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Flagstar Bancorp, Inc. (NYSE:FBC)

Q1 2011 Earnings Call

April 27, 2011 11:00 am ET

Executives

Paul Borja – CFO

Joseph Campanelli – Chairman and CEO

Matt Kerin – EVP

Matt Roslin – EVP, Chief Legal Officer and Chief Administrative Officer

Analysts

Bose George – KBW

Terry McEvoy – Oppenheimer

Paul Miret – FBI

Ben Hockenberg – Venor Capital

Herb Wamboldt

Michael Moskoff – MRM Capital

Bob Hobocan

Operator

Good morning. My name is Melissa [ph] and I will be your conference operator today. At this time, I'd like to welcome everyone to the Flagstar Bank First Quarter Investor Relations Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Paul Borja, Chief Financial Officer, you may begin your conference.

Paul Borja

Thank you. Good morning. I'd like to welcome you to our first quarter 2011 earnings call. My name is Paul Borja and I'm the Chief Financial Officer of Flagstar Bank.

Before we begin our comments, let me remind you about a few things. This presentation does contain some forward-looking statements regarding both our financial condition and our financial results and 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, competitive pressures within the financial services industry and legislative or regulatory requirements that may affect our businesses.

For additional factors, we urge you to please review our press release and the SEC documents as well as the legal disclaimer on page two of our slides that we posted on our Investor Relations Web site for this speech. I'd like to now turn the call over to Joseph Campanelli, our Chairman and Chief Executive Officer.

Joseph Campanelli

Thank you, Paul and good morning everyone. I'd also like to welcome you to our first quarter 2011 earnings call. I'll begin today by updating you on our first quarter financial results and discussing the key items that drove those results. I'll also spend some time discussing on progress we've made in our transformation to a more diversified super-community bank model.

This progress is very important, but not fully reflected in our financial results this quarter. Paul then discuss the financials in greater detail and then I will update and review our key business drivers for 2011. Finally, Paul and I along with the rest of my executive management team will be available to answer questions you may have.

Last night, we reported first quarter net loss to common shareholders of approximately $32 million, as compared to $192 million loss in the fourth quarter of 2010 and then $82 million loss for the first quarter 2010. Our quarterly loss was an improvement from prior quarters and we believe we remain on track in meeting our primary goals and targets.

We continue to identify ways to conduct our business better faster and cheaper. Productivity gains have funded our investment new products, enhanced our share – our customer experience and support investments and risk management.

The improvement in the first quarter was driven primarily by a decline in our credit related expenses. Our biggest – our three biggest credit cost provision for loan losses as to resolution expenses and secondary marketing reserve provision have now decreased in total for four consecutive quarters.

We continue to maintain a prudent level of reserves and we believe we are starting to see the light again at the end of the tunnel. Many of our key asset quality metrics continue to trend in a positive direction, non-performing assets in total decreased on a linked-quarter basis both at absolute value and as a percentage of total assets. Regardless, we continue to maintain a healthy allowance with our reserve to non-performing loan coverage ratio at 74% at March 31, 2011.

At the same time, we remain committed to continuing to derisk the balance sheet through opportunistic sale of assets. During the first quarter, we sold $80.3 million non-performing residential first mortgage loans, which represents a vast majority of the loans which are moved to our available sale portfolio on our balance sheet. The $80.3 million in non-performing loans was essentially sold at the carrying value so there is no material effect on our P&L.

Given our strong capital, liquidity and reserve levels, we believe we're in a good position to selectively pursue other opportunities to accelerate the de-risking of our balance sheet by selling legacy asset at or near the carrying value. Aggressive write downs, prudent oversight, and improving marketing positions have put us in a position for continued improvement in our asset quality.

During the quarter, we also increased our capital ratios. We ended the first quarter with a Tier 1 ratio of 9.87 and a total risk-based capital ratio of 20.51%. Our first quarter equity to asset ratio was 9.5%.

The improvement in credit cost was offset by two key items, first a decline in net interest margin and second, the lower mortgage banking revenues. In the first quarter, the bank had a net interest margin of 1.68%, down 19% from the prior quarter level of 2.08. The decrease in margin had a negative impact of approximately $10 million on our bottom line P&L.

The decreased net interest margin was driven by reduction in average loan balances in both our available for sale and warehouse portfolios. Consistent with the slowdown in the mortgage banking business and an increased short-term liquidity position, we provides for the funding for new asset generation.

Like most banks, we also lost margins as a result of the phenomena, analysts are calling the Curse of Cash. Our liquidity position increased by 80% since fourth quarter level as we are holding excess cash for investment in new assets we're in the process of generating. That cash is only earning a marginal interest rate which in turn temporarily deteriorates our net interest margin.

However, we believe that the reduction in net interest margin this quarter is a timing issue and we're still on track to meet our year-end target. As is the case with the prudent build out of any new business line, there is a period of time before you begin to realize the benefits of your investment. We are well along away in generating attractive earning assets.

Over the past 18 months, we have made significant investments in our infrastructure and personnel build up. We have recently begun to prudently originate quality interest earning assets including commercial and small business loans which will be invested on our balance sheet.

I am optimistic that the results of these efforts will be demonstrated over the coming quarters as we begin to see a meaningful and positive impact on our net interest margin and other fee income. We are transitioning towards full service super Community Bank and we're off to an excellent start.

