Flagstar Bank CEO Discusses Q2 2011 Results - Earnings Call Transcript

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 |  Includes: FBC
by: SA Transcripts

Flagstar Bank Corporation (NYSE:FBC)

Q2 2011 Earnings Call

July 27, 2011 11:00 am ET

Executives

Paul Borja – Chief Financial Officer

Joseph Campanelli – Chairman and CEO

Macek Ken – Business Analyst

Analysts

Bose George – KBW

Kevin Bartner– FBR

Terry Mcevoy – Oppenheimer

Marc Steinberg – Dawson James Securities

Operator

Good morning, my name is Tiffany and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter earnings 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) Paul Borja, you may begin your conference.

Paul Borja

Thank you. Good morning everyone. I’d like to welcome you to our second 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 that this presentation does contain some forward-looking statements regarding both our financial condition and our financial results and that 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 business.

For additional factors, we urge you to please review our press release we issued last night and SEC documents, as well as the legal disclaimer on page two of our earnings call slides that we have posted on our Investor Relations website.

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 second quarter 2011 earnings call. I'd like to begin today by updating you on some of the early successes we see in our key initiatives in transforming the company

Paul will then discuss our financial results and then I will update and review our outlook for the second half of 2011. Finally, Paul and I, along with the rest of the executive management team will be available to answer questions you may have.

First off, last night we announced the divestiture of Georgia Bank branches to P&C Bank. P&C is assuming essentially all of our Georgia employees and the deposits of all of our branches in the state. The transaction is expected to close in the fourth quarter of this year.

From a financial perspective the transaction will be essentially breakeven relative to book value. However, given the relatively young age of our distribution channel, the revenue stream had yet to mature, resulted in negative contribution margin even before allocation of indirect charges.

This deal allow Flagstar to focus our growth strategy on our two major markets, the Midwest and the Northeast. Our second quarter net loss of $74.9 million is reflective of the continued credit cost associated with our legacy balance and legacy business operations. They were impacted by the continuing high level of unemployment nationally and a continued weakening of the Home Price Index or HPI.

When I joined Flagstar in September 2009, we began making changes in implementing initiatives to build out other lines of business to augment the revenues produced by a best-in-class mortgage banking franchise. Thus transforming Flagstar to a full-service super community bank.

We are encouraged by the steady results we are seeing from these initiatives and the continued progress that we have made in our transformation. I’d like to take a few minutes to discuss those initiatives. We continue to take aggressive steps to put legacy issues behind us and remained focused on reducing balance sheet risk and addressing underperforming asset concentrations.

During the second quarter, we sold $68.1 million of non-performing assets from our commercial real estate and real estate own portfolios. These assets were sold for small gain reaffirming the current march we have on the portfolio. Since the fourth quarter of 2010, we’ve sold over $622 million in non-performing assets and we’ll continue to implement strategies to further derisk the balance sheet.

We were able to generate positive core earnings before taxes and credit costs, attributable to the strong revenues from our mortgage banking franchise. In line with the industry, we experienced a decrease in mortgage banking revenues on a linked quarter basis, although a gain on sale remain strong increasing to 91 basis points for the second quarter of 2011.

Equally encouraging, mortgage rate law commitments increased by 16.8% on a linked quarter basis, indicating strong origination trends heading into the third quarter. Late in the second quarter we also launched an initiative to promote prime jumbo mortgages which will improve our return on excess cash and lead consumer demand while maintaining strict underwriting criteria.

Early volumes were encouraging as you had approximately $136 million in rate lock commitments at June 30. We believe this is a promising initiative that addresses the continued demand for these mortgage products, from segment of the market that is been underserved, and has attractive credit and profit fundamentals.

We recognize really an opportunity for jumbo origination growth to support both home purchases and refinancings.

Turning to commercial banking we are pleased with the early success of our recently launched commercial banking initiative. Over the past year, we have funded significant investment in foundation for solid commercial banking platform. Investments in new systems, enhanced policy procedures and experienced leadership, complemented with robust cash management and other non-credit products and services have begun to pay off.

