Mark T. Hammond - Chief Executive Officer
Thomas J. Hammond - Chairman of the Board
Paul D. Borja - Executive Vice President and Chief Financial Officer
Flagstar Bancorp, Inc. (FBC) Q2 2009 Earnings Call July 29, 2009 11:00 AM ET
Good morning. My name is Rachel and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Second Quarter 2009 Investor Relations Conference Call. All lines have been placed on mute, to prevent any background noise. (Operator Instructions). Thank you. Mr. Hammond, you may begin your conference.
Mark T. Hammond
Thank you. Good morning, everyone. Welcome to Flagstar's Second 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, and we recommend that you refer to it, as we represent 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 website in the Investor Relations section at www.flagstar.com.
I am here 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'll be addressing the questions that we received by e-mail or that we have been frequently asked.
Before we get started, please first direct your attention to 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.
Thomas J. Hammond
Good morning, everyone. Thank you for joining us. During the second quarter, we continued to face challenging economic conditions, which have persisted for several quarters now.
Despite these challenges, we have consistently generated positive income on an income operating and we're diligently with customers to mitigate losses in our held for investment portfolio. A portfolio which has had few additions over the last two years and is operated at capital levels in excess of well-capitalized regulatory requirements.
Last quarter as part of our previously declined capital plan, we announced that we had completed three of four planned tranches of new capital investments into the bank, with the remaining tranche to be completed in the second quarter.
At the end of June, we announced that we had completed the fourth and final tranche, with an investment of $50 million MP Thrift Investments LP.
For the investment, we issued 50,000 shares of convertible trust preferred securities. The details of that investment can be found in our June 30, 2009, press release, and corresponding 8-K.
With this final investment completed, we have now raised $621.9 million in gross capital in 2009, in addition to the $100 million we raised in 2008.
We would like thank MatlinPatterson for their investment and confidence in Flagstar.
Please turn to page three of the presentation. Last evening, we announced our financial results for the second quarter of 2009. During the quarter, we lost $76.6 million as compared to a loss of $67.4 million in the first quarter of 2009.
Our mortgage banking business continued to generate solid operating revenue, although not as high as the previous quarter, and our retail deposit franchise continued to operate well. However, we continue to see high credit costs, which offset the operating income that regenerated in the second quarter.
Turning to page four of the presentation, you can see that we had earned $78.9 million in pre-tax, pre-credit preferred dividend income in the second quarter. This income was unfortunately offset by a number of credit-related expenses, which totaled a $180 million for the quarter.
Let's go through those items individually. Number one, in the second quarter, we had provision for loan losses of a $125.7 million, of which $117.7 million were in charge-offs net of recoveries, with the remaining $8 million being used to increase our allowance for loan losses.
Our total allowance for loan losses was $474 million as of June 30, 2009, which represents 5.63% from our loans sold for investment portfolio, as compared to 5.21% at March 30, 2009.
Item two; we had $18 million in asset resolution costs, related to valuation adjustments and foreclosure costs, and our real estate owned portfolio, which flows to our non-interest expense.
Item three; we had a $24 million provision for our secondary marketing reserve to cover an increase in expected losses related to loans sold in prior quarters. This is in addition to the $7.1 million of provisions for our secondary marketing reserve that we set aside in the normal course, as a reduction in gain on sale.
Item number four; we had a $3.4 million write-down on our residual interest, which is recorded as a loss on trading securities. As of June 30, 2009, our balance of our residual interest was $16.4 million, which has been written down by 77% of its value since June 30, 2007.
All the remaining interest relates to one securitization originated in 2005, which continues to perform relatively well.
Item number five; we had a $10.4 million provision to our reserve for anticipated mortgage insurance losses and our captive reinsurance subsidiary, which also flows through our non-interest expense. The expense associated with losses on our reinsurance subsidiary are believed to be kept with an expense of approximately $4 million remaining which we expect to incur in the third quarter.
Please turn to page five. In addition to credit cost, we had $20.8 million in expenses that were unique to the second quarter. And that we do not expect to reoccur for the remainder of 2009.
First, we incurred $7.8 million additional premium expense for FDIC insurance, because of the special assessment leveled on all banks in 2009 for deposits held as of June 30, 2009.
Second, we recognized a $22 million one-time expense related to the issue of warrants of the United States Treasury. Please note, we increased our book value of this amount, once shareholders approved stock for the warrants in May, and no longer had to record the expense.
However, accounting rules required us to still show the $22 million as an expense, with 9.1 recorded in the first quarter and 12.9 recorded in the second quarter. We also have warrants, which are issued to certain investors as a result of our capital raise in May 2008.