During the first quarter, we announced Steven [ph] and Mike Candy [ph] had joined Flagstar's leadership team. Steven's appointment for the position of Executive Vice President and Managing Director, Commercial banking will oversee commercial banking division and serve as our market president for the New England division.

Mike was appointed for the position of Executive Vice President and Managing Director, Retail Banking and will oversee the Retail Banking division and serve as our market president for the Midwest region. We're excited that we are able to attract this great banking talent to our team.

Steve brings over 30 years experience in understanding the needs of small and medium sized businesses and poses the keen knowledge of how to grow especially lending lines of business. He also brings the network of longest harvest relationships to Flagstar.

Mike has also seasoned commercial banker as well with over 30 years experience in Michigan and Midwest markets. Both are highly regarded in the banking industry and in the communities they serve.

Today, we have strategically positioned leadership teams in key markets in Michigan and New England. We'll continue to build our commercial strategy over the next year as we continue to hire experienced relationship managers, each of whom brings with them relationships with the established clients and a sense of influence.

As of today, we've recruited over 30 professionals involved in commercial lending, credit and operations. Our commercial mortgage lending teams are working together to elevate market awareness for the Flagstar brand. This team work enhances the customer experience and allows us to more effectively cross sale multiple products and services.

We remained very focused and committed to building out an exceptional risk management function. We recognized the growing level of regulations in a more challenging and volatile economic environment. We have made significant investment in people, process, and systems to identify, monitor and manage risk.

We all know that lending money is the easy part. The harder part on occasion it to be getting it fast. Prior to rolling out our commercial strategy, we spend a great deal of time and energy on building a solid credit infrastructure and culture.

During the quarter, we're excited to announce that we recruited Dan Landers as our Chief Credit Risks Officer. Dan brings exceptional leadership and discipline with over 30 years of operational, credit and management experience. Dan along with Steve and Mike set the foundation for a very successful and profitable operation.

Over the past several months, we have built an active and robust pipeline of commercial prospects. The majority of these potential relationships are businesses that our relationship managers had dealt within the past and are well-known to management. Given that familiarity, we expect to close majority of the pipeline and anticipate increasing our loan balances significantly over the course of the year.

We expect to generate divisions deposit balance and fee income from these customers as well. We are also developing an actively managed and appropriately sized investment portfolio, which will further improve our net interest margin.

Our current liquidity portfolio earns approximately 25 basis points and we believe there is an opportunity to enhance our investment returns with an acceptable assets and liability framework, while building a diverse and high-quality investment portfolio.

We continue to see a decline of our overall cost to funds as we focused on replacing maturing high class wholesale and retail certificate deposits with low cost core deposits. For the first quarter of 2011, our cost deposits was 1.63%. A quarter-over-quarter improvement approximately 9% and the year-over-over improvement of 29%.

As far as the strategy for reducing our overall cost of funds, total core deposits increased by 10% on a linked quarter basis. The increase is attributable to a 24% increase in government core and a 7% increase in retail core from quarter during the prior quarter.

At March 31, 2011, our ratio of core to total deposits increased to 36.3% up from the prior quarter level of 32.1. We attribute our ability to grow core deposits to our culture builds around exceptional customer service.

For the second consecutive year, J.D. Power & Associates has ranked Flagstar Bank highest in customer satisfaction in North Central region which includes Michigan, Indiana, Ohio, Kentucky and West Virginia. The J.D. Power survey measures retail customer satisfaction based on account activities, account information, banking facilities, fees, problem resolution and product offerings.

Our overall score, of 802 in 2011 ranked 37 points above the national average. Receiving this award in consecutive years, illustrates how our retail associates take care of our customers and bodes well for our continued transformation to a super community bank.

Turning to the mortgage business, we experienced a decline in mortgage banking revenues as result which reflect of a lower origination volumes industry wide. For the quarter, total banking, mortgage banking revenues including interest income on mortgage loans securities, gain on sale income, loans fee income and income for our mortgage servicing rights portfolio was down to 18% in the fourth quarter.

The decline in mortgage banking revenues for the quarter is consistent with what we are seeing throughout the industry, while we're optimistic that buyers will increase in the second and third quarters as a result of increased purchase business which has been seen repeatedly over the years.

Our model is also scalable to capitalize that increased refinance activity on present. More specifically, gain on loan sale income for the quarter declined by 35% from the prior quarter, driven by decreased rate lock commitments. Gain on sales margin was 86 basis points in the first quarter relatively flat from the prior quarter level of 89 basis points.

First quarter mortgage originations decreased to 4.9 billion, which reflects the typical seasonality of declining purchase business and is consistent with industry mortgage origination trends. As a result, we experienced lower loan fee income.

The decline in gain on sale income and loan fee income was partially offset by an increase in income for mortgage servicing. We continue to enjoy strong returns on this asset driven impart by the steepness in the yield curve and the effect of hedge performance.

Our mortgage banking revenues were down this quarter. The housing finance industry is still arguably one of the most important industries to U.S. economy. Mortgage banking continues to provide significant non-interest income to us and we are committed to remaining major player in the industry, whether the sector stage with a strong focus and paying the equity, I'll move towards the private sector.

We feel we're well positioned to maintain overall market share given our strength in distribution at high quality originations. We're also actively working with private sector participants to evaluate your product and process requirements.

Our strong third-party origination control process and systems make us a desirable partner in equation of high quality loans that attract the investors in this newly developing sector. As I am sure, you're aware enforcement orders were recently issued against a number of residential mortgage services throughout the country. Fortunately, lifestyle was not one of them.

