickly over night.

Bose George – KBW

Okay, great. Thanks a lot.


(Operator instructions) And we do have a follow up from Kevin Barker from Compass Point.

Kevin Barker – Compass Point

Yes. In your third quarter 10-Q, you mentioned wholesale relationships were about 1800 brokers and then you had about 1400 correspondent lenders, and then those numbers came down by about 100 brokers and about 100 correspondent relationships in the 10-K.

Has that number changed, or are you growing or shrinking the amount of relationships you have with brokers and correspondent lenders?

Michael Tierney

We’re constantly evaluating our correspondent broker relationships both from an efficiency perspective, the quality of loans we get. And you know, there’s just a natural attrition, there’s also pruning based on performance and loan characteristics.

So we consistently have done so, or adding new brokers and correspondents and eliminating others in part for production reasons and part for quality reasons. It could be any number of factors. But I think you’ll continue to see a gradual reduction in our overall number of customers.

Kevin Barker – Compass Point

Okay. And then Paul, you mentioned that credit cost will be elevated in the second quarter due to payment acceleration. Can you just give some color on that and how that’s going to play out over the next couple of quarters?

Paul Borja

Sorry, Kevin. Payment acceleration you’re saying?

Kevin Barker – Compass Point

I missed that comment at the end of your prepared remarks.

Paul Borja

With respect to credit cost for Q2, what I mentioned was that we expect there to be continuing challenges with respect to our portfolios. And what we talked about was that we’re continuing to look at loans that have potential payment shock characteristics such as our investor, I’m sorry, interest only loans.

So as we continue to look at that as we continue to work through our portfolio, what I mentioned was that we expect our product cost for Q2 to remain a key challenge. And so we would expect it to be a current or just slightly higher levels.

Kevin Barker – Compass Point

Okay. Are most of the IOs having payment shock in the next few quarters or is that mostly a 2013 event or a 2014 event?

Paul Borja

Well actually, just to make sure that we have all that kind of information because you’re questions are good ones, it’s asked by a number of folks, we actually broke is out by vintage in the 10-K and then we expect too in the 10-Q that we’re filling soon to break it out again. So it will be a quarterly presentation we may want to start doing it during the earnings calls will – also it’s readily available.

So we do see as a lot of others do 2014, 2015, 2016 shocks based upon that disclosure.

Kevin Barker – Compass Point

Okay. I appreciate it. Thank you.


(Operator instructions) And we have no further questions in the queue and I’ll turn the call back over our presenters for any additional or closing remarks.

Paul Borja

All right, we’ll thank you all for joining us today. And we look forward to talking to you in another quarter.


That does conclude our conference for today. Thank you for your participation. You may now disconnect.

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