Flagstar Bancorp, Inc.

Good day and welcome to the Flagstar Bank fourth quarter 2020 earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ken Schellenberg. Please go ahead, sir.

Thank you, Owen, and good morning. Welcome to the Flagstar fourth quarter 2020 earnings call. Before we begin, I would like to mention that our fourth 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 risk and uncertainty. Factories that could materially change our current forward-looking assumptions are described on slide two of today's presentation, in our press release, and in our 2019 Form 10-K and subsequent reports on file with the SEC. We're 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 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 through these most unusual times. I'm joined this morning by Jim Cerulli, our Chief Financial Officer, Lee Smith, our President of Mortgage, and Reggie Davis, our President of Banking. I'm going to start by providing a high-level view of our performance for the quarter and the year, Then I'll turn the call over to Jim for details on our financial results. Reggie will follow with an update on the community bank. Then Lee will handle the mortgage segment, including servicing. And then we'll open up the line for questions. 2020 brought many challenges, and few companies ended the year stronger than they started it. For Flagstar, it's the opposite. We kept getting better throughout the year as we adapted to a new normal and finished the year extremely strong. This is a testament to how we built our business model to have diverse revenue streams and a flexible balance sheet that provides us optionality and less volatile earnings during changing economic environments. You'll recall in 2018, the mortgage business was challenging, yet we still grew earnings as the rest of the company stepped up to contribute. Then in 2019, declining interest rates put pressure on our spread income, but we were able to temper this by capitalizing on favorable conditions in the mortgage market, and this carried into 2020. Today, we're looking at an exceptionally strong fourth quarter, checking off what I consider to be the most successful year in our history. As reported, we posted net income of $154 million, or $2.83 per share, up a phenomenal 183% from the same quarter last year. For the fourth quarter, we achieved net income of $538 million, or $9.52 per diluted share, topping the results for the full year 2019 by 151%. In fact, our earnings this quarter alone are roughly three quarters of what we earned in all of 2019. Mortgage continued to lead the way in the fourth quarter as it has for most of the year, but the contributions from our banking and servicing businesses should not be overlooked. I strongly believe relationships are forged in favor and strengthened through adversity. This couldn't be truer in our banking business as our team focused all year on supporting our borrowers and helping them navigate the challenging conditions brought on by the pandemic. We want our borrowers to remember that we stood by them every step of the way. It's times of adversity that build the kind of long-lasting relationships we want to be our hallmark. At the same time, banking produced steady results, again, led by the warehouse business, which is now the third largest in the nation. On to mortgage. What an incredible year. The mortgage team delivered amazing results throughout the year as they took advantage of an extraordinary mortgage market while maintaining pricing and expense discipline. As always, we managed our volume to maintain industry-leading service levels while producing margin and revenue we haven't seen in a very long time. And our servicing business kept delivering consistent results, supporting a mortgage business, providing efficient funding, adding fee income, and keeping the number of loan service or subsurface steady, even in the face of historically high payoffs related to the robust refinance market. I couldn't be more pleased with how we ended the year and the many milestones we achieved, not the least of which was the investment grade rating for Moody's. This further validates the strength of our balance sheet and the earnings pile of the business model. It has been a long and winding road, but I believe we have built a very special company with a very bright future. We move into 2021 with a stable net interest margin, the power to generate strong non-interest income, and a full interest balance sheet, ready to take on whatever 2021 throws our way. With that, let me now turn it over to Jim.

