Flagstar Bancorp Inc. (NYSE:FBC)
Q4 2007 Earnings Call
January 30 2008 11:00 am ET
Mark Hammond - CEO
Thomas Hammond - Chairman
Paul Borja - CFO
Bose George - KBW
Frank - Friedman, Billings, Ramsey
Gary Gordon - Portales Partners
Brad Vander Ploeg - Raymond James
Tyson Strawser - Vision Research
Ron Rubin - Rubin Enterprises
Good day everyone, and welcome to the Flagstar Bank Fourth Quarter 2007 Investor Relations Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Mark Hammond, Chief Executive Officer. Please go ahead, sir.
Thank you. Good morning, everyone. Welcome to Flagstar's fourth quarter Earnings Call. My name is Mark Hammond, and I'm the Chief Executive Officer of Flagstar. Please note that we will be using a PowerPoint presentation during this call and we recommend that you refer to it, as we reference it throughout the call.
This presentation, as well as our earnings press release that we issued last evening which contains detailed financial tables, was posted on our website in the Investors Relations section at www.flagstar.com.
I'm here today with Thomas Hammond, our Chairman of the Board, and Paul Borja, our Chief Financial Officer. Tom will provide prepared remarks about our fourth quarter, as well as the 2007 year, and then I will update our drivers and provide an outlook for 2008. Paul and I will then answer questions. Please note that we will be addressing the questions that we received by e-mail or questions that we have been frequently asked.
Before we get started, I'd like to first direct your attention to the legal disclaimer on the second page of the presentation. The content of our call today will be governed by that language.
With that, I will turn the call over to our Chairman, Tom Hammond.
Good morning everyone. Thank you for joining us. Last evening, we announced our financial results for the fourth quarter and full year of 2007. As everyone is aware, the second half of 2007 was a period of turmoil resulting in significant stress in the banking industry and, in particular, those banks that are heavily involved in the mortgage and credit market.
Our financial performance reflects those market conditions. Although the last six months are very challenging and result in a financial loss, we believe that we have navigated the environment well, given that our balance sheet and business strategies were heavily concentrated in Michigan commercial real estate and national residential real estate lending. We will continue to focus on managing through a period of possible further real estate declines and weakening economy.
However, we believe there are a number of trends and underlying fundamentals that appear to be very positive. Significantly, higher market share in the mortgage industry, overall increased loan production, improving gain on sales spreads, the potential for higher Fannie Mae, Freddie Mac and FHA loan limits, increased credit spreads, and lowering finding cost, resulting in improved net interest margins are all currently occurring or appear on the horizon and should be considered when reviewing our financial results.
Let's turn to our results. During the quarter, we lost $30.1 million as compared to a loss of $32.1 million in the third quarter and a gain of $6.9 million in the fourth quarter of 2006. For the 2007 year, we lost $39.2 million as compared to a gain of $75.2 million for the full year of 2006.
Our fourth quarter loss related primarily to increased credit cost; costs associated with selling and transferring jumbo prime loans out of our available for-sale portfolio in an illiquid market and write-downs above our residuals and our securities.
Turning first to credit cost, the fourth quarter loss includes several significant credit related and market related charges that were not present in the fourth quarter of 2006. These include a $30 million increase in the provision for loan losses, a $2.8 million reduction in the valuable of our available for-sale securities, and a $23 million reduction in the value of our residuals from earlier securitizations.
In the fourth quarter, we also sold $538 million in prime jumbo loans from our available for-sale portfolio to other investors, resulting in a $4.3 million loss. We also transferred $1.15 billion in prime jumbo loans from our available for-sale portfolio to our investment portfolio, which resulted in a $2.3 million lowering of cost for market adjustment.
In addition, we incurred $9.5 million of losses associated with the underlying hedges of those prime jumbo loans which were held in our available for-sale portfolio. Those loans which are now in our investment portfolio are matched and funded with longer-term funding at attractive spreads. Cumulatively this credit related and market related charges represented $71.8 million of pre-tax cost that we historically have not incurred.
