Good day, and welcome to the Flagstar Bank Third Quarter 2020 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Ken Schellenberg. Please go ahead, sir.

Thank you, Sherry, and good morning. Welcome to the Flagstar third quarter 2020 earnings call. Before we begin, I would like to mention that our second quarter earnings release and presentation, are available on our website at flagstar.com. I would also like to remind you that any forward-looking statements made during today’s call, are subject to risks and uncertainties. Factors that could materially change our current forward-looking assumptions are described on Slide 2 of today’s presentation, in our press release, and in our 2019 Form 10-K and subsequent reports on file with the SEC. We are also discussing GAAP and non-GAAP financial measures, which are described in our earnings release and in the presentation we made available for this earnings call. You should also refer to these documents as part of this call. With that, I’d like to now turn the call over to Sandro DiNello, our President and Chief Executive Officer.

Thanks, Ken, and good morning to everyone listening in. I hope all of you and your loved ones have been able to stay safe and healthy. I'm joined this morning by Jim Ciroli, our Chief Financial Officer; Lee Smith, our President of Mortgage, and Reggie Davis, our new President of Banking. As you may know, we had a bit of a change in our leadership team during the quarter. Reggie joined us on August the 3rd, and I'm thrilled to bring a person of his stature in the banking industry, to Flagstar. He could have gone to a lot of banks, but chose to join us. Further, Kristy Fercho, our President of Mortgage, left Flagstar on that same date. While we hated to see Kristy go, fortunately, we had a great internal solution. Lee Smith, who been with me from day one of Flagstar's turnaround, was already overseeing mortgage fulfillment as part of his COO responsibilities. Plus he was also overseeing mortgage servicing. So it made all the sense in the world to place him in the role of President of Mortgage, allowing us to have originations, fulfillment, and servicing, under one highly respected leader. Given these leadership changes, Jim will expand his remarks a bit today to cover some of Lee’s former areas. Reggie will follow with an update on the Community Bank, and then Lee will handle the mortgage segment, including servicing. As usual, we'll then open the line for questions. A few more comments about Reggie. He's a talented, versatile, seasoned banker, with a proven track record of success. As many of you are aware, diversifying our earnings has been an ongoing key strategy, and growing our Community Bank, is a pillar of that strategy. And we've made a lot of progress on that strategy, and therefore…

Thanks, Sandro. Turning to Slide 6, net income this quarter was $222 million or $3.88 per share. This performance compared to the $116 million or $2.03 per share last quarter. The increase on a linked quarter basis, was largely due to stronger mortgage results, and a nice increase in net interest income, the result of higher warehouse lending, and a lower credit provision score. Diving deeper into this quarter's performance, our pre-tax pre-provision earnings were $327 million, compared to $250 million last quarter. Net interest income increased $12 million or 7%, while average earning assets grew $2.0 billion, and the reported net interest margin decreased by 8 basis points. These were impacted by loans with government guarantees that have not been repurchased, and are only the result of an accounting gross-up. Excluding these assets, the net interest margin actually increased six basis points. This performance was primarily driven by the strength of our warehouse business that has rate floors in place to protect from margin compression, and our core deposits, which benefited from higher custodial balances, and also for the maturity of higher cost CDs, and the exploration of promotional rates on savings accounts. We'll review these numbers in a couple of slides. Mortgage revenues were $358 million, an increase of $63 million compared to the very strong number we reported last quarter. During the quarter, we saw gain on sale margins increase. Asset quality remained strong. Net charge-offs were only five basis points, and early stage delinquencies stayed low. Non-performing loans ticked up slightly, as we had one commercial credit of 10 million that we put on non-accrual status. Despite all of this, we increased the allowance for credit losses to $280 million, up from $250 million at the end of the second quarter. This reflects our views on…