However, we're closely analyzing the orders and assessing the expense if any that our current servicing practices might want modification and we're treating the standards set forth in the orders as best practices in the industry. As such we are voluntarily adjusting as appropriate.

With respect to certain issues such as service level requirements, the orders are vague and we will need to continue to monitor developments closely and we find as necessary. We anticipate but have not yet quantified if there will be some additional expenses associated with the servicing business, but at the same time we believe that our efforts over the last year have resulted in many of these costs having already been embedded in their process.

We remain comfortable with both expense projections and our MSR valuation. In addition, we believe that the higher bar for servicing standards will post significant barriers to entry and will further improve our competitive position as the leader in the residential mortgage origination and servicing industry.

With high scrutiny being placed on servicing, we continue to monitor and look for ways to lower our MSR to tier 1 ratio and observing increased interest in the secondary market for our servicing and our confident with the valuation of our servicing asset. Another area we are seeing industry pressure relates to overdraft fees.

In that regard, Flagstar start has been an early adaptor of best practices guidelines issued by our primary regulator. As such, we've already taken steps in the execution of these risk practices which has resulted in a reduced fee income.

At this time, we do not believe there is a significant risk for further maturity of clients in overdraft fees. This assessment is of course subject to any new regulatory guidance that may become applicable.

I'd like to turn things over now to Paul Borja who'll take us through the financial results before we discuss the drivers and open it up for questions.

Paul Borja

Thank you, Joe. For the quarter ended March 31, 2011, we had a net loss of $31.7 million. This was a decline from the net loss in the fourth quarter 2010 of $192.1 million. It was also a decline from the net loss in the first quarter of 2010 of 81.9 million. Joe has discussed the key reasons for our performance for the quarter. I'll discuss the particular P&L and balance sheet items affected.

Our net interest income decreased to $39.8 million for the first quarter 2011, as compared to $54.4 million for the fourth quarter 2010. This reflects the reduction in the average balance of interest earning assets during Q1 of 2011 to $9.7 billion from $10.8 billion during Q4 2010.

The overall yield on the interest-earning assets also declined by 32 basis points. As a mix of assets changed from higher yielding available for sale loans and warehouse loans to lower yielding cash deposits.

At the same time, deposit cost declined by 15 basis points to 1.63% as Joe pointed out, from 1.78% during Q4 2010 and a level of interest-bearing liabilities declined by $500 million. Overall borrowing costs declined by four basis points.

With these changes, the bank's net interest margin declined in Q1 2011 to 168 from 2.08% in Q4 2010. But we are still higher than the net interest margin for Q1 2010 of 142 and for the 2010 year overall of 1.64%.

Our provision expense continued to decline even after taking into account the provision expense in Q4 2010 that was associated with the sale of residential non-performing loans during that fourth quarter. We continue to add to the loan-loss allowance with provision expense but at a reduced rate based on improved overall loan performance.

At the same time, our loan charge-off exceeded our provision. As a result, our loan loss allowance declined slightly by $3 million to $271 million at the end of Q1 2011. However, our ratio of the loan loss allowance to our loans held for investment increased at March 31, 2011 to 4.7% from 4.4% at the end of 2010. Also, we still had a good coverage ratio, that is the ratio of the allowance to our non-performing loans of approximately 74% as compared to 47% at March 31 of last year.

Our non-interest income declined for the quarter as loan fees and net gain on loan sales declined offset in part by an increase in our net loan administration revenue. Our loan fees and charges decreased to $16.1 million in Q1 of 2011 versus $28.6 million in Q4 of 2010. This reflects a decrease in origination to our loan closing to $4.9 billion in Q1 of 2011 from $9.2 billion in Q4 of 2010.

Our net loan administration revenue is the loan administration income from our servicing portfolio plus the effects of our hedging of that MSR portfolio. Beyond balance sheet hedge, results are reflected under gain loss on trading securities and we combine them with a loan administration income to reach the net loan administration revenue number.

Overall, this increased to $39.3 million during Q1 2011 as opposed to $28.1 million in Q4 2010. The mortgage servicing rights asset, which gives rights to this income, continues to provide an above-average return while maintaining our exposure well within acceptable risk tolerances.

Our net gain on loan sales decreased to $50.2 million in Q1 2011 versus $76.9 million in Q4 2010. This decline reflects several items, a decrease in interest rate locks to $5.5 billion in Q1, 2011 from $8.9 billion in Q4, 2010, a decrease in residential mortgage loan sales to $5.8 billion in Q1, 2011 versus $8.6 billion in Q4, 2010 and a slight decrease in the margin on loans sold to 86 basis points during Q1, 2011 from 89 basis points in Q4, 2010.

Our non-interest expense declined during Q1, 2011 to a $134.5 million as compared to $150.8 million during Q4, 2010. Some key reasons for the decrease are compensation expense decline which includes benefits and commissions decreased to $63.3 million versus $66 million in Q4, 2010. This decline reflects a decrease in the commissions that we paid as a result of decreased loan production which is partially offset by some compensation to build our new commercial banking business.

Our asset resolution expense declined to $25.3 million in Q1, 2011 versus $30 million in Q4 of 2010. And this decline reflects some reduced provisions that we keep for possible losses on foreclosed property. Also under warrant expense we actually get income of 800,000 in Q1 of 2011 versus an expense of $7.9 million in Q4, 2010. This decrease in the value of the warrants is based on the decrease in the first quarter stock price and therefore reversal of the charges we took during Q4 when the stock increased the price.