Now, let's drive some more detail regarding asset quality. The increase in the provision in the fourth quarter to $38.4 million from $30.2 million in the third quarter reflects two factors; an increase in charge-offs in the fourth quarter to $12.2 million from $5.8 million in the third quarter, and an increase in both general and specific reserves.
The charge-offs in the fourth quarter net of recoveries were primarily in commercial real estate loans $4.2 million, residential mortgage loans $3.3 million, home equity loans $2.3 million and second mortgage loans $1.6 million. The increase in our loan loss reserve reflects the increase in charge-offs and the increasing delinquency trends in the first mortgage loans and commercial real estate loans. Accordingly, we increased our general reserves by $10.1 million primarily in first mortgage loans, and we increased our specific reserves by $16 million; substantially, all in commercial real estate loans.
Net charge-offs increased to $30 million in 2007 from $19 million in 2006. Overall charge-offs of loans that we have repurchased from the secondary market declined to $10.2 million in 2007 from $13.6 million in 2006. We take a formula-based approach to managing reserves and adjust our allowance based on delinquency trends in the current environment. If delinquency trends continue to deteriorate, we will have to adjust reserve levels accordingly.
Our most recent review suggests a trend of leveling off of delinquencies in commercial real estate loans and second mortgage loans, although residential first mortgage loan delinquencies continue to increase on a broad basis. The frequency of first mortgage related delinquencies will represent our greatest challenge going forward. Therefore, we have added significant resources to our collection, loss mitigation, and workout staff.
The loss severity of first liens, however, is expected to be lower than on second liens and commercial loans due to the fact that our average LTV on our first mortgage investment portfolio is 73.4% and the average FICO score is 7,119. In addition, the high LTV first mortgage loans typically have mortgage insurance.
On the commercial side, to address delinquencies we have also increased our workout staff to work through the loans that we move into a serious delinquent status. It is important to keep in mind that these were typically loans underwritten prudently with equity and personal guarantees that we are operating in recession environment in Michigan.
The write-down of our residual balances during the fourth quarter reduced our residual balance on our prime HELOC and second mortgage securities from $63.4 million to $47 million. On a positive note, 2007 residential mortgage loan volume was $26.7 billion; an increase of 32% compared to 2006 despite the fact that industry loan production decreased significantly from 2006 to 2007.
December lock-in volumes was the highest December volume in four years in January 2008, new lock-in production will be the highest than any month since 2003. We continue to gain market share as industry further consolidates. In 2007, we hired dozens of season commission-based loan executives to enhance market share. We almost exclusively originate confirming residential mortgages for sale via the GSEs and FHA and making strong relationships with both of these.
Our scalable lending platform includes FHA capability as well. We will be situated very well to capitalize on any legislative increase due to Fannie Mae, Freddie Mac or FHA loan limits. We have for, example, 138 FHA underwriters to review the expected substantial increase in FHA business.
Bank net interest margin has started to improve as well. In the forth quarter, our bank net interest margin improved to 162 basis points, compared to a 152 basis points in the third quarter. The increase is attributable to a decline in funding costs following the fourth quarter rate cuts especially reflected in our FLB advances.
We also saw an increase in our gain on sale margin. During the fourth quarter, our gain on sale margin was 32 basis points as compared to a loss of 29 basis points in the third quarter. Our assets decreased to $15.8 billion, in the fourth quarter, from $16.6 billion in the third quarter. We continue to be well capitalized with a cushion over the minimal regulatory capital ratios.
In the fourth quarter, our core capital ratio was 5.78%, and our risk based capital ratio was 10.66%. We also maintain a multitude of reliable sources of liquidity. These include a growing retail deposit base of $5.1 billion at December 31, 2007 and a vibrant public funds division, access to wholesale deposit, a $7.5 billion line of credit with the Federal Home Loan Bank, and unused line of credit with the Federal Reserve discount window, borrowing capability in the form of Federal Funds, and unencumbered agency and AAA rated mortgage-backed securities that we can borrow against through the repo market.
The strength of our funding capabilities can be evidenced by the manner in which we were able to easily restructure our liabilities though the credit crisis of the last six months. For example, June 30, 2007, outstanding security repurchase agreement stood at $1.7 billion. The events of the summer made that an expensive funding source, but we were able to quickly transition out of repo's and to replace them with a $500 million increase in total deposits and an $800 million increase in FHLB advances, while reducing our outstanding repo's to 108 million.