During the second quarter, we originated approximately $100 million in new commercial and specialty relationships and also have grown a significant pipeline of established companies across the middle market business banking and specialty lending market.

Flagstar values the role we can play in helping grow the economy in our target markets in assisting and small and medium size business with their individual plans of expansion, job creation and capital investment.

For the second quarter, our bank net interest margin was 1.86%, essentially flat from the prior quarter at 1.87%. Increases in interest income from our commercial banking initiative and reduced funding cost to offset by a reduction in average loan balances on our mortgage-related portfolios with linked-quarter decreases in both the available for sale and wholesale lending portfolios.

And as we continue to add high quality commercial and specialty loans with attractive spreads to the balance sheet, we expect to see future improvements and reduced volatility in our net interest margin. We’ve also made progress in building out and launching our treasure management services which help deepen customer relationships and provide an annuity like recurring stream of fee income to supplement our spread income.

We are optimistic about the initial success and positive feedback from our commercial customers are using our treasury products and services. In addition, this month we launched our enhanced business online banking product, which has received excellent reviews from our valued customers. We also signed a contract with a private-label payroll service provider.

Flagstar payroll services will not only be a source of incremental fee revenue but also provide direct relationships with new customers across market retail services. Most importantly we continue to attract talented and seasoned veterans to lead the execution of our business strategy.

Our commercial banking operation has made great strides and is well positioned to serve clients in New England and Michigan as well as our other specialty lending businesses. We are now up and running at four locations in New England with offices in Boston and Boxborough, Massachusetts, Providence Rhode Island and West Hartford Connecticut. We are also in the process of establishing a regional commercial banking office in Metro Detroit and it is a consumer bank as we have at our headquarters in Detroit.

As I said earlier, we are familiar with and experienced in these markets and are confident in our ability to grow these business lines in a prudent and responsible manner and established Flagstar brand with a new universe of high quality customers.

Turning to retail banking. We’ve been working to enhance our sales culture as part of the D&A of our banking staff and are seeing positive results. The retail team is building on the culture of service excellence, which has earned a two straight J.D. Power award for excellence and customer satisfaction and making a shift to and focus on servicing all of the customer financial needs.

To that end, a new company-wide sales program was rolled out in June this last year. The banking centers have been selling mortgages, generating non-interest income to the sale of investment products and targeting businesses, who we can offer consumer banking products and to the employees. We have clearly built the momentum in the banking centers consistent with our efforts to transform Flagstar into a full-service super community bank. We have also stepped up our emphasis on investment insurance products as well, as retail CDs mature, we are offering customers not only core money market and savings accounts, but also annuities mutual funds and other investments that generate valuable fee income and increased customer retention.

During the quarter, the borrower bank rating was – our borrower bank rating was upgraded as a result of improvements we’ve made to our balance sheet and capital position. This is important as it opens the door further for discussions with addition municipalities or previously limited by the amount of business they could do with us prior to our rating upgrade.

Consistent with our overall retail banking strategy, we continue to experience a decline in our overall cost of funds. As we are focused on replacing maturing high cost wholesale and retail certificates of deposits with low cost core deposits. For the second quarter of 2001, our overall cost, this is 1.5%, down from 1.6% during the first quarter of 2011.

This improvement translates to quarterly savings in interest expense of approximately $2.1 million.

Retail core deposits, as a percentage of total retail deposits increased approximately 47% as compared to 42% at March 31, 2011. As we continue to push to grow low cost core deposits. During the second quarter, we had approximately $632 million in retail CDs mature, which carried a weighted average interest rate of 183 basis points. We selectively retained approximately two-thirds of those CDs at a weighted average rate of approximately 75 basis points, which also help drive sound funding costs.

As previously announced, we’ve been developing a credit card program as part of our transformation to full service bank and are slated to launch in the fourth quarter of 2011. We also implemented a number of other retail banking initiatives, including refreshed and updated home page of flagstar.com and a more user-friendly online banking application.