On our balance sheet our assets decreased to $13 billion at March 31, 2011 from $13.6 billion at the end of 2010. The key changes in our asset mix or an increase in the interest earning deposits of $772 million, a decrease in our loans available for sale of $976 million and a decline in our help for investment loans of $541 million. Our liabilities decreased, which reflects a decrease in deposits of $249 million and also a decrease in our FHLB advances primarily short-term advances of $325 million from the end of 2010 to the end of Q1, '11.

At this time, I'll turn this over to Joe for a discussion of our drivers for the year.

Joseph Campanelli

Thanks, Paul. On page 17 of the presentation, we provided our outlook for 2011 for each of our key drivers. With respect to asset size for 2011, we're revising our range for target asset size from $14.3 billion and $15.5 billion down to $13.8 billion to $15 billion. We do this reduction in target size.

Largely as timing issues, we believe that we have reached the inflection point of shrinking the balance sheet and are poised for growth. We have excess liquidity, ample capital on our product set and market position we believe it will well position us. We want to make sure to grow assets prudently and temptation to leverage up the capital of the short-term gains.

As to rule of fall within the forecasted range is going to be largely a function of refinance activity in the residential mortgage business as that drives both the outstanding balance on our AFS portfolio as well as draws on our warehouse business.

With respect to – we're reiterating our forecast of $21 billion to $25 billion of residential mortgage originations. Our first quarter production of $4.9 billion is slightly below that range on a run-rate basis, but as advance in the buying season, we believe that buying will pick up and our expertise proportionally large market position with FHA originations positions us well to capitalize more purchase business in upcoming months.

We observed the similar trend in 2010 and was also aided by increased refinance activity in the second half of the year. Should that happen again we'll be able to hit the higher end or even exceed our forecast as we did in 2010.

We still intent to sell a vast majority of our component production in 2011. If for loan sales in 2011 are also forecasted in a range of $21 billion to $25 billion. We reiterated our margin; our 2011 estimate the margin on the origination sale of loans between 85 basis points and 115 basis points. We are pleased with our margin of 86 basis points in the first quarter despite a sizable reduction in volume, as well as pricing pressure from the market competitors.

As with the origination volume, we would expect to hit the higher end of the range if refinance activity picks up as it did in 2010. But based on current volumes in lots, we believe that we’ll be in the lower end of the range. The net interest margin, we are reiterating our range with bank net interest margin for 2011 of 200 to 260 basis points.

Now, we're standing in the first quarter and then we are 168. The drag on the end that we’re experiencing is primarily due to the excess liquidity that we are holding and we believe that we'll be able to prudently deploy these funds as we close commercial loans at upcoming quarters. In addition, we expect mortgage volume and related warehouse volume to increase and as such to see the positive trends and than that we saw in 2010 returning for the remainder of 2011.

In order to achieve the higher end of our range, we would likely need to see an increase in mortgage originations along the lines what occurred in 2010 to drive AFS volume as well as warehouse gross. We are reiterating our estimate of provision expense for 2011 between $85 to $120 million.

Credit trends continue to improve now withstanding increase residential NPAs that we have observed and expected in the first quarter, that increase resulted largely from the national migration of 30 and 60 day delinquent loans that were included in our NPA sales in the fourth quarter. The lack of 60-day plus loans that would migrate to OREO or that would otherwise reversed in normal course or sense of reverse migration. Overall, we are encouraged by the size of reduction 30 day delinquencies in the residential portfolio.

On the commercial side, we continue to actively manage the legacy portfolio and our level of NPAs continues to decline. We've had a number of discussions with potential buyers of our non-performing commercial loans and those discussions given further clearance to our belief portfolios appropriately marked. We'd expect to hit the lower end of our range for provision as these credit trends continue and expect that the upper end would only occur if loan growth is better than currently forecasted.

With that said, let me turn it back over to Paul to lead our question-and-answer session.

Paul Borja

Thank you, Joe. At this time, if there are any questions, we'll be happy to take.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Bose George from KBW. Your line is now open.

Bose George – KBW

Hey, good morning. I had a couple of questions. Actually first on the mortgage side, your gain on sale margin held up very well, but your volumes were down, it looks like probably more than the industry. So I was wondering if that indicated – are you backing away from some lower margin business or can we read anything into that?

Matt Kerin

This is Matt Kerin.

Bose George – KBW

Hi, Matt.

Matt Kerin

I guess to answer your answer, I think we're relatively in line with most of the industry we are obviously not a price leader in the marketplace and we've continued to look to our distribution network to maximize the production that we can get through that. I think there was also similar to last year a lot of the same lack of activity in certain portions of the early part of the year that have kind of ticks up pretty dramatically as the quarter progressed.

Bose George – KBW

Okay. Great. Just switching to rapid volunteer, I assume you can't comment on the assured guarantee lawsuit, but I was wondering if there are other wrapped second lease deals that we should think about. And then just on the other side, I mean you guys hold securities as well private label, all kind of securities while there are any potential recoveries on any of those or any of those wrapped?

Matt Roslin

Bose this is Matt Roslin. The only other securitization is not agency securitizations that we did where it's a great second transaction better up by MBIA. And in that regard, if you look at our 10K disclosure on loss contingencies there are similar issues there but yeah we're pretty comfortable through that.