In more recent weeks, as retail deposit pricing has lagged, the decline in interest rates and order has been somewhat restored to the agency repo market and we've been able to reverse course and back off on our deposit pricing due to our ample alternative funding sources. We believe that the advance of 2007 clearly demonstrates the importance of our deposit franchise and bank charter and explains why the growth of our banking operations continues to be a focus of our business plan despite the startup cost for new branches.
Another thing, we want to emphasize that we have historically avoided originating many of the riskier assets that have recently come under scrutiny in the news. As we have said before, we hold minimal sub-prime loans on our balance sheet. At the end of the fourth quarter, sub-prime loans totaled about 1% of total assets. About five years ago, we made the decision to avoid originating sub-prime loans.
Further, we do not have any CDOs or SIVs. In addition to the residuals mentioned earlier, the only securities that we hold are one of three types; AAA rated agency securities created using prime loans that we originated and securitized on our balance sheet; AAA rated securities created using second mortgages that we originated on our balance sheet; or AAA rated prime securities that we invested in.
While we have scale back, we continue to build bank branches. In 2007, we built 13 new branches 7 in Michigan and 6 in Georgia, bringing our total to 164. We also added 15,300 new accounts in 2007 for a total of 293,200 total retail accounts at the end of 2007.
Looking ahead to 2008, we expect the banking industry will continue to be challenged in our primary market. We plan to curtail the expansion of new bank branches to about the same number as 2007. Well, some may question our decision to build branches given the current environment; we feel it has paid off, as we were not relying on Wall Street for funding during the liquidity crisis.
Before turning over to Mark, I will just take a step back from financials and talk for a second about some intangibles. We have a seasoned management team who has managed through other tough cycles, including the early 80s, high interest rate, the savings of loan crisis, the stock market downturns of 1987 and 2001.
Our bank franchise has considerable value, and, recently, in three separate independent surveys, our customers ranked as apt or near the top of the list for overall customer service satisfaction. Flagstar also ranked among the top in terms of our customers likely to refer us to a friend, and a category of customer loyalty. We were also recently recognized by Freddie Mac as a Platinum Service provider with a top servicing level.
To sum it up, the quarter and the year were disappointing, but there are many positives. Until we have a greater certainty on when market and credit conditions stabilize, we are going to guard our capital closely by limiting balance sheet growth, reviewing and possibly suspending our dividend, and only originating mortgage loans that could be sold to the GSEs or FHA.
We continue to monitor our capital plan closely in this environment and if future credit concerns continue to exceed the positive results we are seeing from improvements to our net interest margin, gain on sales spreads, and our loan production, then we will also consider additional capital strategies including shrinking the balance sheet and/or raising potential capital.
With that, let me turn things over to Mark.
Thanks, Tom. Slide on page 15, outlines our 2008 outlook for each of our key drivers. Staring with branch openings in 2008, we have lowered our previous guidance and now anticipate opening 11 to 15 new branches, but the majority of those being in Georgia.
We are revising our asset growth from 10% to 14% to 0% to 2% due to credit market uncertainty; we do not feel that it is prudent to significantly grow the balance sheet at this point. We are expecting a relatively flat balance sheet for 2008. We also expect our balance sheet to remain flat for our commercial real estate portfolio.
As Tom mentioned in his speech, we are seeing strong residential mortgage loan production early in 2008, so we are revising our origination estimate between $33 billion and $38 billion. The majority of those above 95% will be agency loans. Given the revised balance sheet strategy, we are also raising our estimates for loan sales from $28 billion to $36 billion to a new level of $30 billion to $38 billion.
We are increasing our gain on sale margin outlook for 2008 from 30 to 40 basis points to 45 to 55 basis points. The increase in margin reflects the more rational pricing environment with less competitive pressures that we have been experiencing. About us B011 1:42 early in the new year, we have seen significant pricing power and currently pricing for gain on sales spread is at the high end of that range.