Like our commercial banking area, we continue to attract, experienced and talented key executives to lead our retail banking division.

Turning to the balance sheet, total assets decreased to $12.7 billion in the second quarter of 2011, from $13 billion in the first quarter as we reinvested excess liquidity into interest earning assets. As a result, we saw a 19.6% increase in available for sale loans and a 3.6% increase in held for investment loans.

Given the reduction in assets, we are able to allow for selective reductions in some of our non-core deposits which help lower funding costs. During the second quarter, we also purchased some agency mortgage-backed securities, and brought some of our off-balance sheet hedges back on, which should improve our net interest margin and collateral management.

With respect to asset quality, non-performing assets decreased on a linked-quarter basis, both in absolute value and as a percentage of total assets. The decrease reflected a sale of non-performing commercial real estates and a decline in the level of real estate-owned properties, partially offsetting the overall decrease was an increase in 90-plus day delinquent residential loans, which will be discussed in greater detail during the call.

At the same time, we continue to maintain a healthy allowance with the June 30, 2011 allowance for loan losses in non-performing loan coverage ratio at 16 at 7.9% and allowance for loan losses to help investment loan ratio of 4.59%.

On the expense side, our second quarter 2011 non-interest expense declined by $16.3 million, or 11.1% from the prior quarter. The decrease was driven by a decline in asset resolution expense and a decrease in compensation benefits and commissions. We remained committed to pursuing ongoing improvements and operating efficiencies and expense reductions as we continue to diversify the company.

Our capital liquidity levels remain strong. We closed the second quarter with a tier-1 ratio of 10.07% and a total risk-based capital ratio of 19.73%, consistent with our business plan; we invested $50 million in capital from the holding company to the bank during the second quarter as an equity investment. We ended the second quarter with a liquidity position of $1.6 billion consisting of cash-on-hand, interest earning deposits, and marketable securities.

Before I turn things over to Paul, I’d like to spend a few minutes and discuss some of the key industry issues and how they impact Flagstar. As you know, the Federal Reserve Bank, recently issued its final rule in connection with the Durbin Amendment. This rule, while much more favorable to banks than the original proposal still represents a 45% loss in revenues that we used to provide low cost accounts to customers and to deter fraud.

We are currently in the process evaluating how this rule fully impact our current checking account offering and expect some changes to be introduced during the course of this year. Despite this negative impact on our business and the industry in general, we still believe we are uniquely positioned to respond in a way that will allow us to continue to grow our core deposits and fee income effectively.

We are committed to delivering service that earned us two consecutive J.D. Power awards for excellence and customer satisfaction, which we will combine with the best-in-class retail products. There has been much talk in the media about the settlements for 14 of the major servicers and the impact will have a cost of servicing for others. Flagstar was not a part of that settlement, how we view this subsequent guidance establishing a baseline for best practices in the industry.

We are constantly updating the factors we use to determine the valuation of our mortgage services assets and believe as the quarter end, we have factored into our valuation, the additional cost of service.

I’d like to now turn things over to Paul Borja, who will take us through the financial results, before we discuss drivers and then move on to Q&A.

Paul Borja

Thank you Joe. I’d sort of review the financial operating results for the quarter versus the prior quarter. We had a $74.9 million loss during the second quarter as compared to a loss of $31.7 million in the first quarter. The increases that contributed to this loss included an OTTI charge in our securities evaluation charge of about $16 million, a decline in our loan administration income of about $9 million, a decline in our gain on loan sale income of about $10 million, and an increase in our loan loss provisions of about $20 million.

These were offset in part by our improvement in our non-interest expense of about $17 million as Joe mentioned earlier. Within that net loss in the operating – in the operations of the company, we had a net interest income decline of about $1.2 million which gave rise to relatively flat NIMs.