Thank you, Jim, and good morning. As this is my first opportunity to be in front of many of you, I'd like to comment on the potential I see in the Community Banking business at Flagstar. What excited me about coming to Flagstar, was the tremendous potential of this franchise. Looking at this company from the outside, I've been impressed with the way that the company has been able to grow its loan book in a well-diversified manner, with a focus on building advisory relationships with our clients. Now, having been inside for nearly 90 days, I'm even more impressed with the energy and commitment of the Flagstar team. This team is on a very deliberate journey to build a best-in-class, client-focused organization. The two deposit acquisitions meaningfully transform the retail deposit base to where we can focus more on full relationships. This will continue to be our focus as we build out an Omni-channel experience for our retail clients. In the near term, we want to focus on sustaining the strong performance we've seen from the warehouse lending team, and take this opportunity to improve our productivity across all businesses in Community Banking. Please turn to Slide 15. Quarterly operating highlights for the Community Banking segment include, average warehouse lending balances increased $1.9 billion or 51% to $7.6 billion in the quarter, due to the low interest rate environment driving strong refinance volume. Our relationship-based approach, and speed of execution, also enabled us to add new clients, as well as increased lines for existing customers during the quarter. We continue to maintain our disciplined underwriting in this business. Average commercial and industrial and commercial real estate loans, decreased $450 million or 9%, with the decrease being driven predominantly by the sale of PPP loans that we closed in July.…

Thanks, Reggie, and good morning, everyone. We couldn't be more pleased with how our mortgage and servicing businesses are performing right now, providing significant and valuable non-interest fee income in this low interest rate environment. The $346 million of gain on sale revenue generated during the third quarter, was a record of Flagstar, as mortgage banking revenues increased an incredible $63 million or 21% quarter over quarter, as we continue to take advantage of the strong refinance market. Furthermore, we ended the quarter servicing or sub-servicing just over 1.1 million loans, an increase of 6% from the previous quarter, as we added over 100,000 non-Flagstar originated loans to our best-in-class servicing platform. Our unique one-stop shop mortgage business model, allows us to originate mortgages across multiple TPOs and retail channels, provides optionality in how we sell or distribute the loans, and also enables us to sell the mortgage servicing rights created, and retain the sub servicing on those loans. This is complimented by our warehouse and mortgage lending capabilities. And the custodial and escrow deposits generated by the servicing business, also help us fund that balance sheet. This model allows us to build deep partnerships, remain nimble and flexible, and maximize earnings throughout the mortgage life cycle. I will now outline additional key operating metrics from our mortgage and servicing segments during the third quarter. Please turn to Slide 19. Quarterly operating highlights for the mortgage origination business include, full out adjusted lot volume increased 8% to $15 billion quarter over quarter, while the net gain on loan sale margin increased 12 basis points to 231 basis points. As a result, gain on sale revenues increased a significant $43 million to $346 million in the quarter. The majority of our lot volume growth was seen in our higher margin retail…

[Operator Instructions]. Our first question will come from Daniel Tamayo from Raymond James.

Hey, good morning guys. Congratulations on a great quarter. I just wanted to talk a little bit about first, the sustainability. I asked this last quarter, but clearly holding up the sustainability of the warehouse yield, if you're still able or given kind of the competition there, but if you're still able to charge these higher rates for clients using the period end balance sheet, or if there's some other factor going on there and if you envision that changing at all going forward

I do not envision a change, and we have not had the competencies at all on any of our annual leave rates that we are charging. As you probably know Danny, most, if not all of these warehouse lines, are at their floors. So I think the sustainability of the yield is - the likelihood of that is pretty high. In terms of the balances, as Reggie noted, through yesterday or so, we're at $7.4 billion average balance thus far in October. So that's hanging in there as well. So I think, you know, I mean, we do have a disciplined concentration policy. And so, you know, growth will be measured against our capital growth, but I think the opportunity there going forward is pretty strong. Let me see if Reggie has anything he wants to add to that.

No, nothing to add. I mean, we've got a fairly disciplined approach. We like that business. We think we can get paid for it, and we're seeing more and more opportunities as our competitors struggle to execute.

All right, terrific. And then maybe just stepping back a little bit, you know, as the potential for a steeper yield curve comes into play here, you know, if you could talk about what levers you have to pull, you know, kind of overall in order to mitigate that, how that might impact the business overall. And then, you know, you've talked a lot about capacity being - you know, outstripping demand on the volume side and mortgage for the last several quarters. How much that - you know, maybe a delta there is there that if you do see - we do see a steepening yield curve and lower demand before you would see a significant reduction in kind of volumes on the mortgage side. Thanks.