Turning to bank net interest margin, we are increasing our outlook from 155 to 165 basis points to 165 to 175 basis points. We have recently seen an improvement, and anticipate further enhancement particularly due to the anticipated spread increase and our available for-sale portfolio. Net interest margin improvement is the management focus for 2008 and we hope to increase them to 2% on a run rate basis by the end of 2008. We intend to achieve this through lowering funding cost and improving credit spreads without assuming a higher credit risk profile.
We are maintaining our outlook for retail deposit growth of 4% to 6%. We anticipate good growth, as our recently opened branches begin to season, as well as from the 13 or so new branches we plan to open in 2008. We anticipate flat to minimal growth in our matured branches.
We are increasing our estimates for both mortgage servicing right sales from $10 to $15 billion to $20 to $30 billion. However, we are not anticipating any spread on those sales, as gain opportunities have been minimized by falling interest rates. For quarter, we are estimating to book no gain on both mortgage serving right sales in 2008, but plan to sell a sizeable portion of our portfolio to minimize hedging cost and capital exposure.
Finally, we are modeling loan charge-offs of $45 to $55 million in 2008 up from $30 million in 2007. We are also modeling allowance for loan losses to be 128 basis points, as a percentage of our held-for investment portfolio. This is challenging to predict, and we will be dependent on the extent of future broad real estate declines and the health of the overall economy.
With that, let me turn it over to CFO, Paul Borja for the questions-and-answer session.
Thanks, Mark. I'll be reading question we received today from various persons and either Mark or I will respond to them.
The first set of questions, we received are from Bose George of KBW.
The first question: your commission number was up pretty sharply versus the last quarter and Q4 of '06, but volume was not materially different and gain on sale was similar to the number in Q4 of '06. What drove the increase in commissions? I'll turn this to Mark.
Okay, thanks Paul. Yes, we've seen an increase in the commission expense primarily due to the composition of the production channels of our origination. And the third quarter we added a number of retail residential loan originators and the retail residential loan originators that were added in the third quarter's closings were reflected in the fourth quarter.
The retail loan originators typically receive a lot higher commissions than third-party channels. Retail originators typically receive commissions around a 100 basis points, where third-party originator commissions are closer to 10 basis points. And that difference is reflected on the commission expense side. However, we have to remember that the retail people are not receiving the same pricing; it would be the wholesale or correspondent people.
So, the net cost to originate from a channel standpoint is not really any different to us. But you are seeing an expense that's reflected on the commission line and not the associated revenue. We typically report net gain on sale numbers. So, the associated revenue that was offsetting the additional commission cost is not reported on our gain on sale numbers.
So, you won't see the difference on the gain on sale numbers; different than a lot of our competitors. When we report year on sales, we are reporting a net number as opposed to higher revenue number. So, it really is just a composition of originations, as we continue to take advantage of our market opportunity to higher retail originators given the consolidation that's occurred across the country.
The next question: your employee count continues to trend up even if you exclude loan officers. Is this primarily driven by employees at the new branches?
Okay. It's a combination of employees at new branches. We opened a number of new branches in the fourth quarter. It's also increased production staff for new loan production as our new loan volume is up pretty significantly including processors, closures and particularly credit people and underwriters. Additionally, we significantly added people to our collection staffs, workout foreclosures and loss mitigation staffs. And the rest of the staff counts are pretty well flat to small decline.
The next question: your cost of deposits was 4.32% in Q4 of '06 and your cost of funds in Q4 '07 was 4.35%, three months LIBOR is down by over 200 basis points during that time. Can we expect a pretty sharp decline in your cost of funds? How soon will the CDs, wholesale deposit and municipal deposit start re-pricing down?
Okay. Yes, we should expect a decrease in the cost of funds. Cost of deposits that we reported it's an average number for the quarter. The improvement that we've seen in the three month LIBOR came towards the end of the quarter and into January.
So, there is a tiny difference represented in the question. We anticipate that absolutely funding costs will be going down. We anticipate also seeing net interest margin improvement particularly towards the end of the first quarter. And as we mentioned for the year, we are anticipating 165 to 175 bank net interest margin and closer to 200 basis points towards the end of the year.
Next set of questions comes from the net Frank B015 0:7 at Friedman, Billings, Ramsey.