Bose George – KBW

Okay. Great, thanks. And then just one last thing where did the DTA stand at the end of the quarter?

Paul Borja

This is Paul Borja, the DTA at the end of Q1 was $340 million, which is an increase from the end of Q4, 2010.

Bose George – KBW

Okay. And is there actually any restriction on when that reverses on how does it on the utilization does that have to be utilized, is there any limit to how much can be utilized in any given year or is that something that can be reversed once its profitable and utilized fully at that point?

Paul Borja

It is actually two aspects there, one is the valuation allowance which can be reversed once we hit that profitability inflection point. The second is the actual utilization of the net operating losses which is carried by a 20 year term I believe only two years in the 20 year term for some of them. There was a restriction on a portion of intervals and kind of January 2009 infusion of our investment back in January 2009 we have changed in control but that the rest of intervals are not affected, so.

Bose George – KBW

Okay. Is that a pretty small part of the intervals?

Paul Borja

It's less than half of the intervals, we'll have a schedule. We normally have a schedule that we publish and we'll put one later on and we'll show the breakdown between the two.

Bose George – KBW

Okay. Great. Thanks a lot.

Matt Kerin

Thanks, Bose.

Operator

Your next question comes from the line of Terry McEvoy from Oppenheimer. Your line is now open.

Terry McEvoy – Oppenheimer

Thanks. Good morning.

Paul Borja

Good morning, Terry.

Terry McEvoy – Oppenheimer

I just wanted to talk a little bit about the excess liquidity the cash and interest bearing deposits up $800 million and it sounds like you want to move a good percentage of that into commercial loans. I don't know you talked about your initiatives, but could you just run through over the near term geographically speaking where you expect to see that growth and do you think that $800 million or something that will be put into loans over the next three quarters or by the end of this year?

Joseph Campanelli

Yeah. Terry, we're not getting down to specific numbers by MSA and geography. Our goal is to grow diversified portfolio throughout New England and the Midwest along with the absorption on the warehouse lending, aside you saw a pretty significant dip in the warehouse outstanding. So a combination of return to normal levels on warehouse lending the penetration of our market presence throughout the northeast with our team that we have in place today. We feel that our pipeline and our forecast will absorb that excess liquidity and it's a good source of funding.

Terry McEvoy – Oppenheimer

And could you just talk about commercial loan performance, I'm sure its somewhere in the slide deck and whether you have an appetite to grow that portfolio?

Joseph Campanelli

Yeah. We've really looked at it two different ways, one we see while the industry is not experiencing a rapid recovery, it's consistent with the economic environment and loans remaining et cetera. We believe bringing in seasonal experienced people that maintain very strong relationships and our positioning is to provide a host of credit and noncredit products that's competitive with the large bank. We delivered on a very personalized relationship basis. We see a lot of that taking attraction in the form of our pipeline in our anticipated closures.

So that's board in – what our expectations were. As far as the legacy portfolio is a couple of $100 million in our portfolio that's within our footprint that we have access to gross sale and my team and his team has already began relationship reach out looking for the opportunities to do business with that client base. And the balance is really just will be run off as that matures, so it really is – the run off legacy portfolio and really drive the relationship driven component.

If you're familiar with the company about our net portfolio it was put in place which is very much of loan strategy, where we're talking about in a super community bank model as we're building relationships with the companies that we know and understand and that we can provide a variety of products and services, so many of these people we've dealt with over the last decade or two.

Terry McEvoy – Oppenheimer

Helpful. And then just a last question as allocated your deposit cost is there room to go much lower total retail deposits 135 still sitting on a fair amount of higher costing CDs that the grade there 1.84% though as I did immediately log on to your presentation today as you've got a smart saving account at one in a quarter percent, which is above where your current savings and money market deposits are yielding right now. So can you bring those deposit cost lower to help that margin getting closer to your guidance for the full year?

Joseph Campanelli

Yeah. We believe we can especially building on the core retail and commercial customer Mike, why don't you add a little color to that.

Matt Kerin

Sure – no we are – because of our liquidity position we are – we've really lowered our new rates on CDs. So we can afford lower run off there and the smart savings account that you saw that's a 90 day upfront formal rate and then it drops to 80 basis points. So we're comfortable that we'll continue to see declines in the cost as the retail deposits and that will continue with our favorable mixed trends, our core percentage continues to move up.

Terry McEvoy – Oppenheimer

Thanks a lot. I appreciate it.

Joseph Campanelli

Thanks, Terry.

Operator

Your next question comes from the line of Paul Miret from FBI. Your line is now open.

Paul Miret – FBI

Yeah. Can you talk about a little bit of your activity you've gotten on so far in April as some of these warehouse lines utilization rates going up. And have you seen higher production level so far in the spring-buying season?

Joseph Campanelli

Maybe we looked at the quarter that Karen just mentioned that at the beginning of the year given the weather and the environment was not – it was just in cold inside as it was outside I think. Unfortunately towards the end of the quarter we saw the pickup that continues to build momentum as we expect.

Paul Borja

Yeah. I think we do have strong momentum and we're actually looked at some targeted programs in using pricing changes and variances as it became more competitive marketplace we saw the opportunities to kind of continue to aggressive share. I think it relate to the whole of – if you see the number of the firms looking at their MSR and doing some write downs that's putting us in a more favorable pricing initiative in the marketplace and that's offering some opportunity and that should continue given we are MSR essence in the market.