Thanks, Andrew. Turning to slide six, net income this quarter was $154,002.83 per share. This compared to $222,003.88 per share last quarter. The decrease on a linked quarter basis was largely due to the extraordinary levels of gain on sale revenue last quarter. An increase in net interest income and a lower credit provision this quarter partially offset the lower mortgage revenue. For the year, we had net income of $538 million or $9.52 per share compared to $218 million or $3.08 per share that we earned in 2019. Current year earnings represent 2% return on assets and a 28% return on equity. Diving deeper into this quarter's performance, our pre-tax, pre-provision earnings were $207 million compared to $327 million last quarter. Net interest income increased $9 million, or 5%, as average earning assets grew $1.4 billion, while the net interest margin was flat at 2.78%. Excluding loans with government guarantees that have not been repurchased, the net interest margin actually increased four 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 from the maturity of higher cost CDs and the expiration of promotional rates on savings accounts. We'll review these numbers in a couple of slides. Mortgage revenues were 232 million, a decrease of 126 million compared to the very strong number we reported last quarter. During the quarter, we saw gain-on-sale margins decrease from last quarter's record levels. Asset quality remained strong. Net charge-offs were four basis points. Early-stage delinquencies were only 22 basis points of total loans. Not performing loans were 57 million, up 12 million as a result of two commercial borrowers being put on non-accrual status during the quarter. Our allowances for credit losses remained flat to the prior quarter at $280 million, and our coverage ratio, excluding warehouse, increased to 3.2% from 3.1% at the end of the third quarter. We'll provide more details when we get to the asset quality slide and take a deeper dive into CECL. Capital also remained solid. Total risk-based capital was 11.9% at December 31st. Our CET1 ratio was 9.1%. and our Tier 1 leverage ratio was 7.7%. We repurchased $150 million of stock, which caused our capital ratios to decline. This was more than offset by our earnings, and total assets grew $1.6 billion, causing our CEG-1 and Tier 1 leverage ratios to decline slightly. Total risk-based capital increased due to the subordinated debt we issued during the quarter to fund the stock buyback. Finally, we continued to demonstrate in capital generation, with growth in our tangible book value per share to $38.80 a year end, up $3.20 from September 30th, and $10.23 from one year ago, a 36% increase. So let's turn to slide seven and dive deeper into the income statement. Net interest income increased $9 million to $189 million this quarter, up 5% from last quarter, Average earning assets grew $1.4 billion, led by warehouse lending. Deposit costs came down 15 basis points, while average retail banking and customer deposit balances increased $0.3 billion and $1.2 billion, respectively. We'll dive deeper into net interest income and our interest rate position on the next slide. Non-interest income decreased $115 million to $337 million due to lower mortgage revenues and non-interest expense was $319 million, up $14 million from the prior quarter. Finally, our effective tax rate was 24.8% this quarter. This is the result of $2 million in additional state-level taxes that resulted from Matlin-Patterson's exit and certain non-deductible expenses, including FDIC insurance and incentive compensation. We expect that the effective tax rate in 2021 will be approximately 23%. Turning to slide eight, average earning assets increased $1.4 billion from last quarter. This resulted from a $1.3 billion increase in warehouse loans and a $0.4 billion increase in the loans with government guarantees that have not been repurchased. The increase in warehouse loans resulted from continued success in bringing on new customers. Declines in securities and in mortgage loans held for investment were due to faster prepayments that partially offset the balance sheet growth. C&I balances also declined by $200 million, primarily driven by the full quarter impact of the sale of the PPT loan portfolio in the third quarter. While the balance of the loans with government guarantees peaked at the end of last quarter, the balance declined only slightly throughout the fourth quarter, resulting in the average balance increase. We expect to see balances gradually decline throughout 2021. As we've stated previously, we do not believe there is significant downside to holding these loans, either by buying them or through this accounting close-up. If we were to repurchase these loans, we can pledge the loans to the FHLB, and they're a 20% risk-weighted asset. Further, if we do repurchase the loans, we could resell those at a later date, which is attractive for us, and they remain government guaranteed. Average deposits increased $1.5 billion from last quarter. Custodial deposits drove $1.2 billion of this increase. We also saw growth of $311 million in DDA and savings account balances a 5% increase from last quarter, and a $188 million seasonal increase in government deposits. Overall, we managed deposit costs lower by 15 basis points as deposits continued to reprice into the new curve environment, providing support for our net interest margin expansion. We continue to believe that our interest rate risk position is in a good place due to the actions we've taken in this lower interest rate environment. We feel that we can protect our net interest income and net interest margin and believe that our net interest margin should be relatively flat to where it's been the past three quarters. There are interest rate floors in place on a large portion of our commercial loan book, and these floors help protect us against further margin compression. The actions we took earlier this year to lock in $2 billion of lower rate funding remains in place. While this has made us more asset sensitive in our structural balance sheet, Our mortgage origination business is naturally liability sensitive, so we believe the combination positions us well for future success regardless of where rates are. We continue to have a strong liquidity position driven by the strength of our deposit base and access to multiple sources of liquidity, both on balance sheet with our high-quality securities portfolio and off balance sheet with our undrawn FHLB facilities. At December 31st, we had ready liquidity of $4.5 billion. not including the ample access we have to borrow at the Fed discount window. Let's now turn to slide 9, which details our non-interest income and non-interest expenses. Non-interest income decreased $115 million due to the extraordinary levels of mortgage revenue in the prior quarter. Our day note sale revenue of $232 million represented a decrease of $114 million. Fallout adjusted locks decreased decreased 20% to $12.0 billion, and the gain on sale margin was 193 basis points. Channel margins continued to come down gradually, and Lee will provide more insight into gain on sale revenues later. The net return on mortgage servicing rates declined $12 million from the prior quarter. Pre-payments continued to be elevated, resulting in higher runoff. The capitalization of our MSRs remained relatively flat at 86 basis points of UPB at the end of the quarter, up only one basis point for the prior quarter end. We would observe that the MSR market continues to show signs of improvement, as shown with the bulk and flow sales that we executed during the quarter. Non-interest expense increased to $319 million for the third quarter, compared to $305 million last quarter, primarily reflecting a $7 million loss recognized on the early extinguishment of our senior notes. and $2 million of extra charitable contributions we made to Flagstar Foundation in support of its efforts to help those in greatest need in the communities we serve. Both of these items will not recur next quarter. We saw a $7 million increase in mortgage expenses, which was driven by efforts to expand capacity along with the higher retail channel mix. Lee will provide more insight into mortgage expenses later. We expect non-interest expense of 295 million to 305 million and an efficiency ratio in the low 60s for the first quarter of 2021. So let's now turn to asset quality on slide 10. Credit quality in the loan portfolio remains strong. Early stage delinquencies continued to be relatively low as early stage consumer loan delinquencies as of December 31st were flat and early stage commercial loan delinquencies increased driven by one commercial loan that is beyond its maturity date, which we haven't renewed yet, but which remains current with respect to interest payments. Total early-stage delinquencies were $36 million at December 31st, or only 22 basis points of total loan sale for investment. Commercial deferrals were only $22 million at December 31st. We continue to be pleased with how well the portfolio is holding up, despite what the economy has done this past year. Not performing loans ticked up slightly as we added two small commercial credits to non-accrual status. Our allowances for credit losses of $280 million covered 1.7% of total HFI loans. Excluding warehouse loans from the denominator, given their relatively clean credit loss history and considering that substantially all of these loans are collateralized with agency or government-backed loans, our coverage ratio stands among the best in the industry at 3.2%. On slide 11, we can see that we ended the quarter with $280 million of allowances for credit losses, consisting of $252 million of allowance for loan losses and $28 million in the reserve for unfunded loan commitments. As we did last quarter, we used three different Moody's forecasts of the next two years to guide our allowance level. An S1 growth forecast weighted at 30%, a baseline forecast weighted at 40%, and an S3 adverse forecast weighted at 30%. All forecasts use the December release. The resulting composite forecast for this quarter was slightly better than the composite forecast used last quarter. Unemployment increases only slightly in 2021 and begins recovering in 2022. GDP recovers slightly by the end of the year from current levels and does not return to near pre-COVID levels until 2024. HPI decreases 1% throughout 2021. While there are positive economic signs, We continue to be cautious in our confidence about the recovery until we see more evidence that the recovery will sustain. Accordingly, we have qualitative reserves of $77 million primarily in our commercial real estate and C&I portfolios guided by the CECL allowance model output using the Moody's adverse scenarios to provide coverage for industries and customers that we believe could be more exposed to the stressful conditions in our forecast. We feel very comfortable about the strength of the credit in the portfolio, but feel it would be difficult to provide future guidance. We provided a portfolio by portfolio breakdown of the resulting ACL coverage ratios in our appendix. On slide 12, we've updated our exposure to those industries that we believe are more likely to be most impacted. In total, we have 1.0 billion outstanding loans in this category, representing 6% of our total loan portfolio. It's interesting to note we have almost no loans and deferral in these portfolios today. In our commercial and industrial loan portfolio, the COVID impacted loans total 0.3 billion. You can see that the exposure here is relatively low, especially as there are no deferrals and only one 10 million loan classified as not performing. We have no oil and gas exposure. In our commercial real estate portfolio, we have 0.7 billion outstanding in the areas most impacted by COVID, including commercial real estate loans secured with hotels, retail properties, and senior housing. Of the loans in this category, our average pre-COVID LTV was 55%, and our average debt service coverage was 1.6 times. We still don't have any loans in these portfolios that we believe will default. While we believe that we will have losses, we continue to see strong borrower support across the portfolio. We feel good about our credit risk in this portfolio as we are starting from a position of strength from our carefulness about who we lend to, to the disciplined underwriting of those credits, and the pre-COVID LTVs and debt service coverage ratios in the CRE portfolio. Turning to slide 13, our capital ratios remain solid and nicely above our stress buffers. At December 31st, our total risk-based capital was 11.9%, our CET-1 ratio was 9.1%, and our Tier 1 leverage ratio was 7.7%. As I mentioned before, we repurchased $150 million of stock, which caused our capital ratios to decline. This was more than offset by our earnings, and total assets grew $1.6 billion, causing our CET1 and Tier 1 leverage ratios to decline slightly. The total risk-based capital increased as a result of the subordinated debt we issued during the quarter to fund the stock buyback. As we pointed out, with our warehouse loan portfolio, loans held for sale, and loans with government guarantees, we have more than half our balance sheet and over 1,100 basis points of risk-based capital dedicated to these three asset categories that have very little risk content. Warehouse loans are secured with recently originated first mortgage loans and turn over every 10 to 15 days. Loans held for sale turn over every one to two months, and this portfolio is carried at fair value. The portfolio of loans with government guarantees has little downside and perhaps a modest upside. When you take all of this into consideration, we believe that we're operating at strong capital levels given our low-risk balance sheet composition. If we just weighted our warehouse loans at 50%, they're weighted at 100% under current risk-based capital rules. You'd see there are capital ratios compared favorably to most other mid-sized banks. This makes sense. The loans are fully collateralized by 50% risk-weighted assets, and those assets remain under our custody while the loans are on our lines. Further, there is even an outstanding proposal from the Mortgage Bankers Association to make this distinction in the risk-based capital rules, a proposal we wholeheartedly support. So adjusting the risk weighting on the warehouse loans, our total risk-based capital would be 14.0%, over 200 basis points higher, which would put that ratio above the average for all mid-sized banks. Our CET1 ratio would be 10.7%. So that provides the rationale behind our belief that we have solid, I even say strong, capital ratios. I will now turn it over to Reggie to cover community banking.