Yes. Well, you know, it's hard to look out that far into the future, Danny, but I guess I'd say this. I think our view is that we've got some runway in the mortgage business, and we're going to continue to take advantage of that as long as we can. You know, should we see rates start going the other way, a steep in the yield curve, I think there's other pieces of the business that kick in at that point that might mitigate, that could and probably would mitigate any reduction we'd see in the mortgage business. Let me see if Lee or anybody else wants to add anything to that.

I agree with those comments, Danny. You know, you really have to look at the balanced model we have. And so while that could crimp the mortgage business a little bit, think about how well the servicing business would do in that kind of an arrangement, and think about how the Community Banking business is going to perform in that scenario. And so, you know, we're not really able to predict where rates are going to be, obviously, but we've positioned the company to do well regardless of where they're heading.

Yes. And Danny, this is Lee. So I want to emphasize that. The diversified model, we've always said we can be successful, whatever happens to interest rates. So, won't repeat anything Sandro and Jim have said. On the mortgage side, and we've said this before, you know, 70% to 75% of our expenses are variable, semi-variable. And so as the volume goes down, you're going to have some natural flex in your expense base as well.

That's terrific. I appreciate all the color. Maybe just the last one on that - on the expenses. As you mentioned, you know, lower than they've been running in the quarter related to mortgage. You mentioned the Opes Advisors incentives have come out. Is that just the driver there and you think that percentage is going to be lower than kind of what we've seen prior to this quarter going forward?

Yes. The main driver for that, Danny, is the Opes earn-out coming to an end. And so that's come out. You won't see going forward. I think in terms of where you’re seeing the run rate on mortgages, and we've got a chart, I think it’s Slide 42, I think that's the zip code, give or take, of where you can expect the expenses to be as a percentage of closings.

Terrific. Thank you for all the color.

Thank you. Our next question will be from Scott Siefers from Piper Sandler.

Good morning. This is actually Jamie Benjamin on for Scott. Thanks for taking my questions. First, gain on sale margins held up very well, with some benefit from the securitization transaction quarter. I was wondering if you could clarify what that benefit was this quarter.

How much the benefit was from the RMBS?

Yes.

Yes. We haven’t actually disclosed that. No, it was rather - it was sizable, but it was only maybe half of that benefit. The other half was really just what I call other execution improvements that we made on the secondary side.

Yes. I'll just jump in. and Jim is right. Half of it was RMBS. We got better execution around the hedge, and we did see an increase in our non-del correspondent channel quarter over quarter from a margin point of view. That's our biggest channel volume wise. So those were the three drivers.

Perfect. Thank you. And then one follow-up. Appreciate the clarity around the decrease in deposit costs. Was wondering, moreover, could you tell us a little bit about what additional levers you could flex on the net interest margin? Whether that's balance sheet movements, more deposit cost leverage, et cetera. Thanks.

Well, so I think we're pretty - we feel pretty confident that the yields are going to hold because of the influence of the warehouse side. And I think on the deposits, there's still some runoff from higher rate CDs that are going to come into play and just drive the discipline. Let me let Reggie comment on that.

Yes. I think one of the things we've been pleased with this year is, as we've had the maturity happen with the CD portfolio, we've been able to move that into lower cost products. We know, because of the maturity schedule, we've got additional opportunities for the balance of the year. So we would expect that trend to continue.

Perfect. Thank you very much.

Our next question will be from Henry Coffey from Wedbush.

Yes. Good morning, everyone, and thanks for taking my questions. Two specific areas. One, you know, you talked a little bit about the Ginnie Mae EBO opportunity. Exactly how does that work, especially both with the servicing you may own, or with the servicing you may be subservicing? So what - I mean, I know it's a capital impact, et cetera, but I'm thinking about it more as an opportunity. And what is the governor behind converting that $1.8 billion of loans in forbearance into EBO and then EBO into resecuritization gains?

