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

Thank you, and good morning. Welcome to the Flagstar second quarter 2020 earnings call. Before we begin, I’d 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 uncertainty. Factors that could materially change our current forward-looking assumptions are described on Slide number 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 Chief Operating Officer and Steve Figliuolo, our Chief Risk Officer. I'm going to start the call by providing a high level view of our performance for the quarter, then I'll turn the call over to Jim for details on our financial results. Lee will then follow with a review of our business segments and strategic initiatives, and then we'll open the line for your questions. Well, it was an absolutely fantastic quarter for Flagstar. In my opinion, the best in the company's history. Not only did we report outstanding earnings far exceeding anyone's estimates, but we continue to build a fortress balance sheet. We've talked a number of times about how our results are validating the earnings power of the business model we've built starting in 2013. There have been quarters when mortgage results fell off when banking returns a lag, when interest rates soared and when they slumped, and still we produced strong returns quarter-after-quarter. The knock-on Flagstar by many has been a mortgage business. It's too much of our revenue. It has regulatory risk. It's too volatile. I think we've laid those concerns to rest. Not that long ago the mortgage business was challenging, as challenging as it has ever been, and the rest of the company carried us. Now we're in a recession and the mortgage business is off the charts. But that's not the most important story of the quarter. The most important story is the expansion of our net interest margin. Yes. Expansion. How did we do it? First and foremost, the yield on our…

Thanks Sandra. Turning to Slide 6. Net income this quarter was $116 million, $2.03 per share. This performance compared to the $46 million or $0.80 per share last quarter. The increase on a linked-quarter basis is largely due to stronger mortgage results and a nice increase in net interest income, the result of higher earning assets and growth in the net interest margin, only partially offset by $102 million credit provision this quarter. We had adjusted net income of $41 million or $0.71 per share in the same quarter last year. Diving deeper into this quarter's performance. Our pre-tax pre-provision earnings were $250 million this quarter compared to $70 million last quarter. Net interest income increased $20 million or 14%. Average earning assets grew $2.5 billion. Net interest margin increased by 7 basis points, excluding the 2 basis point impact of lower yielding PPP loans. This performance was primarily driven by the strength of our warehouse business that has rate floors in place to protect the margin compression due to lower rates, and a strong core deposits, which benefited from higher custodial balances and also from maturities of higher cost CDs and expiration of promotional rates on savings. We will view these numbers further on the next slide. Mortgage revenues were $295 million, an increase of $199 million compared to the prior quarter. During the quarter, we saw gain on margins increased significantly. This primary, secondary spreads remained wide, and we worked to manage capacity. As the quality remains strong, net charge-offs were only 11 basis points and nonperforming loans were relatively flat to the prior quarter. Despite all of this in reflecting our views on the uncertainties within the economy, our allowance for credit losses or ACL, which include the reserve for unfunded loan commitments were $250 million at…

Thanks, Jim, and good morning everyone. We're extremely pleased with our net income of $2.03 per diluted share for the second quarter, which increased tangible book value to $31.74. More importantly we've strengthened our balance sheet by increasing our ACL reserve to $250 million or 2.6% of loans held for investment excluding warehouse loans. We've deliberately designed our business model to be balanced between interest income and fee income revenues, and have businesses that accounts are cyclical such as mortgage originations and warehouse lending. So we're able to generate stronger earnings in any interest rate environment. This diversified model has delivered record earnings this quarter, bolstered our capital and created the liquidity we need to fund our balance sheet growth. Given this low rate environment, it looks as that it will persist for some time. We believe we will continue to generate strong earnings, increased book value and deliver exceptional results for our shareholders. On our last call, I mentioned how I couldn't have been more proud of how we've responded as an organization to the COVID-19 pandemic, and that continues to be the case. Our three main priorities have been ensuring the health and safety of our employees, continued best-in-class service to our customers and given them easy access to CARES Act and stimulus programs, protecting the Bank's position, given the uncertainty COVID-19 has created. The vast majority of our employees continue to work from home and our productivity levels have been unaffected. We've actually seen increased productivity in certain areas and we continue to serve our customers and partners with the same exceptional standards that come to expect from us. For those employees working from Flagstar facilities, we're ensuring comprehensive distancing standards, cleaning regimens and the necessary personal protective equipment is available, in order, our employees, feel safe…

[Operator Instructions] And our first question today comes from Scott Siefers of Piper Sandler.

Good morning, Scott.

Hey. How are you doing?

Very good. Thank you.