Thank you, Jim, and good morning. The last 12 months have been like nothing we've experienced before. At the start of the year and in response to the COVID-19 pandemic, the Fed took unprecedented action by significantly cutting interest rates and putting immense pressure on the net interest margin for many banks. Additionally, in response to the uncertainty around the duration and impact of the pandemic, We took a conservative approach in the bank by tightening the credit box and being thoughtful around new lending opportunities. This has served us well so far and will be our approach into the foreseeable future. We'll continue to lean into lower-risk commercial lending opportunities and be diligent in adding new relationships as we continue to navigate these uncertain waters. Please turn to slide 15. Quarterly operating highlights for the community banking segment include... Average warehouse lending balances increased $1.3 billion, or 22%, to $6.9 billion in the quarter as the low interest rate environment has persisted, driving strong mortgage refinance volume. Our relationship-based approach and speed of execution also enabled us to add new customers as well as increase lines to existing customers during the quarter. We continue to maintain our disciplined underwriting in this business. Average commercial, industrial, and commercial real estate loans decreased to $146 million, partially impacted by the timing of the sale of the PPP loans in the third quarter, as well as a thoughtful approach we continue to take in terms of new facilities. We believe our conservative credit policies and diversified portfolio will be a strength as we get more clarity around the fallout from this pandemic. Average consumer loans held for investment decreased $241 million, a result of increased payoffs in our first lien mortgage portfolio, partially offset by growth in the other consumer loans which is predominantly our indirect marine RV loan portfolio, which has performed rather nicely in this environment. I'm also proud of the success that the retail team has achieved. Average community banking deposits, which exclude custodial accounts and broker deposits, increased $269 million, or 2.4%, over the last quarter to $11.5 billion. We continue to see solid growth in governmental deposits due to seasonal tax collections and higher non-interest-bearing DBAs and low-cost savings accounts. We also saw these CD balances contract $257 million. The overall cost of these deposits declined by 16 basis points to 26 basis points from 42 basis points for last quarter. The retail team did a great job retaining CDs that were maturing and redeploying these deposits into DBA and savings accounts. Turning to commercial lending on the next slide, we continue to manage our well-diversified commercial loan book. In the warehouse lending book, we've been using our quarter-end balance sheet to accommodate the needs of our customers despite this having a direct impact on our period and capital ratios. Momentum built in prior quarters carried over this quarter as warehouse loan balances remained elevated, which is a testament to the strength of the relationships we built with our warehouse customers. In commercial real estate, we're in constant contact with our customer base. The Home Builder book continues to perform well, the result of doing business with strong and experienced clients, and the close relationship that those clients have with our lenders here at Flagstar. The C&I book remains well diversified, and we're starting to see our customers get their business back on track. We're taking steps now to build our relationships in our markets so that we can be in a position to fully serve these customers when the opportunity presents itself. I'll now turn things over to Lizzie.