First, please provide more detail for your non-performing assets and: can you breakout loan type vintage and LTV, FICO on these loans that are going delinquent?
As to that request we've on page 6 of the presentation a more detailed breakout than we use to provide regarding non-performing loans on a loan by loan category. We will provide additional information such as LTV FICO in future presentations and probably also in the 10-K.
The next question: why are these borrowers not making payments any longer? And: explain your efforts to reduce your loss exposure on these loans that are not performing I'll turn it to Mark.
Well, I also like to add to Paul on page 13 of our presentation, we also provide even more detail on our commercial real estate loan portfolio and in addition to the detail on page 6 to provide some more color on the delinquencies picture.
As far as: why borrowers not making payments? It's a combination of a number of reasons: clearly it's effect of slowing economy certainly we are having more issues in different regional geographic areas in particular California, Arizona, Florida being caused by access property and property evaluation declines particularly the higher LTVs the people with our equity particularly those who've had some sort of life changing event, losing a job or health issues get into a scenario that they don't have the property value there that we are seeing people walk away from homes.
Little bit different picture in the Midwest and parts of New England, where you have a slowing economy and lack of demographics that brings as far as job growth and population increase that accreting to overall recession type situation that's creating an affect not paying.
As far as reducing our exposure, we've a staff that is focused on working with customers and where appropriate trying to mitigate loss through a series of loss mitigation techniques, whether it's forbearance plan, whether it's modifications, whether it's loan restructurings or loan refinances. And this will be something that the industry as well as also we will have to deal with throughout the year.
Particularly, there are concerns on the commercial real estate portfolio, because of larger exposure on a prolonged basis. And then on the HELOC and second portfolio, where we don't have a lot of equity and higher LTVs, although, as we mentioned in the speech, the incidence rate is going to be high on the first mortgage portfolio. At this time we do have a pretty good portfolio as far as equity position and FICO scores. So, we expect the frequency in incident will be high, but the severity will probably be a little lower in that portfolio.
The nest question: explain the significance increase in commission expenses in Q4 and also explain your efforts to reduce your cost structure.
I'll take that. We already answered the first part of that. The second part of that is, we are continuingly monitoring our cost structure and trying to focus on managing non-production related costs clearly in an environment, where we have more production. There is going to be cost associated with handling that production. But we are also dealing with increased cost in handling loss mitigation forbearance collections.
Outside of those, we are expecting very minimal increases in cost and it's a continuous effort to manage and to be focused on managing the overhead associated with those other areas
Our next set of questions comes to us from Gary Gordon of Portales Partners. The first question: sounds like non-home mortgage delinquencies are up a lot, please discuss that a bit. And I'll turn this to Mark.
As we mentioned for the quarter the commercial real estate and some of the consumer loan delinquencies are up, but one of the positive trend is towards the end of the quarter and going into January. We've seen the new delinquencies flatten out. Unfortunately another disturbing trend now is we're seeing that once somebody goes delinquent they are often going down from day 1 mean by that is and years pass sometimes you would see somebody go delinquent and there might be 30 days delinquent to six months and then either a fall further or [adhere].
One of the disturbing trends we're seeing is that high portion of customers that go 30 days delinquents are going immediately 30, 60, 90 then right into foreclosure. So, positive trend, we are seeing in the commercial real estate and seconds flatten out. Some of the negative trends we're seeing that people are going to more severe categories right away. And then on the first mortgage portfolio we're continuing to see increases in all categories 30, 60 and 90 and we've not seen that level out.
And the next questions from Gary, what was you MSR mark to mark adjustment? And: do you hedge this?
Okay. We did not have MSR mark to mark adjustment for the quarter. And our MSR portfolio is part of our overall hedging strategy. We take an aggregate view to managing interest rate risks and we aggregate all of our different interest rate risks and the MSR portfolio adds to the hedge itself for us towards rising interest rates.
Also on the concern with impairment performing interest rate, one of the macro hedges that we've relative to the MSR portfolio is that if interest rates fall, generally we are seeing increased production with increased gain on sales spread, which are an offset to the potential for impairment.