As I mentioned earlier, our provision increased about $20 million on a linked quarter basis. The commercial provision portion of that declined slightly during the quarter due to a lower amount loan downgrades and fewer declines in the appraisals. Our residential provision did increased during the quarter, due in large part to an increase in over 90-day delinquent loans and higher loss rates that we’re applying to loans in our legacy portfolio.

From a non-interest income perspective, our non-interest income declined $38 million on a linked quarter basis, as compared to Q1. Included within that decline was the, other than temporary impairment charge I mentioned earlier on our CMO securities of approximately $16 million.

Additionally, our gain on loan sales declined about $10.4 million, we did had higher locks during the course of the quarter, but we did had lower margins and we did see stiffer pricing competition. Our loan administration income, which is the income we earn off of our mortgage servicing rights as well as the income we earn off of our securities that we used to hedge it, declined about $9 million on a linked-quarter basis.

This decrease and the level to return was attributable primarily to a decline in the value of the MSR due to a lower and more volatile interest rate environment during the second quarter. From a non-interest expense perspective, our non-interest expense declined about $17 million, key among that was a decline in our asset resolution expense which is the expense that we record for foreclosure costs and for curtailment cost on our in our Ginnie Mae portfolio. That decline was due in large part to reduced provisions that we took for potential real estate losses. We also had some income that was a credit to the non-interest expense side arising from a decline in warrant expense that we expect to pay on outstanding warrants.

From an asset quality side, we touched on that briefly in Joe’s comments. Our non-performing assets did decline on a linked-quarter basis to $519 million from $554 million. Our coverage ratio remains strong at the 67.93%, as compared to 74%, so just a slight decline. And we still have a strong interest level to held for investment loan portfolio ratio of 4.59%.

Overall, our NIM remained essentially flat on a linked-quarter basis. We had some decline in interest expense which offset the declines on our interest income. Our liquidity remains strong at quarter end, we’ve cashed on our balance sheet of about $758 million and total liquidity when combined with our marketable securities of $1.6 billion at June 30.

We remained strong at tier-1 with a 10.07% tier-1 versus 9.87% at the end of Q1 and our risk-based capital remains strong at 19.73% at the end of the quarter. Also you’ll notice from these slides, we did have a brief presentation on our deferred tax asset valuation allowance. At the end of second quarter our deferred tax asset valuation allowance was approximately $365 million. That translates into a book value of approximately $0.66 per share.

With that, I’ll turn it back to Joe.

Joseph Campanelli

Thanks Paul. On page 18 of the presentation, I’ll provide you our outlook for 2011, for each of key drivers. And if you turn to page 18, I’d like to address each one. Starting with asset quality, assets size, while we expect to continue with our earning assets, we also expect the balance sheet would decline due to the shrinkage from the Georgia branch sale as well as the continued disposition of non-core and non-performing assets.

As such, we are reducing our estimate of year-end asset size to a range of $12.5 billion to $13.5 billion. With respect to residential mortgage originations, we are slightly reducing our outlook for originations at conforming residential mortgage loans to a range of $20 billion to $24 billion. This is based on our assessment of the expected decline overall in the industry production as indicated by a recently published forecast and trade groups which is consistent with our recent experience and factoring in our origination initiatives.

On loan sales, we expect to sell most of our conforming residential mortgage loans that we originate, we have not changed the outlook for loan sales for the year. With respect to gain on loan sales, our experience over the years that margins on loan sales tighten as overall industry production declines, as we discussed above, we expect industry production to decline during the rest of the year.

Accordingly we are reducing our outlook slightly to a range of 75 to 100 basis points for the year. On the net margin side, our goal has been to transform our operations to a super community bank to development of commercial lending franchise and as opportunity permits, origination jumbo loans.

We’ve begun originating in each of these areas this year, although later than initially planned as we built out the appropriate controls and procedures and as we manage through the recent volatility in interest rates.

As such, operations will not have the benefit of the revenue contribution for those loans for the entire portion of the year. Accordingly we are lowering our estimate on net interest margins slightly to a range of 190 basis points to 210.