Yes. So let me take this, Henry, and then Jim will probably want to point. In terms of the $2.5 billion Ginnie EBOs we referenced and the $1.8 that are on the balance sheet because the borrowers are in forbearance, that is all Flagstar owned Ginnie MSR. So they’re Flagstar owned EBOs. The accounting consequences I mentioned in the prepared remarks …

Do you own them or you’re just putting them on your balance sheet?

Yes, we’re putting them on the balance sheet. We have not bought them out. And this is where - this is what I'll explain. The accounting consequence of owning the MSR is to show them as an early buyout, whether you buy them out or not. And so the biggest impact for us is against capital. These loans were all performing prior to the pandemic. And we think a big portion will go back to making payments and get reinstated after the forbearance period expires, either on their own or through the partial claim process. Once they're reinstated, they're no longer categorized as an EBO. A small number will get modified outright, or they'll get modified in conjunction with a partial claim. If that's the case, we will then buy them out and realize the gain on sale benefit of resecuritizing the modified loans.

And what is the size of that number, or you don’t know?

We don't know yet. We're working - you've got to remember that the first six month period per the CARES Act for forbearance, is expiring now. And so borrowers have the option to extend for a second six months, or they can opt out because they just continue to pay and they don't need forbearance, you know, or we're sort of working through those loans that don't want to extend. And we can either correct through a partial claim process or a modification and a partial claim. So we're working through that, but we cannot say right now X marks the spot because there's so many moving parts. And it’s been on the …

The 1.8 billion in foreclosure, in Ginnie Mae government …

It’s in forbearance.

Forbearance. I'm sorry. I misread my own notes. Okay. If you look at the 1.8 billion in forbearance in Ginnie Mae land, those are counted as delinquent, right? And so if they go 180 or longer delinquent, isn't there an opportunity to buy the loan out? Or I’m thinking about it from an opportunity point of view, not from a capital constrained point of view, that the $1.8 billion of loans that are fairly healthy, that are theoretically in delinquency status, when forbearance is over, then they have to - don't they have to all go through some kind of modification to get current and restate the principle and all those sorts of things that we see with Fannie and Freddie loans, or?

No, not all of them. Some of them have continued to pay. And so they remain current and they will just opt out. Some of them will get corrected through a partial claim process only. And then those that need to be corrected through a partial claim and a modification, or just our modification, then yes, we will buy those out. But there's a clear waterfall that you have to follow.

What we don't know is how much is in each one of those buckets.

Correct.

No, no, this is helpful. I'm just - I’m thinking of it more as an opportunity than as a problem, because you have lots of liquidity and you have lots of capital.

Yes. Jim noted in his comments that it could have some upside. We just don't know what it is at this point.

Right. And we haven't quantified that yet. But also keep in mind that a lot of our subservicing clients, you know, have a good relationship with us and whatever that opportunity is, I'm sure we'll be able to partner with them to develop the opportunity as well within their own loans.

No, no, I agree. I'm just trying to figure out what the benefit ultimately could be. Gain on sale for the fourth quarter, the number was - the revenue number you quoted, could you give that to me again, Lee?

Yes. 200, 2-0-0, 200 million.

So that's obviously down from what we saw in the last two quarters. And is there going to be sort of a disconnect with locks being down because of the seasonality of the business, but originations, you know, actual closing still being fairly high, and then you get some cost compression in there, or how do you think that plays out?

Yes, no doubt about it. I think you'll find that closings will remain strong because originations or fallout adjusted locks were high in Q2, Q3. So we're going to continue to push those closings through into the fourth quarter. Full out adjusted locks, that - there is going to be a reduction in volume and margin because of the seasonality that we usually see in Q4, fewer business days, and the winter months affecting the purchase market in particular. And if you look at the agency and MBA forecast, they've got volume coming down in Q4 as well, consistent with what I just said.

No, no, I - how are all these IPOs affecting the competitive landscape for you all right now? I think we're at number - if you call - if you include the specs, we’re at six since August, so.

Yes. It's not impacting us at all from a business point of view. What I would say though is, I'm obviously thrilled to see a number of new investors looking at mortgage favorably, and I would hope and think that that could bring more new investors into the Flagstar stock.