Paul Miret – FBI

Okay. And then the other issue I believe if you've addressed it I missed it on the TDRs that you guys talked about selling about six months ago, are you guys still actively trying to sell your TDRs, I think it's like $400 million?

Joseph Campanelli

We’re looking at the opportunity and looking at what our cumulative loss rates would be versus what market conditions are like. In certain markets, we have seen a lot of activity, especially around commercial real estate coming up. We haven't seen a similar pick up in the TDR market. So we continue to evaluate whatever shareholder return is on a whole basis versus sale basis.

Paul Borja

And Paul its Paul these are still (inaudible) assets. So we take that into account for as compared to the non-performing loans that we sell back

Paul Miret – FBI

Yeah. And the TDR behavior, I mean, how is the re-default rate did they ever going to finance some people to find TDRs in many different ways. Some of them they never going to default some they default, they re-perform and then there is a performance measure afterwards, can you talk about that a little bit on these TDRs?

Joseph Campanelli

Yeah. In order to be considerable performance in 12 month payment period they have test to meet and to your point the challenge in the industry is that not all TDRs are grade equal. So while as a unit, designation its certainly different characteristics within each organization. So we don't consider one would be performing both at successful payments.

Paul Borja

And to Joe's point if you look at our TDR performance, there are certain clearly advisable public sector performed very well from a default perspective well, I don't have the accurate data to support that looking at our default rates with other industry player with good yielding assets given our excess liquidity at the moment as well as continuing to look at our TDR strategy and assist opportunities to manage that portfolio, probably with a number of disciplines, we got a lot of latitudes in terms of still with the times to if you want to pull the trigger or not.

Paul Miret – FBI

So I mean I don't know if it's working or not but you’re leaning towards more, sense holding on to these TDRs now versus selling them like you said in the past?

Paul Borja

Well, I think this is Paul, I think what we are saying in the past is there are four potential asset categories that we thought would be helpful in de-risking the balance sheet. One of the key ones is the residential NPL side which we executed those in November and February to complete that, except for I think a slight bit is left over. We’re also looking at other opportunities as Joe mentioned the course of his speech, including some of the commercial opportunities.

Overall though our focus is to increase the revenue and as to sort of echo Matt Kerin’s comments, we are looking at interest earning assets; this is a good interest earning asset. We do see that it's a TDR classification purposes I believe under S&L is considered not a good asset. But it certainly contributes currently to our net interest income and our net interest margin.

So, we’re going to look at that carefully, but we are also sensitive to the fact that if you dispose off an asset and receive cash and if you reinvest in other interest earning asset. And as we mentioned with respect to the interest earning deposits we are currently looking at a 25 basis points return. So we certainly want to make sure that we maximize our return on interest earning assets.

Paul Miret – FBI

Is there a different risk rating for these TDRs? Is it additional capital head?

Paul Borja

I believe it is. Same time I believe our risk related capital at the end of 3/31/2011 was not – was 20.5%, I believe.

Paul Miret – FBI

Okay.

Paul Borja

So risk based capital is not an issue at this point of time.

Paul Miret – FBI

Okay. And getting back to your NIM, I mean your NIM has been, not been bounced around and that's why they’re asking about what the activity has been so far towards the end of the quarter relatively speaking of April? But I think I'm going to get a lot of questions today, like can they get back up that 200 basis points and so can you just add a little bit more color, are you going to buy securities if you don't get commercial real estate loans or you get some more commercial loans. Is how can we get comfortable that you will get back above 200 basis points on that NIM?

Joseph Campanelli

Yeah. Here is one of the issues from 18 months that we talked about is the benefits of a more diversified revenue stream and being highly concentrated volatility to mortgage market which is ties to the AFS and we're spending components that really drive the earning asset side of the equation. So, it made a lot of good success on the liability side with loan and deposit cost just talked about. My concerns during the team we're looking ways to drive more traffic to our branches grow our core deposits we also talked about the restructuring of the FHLB advances to bring down the cost on that side of the house.

On the asset side, we're not panicking and trying to make security trades, we said manufactured in. When you look at the spreads that are available in general small business lending and middle market specialty lending, everyone has got their own range, but if you look at any common index you looking at 300 to 400 basis points rise in those business.

We're cognizant to the fact that you really want to build a good foundation before you start putting on loans, that's where we've spent the last 18 months bringing in Todd McGown and bunch of other people including the lenders and really putting in new commercial loan operating system and advanced refitting every policy procedure, develop non-credit products in lots of source, we'll really to go from a building stage now to an presentation stage.

So, as I said earlier, lending money is easy, something want to add, that you can buy market share for you to comprising underwriting the pricing. We've taken the steps to make sure that we're building relationships and we are in the process comfortable with the pipeline we build, customers and credits that we know and understand, they are confident in rolling out. Therefore we don't feel the medium pressure and we’re always start putting out securities taking any undue risk in duration and some of the other things that you may be seeing out in the marketplace.

So, yes, there’s opportunities to be a little more prudent and aggressive on the security portfolios, seeing that we're pretty much of nice liquidity 25 basis points. We will certainly not looking to be placed out with the security yielding 300 because of the duration as we may come on it.

Paul Borja

Yeah. I think to just follow-up on Joe's point. So when you take a look at the excess liquidity we'd expect over the course of the year for that to decline at some point, but with some don’t – the mix of liquidity to be comprising part of securities that we currently select to ensure that we got the duration down and we're comfortable with risk.