As we discussed earlier, we have seen an increase in the over 90-day residential mortgage loans and also the effect of a more severe outlook on home prices in the near term. With this in mind, we have revised our outlook for expenses associated with our loan loss allowance and are increasing it to a range of $110 million to $115 million for the full year.

With that said, let me turn it over this discussion to our CFO, Paul Borja to start the question and answer session.

Paul Borja

Thank you, Joe. And if anyone has any questions, be happy to address them.

Question-and-Answer Session

Operator

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

Bose George – KBW

Hi, good morning. I had a couple of questions I just wanted to start with the net interest margin outlook. Can we think of this as secondly being pushed out into 2012 and sort of the ending point for – kind of get to the same point is just being deferred a little bit?

Joseph Campanelli

Yes, as you are familiar the business models we’ve build the consumer and small business and portfolios, those are not as volatile as the available for sale. And actually have more stability in that margins. So, it’s an issue of timing.

Bose George – KBW

Okay, and is there any way to think about, like how much the timing has been deferred over the course of this quarter?

Joseph Campanelli

It hasn’t been significant, that I put in a range of 90 to 120 days. Steve?

Paul Borja

Steve would you like to comment on that?

Steve Issa

Yes, I think 90 to 120 days was, yes.

Bose George – KBW

Okay, great thanks. And then, if we were to switch to the reclassification you guys did on the FHA loans, I understand why you reclassified them and raise the interest income, but I don’t really fully understand why you took the loss resolution expense up. My understanding is that, the interest is fully reimbursed by the FHA are you anticipating curtailments or just walk through that a little bit would be great.

Paul Borja

Sure, the asset resolution expense that we’ve shown in prior quarters has been a combination of the expense associated with the Ginnie Mae’s offset in part by the income associated with Ginnie Mae’s. What we’ve done, because of the size of the assets is to break out the P&L portion as well as the balance sheet portion as we’ve done in the past. We’ve had discussions with outside advisors and we reviewed outside financials and believe this is best practice and most transparent to investors.

In doing so, we’ve taken the income portion that was otherwise offsetting asset resolution expense and moved it up into the interest income side. What this does then is, it increases the asset resolution expense by a corresponding amount.

Bose George – KBW

But just to make sure I understand the interest expense or the interest component of the FHA is fully reimbursable to you guys right eventually?

Paul Borja

Yes.

Bose George – KBW

When that loan is submitted. So over time, the interest would exceed the asset resolution expense is that right?

Paul Borja

The principal it’s a 100% sure. The interest is earned a debenture rate. We pay the interest less any sort of curtailment claims that apply to the particular loans. So, the goal is to receive a 100% principal insurance and to receive the interest income less to any curtailments. So we should be able to receive all the interest income similar no curtailment. To the extent there are curtailments, that expands and it is set forth in the asset resolution line item on the P&L.

Bose George – KBW

Okay. Great, thanks very much.

Operator

Your next question comes from the line of Paul Miller with FBR. Your line is open.

Kevin Bartner– FBR

Hello, it’s Kevin Bartner filling in for Paul Miller. As far as the provision expense going forward the 110 or 150, could you just give us some color on what that entails? What you are looking at as a run rate and do you expect that the delinquencies from the residential portfolio to stay slightly elevated going forward? Or you did see the NPAs tick up? Do you expect that to continue? Do you expect to be a little bit soft over the next couple quarters? Can you just give us a little bit color on it?

Paul Borja

Sure, this is Paul. I’ll start and Macek Ken will also jump in. From the provision perspective, the increase is primarily reflects our outlook from a residential provision side. One of the drivers there is the increase in the over-90 day loans within our held for investment portfolio. The increase in the over 90-day loans arises in stark effect, because as you may recall back in November we sold most of our non-performing loans.