Thanks, Reggie, and good morning, everyone. We're thrilled with how our mortgage origination and mortgage servicing businesses have performed in what was an unprecedented year. Both business lines have demonstrated their resiliency and delivered important and significant non-interest-free income for the bank in this low-rate environment. During the year, we generated an incredible $971 million of gain-on-sale revenues, including $232 million in the fourth quarter, as we continue to leverage our diversified mortgage platform in this strong mortgage market. We ended the year servicing or subservicing approximately 1.1 million loans, consistent with the end of the third quarter and where we ended 2019. What is noteworthy, however, is we processed over 350,000 payoffs during the year, given the low interest rate environment and boarded over 290,000 of non-Blackstar originated loans, a remarkable achievement in this highly volatile work-from-home environment. The earnings generated from our mortgage origination and servicing businesses have contributed significantly to our overall earnings per share of $9.52 for the year. And given mortgage and other economic forecasts for 2021, we believe that foundations are in place for us to continue to be successful and generate strong returns for our shareholders. I will now outline additional key operating metrics from our mortgage and servicing segments during the fourth quarter and full year. Please turn to slide 19. Quarterly and full year operating highlights for the mortgage origination business include were very pleased with our gain on sale revenues of $232 million during the quarter, which held up remarkably well in a remarkable year for mortgage. Both volume and margins remained seasonally strong as we continued to see robust refinance and purchase activity in all channels. One channel that did stand out was our consumer direct or direct lending business, where we saw a 20% increase in lot volumes. and 21 basis point margin expansion quarter over quarter. This is a channel we've been actively growing in 2020, and it also plays a key role in our recapture capabilities. We expect to see continued growth in this channel throughout 2021. Refinance activity accounted for 64% of our lot volume during the quarter, and retail accounted for 36% of lot volume, up from 33% in the third quarter. Mortgage closings were 13.1 billion in the fourth quarter, a 9% decrease from the previous quarter, given the seasonal holidays and employees using PTO towards the end of the year. Our mortgage operations team continues to operate effectively in this work-from-home environment. We've increased capacity 47% in 2020 versus 2019, and we've continued to hire and train new fulfillment staff in the fourth quarter, setting us up well for 2021, given the strong mortgage market outlook. The increase in capacity in the fourth quarter on both the sales and operations sides of the business, together with a higher percentage of retail business and lower closings given the holidays, drove the increase in mortgage non-interest expense to closings from 1.02% to 1.18% quarter over quarter. During the quarter, we started to roll back some of the overlays and product halts we put in place as a result of the pandemic, as we became more confident around market liquidity and the economic outlook. At period end, we have approximately $2.5 billion in Ginnie Mae early buyouts on our balance sheet. Of this, approximately $1.9 billion were a result of borrowers opting into forbearance as a result of the pandemic. The accounting consequence of owning the MSR is to show them as early buyouts whether you buy them out or not. As we've analyzed these loans in more detail, we believe 800 million will cure through the partial claim process, and our intention is to buy out these loans and re-securitize them. The gain on sale benefit from doing this is approximately 32 million, 23 million of which will be realized in the second half of 2021 and 9 million in 2022. We think a further 250 million will cure through a modification. And again, we will buy these loans out and re-securitize, realizing approximately 10 million of gain on sale revenue, 7 million in 2021, and 3 million in 2022. If anything from the remaining population of 850 million were to cure through a partial claim or modification, we would buy them out, re-securitize, and realize the gain on sale benefit. Given the increase in home prices over the last few years, and equity most owners have in their homes, we don't anticipate many borrowers going into foreclosure following the end of the forbearance period. Finally, given the slightly smaller estimate of the mortgage market in Q1 versus Q4 from the agencies and MBA, and continued tightening of margins, We forecast gain-on-sale revenues to be between $200 and $220 million in Q1. We couldn't be more pleased with the performance of our mortgage business in the fourth quarter and during 2020. We believe it will continue to be a meaningful contributor to the bank's earnings in 2021 and beyond, particularly given the low interest rate outlook. Moving to servicing. Quarterly operating highlights for the mortgage servicing segment on slide 20 include we ended the quarter servicing or subservicing approximately 1.1 million loans, of which almost 870,000 or 80% are subservice for other MSR owners. The number of loans serviced for subservice stayed relatively flat quarter over quarter as we added in excess of 100,000 non-Flagstar originated loans. And despite the high levels of refinance activity, we're able to replace runoff with new loans from our mortgage origination business, another advantage of our business model. Today, we have the capacity to service or subservice 2 million loans, as well as provide ancillary offerings such as recapture services and financing solutions to MSR owners. If you look at slide 37, you will see that we are generating 5 to 7 million of operating profit before tax for every 100,000 loans we add to the platform as we continue to achieve economies of scale benefits in this business. As it relates to forbearance, through December 31st, 83,759 borrowers, representing 8% of the first lien mortgage portfolio that we either service or subservice, have requested forbearance relief because of COVID-19. We've seen a significant decrease in new forbearance requests since the peak weeks at the outset of the COVID pandemic. Of the 83,759 borrowers in forbearance at year end, 12% are current. So 7% of the loan book with service or subservice are actually using forbearance. The peak number of loans in forbearance was 129,332. And as of December 31st, that number has declined by approximately 45,000 or 35%, as borrowers who had initially opted in have opted out, paid off their loan, reached out to say their hardship has been resolved and their loan is current, or had their loan modified. During the quarter, we sold $2.6 billion in bulk and $2.6 billion in flow for a total of $5.2 billion in MSR deals. The market for MSRs is certainly bouncing back after it dried up at the outset of the pandemic, and our MSR to CET1 ratio is currently 16%, significantly below the 25% threshold before it becomes capital punitive. Finally, custodial deposits averaged $8.5 billion in the fourth quarter, a 16% increase compared to the prior quarter. Our subservicing business has had another successful year despite the volatility and uncertainty brought about because of COVID-19. It complements our mortgage origination capabilities and provides several other benefits to Flagstar, including low-cost deposits to help fund the balance sheet. This concludes our prepared remarks, and we will now open the call to questions from our listeners.

Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star one to ask a question. Our first question comes from Bose George with KBW.

Morning, Bose. Hey, guys.

Good morning. Great quarter. I wanted to ask first about the net interest margin guidance. You noted that it's going to be, I guess, roughly flat the next few quarters. Just what are your thoughts there in terms of expectations for the warehouse since it's obviously been very supportive to the margin? How do you think that sort of plays into that guidance?

I think we can expect to see more of the same in warehouse. We've been maximizing our balances there based on the capital of the company, and we're going to continue to be disciplined around that. But given the fact that the mortgage business appears to be still strong and In the first quarter, I think it's a business that's going to continue to be very helpful to us in maintaining our margin going forward. Reggie, anything you'd like to add on that?

No, I think that's right. We're very selective with borrowers that we do business with, and we've tried to build that business as a long-term business. And so it's less about price and more about our ability to fulfill and be consistently there for them. And so we feel really good about the dynamics of the portfolio we built, and that business obviously still has a lot of strength.

Yeah, that's a good point, Reggie. The pipeline in terms of incoming new business is still strong. And so as we gain more capacity just because of growth in capital, and obviously we're generating a lot of capital right now, that will allow us to continue to bring that new business online.

And we're still investing in that business. We're at work. that business.

Okay, great. Thanks. That's helpful. And then actually I wanted to go back to these comments just on the forbearances. On the FHFA, on the GSC forbearance side, can you remind us what the deadline is for that? Is there a clear deadline for when that ends? Are you guys still doing forbearances there? How does that program kind of play out?

Yeah, so if you remember, Bo, under the CARES Act, we were allowed to offer two six-month forbearance periods. And so if you think that that came into play sort of around April, when we look at when most of the loans are going to be ending their second six-month forbearance period, it is April of this year. So unless there is a new announcement further extending that, the way it's currently constructed is Most of the loans, because most opted in when it was made available, will be coming out around April time.

Okay, but are new forbearances being offered now? So can a borrower be a new forbearance currently?

Yes, they could call a new forbearance, correct.

Okay, perfect. Thank you.

Our next question. Our next question comes from Scott Seifers with Piper Sandler.

Good morning, guys. So congrats. I was just hoping, I know you don't like to provide too specific guidance, but gain on sale margin is obviously a huge topic. Just wondering, even qualitatively, any thoughts you can give on sort of ability to support? Because I guess as I look at things, in addition to just the normal market ebbs and flows, What's a little more idiosyncratic to Flagstar is just your kind of ability to create, as you've been doing, kind of richer origination mix, which I would think would hold up your margins a little better than perhaps the industry at large. So we'd be curious to hear any thoughts on sort of where you see things and how Flagstar in particular supports it.

Yes, Scott Lee, good morning. So if you, I mean look, we rely on the primary secondary spreads and if you look at the primary secondary spreads, they were 1.71 in Q3 and in Q4 they were 1.59. So we did see a little bit of tightening in the fourth quarter and we've seen a little bit of tightening in the first quarter or month to date, January. The advantage that we have, as you mentioned and we've spoken about, is we have a diversified mortgage business. And what I mean by that is we're originating in all six channels, whether that's bulk, delegated correspondent, non-dealt correspondent, broker, distributive retail, or direct lending. And so we're able to maximize earnings based on where we get the biggest advantage from and guide capacity to the channel where we think best serves us. And so, you know, that's how we sort of take advantage of it. But at the end of the day, you know, that primary-secondary spread, and as we're seeing that sort of come in, that does affect us as it affects every originator.

Yeah, and I would add, Scott, that we really do focus on the revenue targets and what the best way to get there is. And so, you know, the... The margins, while obviously they're very, very important, the market will give you what the market will give you, and then you've got to figure out where the best opportunity there is to get to your revenue targets. I think we've done that pretty well, and in Lee's speech, he made reference to the fact that we're seeing great success in growing our direct-to-consumer business, and obviously that's a business with a pretty strong margin. You know, we're very bullish on the mortgage business and its strength going forward here. So we'll continue to focus on the revenue target. And, you know, you heard Lee say $200 to $220 million. So, you know, when you think about that against fourth quarter, given what the market thinks is going to happen in Q1, that's a pretty good number if we get there.

Yeah. Okay. That's perfect. I appreciate those thoughts. And then separately, I guess this is more of an emerging issue, but... So the GSEs are now limiting the number of lenders that can access the cash window. Just curious, although I know it's sort of a newer issue, to what degree have you guys thought about that? Are there any opportunities that presents to you guys, or how are you thinking about it at a top level?

Yeah, so it is an emerging issue, Scott. So because it's the cash window, it doesn't affect us. We're obviously operating at scale. And so I think that it's going to affect more the smaller originators. It's not going to affect as much or at all the big originators who are operating at scale like ourselves and some of the other big names. In terms of opportunities, I need to think about that more, but I think that the effect is going to be on the smaller originators, as I said.

Which should be a positive for our TPO business, particularly, obviously, our business with small correspondents. And as you know, we historically, Flagstar, that was its bread and butter, was the small correspondent. And frankly, as many of us were able to get into the cash window and even come into the bulk space, that had an impact on us. So it remains to be seen where that goes, but it could be a benefit to those mortgage originators that have a strong third-party business.

Yeah. Okay. Perfect. All right. Thank you guys very much.

Thank you, Scott.

Our next question comes from Daniel Tomeo with Raymond James.

Hi, Danny. Good morning. Hey, good morning, everybody. Nice quarter. Just a question on the expenses first, probably for Lee. Specifically on the mortgage side, you mentioned in the release and talked about it being driven by the efforts to expand capacity as well as the higher retail mix. Sounds like that higher retail mix will continue to be the case. So I'm expecting that you would say the mortgage expense ratio to closings would be a little bit higher than what you were thinking prior. How are you thinking about that number going forward?