Warrants to purchase 11.1 million shares of remaining outstanding, and we'll continue to be marked-to-market until they expire for our exercise. For the year, the May investor warrants resulted in expense of $2.1 million.
Turning to page six; for the second quarter of 2009, we had $104.7 million in loan sale gains in our margin on the gain on origination sale of loans was 106 basis points; down from the historic highs we experienced in the first quarter, although still high by historic standards.
We mentioned on our last quarterly earnings call that we did not expect spreads to continue at the levels we saw in the first quarter. One reason for our first quarter gain on low sales was positively impacted by the adoption of fair value accounting for available for sale portfolio.
Turning to banking; our bank net interest margin increased to 169 basis points in the second quarter from a 167 basis points in the first quarter. We experienced a decrease in funding costs most noticeably in our retail and municipal deposits.
In addition, we significantly increased our custodial account balance during the period. Custodial deposits represent an interest refunding source in contributing to lower funding cost.
On the income side, we had lower interest income, as borrowers refinanced into lower interest rate loans. The increase in non-performing loans also had a negative impact on the net interest margin, as we stopped recurring interest on loans, which are over 90 days delinquent.
Now, let's talk about loan production; turning to page seven, residential first mortgage loan production was down slightly from quarter -- from the first quarter production, but still continues to outpace 2008 production.
Turning to page eight; on the second quarter 2009, we originated $9.3 billion in residential first mortgages, as compared to $9.5 billion in the first quarter of 2009, and $8.2 billion in the second quarter of 2008.
Turning to page nine and 10. We identify our loan underwriting volume and our historical loan lock rate commitments. As you can see from the charts, both underwriting and lock volumes have slowed from their first quarter pace, tracking industry trends, which resulted from rising interest rates.
In January 2009, the MBA monthly mortgage finance forecast projected $2 trillion in total industry originations. As of July 2009, the MBA have lowered their projection to $1.6 trillion.
We believe that our decrease in mortgage origination estimates are inline with the industry, however we do not anticipate loosing market shares. Similarly, Freddie Mac and Fannie Mae also lowered their forecast.
Page 11. This shows our historical residential loan closings, which have remained steady as compared to the lock line in the first quarter. Mark will talk more in detail about our residential mortgage origination estimates for the remainder of 2009. Based on first quarter 2009 data, which is the latest data available, Flagstar remains as one of the 10 largest overall mortgage originators in the country.
Loan administration income reflected a gain of $41.9 million in the second quarter, offset by a $39.1million loss on the value of hedges, as compared to a loss of $31.8 million in the first quarter, offset by $23.7 million gain on the value of our hedges.
Overhead expenses decreased to $171.8 million in the second quarter, as compared to $182.7 million in the first quarter. During that period, we revised our commission structure and had lower asset resolution costs, which decreased our overhead expenses.
Now let's turn to liquidity. Please turn to page 12. During the second quarter, our retail deposits decreased to $6 billion from $6.2 billion in the first quarter, as we had planned. It is important to note that this decrease was part of our previously announced plan to shrink the balance sheet.
To do this, we targeted higher costing certificated deposits and money market accounts to run-off. Conversely, our core deposits increased, and we plan to continue that trend.
Turning to page 13, you can see we have increased our core deposits in each of the last four quarters, with an average annual increase of about 15%. The increase in core deposits, which typically carry a lower interest rate, has resulted in decreased funding costs to the bank.
Our weighted average rate on retail deposits decreased to 291 basis points at June 30, 2009, from 313 basis points as of March 31, 2009.
The weighted average rate on our public funds also decreased to 120 basis points at June 30 from 180 basis points as of March 31, 2009.
During the second quarter, we closed two banking centers, leaving us with 175 at June 30, 2009. Of those, one banking center was a traditional branch in Indiana and the other was at in-store location in Michigan.
We are looking to consolidate up to nine more banking centers by the end of the year, mostly in-store location with small deposit bases.
In the second quarter, we opened on a net basis over 4600 new checking and savings accounts. We anticipate that we will able to continue adding retail customers, while we decreased our reliance on wholesale funding and borrowings.
Now, let's talk about assets. Please turn to page 14. For the quarter, our balance sheet decreased by $386 million, with total assets of $16.4 billion at June 30, from $16.8 billion at March 31.
Majority of the decrease came from our loan portfolio, with decreases in both our held for investment and available for sale loan portfolios. A decrease in our loan portfolio was partially offset by an increase in cash and cash equivalents arising from end of the quarter loan sales.