We’re now seeing non-performing loans come in as they roll routinely from over 60 to over 90. In a normal course you will see those over 90-day loans, similarly roll out into foreclosure. Because these are new loans and not yet seasoned. They are not yet been in a position to roll out. We are seeing a trend that has been going off and I think Macek Ken will speak to where that trends is tended to level off.

Macek Ken

I think this, from the perspective to how we are looking at our 90-days, when you look at cleaning out basically $600 million plus of delinquent loans 60 to 90 plus, you’ve essentially eliminated a population of loans that otherwise would go to foreclosure or other resolution on the course. So we saw a modest uptick in the inflows into the over 90 in part because we took back a substantial portfolio that was being serviced by others and in the course of the transferred loss mitigation activities were temporarily postponed. So you don’t have a hand up issue there and also you saw your typical uptick in delinquencies through a normal servicing transfer.

At the same time, we are beginning to correspond, we are looking at a portfolio that now has probably an average 90 at about nine months. So we are just getting to the stage where we should begin to see the outflows and I’m optimistic by year end we should see a turn that the inflows will be exceeded by the outflows.

Kevin Bartner– FBR

Just one follow-up on the temporary impairment on AFS Securities, the CMOs. How many those do you have left? How should we look at those? Is there, just still some deterioration there? Was it something that sold off this past quarter and then we had some, the market took a turn towards over the second quarter, reselling in a phase of that?

Paul Borja

This is Paul. We did not sell any of the CMOs. The other than temporary impairment reflects our quarterly valuations. Part of the quarterly valuation process involves our review of the general trends out there, delinquencies and values and in particular the home price index and we are viewing that and establishing our own views of that we take into account views of others, other independent persons. We did see and we mentioned in the press release I believe I mentioned Steve, a negative outlook for at least the next two years in the home price index. That particular outlook that is factored into our view of the current values of the CMOs and it’s reflected in the OTTI impairment.

Kevin Bartner– FBR

How many of those you have left in the CMOs?

Paul Borja

We have the same amount that’s left for us, it’s one to through six in our intent, 11, I believe from page 31.

Kevin Bartner– FBR

Okay, and then finally, has there been any change in whether you are looking to offload the TDRs? Or perhaps maybe another large scale non-performers or do you consider where the balance sheet is right now, where you are looking to take it going forward?

Paul Borja

We’re continuing to aggressively work both the residential and commercial portfolios and constantly weighing the best execution. I don't contemplate any material size of the bulk sale, but we are continuing to clear the pipeline has run-off portfolio, the average origination, they sort of back in on the commercial side and mid to late 2005 to 2008, same thing on the revenue side. So we’ve got some good granular datapoints and we’re just going to continue to work them down with the team of people we have, and be aggressive on that front.

You saw this past quarter, we’re able to pass on the commercial side of package of pools which is about $70 million above our book value. Those opportunities present themselves will take them, if not we’ll continue to work individual asset levels.

Kevin Bartner– FBR

Okay, thank you very much Joe, thanks Paul.

Operator

Your next question comes from the line of Terry Mcevoy with Oppenheimer. Your line is open.

Terry Mcevoy – Oppenheimer

Thanks, good morning. As I look at slide five the pre-tax pre-credit cost income, dip down to $41 million, as you look at your guidance for the next couple quarters and I have not done it yet my model. Are you calling for that, that pre-tax pre-credit cost income? Is this the bottom do you think that grows from here based on what you know and see today?

Paul Borja

What we know and see today, it’s just a PPNR decline is attributable on a linked-quarter basis decline and mortgage income decline in MSR income. The MSR income is a volatile one and mortgage income ties into our production trends. However from our perspective, we’ve not given guidance on the PPNR, but we don’t see that as something that we would expect to decline significantly further.

Joseph Campanelli

And that volatility is, Terry is, part of the business model mortgage banking which we want to diversify and smooth out of it. So while we expect it to have, if you look historically it’s smoother on a bit given those shifts. So we would expect the same type of movement in 2011 until we get into out here as we are more balanced offset with commercial and retail banking.