With that being said, we anticipate, as we mentioned selling a portion of our portfolio through the year to minimize the aggregation of MSR from a capital standpoint and from an interest rate risk standpoint particularly relative to systemic large downward movement. But if we are for some reason unable to sell a portion of our MSR portfolio to minimize their risk, then we put specific hedges on to protect against the downward interest rate risk.
The next questions come from Brad Vander Ploeg of Raymond James.
The first couple of questions are related: can you elaborate on the securities impairments in the AFS and trading portfolios? And: can you walkthrough what happened to the residuals?
In the AFS and trading portfolio, as we’ve both securities and residuals, so let me talk to the AFS securities first. With the AFS securities, we value those based on FASB 157 requirements for level one, two and three. We took a look at the marks that were available and what is a thin market out there and made an assessment as to whether any kind of impairments were either temporary or other than temporary to the extent that the marks were other than temporary those are reflected in our profit and loss statement with the remainder being reflected in our other comprehensive income. And so, that is really just a function of marks in the market.
As to the residuals, we've residuals that we include in both the available for sale line as well as the available for trading line. With respect to the residuals, we run various models using market based assumption as allowed under level two for FAS 157. With respect to the residuals, we'll provide details of the different assumptions in our 10-Q. When we looked at both, the loss portion as well as the discount rates involved and what we were seeing in the marketplace in order to come to the evaluations for the residuals and the resulting adjustments.
The next question: what is your view of the potential raising of the jumbo cap for Fannie and Freddie? And how about if they can portfolio more, Mark?
Yes. This will be great for us. It's a market segment that we've been out for the last six months. We’ve had very minimal jumbo origination capability and there will be given the fact that we haven't been looking to securitize, it's not been an active both jumbo wholesale market to sell loans. And Fannie and Freddie would really create a lot of opportunity for us to increase production as well as increase gain on sales spread. So, it would be fantastic for us.
As far as: how about if they can portfolio more? That really won't have a direct impact on us. We don't generally sell home loans to Fannie and Freddie. We generally form MBS and PC securities and get their guarantee fee. And then they generally go back into the market and use their portfolio to buy their own securities. So, I think it would be good for the overall market if they had more portfolio capability, but it won't necessarily have a direct impact on us.
The next question with regard to net gain on loan sales spread just to clarify: where are these loan level pricing adjustments?
Okay we had to deal with three different impacts to increase guarantee fees or Fannie-Freddie credit enhancements on our MBS and PCs in the last couple of months. The three impacts have been, Fannie and Freddie have dramatically raised their loan level pricing adjustments for different various credit risks, and various different products throughout their product mix. In addition, our new master agreements were negotiated and also like the majority of our peers saw our guarantee fees to do base business with them rise in January.
And then thirdly, Fannie and Freddie have both announced across the board in all products they are going to raise an additional 25 basis point. So, the credit costs have gone up dramatically for getting the Fannie-Freddie guarantee fees. The positive of that from our perspective is we've been able to pass 100% of that additional cost on to the marketplace to our production channels and consequently to the consumers.
So, we've not had to bear the cost of that. In addition of that we've also been able to raise our spread that we are getting from the consumers due to more rational pricing environment and less competitor. So, at the end of the day, Fannie and Freddie are receiving more revenue on a prolonged basis, and we are also receiving more revenue on a prolonged basis.
Next question: can you describe the secondary market environment right now? Mark?
The secondary market is still very healthy for Fannie, Freddie Ginnie Mae business and pretty much non-existence for business outside of that it pretty much sums it up.
Right. On to the next question: Are you asset or liability sensitive? And: what will be the effect of recent Fed cut rates for you? How about if the Fed cuts again today?
Okay. We run a match book and we are not extremely asset or liability sensitive. We do have the effect that for prime based loans they often adjust immediately the day prime changes, whereas the liability sometimes takes a couple of weeks to re-price that offset those. So, in a very short term in a one, two week window, we are little bit more sensitive to have such reprising. But generally we run very low sensitivity and very well matched organization.
The bigger effect to us on the lowering of interest rates has to do with the shape of the yield curve. And this has to do with our available for sale portfolios predominantly a 30 year fixed portfolio but only has a couple of months life with us. So, we generally have an “arbritarized opportunity” as we are selling loans for securities in a way that we are to able to match the 30 year asset with 30 day or 60 day funds.