But the majority of the growth you're going to see is going to transition over to the health investment side, as we continue to grow the commercial, C&I and the warehouse lending side. So we expect that to be funded by a slight increase in deposits but certainly by looking at short-term FHLB advances depending upon the pricing mix.

So we see – decent help for investment, as well as decline in liquid cash into higher yield and securities, that is higher than 25 basis points as together creating a mix that allows us to reach our target.

Matthew Roslin

This is Matt here and other issues underway on the warehouse front, that we'll continue to build back our balance sheet with our existing customers and our new customers in the marketplace that we had kind of traveled back in the fourth quarter given the high level of activity with our existing customers, who want to make sure we had ample balance sheet capacity to support their origination needs, especially when it came to slight start origination.

Joseph Campanelli

Yeah. We’re not going to be tempted by taking trading credit risk from the past and interest rate risk for the future because we acquired challenge, we're sensitivity to it, it's a little bit frustrating but its operating environmental and we'll manage our way through this in a prudent fashion that we've laid out over the last 12 months.

Paul Miret – FBI

Okay. Thank you, gentlemen.

Joseph Campanelli

Thanks Paul.

Operator

(Operator Instructions) Your next question comes from the line of Ben Hockenberg from Venor Capital. Your line is now open.

Ben Hockenberg – Venor Capital

Hey, guys. (inaudible). I was hoping you know just kind of reiterate Paul's question, you kind of restated your guidance on NIM. But in the quarter obviously you are below – below end of that guidance. Could you kind of provide bridge to how over the next three quarters you can bring that number up to get even to somewhere within the middle of that range?

Paul Borja

I think with respect to the bridge, this is Paul, I think Joe has never commented towards. With respect to the bridge, if we take a look at our March 31 balance sheet and look at the high level of liquid assets, take a look at the available sale loans to help for investments loans.

What you would expect to see by the end of the year should be a reduction in the amount of liquid assets, with the liquid assets earning more than 25 basis points because of the redeployment of part of that into securities. You’d expect to see a significant portion of the liquidity go into the growth of the held for investment portfolio including C&I loans and especially warehouse loans and commercial loans, especially lending and you’d expect that to be funded by low cost core deposits and funded by low cost short-term FHLB advances. Those taken together we believe will allow us to reach the target by the end of the year.

Ben Hockenberg – Venor Capital

Great. And what should we be thinking about kind of a target asset yield that does liquid assets can be redeployed into?

Paul Borja

Well, with respect to the securities, I think we’re looking at, to Joe's point as we want to be careful and prudent in low interest environment, but we’ve talked – we've looked at ranges for that, run 1% with respect to the some of the assets, we're bringing on Board, I believe we spoke earlier back in November and also beginning of the year we’re talking in the range the 4% to 5%.

And as far as the deposit side, I think you take a look at our low cost deposits. With respect to the overall deposit cost what you’d expect to see during the course of the year as that to go down as higher cost wholesale deposits roll off and as we continue to replace them with core deposits?

Ben Hockenberg – Venor Capital

Great. And one final question if I may, now that you've brought on a good team of underwriting professionals. Could you give us some sense of what you're loan backlog is, just so we could think about the magnitude of the C&I and other products that we could see roll on throughout the year?

Joseph Campanelli

Yeah. I don't think we've publicly disclosed any of our pipeline numbers. But there are consistent with other conversations we had growing things well the hundreds of billions – hundreds of millions – I must get a little bit.

And there is the typical type of credits that you’d expect to see in small business and middle market and especially mass lending and others. So it's a pretty diversified portfolio consistent numbers over there, which you expect at any commercial bank when you look at per RM backlogs and pipelines.

Ben Hockenberg – Venor Capital

Great. Thanks for taking my question.

Joseph Campanelli

Thanks.

Operator

Your next question comes from line of Herb Wamboldt [ph], an Individual Investor. Your line is now open.

Herb Wamboldt

Good morning, gentlemen

Joseph Campanelli

Good morning.

Paul Borja

Good morning.

Herb Wamboldt

The questions I have are based around TARP, when I look through all your financial reports, I see TARP located nowhere. I mean, what is the amount you owe TARP? Where are these funds located and do you have that money to pay back and how that’s going to impact you for the business financially?

Paul Borja

Sure. This is Paul Borja. The TARP investment is was made by the purchase of U.S. Treasury of preferred stock from the holding company. So what you'll see on the balance sheet is common stock and preferred stock. The preferred stock is the TARP stock.

Now the total amount we purchased or that was purchased from us was $267 million back in January 30, 2009. It accrues a 5% per year that's a dividend rate and afterwards its goes to a 9% rate.

Our current overall plan is for us to return to profitability to be able to secure the reversal of the valuation allowance associated with the deferred tax assets, that'll be used as replacement capital so that we can repay the TARP. And that’s part of the overall plan is to repay the TARP once we return to profitability.

Herb Wamboldt

And you don't return to profitability in this year than you paid a higher rate when you do? In other word 2012 you've return to profitability but the cost the TARP now goes from 4%, 5% to 6% or 7%?

Paul Borja

Well, the cost will go to 5% to 9% after five years. So at January 30, 2014, the rate will change to 14% – 9%, I'm sorry. So we’d certainly want to run make sure we do it before that.