Macek Ken

Terry, this is Macek Ken, I would also suggest that some of the production numbers and gain on sale are attributable to the uncertainty around Dodd Frank and some of the lender, loan officer, paid compensation issues that kind of flesh themselves out late in the timeframe for the first quarter and in early second quarter and with where the business is right and the pipeline and what we are seeing some of our various initiatives, I think, we’re fairly comfortable with our guidance.

Terry Mcevoy – Oppenheimer

And then just looking at the branch network, are you pleased with the pace of improvement in the branches, more multi-product customers and is the multi-product customer today, is that just and old Flagstar customer or is this more foot traffic or an increase of foot traffic and you are able to hopefully sell that more than a high cost CD?

Mike Tierney

This is Mike Tierney, we are definitely pleased with the improvements in cross-sell. Cross-sell has improved five straight months and we’re hard at work to get revising our products. We’ve introduced a whole new sales training process to all of our colleagues to help them cross-sell and we’ve also become much more efficient in the branches. We scale back our hours which I think is very well received our by our colleagues and was really done without any issues from our clients. So, we are very pleased with the sales enhancement while at the same time becoming more efficient.

Terry Mcevoy – Oppenheimer

And then just one last question. If I look at loan growth going forward, Northeast versus Michigan Midwest, where is the best pipeline and that mix going forward? Is it going too skewed towards any one market?

Steve Issa

Hi, it’s Steve Issa. Basically, in the future with the full build on the commercial team both in the Midwest, Michigan and in the Northeast New England, we expect it to be evenly balanced in the quarters to come and that growth has come probably I’d say 55% to 60% in New England in specialty, because we didn’t really have the team built out in Michigan yet which we do now.

Joseph Campanelli

And I think the strategy is always, we only look the demographics the Northeast has been less severely impacted over the last multiple year recession to underlying asset values and diversification of the economy allows us to grow a little faster in that region. We are being thoughtful and careful and our credit exposures going forward have a very balanced approach to executing that strategy.

Terry Mcevoy – Oppenheimer

Appreciate it, thank you.

Operator

(Operator Instructions) Your next question comes from the line of Marc Steinberg with Dawson James Securities.

Marc Steinberg – Dawson James Securities

Thank you. Good morning. I have a question for you and that is that in laymen’s terms, taking into account the levels of high unemployment in the housing market, why do you think that the actual loss per share was so much higher than what the analysts who follow Flagstar thought it would be?

Joseph Campanelli

The loss is relative to our loan portfolio.

Marc Steinberg – Dawson James Securities

Actually, the actual loss per share, what was estimated to be the loss per share and what was the actual? And why do you think the analysts thought it would be so much less than it actually was, the analysts who follow what’s happening with the company and with the industry?

Joseph Campanelli

I can’t speak to the specific analysts reconcile them, but as Paul Borja mentioned earlier we took a $15 million or $16 million impairment on the CMOs factoring in, the factors in the second quarter relative to future house expectations. I think that was somewhat disappointing from an industry standpoint looking at housing prices backing up and the impact that would have on both the carrying value of the CMO portfolio and on a severity level, delinquencies that we would have on our residential area. So I think those two factors accounted for probably $35 million of higher impact from an lower housing market. I’ve in fact that’s on a per share differential way.

Marc Steinberg – Dawson James Securities

And assuming that the housing market doesn’t improve anytime sooner or at least materially, what’s the plan to offset that?

Joseph Campanelli

If you look at where those losses are coming is in the legacy portfolio that is getting runoff states for couple of years now. So it’s very seasoned. We are looking aggressively within HFA portfolio to identify specific areas that are impacted and we are talking housing in general, with the reality of it it’s a very local index. That depending on where you are in Michigan or California, there are difference experiences. So we really filled our portfolio down in the different regions and look to how we can affect our servicing of the portfolio to be more anticipatory.