And that normalized interest environment, where we've some shape or steepness to the yield curve that provides a nice “arbritarized opportunity” for us. In the last couple of years that's been wiped out. So, if the Fed lowers interest rates and we do not see a corresponding decrease in the longer term yields that will have the most positive effect for us.
And the next question: any share repurchase activity this quarter?
No, we've had no share repurchase activity and do not intend on repurchasing shares. We clearly think our stock price is good, would be a good buy and a good price. However, we are being prudent with capital given the not uncertainty of our strategy, but uncertainty of the broader overall markets. And how much the general economy may slowdown and how much residential, real estate and commercial real estate value is going to continue to fall. So, looking to be prudent with capital given the uncertainty of the broader market, although we do feel our stock price is attractive.
Last question from Brad: can you elaborate on areas of concern for your loan portfolio in terms of type and geography?
Yeah. Just as we've mentioned before, on the commercial real estate, the residential development loans clearly are concern for us. We have $159 million of residential development loans of which $70.6 million are currently delinquent that is a trouble portfolio.
The big question really is going to be how well our guarantees hold. The new residential construction is at long-term historic low, and we do not anticipate that some of those developments, we'll be able to pull out. So, the question mark really boils down to how well the guarantees hold.
Other concerns, we've geographic concerns, as we've mentioned before with the development states or the growing states where there is over speculation, over building, too high of investment properties and where there is overhead. Concerned with Phoenix, concerned with Southern California, concerned with Florida, particularly the southeast coast, and those portfolios are underperforming from a geographical standpoint.
Unfortunately although we had a diversified both the business, do business in all 50 states, we do have a heavy concentration in Florida, California and Michigan. Those three states represent 50% of our investment portfolio little bit small percentage of our production. So, we do have some geographical concerns.
On the HELOC and Fixed Seconds, our concerns are the high LTV piggybacks that we did the lower LTV loan seem to be performing fine. The higher LTVs even with the good credit scores have come under stress and quite frankly that's affect us in two fold, one our investment portfolio, which we only have a couple of hundred million, but more importantly it's affected us in our residuals, for the couple being in securities that we originated and sold.
So, we are moderating those and working aggressively to mitigate losses in those. Those affect, we are having as been a challenge with the media and with consumer groups and with consumer willingness just to walk away from loans. We haven't seen any thing like this since taxes in the oil, during the oil bust and people just willing to declare bankruptcy and walk away. We are seeing a lot of that similar type social phenomena and occur particularly in California, which is also concerning to us.
The next set of questions are from Dan Smith. The first question: please comment on your thoughts about eliminating the dividend?
In Board meeting that we usually discuss the dividend. In our next Board Meeting, we'll have more of a formal review and generally don't do that with the quarter end Board Meeting. But I'd say right now that the atmosphere is one of capital preservation until we can have some more clarity on the severity of potential further credit impacts due to the further broadening declines.
We feel that we are adequately reserved and adequately taken associated charges given the market as it sits here today. So, we feel that we are comfortable. But, if property were to decline another 10% or we were to enter a broad recession, when unemployment goes up to 6% to 7% those clearly would have impacts on credit cost and it makes sense to preserve capital from that standpoint.
Next question from Dan: are you going to continue to build branches?
As we mentioned in the speech, “yes”: we've pulled back at our branch expansion, but we do own the real estate for two years worth of building and so from that aspect we already have an asset in the real estate that's a non-interest producing asset. You got to remember we built branches the cost to build those are capitalized over a number of years.
The larger expense is really the employee expense associated with staffing the branches. Generally have about 6 FTEs per branch and we need to balance that off with the advantages of bringing in retail deposits. The advantages to cross sell those customers and build our customer base and build a franchise value and also make sure we've a good solid retail funding source so that we can mange any potential liquidity concerns and not be rely on Wall Street for funding.
The nest question: can you address original LTV and credit scores versus what you think those numbers look like today, both locally and nationally?