Our residential mortgage servicing rates asset increased to $658.2 million at June 30, from $515.5 million at March 31. The increase in servicing rates was a result of new loan production and a $59.6 million increase in the fair value of the portfolio.
During the second quarter, we had a bulk sale of $2.3 billion on loan service for others, which decrease the value of the mortgage servicing rates by $25.5 million.
Slides 15 through 18 provide further analysis of our residential first mortgage portfolio by state, loan to value, original FICO score and vintage year. Of the loans with an original 80% LTV or higher, virtually all are covered by mortgage insurance.
Page 19 provides a breakout of our non-agency investment securities. During the second quarter, we incurred $300,000 of other than temporary impairment on our non-agency securities for sale, as compared to 17.2 million in the first quarter.
Let's now discuss asset quality. Page 20, identifies our key asset quality ratios. Our second quarter provision included net charge-offs of $117.7 million and an $8 million increase in reserves.
For the quarter, $64.3 million of net charge-offs were related to commercial real estate, $30.4 million were related to residential first mortgages, $11.4 million were related to second mortgages and $9 million were related to HELOCs.
Our asset quality by loan type, including a breakout of general and specific reserves is outlined on page 21. As you can see, residential first mortgage represents the largest portion of total reserves, and the majority of the specific reserves are related to our commercial real estate portfolio. Our secondary market reserve for losses on repurchased loans decreased by $3.9 million to $45 million at June 30, 2009.
Turning to page 22, our real estate owned, net of any FHA-insured assets, increased to $131.6 million at June 30, from $106.5 million at March 31.
During the quarter, we added $5 million of commercial real estate-owned property and $24 million of residential real estate-owned properties. We're making efforts to reduce this asset and have added internal and external resources to mitigate losses.
On page 23, our historical 30, 60 and 90 day plus monthly delinquency rates are identified. As you can see from the chart, the total amount of delinquent loans and our held for investment first mortgage, second mortgage and HELOC portfolios have decreased towards the end of the quarter.
The amount of 90 day plus delinquent loans increased in April and May, but decreased in June. The 30 and 60 day delinquent loans were relatively flat, and then dropped off in June. While we are encouraged with these trends for our mortgage portfolio, we remain cautious in light of macroeconomic conditions.
In order to address the deterioration in our portfolio and to take advantage of our market opportunity to service for others, we are focusing on a creation of a high tech service which we expect to be operational in the third quarter.
We believe that by concentrating efforts on higher risk loans in this unit, we will minimize our losses and generate fee income for other investors.
In our consumer loan portfolio, the 30 day delinquent loans have been static this quarter, while we have seen the drop in the 60 and 90 day plus delinquent loans from May to June.
In the second quarter, we had a slight deterioration in the commercial portfolio, with increases in the 30 day and 90 day plus delinquent loans, and a slight decrease in the 60 day delinquent loans.
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. At June 30, our Tier I core capital ratio was 7.19% and our risk-based capital ratio was 13.67%. As mentioned earlier, we planned to shrink the balance sheet during the next six months, which would have the effect of increasing our regulatory capital ratios.
In June, we announced that Mark Hammond will be stepping down as President and Chief Executive Officer by next January. Mark has served his President in the Flagstar since 1995 and Chief Executive Officer since 2002.
Mark would continue as Vice Chairman and plans to serve as an Advisor to the company for up to two years.
The Board of Directors is beckoning presently a national search for a new CEO; and is interviewing both external and internal candidates. We want to thank Mark for his many years of dedication and service to Flagstar.
With that, let me turn these things over to Mark.
Mark T. Hammond
Thanks Tom. It's been a great experience working here for the last 22 years. And I look forward to focusing on my role as Vice Chairman and Advisor, while I purse other interests.
If you turn to page 25 of the presentation, we provide an outlook for 2009, for each of our key drivers. We plan on introducing the 2010 outlook during the third quarter conference call.
Our drivers are now updated to reflect the first six months of 2009, as well as changes in the marketplace and adjustments to our strategic plan. We are revising our target asset size to a tighter range of between 14 billion and 14.4 billion for the lower end of our previous range, to reflect our continuing emphasis on maintaining higher regulatory capital levels.
On the asset side of balance sheet, we plan to sell trading securities and shrink our loans, help for investment portfolio through normal loan, run-off and principle pay down.
On the liability side, we intend on reducing our wholesale deposits, as well as decreasing our federal home loan bank advances and our retail certificates of deposits, while we intend to continue to grow our core deposits.
It is important to note that unlike many other banks, Flagstar has never been primarily reliant on interest spread income. So a reduction in assets is not expected to have a material effect on our ability to generate the revenue necessary to offset anticipated credit losses. This fact is reflected in our operating earnings thus far in 2009.