I can only agree with all of that. So thank you. Thanks for the comments. This is very helpful and congrats on a great quarter.

Thank you. Our next question will be from Steve Moss with B. Riley Securities.

Good morning. Most of my questions have been asked here, but just on credit here, was kind of curious with regard to, you know, where are criticizing classified loans these days?

Yes. We’re wondering the same thing. We really don't see them in our portfolio. Yes. Honestly, I’m not trying to be facetious. I'm being honest with you. We said this last quarter. On a precautionary basis, when loans were in deferral, you know, we took a stance unless proven - unless disproven that those loans should be past watch. So past. They’re not criticized. But at this point in time, we're not seeing a significant amount of criticized loans in our own portfolio.

Yes. You know, you don't want to get overconfident about that. And that's why my comments are cautious around what might happen going forward. And that's why we've taken the liberty to push our ACL as high as we think we can, given the economic scenarios that our model uses and the qualitative adjustments that we’re permitted to make. I mean, we're pushing it as much as we can because we're just going to be careful here. So we're with you, you know. We wonder, like why - we're surprised really, and - but pleased that it is holding up as strong as it is. And, you know, I guess we'll wait and see as we get through the pandemic, how it all shakes out. I mean, right now, I don't believe that we're going to use this reserve. I think our sponsors are of high integrity and quality, and they're going to work through these difficult times, and we're going to be okay. But if we're not, as I said, you know, we hope for the best, but we're prepared for the worst should it happen.

And go back to my comments in my prepared remarks about what our view on the economy is, both in terms of CECL and we're not yet convinced that we've got to a V-shaped recovery.

And remember, you know, look at the balance sheet and identify what really are commercial loans in this organization. If you take away the loans, our residential loans that are available for sale, and you take away the warehouse loans where we've had only $5 million of losses over the last 12 years, including through the great recession, the part of that portfolio that's really exposed to losses is small compared to the size of the company and compared to a typical mid-sized bank with $29 billion in assets.

Okay. That's helpful. And then on the return on the mortgage servicing assets, just kind of wondering, you know, how sustainable the low income is here. You know, what would the downside potentially be if let's say mortgage rates come down another 25 or 50 basis points?

Let me comment and Jim might want to add here. Look, historically, we've been pretty satisfied if we can get a 4% to 6% return on our MSR asset. And we've consistently been able to do that or better. At times, because of particular market circumstances, we haven't achieved that in a particular quarter, but what you saw this past quarter was particularly phenomenal. And to think that that can happen quarter over quarter, I think is unlikely. But I think if in your model, you're looking at 4%, 5%, 6% return on the MSR asset, I think you're going to be in a pretty good place.

Yes. I completely agree with that comment. Look, I mean, this quarter was just - you know, things bounced the right direction for us. But part of it also is, you know, we've been very cautious in how we value that asset. We made some remarks last quarter that we took a very conservative pen to the fair value on that asset in second quarter. And taking that conservative pen is just going to set you up to be at the high end of the range that Sandro, you know, outlined there.

And I might add, you’ve got to have really good people, and we have some really, really good people that manage that asset.

That's helpful. And then one last question. Just in terms of expenses dedicated to the bank, up 10 million quarter-over-quarter. Kind of curious, is that the new level run rate? Just think about that going forward.

Yes. So in my prepared remarks, Steve, there was a comment that some of it was a credit that was in last quarter. It isn't going to recur, and that's having to do with the capitalized origination costs from the PPP loans. We sold those in July. The other, there were some costs related to the MP secondary that happened last quarter that triggered some payments under some executive compensation arrangements. Those are not going to recur. So there's just some non-recurring things that are inflating the level of Q3 expenses right now, and deflating Q2 expenses.

So, to answer your question, it's not a new relic.

That's helpful. Thank you very much. I appreciate that.

Thank you. Our next question will be from Bose George from KBW.

Hi guys. Good afternoon. Yes, I see most of mine have been asked as well, but a couple of little things. You only spoke about the MIM a little bit, but can you just talk about, you know, how it looks next year, if rates remained the same, but as mortgage banking slows at some point, and what that does with the warehouse business and loans held for sale, just how that impacts the margin, you know, next year.