Yeah, on a broad portfolio basis we do testing. We've not seen a decline on the averages of our LTVs and credit scores. And I think you would expect that in LTVs because we got a broad property distribution across the United States and although some markets have seen significant decline to 10%, 20% to 25% other markets have had gains that have been flat. So, the overall average decline across the country is only a couple of percent and likewise we've had principal buy down or principal pay down on some of our portfolio. So, we've not seen a significant increase on the current LTVs relevant to the original LTVs.
Similar in FICO, we've not seen a significant decrease in current FICO scores versus original FICO scores. But yet to remember, we do not lose money on the averages, where delinquencies occur, and where losses occur on the tails. And so it is for the percentage of people that do have the FICO score decrease or lose their job, or have property depreciation it's that smaller percent that create the 2% to 3% delinquencies and not the broader average.
Our next question from [Tyson Strawser of Vision Research]. How did the market for repurchase agreements compared to the third quarter environment? Are you required to provide additional collateral during the quarter related to these arrangements?
Most of the repurchase agreements we've done have been with Fannie Mae and Freddie Mae, PCs and MBS securities. And we've seen strong abilities used as collateral for repo agreements throughout this whole equity concerned. Currently we're seeing very strong executions for the Fannie, Freddie at about 10 basis points over and above sort of home loan bank advance costs, which have been some what lower than LIBOR cost.
So, we're still seeing decent execution although we're not relying on those, we do have that as a funding source. For the smaller portion collateral that we have on AAA securities outside of Fannie and Freddie that we can use to report. We've had a market for the last six months made available to us, but the execution hasn't been great. So we haven't done as much repose or been as interested to do repose with the AAA securities that non-Fannie and Freddie brand.
And we've had no need for additional collateral other than the standard margin cost associated with repose.
The next question is from Ron Rubin of Rubin Enterprises.
When evaluating your book value: why do you choose not to have current value of the 78 buildings you own priced into it? But rather, the purchase price since they were bought prior to '96. Don't you think your shareholders should know about this hidden value during the uncertain time that we are in?
I think that's a good question. Even with declines in real estate values, we probably have a value in our buildings over and above book value. But these address the characterization, because most of our buildings have been built in the last five or six years. And they were built not purchased, and we follow normal GAAP accounting rules as far as depreciation rights and recognitions of asset values are relative to those buildings.
The next question from Ron Rubin: What are your intentions in regard to your stock buyback program? Is there an actually process that you have, that you can explain?
Yeah. As we mentioned before, we still have authority to buy shares back. However, we feel more prudent, although we think the stock price is a good value, and just they should note that the majority of our board members, including myself, purchased shares in the fourth quarter.
So we feel that the stock does offer a good buy opportunity. I looked back to 2001 when we had a similar environment with a slowdown in the business from the Fed cutting interest rates and then trading below booking and start 2001 was a great buying opportunity.
And so I start to appreciate quite a bit after to that time period and feel there were a similar type environment now. So on the other hand, we need to balance that with the uncertainty at the over -- broader overall economy.
And as I mentioned before we feel we're well capitalized now. We feel we've adequate cushion. We feel we're appropriately reserved. We feel we've taken the appropriate write-downs given the current market environment we are in.
But if the market were to significantly deteriorate more, we want to make sure that that we had adequate capital to guard against serious market declines and serious broader potential for recession.
And our final question for today, since your banking operation has consistently grown, what is the reason you've slowed down its expansion and focus more on your mortgage division?
Well, I wouldn't say we focus more on our mortgage division. I think we focus equally on our originating capability as well as our banking. Got to remember that the predominant asset we invest in is on the balance sheet of our bank, on the asset side of our bank is mortgage related.
So the mortgage division has the opportunity to have fee income associate origination gain on sale servicing, but it's also the primary asset gather for our balance sheet as a thrift.
And as far as on the bank branch side and bank deposit gathering, it's also important part of our business and we continue to focus on that. But we try to find a balance between being prudence and spending money when we have the money to spend out of earnings. And then also though, continuing to make sure we keep the momentum going for what we've been in the last five or six year. So, it's a balance that we try to find.
That's our last question. With that I will turn it back to Mark Hammond.
I'd like to thank everyone. This concludes our conference call and I hope everyone has a great day. Thank you.
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