Yeah, I would actually say slightly differently. I think that it will be in the same zip code. I think the retail mix will sort of be similar to what you've seen the last couple of quarters, and I think that 1.18%

result uh you know that's i would expect us to be in a similar zip code uh next quarter so that's how i would think about it well danny you know go back to my earlier comment about managing to the revenue we really manage to the net revenue when it's all said and done so you know if you're if you're generating business from higher expense category or delivery channel then you're going to need more revenue to support that i think we've shown our ability to to tie the revenue changes to the expense changes, and that will continue to be the case. So what I'm saying is if all of a sudden the mix of retail went way up, which caused our expenses to go way up, then that probably would mean, if we're doing it right, that the costs we guided to should be more than what we guided you to. So I want to just be real clear about this. We're very careful in terms of how we're managing the net revenue in the business.

No, that's great, and you certainly have proven that. And then, you know, I guess on the non-mortgage side, maybe for Reggie here, but how do you think about the expenses in that side of the business as we're perhaps, you know, anticipating a shift on the balance sheet? Is there an efficiency ratio or profitability target there? that you use to govern there, or is it just too tough to pin down given all the moving parts?

Yeah, I don't know about an overhead efficiency target, but we're trying to basically keep expenses flat. We are looking for opportunities where we think that the spend can be optimized in certain channels and businesses, and we're also looking for opportunities to move expenses from non-growth areas or where we think we have less growth to things like technology and other things that will ultimately drive the overhead efficiency ratio. So that's kind of the mode that we're in, but it's hard to peg a number right now.

Yep, no, I understand that. And then finally, I guess, given, you know, the stronger warehouse business and, you know, really taking share there, your ability to grow that business and the demand and everything that you've mentioned, how does the more traditional commercial lending fit in in the CRE and the CNI? Especially the CNI has been kind of declining over the last year or so, understandably. But how do you think about the growth of that business given the, you know, kind of what we've seen and what you're expecting in the warehouse business going forward?

Yeah, that's a great question. You know, it's funny, you know, having the warehouse business and past experiences, it's a wonderful thing because what it does is it takes the pressure off of us on the commercial side. And so we're being really selective about things that we're looking at. We're there for our existing clients and we know those clients extremely well. But we're looking at external opportunities where we have very strong sponsorship or if it's a project, very strong project. health business to do anything other than that.

Yeah, I think this is a time where you need to be very patient with the commercial business, whether it's CRE or CNI. Anytime you're in a recession, I think you've got to be really patient, and particularly given this unique recession that we're in now that's more about a health crisis than it is anything else. And as Reggie said, it's a terrific advantage to be able to grow the warehouse business by billions of dollars without adding any risk to the balance sheet. So we're going to continue to operate this way, and when the right opportunities present themselves, we'll jump on them. And when the market gets a little more certain, then we'll be a little bit more aggressive.

All right, great. That's all I had. Thanks for all the information.

Our next question comes from Steve Moss with B Riley Securities.

Good morning, Steve. Good morning, guys. On the reserve ratio here, you know, continue to maintain a very strong allowance. Just kind of curious what you want to see for reserve releases going forward here.

Yeah, I wouldn't project any reserve releases at this point. I don't know how you could. I don't know how to project either reserve increases or reserve decreases. And if you've got to push the ball, I'd be happy to to borrow it for a couple of days, man, it's just no way to know what's going on here with the reference to this unusual type of recession. So I think for the foreseeable future, it's prudent for us to stay right where we're at until we have more information that would change our mind. As I think you know, Jim's pretty specific about how we arrive at RECL, using Moody's and so on and so forth. We're going to continue to follow those analytics and add qualitatively. wherever we think it's appropriate. So I've always said since I've been CEO here, we're going to operate on the conservative side of a conservative range when it comes to loss reserves, and this is not the time to change that kind of thinking.

Okay, that's fair. And then on capital here, obviously very strong and looking at another good quarter here, just kind of wondering what is the appetite for additional repurchases or acquisitions?

I'm sorry, would you repeat that? Yeah, well, any and all are certainly possible. We are open to business combinations, business acquisitions, bolt-ons, where it makes sense. We did use our ability to repurchase shares in the last quarter, so that's certainly an option. We increased the dividend last night. We announced that. So those are all all ways to use capital, and they're all on the table. But it's got to be the right situation. We are a patient organization, and we'll wait for the right situation. And if we don't find the right situation in terms of a business opportunity, then we'll figure out another way to reward our shareholders. They've been very patient with us, and they're seeing the benefits of that now.

Okay. That's helpful. And then in terms of just the loan fees here, I know there's elevated for loss mitigation and forbearance. I'm just kind of wondering, you know, how sustainable do we think about that? Is it more like as things come off in April, perhaps that'll pull back a bit? Any dynamic there would be, any comment there would be helpful.

Yeah, so there's a few things going on when you think of fees. You're right, you've got some of the forbearance fees, but We've been waiving late fees and charges as a result of loans being in forbearance. So when the forbearance period burns off, that comes back. And then we've been boarding loans, as I mentioned, and there's boarding fees that are included in there. So as we continue to board loans, we would expect to continue to generate those fees. So there's a lot going on there. I think the I guide the $5 to $7 million of operating profit for every 100,000 loans we have to the platform. I am confident in that guidance, whether we're in the forbearance period or not.

Okay. Thank you very much. Good quarter.

Our next question comes from Giuliano Bologna with Compass Point.

Good morning, and congrats on a great quarter. I guess turning back to a topic that's come up a few times on the warehouse line side, you obviously have done an incredible job growing the warehouse line business, and as you kind of alluded to, there's a lot of demand out there for other opportunities within that business. I'm kind of curious what the pipeline looks like, because you're obviously managing it to capital, which implies that there are other opportunities out there that you could take advantage of. The capital wasn't the constraint here. But what I'm trying to figure out is kind of like what the magnitude of the opportunity that you're potentially turning away might be, because that could be relevant when the mortgage cycle does cool down eventually in terms of your ability to kind of take more share going forward.