Many of the charges we took are looking out into the future and factoring in those expectations. So on OTCI standpoint, that’s going to factor into the numbers. We’re not expecting any material improvement in unemployment or corresponding housing prices, if it happens great, but if not, we kind of laid out where we are expecting it to be continue to execute our strategy of what we are doing, fixing the losses coming out the legacy business model. Maximizing revenues that we can get out on the mortgage banking business and diversifying in the commercial and small business in getting more retail revenues out of our branches. So it’s a three-prong strategy.

Marc Steinberg – Dawson James Securities

And if I may ask one further question, can you give a little bit of update as to what’s going on with the assured guarantee?

Joseph Campanelli

It’s subject to litigation. I think the judge is ruling or dismissed to the four charges speaks for itself and it will be something that we’ll manage through over the course of proceeding. It being in litigation we really restrict the amount we can comment and I’m sure, my Attorney look at me, thinks always that too much.

Operator

Your next question comes from the line of Joe Hahn Lieux [Ph] with IMS. Your line is open.

Unidentified Speaker

Few quarters ago we have talked about the Texas rate bill, but since last quarter you haven’t talked about it and what the Texas region of Flagstar Bank Corp. Thank you.

Joseph Campanelli

You we’ll get that quickly for you Joe. Why don’t we take another question while we pull up that ratio and point that would slide the time if you don’t mind Joe.

Operator

Your next question comes from the line of Brace McLachlan [Ph] who is an individual investor. Your line is open.

Unidentified Speaker

Good morning. Follow-up to the two questions back just in terms of analysts' expectations and differentials in results. I understand that you can’t reconcile analysts but, for a couple years now, we’ve been receiving information in terms of business drivers been and a question I have asked over this. When do we start to transition from talking about business drivers to talking about profitability and real financial results that an individual investor invests in a company for. Where are we on that? When do we start to communicate in terms of what, myself as investor need to see out of the bank?

Paul Borja

That’s a good point. We are in the process of doing that. I appreciate when you are saying, we are working on a different set of drivers at a minimum. So that, it better tunes to the different models that are out there and hopefully we will provide better guidance to this analyst. I think that the – what drives, part of this question is, where do the analysts miss as much as Joe indicated, there were a number of different part of issues out there, there is also volatile interest rate markets that occur towards the end of the second quarter which affected in the part of the MSR income and also affected in parts on the loan production. But to your point, our goal is to, to get to a point where we have additional business drivers, some of these will change and our target right now is for Q3 as well as to get to the point where we say, here is what we think our earnings estimate is, or offset some of this for the upcoming quarters.

Unidentified Speaker

Okay, and that’s exactly the crux of the question. So without pinning you down, you think if I choose three, we might be speaking about earnings estimates rather than business drivers, is that a fair expectation I can hold into Q3?

Paul Borja

I think a fair expectation is, we have minimum, we are going to have different and hopefully we will have more detailed drivers work internally it has to, how that number comes out to be able to be communicate that.

Joseph Campanelli

Okay, the goal is to provide more and more transparency to our reporting also start to – the drivers go back at a point in time or some of the legacy issue where we are primarily a mortgaged operation and now we recognize the need to change those as we become a more bank product. So we appreciate your comments.

Operator

There are no further questions.

Paul Borja

To respond an question earlier, on page four of the Investors slide that we have or the earning slide that we have posted, we do have the Texas ratio. In Q1, we had indicated it was 36.75% in our formulation and in Q2 it’s 34.42%. It’s listed on page four under the heading, non-performing assets or NPAs to Tier-1 capital as general reserves.

And this is just to respond to the earlier question that we deferred.

Joseph Campanelli

Stephanie, do we have any other questions?

Operator

There are no further questions at this time. I turn the conference back over to representatives.

Joseph Campanelli

Okay, well, thank you everyone. I appreciate you taking time on your busy schedule to chat with us and obviously follow myself and other members of the management team available for questions that they arise with our release. And we look forward to getting out on the road and seeing all of you soon. So, have a great day.

Operator

This concludes today’s conference call. You may now disconnect

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