Joseph Campanelli

Yeah. The priorities right now doing just as you mentioned returning to profitability, executing the strategy we laid out roughly 18 months ago. And I think today as what we mature we talked about TARP we’re paying fairly with the deferred tax and allowance and other sources the ability to repay TARP is there. And we've been paying our dividend and we plan to pay the dividend as agreed until we retire the entire security.

Herb Wamboldt

Thank you.

Joseph Campanelli

Okay.

Operator

Your next question comes from the line of Michael Moskoff from MRM Capital. Your line is now open.

Michael Moskoff – MRM Capital

Can you guys just talked about the lawsuit regarding a short guarantee $100 million that was announced few weeks back I believe?

Joseph Campanelli

That was, obviously, it's because this pending litigation, we limited our comments. We believe our financial disclosures in our 10-K speak to it clearly and other instance, in the editorial comment, I probably should not respond in life time, but I wanted you to respond to an attorney.

Paul Borja

Yeah. I mean as is disclosed in our 10-K with loss contingency sections. We have had this risk and warranty demand, we're better than. We believe we got appropriate defenses to the action and we tend to defend it.

Michael Moskoff – MRM Capital

Okay. Thank you.

Paul Borja

Thank you.

Operator

Your next question comes from the line of Bob Hobocan [ph], investor. Your line is now open.

Bob Hobocan

Hi. My name Bob Hobocan. I'm an individual investor. And I was wondering, I see the loan, the non-performing loan, the individual loans rather than commercial have increased. What's state – what state is the problem in and do you see that leveling off pretty soon?

Paul Borja

Yeah, I will turn over to Matthew Kerin in one moment. Bob part of it is the fact that we sold off at the end of 2010, and beginning of 2011. Bulk sale of roughly $474 million and that $80 million, it really chopped off the loans. So we delinking are OREO.

Percentage of those loans normally would have been what I call reverse migration would have been returned to performing to various negotiations and repayments. And what you see now is just a run off of migration of the balances and the portfolio in the over 90-day bucket migrating to non-accrual, but so we except those to level off, especially when you look at the level of current loans and the levels – the 30 and 60 day delinquency buckets are actually dropping nicely.

Bob Hobocan

All right.

Paul Borja

When it's more full filling.

Matt Kerin

Yeah I think, a couple of things. One from a geographic dispersion, I think is pretty representative of what it's been going on nationally and it's not to be startled here but it's a function of the fact that we are a national lenders. So our – where we originated in the states like California and Florida and Michigan in particular, which is our home state obviously.

You will see in the portfolio we reflect the trends that have been undergone in that marketplace. To reiterate what our CEO has said that overall I think the trends are fairly stable from a migration perspective. If you go back 12 months and look at the trend lines in the road rates, the zero to 30, 30 to 60 and 60 to 95 buckets were all pretty favorable.

Obviously there has been a slight uptick in the 90 plus and I would suggest it's largely a function of three things, first and foremost as we saw $500 million with NTLs which reduces what I would call the eligible pool of population of loans that would otherwise migrate to REO or otherwise be resolved two short (inaudible) we're charge off.

So when you have the standings steady and slightly declining inflows with no outflows, you are going to have a buildup in NPL category, which I would suggest you is what's occurred in the fourth quarter and in the first quarter. I think there's also been an impact and we brought back a substantial portfolio of our loans that was serviced by others for a couple of years and since we made the announcement to them to do that in December there has been a modest uptick in the delinquency status of those loans.

And I think also you are going to see an impact of the relative seasonality that occurs in a delinquent portfolio to the first quarter. So those are really kind of I guess my key guidance on those factors.

Bob Hobocan

All right. Well, thank you very much. The other question I have is in regards to the profitability, when do you think you're going to return to profitability?

Joseph Campanelli

As soon as reasonable. We haven't put out – the goal really is to reposition the company to the course of 2011, to be in a profitable run rate and we haven't put our guidance along, when but more specifically how and how we are executing quarter-over-quarter.

But accommodation of growing good earning assets improving our net interest margin funding that growth to redeployment of the current liquidity and growing our core deposit base, we're seeing a steady reduction in credit class, all will bring the elements in light of vital long-term return to profitability and not taking any short-term steps towards investing the securities or leveraging the balance sheet.

So it's really been a pragmatic approach to build the strategy, with the plans in place and the control is in place and now we are in offensive mode of executing it. So not to be sure here, but we're doing it in a very thoughtful process that is sustainable.

Bob Hobocan

All right. The other question is do you foresee any more need to raise capital either through bond issuance or stock issuance?

Paul Borja

Fairly, when you look at we have tier 1 capital in excess of 9.8% risk adjusted capital over 20%. We additionally also have significant liquidity as a holding company. We have no short-term pressures clearly on the capital and we've – once we return to profitability at a very sizable preferred taxes and loans reserve that is significant even once if and when decision is made, we pay TARP or whatever that timeline is, we still have excess capital there. So our focus now is on investing it wisely and generating the shareholder returns that will bring us back to profitability.

Bob Hobocan

Well gentlemen. Thank you very much for taking my questions. I appreciate it. Keep up the good work.

Paul Borja

Thanks.

Bob Hobocan

Thank you.

Operator

There are no further questions at this time. I’d like to turn the call back over to your representatives for any closing remarks.

Paul Borja

Thank you, all for joining us this morning and we look forward to following up on our second quarter call when I hope it is much better weather for everyone. Thank you. Have a great day.

Operator

And this concludes today's conference call. You may now disconnect.

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