Well, we have never provided specific guidance on the pipeline. And, you know, it's a difficult question to answer because you don't know how much business your reps out in the field are actually not encouraging because they know that we've got some limitations. But that said, I can tell you, as we go into committee every week, there are new requests every week that come into our committee. And they're not, you know, small requests. In order to come to the committee every meetings that I go to, they've got to be pretty significant requests. So it's been that way all year. Well, in 2020, it's been that way so far in 2021. So it's difficult for me to say how strong or how long that will continue, but I don't know how it could be much stronger right now. Reggie, anything you want to add on that?

No, I think that's right. It's impossible to forecast. We thought we might see some degradation or decline toward the end of the year. Quite honestly, the business has continued to be really strong. And so we're open for business.

That makes sense. And then on the mortgage origination side, you've obviously done a lot on the channel mix side in terms of shifting around channels and managing very effectively on the net margin side. I'd be curious when we think about the direct channel, what kind of upside there is there, and to an extent, what kind of recapture rates you're achieving or where that could go, just in terms of thinking about the upside opportunity on the direct channel side.

Yeah, I mean, we don't provide guidance or our recapture rate, but as I mentioned, we onboarded 290,000 of non-Flakstar originated loans in 2020, and so We're doing something right because if we weren't, we wouldn't be onboarding that many loans. And so we're competitive as it relates to recapture. In terms of the consumer direct channel, yeah, we have been growing that. We brought in a significant number of LOs, strong LOs, who are selling Flagstar, not just selling rate. These are high-quality LOs. And I think there is potential for continued upside in this channel. And the other thing, I think, you know, in this COVID environment where people are doing more things remotely, you know, I think that's another opportunity. for direct lending to continue to grow. I think people are more comfortable doing things digitally or over the telephone versus in person. And so, you know, we feel very good about the potential for our direct lending channel.

Yeah, I would just say that I think that's absolutely right. I think the opportunity in that channel is significant, and I think we've got the right leadership there. And so I'm optimistic about our opportunities there.

makes a lot of sense the the only thing i'd be curious about as a kind of a quicker question is that obviously you know the the implied outlook you know or the outlook implies some pretty strong performance which will obviously continue to add to capital i'm kind of curious you know what uh you know what what kind of asset growth potential there might be out there or how you think about the uh the roll forward in terms of kind of assets versus capital in the next couple quarters or you know Obviously, you might have some growth in your house. It's hard to tell outside of that.

Yeah, Julian, I mean, you've been following the company, and our history is that we're comfortable in this capital area, and so we're going to maximize the reinvestment of our capital the way we always have. So we're going to find ways to load a balance sheet to match the growth in capital, and if we can, then to go to the previous question, then we look for different ways to invest our capital. So it's hard to give you, reluctant to give you a target growth for the balance sheet, but we're going to grow it as much as we can while still maintaining proper capital levels.

That's great. I really appreciate the time, and I'll jump back in the queue. Thank you, Juliano.

And our next question comes from Henry Coffey with Wedbush.

Yes, good morning, everyone. And let me add my congratulations. Fantastic quarter and a great run in the stock. But, you know, turning all the way back to the discussion about mortgage, you know, I think the comments on gain-on-sale margin were very helpful. The overall tone of the market – what are your thoughts in terms of, you know, where the various parties that create mortgage estimates are going to take their numbers? And, you know, there is some real heating up going on without getting into all the details. You've got, you could call it four or five parties that are trying to expand their muscle in the broker direct channel. You've got, I assume a fairly robust set of competitors already and correspondent. You know, what are your thoughts there? One of the things that the broker direct parties talk about is channel conflict. The new battle cry is, you know, don't give your loans to Rocket. They're just going to steal your customers. I mean, we've heard this from people. So, you know, as you look at these different channels, you've got a lot of different places to deploy capital, but Are there some channels that are just going to get too hot to handle? Is the market going to come in bigger or smaller than the about $3 trillion estimate that seems to be out there now? I'm just wondering what are your thoughts about the overall tone of the market and where competition goes by channel?

I'm going to let Lee answer the important part of your question, but I do want to make one comment relative to the reference you made to Rocket, we're not going to go down there. We're not going to worry about what others say about other companies. We never talk about other companies, and I don't buy the argument that there is channel conflict. We have operated in this organization across channels for decades without any conflict. We provide great service to everybody and every channel, and we will continue to do that. So I just don't think any of that makes any sense. So we're going to keep doing what we're doing, and I don't think any customer of ours would ever tell you that the way we've handled their business is in any way impacted by the fact that we operate in six different channels. I just don't buy it. And with that, I'll let Lee answer, like I said, this important part of the question.

All right. Thanks, Sandra. Morning, Henry. Yes, so let me talk about the market first. There were a few questions in your comments. I mean, look, I'm very bullish on the mortgage market in 2021. If you look at the agencies and MBA forecast and the MBA updated days yesterday, so this is hot off the press and you average them out, we're looking at a $3.3 trillion market. That's the second biggest mortgage market in 13 years after 2020, and I think it's the purchase side. You know, on the refund side, there's been a couple of studies in the last six weeks or so that have identified, you know, there's still 19 million good borrowers out there that could save 75 bits if they were to refinance at current rates. Good borrowers meaning minimum FICO of 720, at least 20% equity in their homes. I mean, that was confirmed by one of the major investment banks over the holiday saying that 80% of mortgages are in the money to the tune of 50 bps if they were to rebuy current rates. So I think the rebuy wave has got some room to run here, which I think is positive. In terms of purchase mortgages, the low rates are making home ownership much more affordable, particularly for first-time homebuyers. And the low rates are offsetting some of the home price increases that we're seeing. Home builders are saying that home starts are going to increase 16% year over year. So that's going to put inventory into the market. And then I mentioned COVID a couple of moments ago. People are much more flexible in their work-life balance. And so we're seeing a lot of movement because of that. And then the final thing I'd say on purchase is, The NBA themselves have said they expect this year to be the strongest purchase market ever. So, you know, I feel very bullish on the mortgage market in 2021. The only thing I'd say, based on what Sandro commented on, is, look, we have proven our ability to optimise and maximize revenue. So we will look, because we have the benefit of a diversified mortgage business, we will look to see where the opportunities are, and we will focus resources there. And we've done that, and you've seen us do that in our results. And I would just emphasize we've never run into conflict. No, we just haven't run into conflict. And if you think of Michigan, which is where we're based, you know, we have a lot of retail business, TPO business. That's not something that we've had a problem with, and I think it is because we offer great service to all of our customers. Great.