Look, I think the - if rates remain the same, I think that we're in a pretty good position to sustain our net interest margin. Now, it's hard for me to look farther out than a quarter and, you know, Jim - I think both Jim and I suggested for the next quarter, we feel pretty good. So, going out farther than that, man, I'm going out on a limb here, but I feel pretty good about what our position is there. I think, even if the mortgage business, the clients and the numbers that the MBA, Fannie Mae, Freddie Mac think next year, I think that the warehouse balances can stay pretty strong, because we're gaining market share in that area, and we could do more than we're doing right now. We're being pretty selective about who we're doing it with, and we're being pretty firm on our pricing. So, you know, I think that the prospects for warehouse being strong, even in a weaker mortgage market, are pretty good. But hey, you know how things change from quarter to quarter. So it's pretty hard to go out and talk about next year.

Yes. I also would add to that, Bose, that, you know, if you look a couple of quarters ago, warehouse balances were lower. Even in second quarter, they were lower and we're still delivering, you know, pretty consistent levels of net interest margin, excluding those loans with government guarantees we talked about. So I think there's room to have the warehouse balances rotate down. Not that we think that's going to happen, as Sandro said, but I think there's room to have those rotate a little bit lower and still be able to sustain that net interest margin at the levels we've been reporting the last couple of quarters.

Okay, great. That's helpful. Thanks. And actually just one more on the Ginnie Mae buyouts. You know, some of your peer banks have purchased quite a bit of this ahead of, you know, sort of curing this. I’m just curious what your thoughts are there. Is it - are they sort of institutions with just liquidity to park somewhere? Just, you know, thoughts why there's been a fair amount of buyouts already?

Yes. I mean, Bose, you know we don't comment on other institutions and what they're doing. I can only comment on our approach. And yes, I think I've been over that. We will buy them out where we can modify either outright or as part of a partial claim and re-securitize.

Yes. There’s no benefit to buying them out quickly that we see there. Buying them out is also permanent. So you can't undo that. And so when we buy them out, as Lee was talking through with Henry's earlier question, we're going to be sure that we want to buy out the loans that we're buying out.

Okay. Yes, makes sense. Thanks guys.

Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to our speakers for closing remarks.

Thanks, Carrie. In my closing, for the second quarter, I talked about how the calls for social justice in the world around us, had inspired a cultural change at Flagstar, how in the past we had not communicated much with our employees about what was going on in the world, how we set out to change that, and how we're not turning back. In the third quarter, we continue to engage employees on issues that are important to them, and continue with our diversity, equity, and inclusion initiatives. This is not a passing fad for us. It's the real deal, a fundamental, cultural change. We are changing the composition of our leadership team, and we will change the composition of our board of directors, to achieve more diversity. We're putting money behind support for minority small businesses and nonprofits that support the E&I. We're taking a harder look at our hiring practices, and we're taking cues from our employees about how we can do better. And I'm doing my best to put the arm on fellow bankers and business leaders through organizations I belong to, to support the E&I in their own companies. Why? Well, first, because it's the right thing to do. And second, because I firmly believe it makes for a better company. These past two quarters also happened to be the best in Flagstar's history. Is that a coincidence, or is there a connection with our cultural change? In my mind, there's no question about that. The seeds of the success that is playing out today, were planted when we recruited top-notch executives to run our businesses, when we built affordable risk management structure, when we carefully diversified into commercial lending, when we developed our fee and deposit-generating subservicing businesses, and when we leveraged relationships we had nurtured for years to make warehouse lending a profitable, low-risk operation, now one of the top five warehouse businesses in the country. But I have to think that what we're doing on the DE&I front is not just underpinning, but is accelerating our success. We're a much better company today for it, and expect to be even better in the future because of it. Last but not least, thank you to our employees who own the success. I'm in awe of what you have accomplished in circumstances beyond the imagination. And thanks to everyone who has taken the time this morning to hear the story of a most successful quarter. Talk to you in January. Please stay safe and healthy.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.