Residential mortgage originations; we are revising our residential mortgage originations to a range of between 33 billion and 39 billion. This estimate reflects the increased mortgage interest rate environment, which Tom spoke of earlier.
Through June 2009, we have originated $18.8 billion in residential mortgages. Given the spike in interest rate and the corresponding decline in loan rate lock commitments, we do not expect to see the same level origination volume we saw in the first six months, unless rates fall from the current level.
Loan sales; loans sales have been revised to reflect a decreased origination to a range 32 billion to 38 billion. We still intend on selling virtually all of the residential mortgages we originate during 2009.
Margin on the origination and sale loans. We are maintaining our estimate for margin on the origination and sale loans to a range of 132 basis points to 142 basis points.
To the first six months of 2009, our margin on the origination and sale loans was 171 basis points, including historically high margins of 254 basis points in the first quarter.
The first quarter margin also benefited from the effects of an accounting change. The second quarter margins of 106 basis points are more closely inline with what we expect during the final six months of 2009.
Net interest margin at the bank level. We are revising our estimate for net interest margin at the bank level to a range of a 176 basis points to 186 basis points. Through the first six months of 2009, our net interest margin was 168 basis points, and has been relatively flat throughout the period.
We are decreasing our original estimate range, because the decrease in our interest income is offsetting the positive impact of our reduced spending cost. In the beginning of the year, we have intended on investing in high yielding our RMBS securities.
Since that point yields have gone down to a relative to the price on those securities, which will negatively impact our net interest margin. In addition, some of our performing higher yielding loans have refinanced into lower interest rates.
Provision expense; we are revising the lower end of our range slightly on our estimate for provision expense to a range of 370 million to 424 -- I'm sorry, to 442 million.
Through the first six months of 2009, we had 283.9 million in provision expense. The estimate is relatively lower for the remainder of 2009, as compared to the first six months, based on delinquency trends continuing at their current pace.
If delinquent loan levels bounce back up for the improvement we've experienced at the end of the quarter, we'll have to revise our estimates.
Overhead; the significant portion of our mortgage origination overhead is variable, and we expect our costs to decline if origination volumes were to decline. Additionally, we have identified and planned to implement other revenue enhancements in overhead reductions. We anticipate this to have a $13.1million effect in 2009, and a $46 million effect for 2010. Now I'd like to turn the discussion over to our CFO Paul Borja for the question-and-answer session.
Thanks Mark. We'll be going through some questions that have been an e-mailed to us and responding to them.
First question is from a private investor. Will you continue at workforce reduction throughout the remainder of 2009, in order to control costs.
Our answer is, yes. We always look at workforce reductions as an appropriate tool to manage costs.
Second question from a private investor, how much additional can you expect? I believe Mark has addressed that in the final paragraph of his discussion just now, and we of course, will continue to look at throughout the year.
The next set of questions are from Bose George of KBW. First question is, can you comment on the drivers of the decline, and the gain sale margin in second quarter, relative to first quarter? And with that, I'll turn it to Mark.
Yes. On the first quarter, as we mentioned previously, we saw a historic high gain on sales spreads, which we did not anticipate maintaining and I believe in our last conference call, we were pretty clear that we did not expect to hold those levels.
Competition, margins in the beginning of the year as the Federal Government subsidized purchasing mortgage-backed securities, drove interest rates down and pipeline's got locked from an industry perspective. As those pipelines were clogged, institutions including ourself widened margins, in part to control volume and take advantage of market opportunities.
As resources were added as people worked through those pipelines, and as rates started to rise, also as well as a competition unfortunately backed down the margins.
With that being said, we're currently operating at margins that are historically high, that we've never been at, if you don't take into consideration the first quarter. Also, in the first quarter as we mentioned we had an accounting change switching our pipeline to fair value, which had in effect, to have essentially pushing forward one month worth of production into the first quarter, and that somewhat ballooned the anticipated level of gain into the first quarter.
Next question is from Bose, it's a series of questions on the same topic. Did volume in the second quarter benefit at all from the Home Affordable Refinance Program or HARP, raising loan-to-value limits for borrowers.
Do you think the recent increase in that limit to 125% to loan-to-value from a 105% will help volumes and to the extent that it hasn't helped. What do you think are the reasons?
Yes. About 15% of our business in quarter we had estimate was a result of Home Affordable Refinance Program with Fannie Mae and Freddie Mac. And however, the majority of the benefit is on the lower loan-to-values. The higher loan-to-values where people have lost significant value on their home or where they originally a high loan-to-value to begin with, had a lot of challenges.