The MBA was a little late to the party here relative to their projections for 2021. We felt when Fannie Mae came out early with their increased projections that that was the right number, and that's one of the reasons why you saw us continue to build our capacity, and so we had some additional expenses there in Q4. We're prepared for this, so we're ready for the market, and I think if the estimates that are out there are wrong, I think you'll probably agree with me, they're probably wrong on the low side.

No, it's amazing. I've never seen anything like this in 34 years of being an analyst, so it should be fun. You do have a bank. You have an incredible bank. And generally when we analyze it, there's a tad of asset sensitivity in there. How do you think that plays out now that long-term, you know, the 10-year is up over 100 basis points? It obviously doesn't sound like it's going to slow down the mortgage market. Is there room for margin expansion as the yield curve steepens a little bit from all this? Or, you know, what should our thoughts be? I know you've given guidance around the word stability, but there is some asset sensitivity in your equation, and we're wondering how it plays out.

I think it's time I let Jim talk. We can't go to full pain without Jim saying something.

Henry, just to go back to my prepared comments, and, you know, what I say in there, is I think we're extremely asset sensitive. We're as high as we've ever been as a company in terms of our asset sensitivity. We took actions to lengthen liability duration in this low interest rate environment. So even if we had a steepener come along, I think that's only going to accrue to our benefit. Certainly if we see something move on the short end of the curve, that will immediately accrue to our benefits. But even on the longer end, if we had a steepener, I think we're rather immune on the liability side, and there are things that we can take advantage of in that environment that will help our net interest income. The other thing I'll say, and I didn't put this in my prepared remarks, but with the payoff of the senior notes that we have, keep in mind that those notes cost us over 6%. and we're going to effectively replace that funding at something that's around or maybe a little bit less than 25 basis points. So that alone in 2021 will give us about $3.5 million of lower interest expense per quarter. And if you look at Q4's interest expense, that's about 15% of our total interest expense in just that one move. So I, again, feel pretty confident about where net interest margin is and our ability to maintain that.

And our company with the mortgage business makes all the sense in the world. So that's a strategic position that we've taken.

My last question, and probably directing this to Lee ultimately, but you had a very successful branch acquisition. which you've integrated and done a great job with. You've got the capital. You've increased the dividend. The stock is performing exceptionally well. As you look longer term, particularly in the mortgage sector, would you do another acquisition there? And if you would, would it be a branch-based company, a DTC company? If you have thoughts in that direction, what are you thinking about?

Yeah, I don't think that's the best place for us to go in terms of a business expansion. I don't think the market would reward that. And I think we are at a level in our mortgage business in terms of scale and such that is very comfortable. And I think what we do now with mortgage is simply take advantage of the opportunities that the market gives us as opposed to look at that as, the future growth of the organization's revenue. I think we look to the banking side for that. And we can certainly use servicing as a way to support the mortgage business as well as support our funding. Let the mortgage business generate a lot of capital at times and enough capital other times. And then use that to build up the revenue that comes in from our banking business. I think we've got a great platform to grow from in the banking side. Reggie's got a vision that's going to take us in a – we expect a differentiated place that could provide some real opportunities on the banking side. I think we're strong enough right now in terms of the currency that we have to use in potential bank acquisitions. We're in a position because of how much capital we believe we're going to generate as we go through the next 12 to 24 months that the opportunities – to extend our company into markets that we're not currently in and give us access to customers that we don't currently have access to is really the right way to look at growing the company. I know mortgage is exciting, and right now I think a lot of my colleagues in the banking business who have frowned on the mortgage business may wish they were in it today, and I'm thankful that we are. But I don't think that long-term in terms of creating shareholder value, that that's the smart place to lay our chips.

Great. Thank you very much.

We have no further questions at this time. I'd like to turn the conference back to Sandra Dinello for any additional or closing remarks.

Thank you, Lauren. We talked this morning about financial success that was off the charts for the quarter and the year. And I'm incredibly proud of what we've achieved. But I'm equally proud of the success off the financial field, of what we've accomplished for our employees and customers in our communities. Certainly, it was the year of diversity, equity, and inclusion. And without question, Flagstaff was all in. The killing of George Floyd became a catalyst for us to accelerate our diversity and inclusion journey and to make equity part of it. We realized, more than ever before, that to foster a work environment where employees feel comfortable and do their best work, we had to acknowledge what was happening in the outside world. And this amplified a dialogue with our employees that meaningfully strengthened our culture. Our customers were in the spotlight in 2020 as we worked to help them overcome the challenges brought on by the pandemic. We made PPP loans to everyone who asked, including many who were not our customers at the time. And we work closely with our commercial customers to help keep them afloat and with our consumer customers to help more than 100,000 of them with forbearance. On the community side, we gave more grants than ever before, many to minority-owned small businesses as well as to nonprofits committed to helping those impacted by the pandemic. We supported a program for restaurants to provide meals to hospital workers and supported a local food bank with donations. With our help, a small business converted from manufacturing supplies to clothing to making personal protective equipment. Local fire departments benefited from donations of masks, and all of our communities benefited from our elevated level of giving and our focus on helping those hardest hit by the pandemic. These are just a few of the many actions our company and our employees took on to give back to those in need. In sum, the quarter and year were successful across the board. from the performance of all our business lines, to our progress in DE&I, to our outreach to our customers, and to our contributions to our communities. This level of success and progress couldn't have been accomplished without the tireless effort and sacrifice from all of our team members. Thanks to all of you. I know I say it all the time, but I really mean it. The success of this year belongs to you. Thanks to all for spending a few minutes with us this morning. I look forward to reporting on Q1 in April.

And that does conclude today's conference. We thank you for your participation. You may now disconnect.