In part having to work with subordinate bond leader -- lean holders and their willingness to subordinate. In part dealing with mortgage insurance companies, as well as in part dealing with a lot higher cost with both Fannie and Freddie to refinance higher LTV loans.
So from a percentage basis, the majority of loans we're doing the lower loan-to-values. The new 125% program, although I think it will help, should have a nominal effect, because the higher LTVs will continue to have some of the problems.
In addition to having very punitive cost bumps from Fannie and Freddie, as well as at this point those are not considered good delivery from TBA standpoint. And it's going to make the customers affective yield, if you take in the lack of liquidity on the pricing of way the securities trade, as well as the Fannie, Freddie price bumps, and the other things in the consideration, not very many people will either be eligible or will it make economic sense for them the current interest rate environment to refinance.
The next question from Bose. Can you discuss how your mortgage pipeline looks so far in Q3?
Yes. June saw MBSs fall seven points from their peak. And the majority of that fall was in the month of June. Therefore, our as well as industries production in June of new loan registrations and new lock-ins, which I think was we posted in our slideshow that there was significant decline. That's going to effective the decline in Julys and Augusts anticipated closings.
We have seen somewhat of a recovery and we've recovered about three points back of that seven point fall. In the last couple of weeks of July we've been kind of up a point, down a point.
So recovered three to four points back of the seven points decline from the peak.
So if rates were to stay static, we anticipate that we will close moderately less volume in the third and fourth quarter, than we closed in the first and second quarter. The challenge with the interest rates is, concern over inflation, as well as the markets concern of what happens when the government's $1.45 trillion MBS and agency debt subsidy ends. And the markets kind of taking that in consideration now.
The market is assuming its going to end, MBS yields have been trading off. And we're anticipating that. If deflationary pressures have more of an impact and rates yields fall back down, then we have to revise our estimates and projections providing back up.
The next question from Bose have you done much modification activity under the government's Home Affordable Modification Program? And do you expect that program to gain much traction?
Yes, is the answer. We've done a fair amount and do we expect to gain more traction. Page 34 and 35 of our Appendix will show what we've done with our own portfolio and within the agency portfolio of different type modest mitigation efforts.
The biggest challenge with the government's announced program is it's phenomenally complex. And there's been delays getting guidance from government and government agencies, as to exactly what the rules are, and how to implement the program.
And those have just really been recently available. There has also been a lot of consumer confusion as to exactly what's being offered and a lot of I guess, consumers just in franchise men associated with it, which is provided challenges and clogged a lot of the call centers.
Other challenge we've had with it is the moral hazard. I think everyone in the industry is grappling with the perception of people feeling that everyone should get some of theirs and get some of government assistance, and the concern people requesting modifications and assistance who are still employed, still have jobs, still have the availability to make payments, but are just choosing not to, because they see others getting assistance.
And it makes it very difficult trying to discern the difference between somebody who really has the ability to pay, versus doesn't want to versus, somebody who doesn't have the ability to pay. And then, if you modify it slightly, you can help them and then differentiate versus the first and no matter how much you modify it, you're still not going to have the ability to pay.
So its very challenging. I would say its probably the one of the most complex things we've had to do. But we are committed to, we're putting a lot of resources on it. And we're trying to do our part to make sure if people can get assistance and stay in homes so that we can help them.
The next question also from Bose, can you provide a little color, little more color on the improvement you saw in mortgage delinquency trends towards the end of the quarter?
Sure. We talked a little bit about in the speech. But if you turn back to page 23 of the presentation, the 30 to 60 day delinquencies were kind of flat in the first couple of months in the quarter, and then we saw significant improvement in June.
The 90 day has continued to decline in April, May and then also softer in June. We're also with our own portfolio seeing a better trend in July. Obviously, the month's not over. So we are seeing improvements.
Clearly, we could get a bounce, if unemployment continues to rise rapidly, or property values continue to decline, that's we could see this unfortunate positive trend reverse.
We are seeing in a regional basis though property values fall starting to slow and starting to bottom out on a regional basis. So as anecdotally we are seeing a lot of positive things and experienced a lot of positive things, as well as the numbers appear to be trending positive.
On the Fannie-Freddie book, we're seeing delinquencies continue to deteriorate, but at a much slower pace than we experienced before, and moving more flat. So lot of positive trends going on.
So that concludes our questions for today. With that I'll turn things back to Mark.
Good. I'd like to thank you all and I wish everyone a good day and talk to you next quarter. Thank you.
This concludes today's conference call. You may now disconnect.
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