Good. So a very strong quarter. So congratulations. I was hoping maybe either Jim or Sandro or Lee, if you could talk a little bit more about how this issue with the Ginnie Mae loans sort of plays out. I mean it sounds like you have a plenty of optionality, but what has to happen in your guys minds for them to revolve just as if they were not in forbearance, in other words, what has to happen for this to just sort of go away as an issue?

Yes. So we tried to provide a lot of detail on that in the speech, both Jim and Lee addressed it. So let me let them both enhance their responses here.

Yes. Let me go first, Scott. So as I say, we had $1.8 billion of Ginnie that goes [ph] on the balance sheet at the end of the quarter. $1.1 billion were a result of Ginnie borrowers obtaining to forbearance and the accounting consequence of owning the MSR is to show them those early buyouts. Whether you buy them out or not because we actually haven't bought them out at this time. The loans were all performing going into the pandemic, as I've said. And so, we believe a big portion will go back to making payments and will therefore get reinstated after the forbearance period expires either on their own or through the partial claim process. And once they are reinstated, they are no longer categorized as an EBA. We think a small number will get modified outright or they will be modified in conjunction with the partial claim. We will likely buy those loans out because we would realize the gain on sale benefit of resecuritizing those loans after we bought them out. As I mentioned a lot of borrowers have equity in their homes, because there has been rising home prices for a period of point now, so we don't imagine a lot of these will go into foreclosure. And net-net, we think this asset class is somewhat neutral, it does impact capital, it only impacts liquidity if we choose to buy them out, and we're only going to buy them out if we can resecuritize them and realize the gain on sale benefit.

Yes. So Scott, good question. Look, we've raised this with our regulators. We've put in front of Ginnie Mae. We've put in front of FASB. It's a court, that I don't think anyone anticipated that loans in forbearance could be reconsolidated along the balance sheet, but look there is no downside. There could be as Lee elaborated, there could be some upside from here and that these loans are going to be more likely to have resecuritization gains that we can take advantage of in the future. There is no - from a capital perspective, from a liquidity perspective, it's not something that I'm necessarily concerned about. But just like not have the cosmetic issue on our balance sheet as well.

Yes. Okay. That's good color and I appreciate it. Maybe just as a follow-up, how high could those balances go? I mean, I guess my inclination would be that if forbearance request have already kind of slowed to a trickle or they might increase, it's not as if they are going to double or triple. And I realize that the risk weighting is very low. So the regulatory capital impact is kind of negligible, but not all assets are treated the same from the standpoint of TCE, which a lot of investors look at. So just curious, how - sort of what the appetite is to allow the balance sheet to be impacted by this phenomenon?

Let me say, I'm not worried about the impact on the balance sheet, but trying to predict what might happen, there's a lot of questions, you might ask me about the future that I just am not going to try to answer, because this pandemic is such that we just don't know. We don't know how long forbearance is going to go. We don't know much the government is going to intervene on these things. So I would not want to hazard a guess on that except to say that I think that we're in a position to the nature of assets, would not to be a negative impact in any material way at all.

Yes.

And you're right about the low risk weight and you keep in mind our Tier 1 leverage ratio is where we have the most capital buffer over well-capitalized status, and so this will impact - the leverage ratio a little bit more because it's based upon average balances, but it's not going to bring that ratio in the competition with the risk-based capital ratio is what we are concerned about.

Got it. Okay, perfect. Thank you guys very much.

All right Scott. See you later.

[Operator Instructions] We'll go next to Bose George of KBW.

Hi, Bose.

Hey guys, good morning. Actually just one on the -- on your loan production mix. It looks like you're Ginnie Mae production was down quite a bit. Is that typing the credit box, is that related to the balance sheet issues that were just discussed as well. Just curious, any color there?

Well, it's a lot of all of that Bose. What we determined as we got into this pandemic was that the smart way to go with originations is going to be principally in the agency. So we really downplayed that non-QM in jumbo, limited that to portfolio product and we minimized the Ginnie Mae significantly. We left it out to a little bit for our retail originators, but doing very, very little of it. And the profitability, as you can see has been very, very strong. So a lot of margins is a little wider in Ginnie Mae, right now given uncertainly around a lot of that from a servicing point of view and MSR point of view, given the fact that the agency activity is so strong, we chose to focus there.

Okay, thanks. That makes sense. And then, just given the relative increase in the retail share for you guys. Is that being driven by increased recapture. Just curious there and also just the gain on sale margin trends for direct lending versus recapture, does that -- is there a big difference there?

Well, first of all, relative to the retail. So we are controlling the growth in retail. But we've had opportunity to lift out some very, very strong originators from other organizations. And that's why you see the production being greater coupled with just the strength in the market, of course. But we're being very careful there, because we want to make sure that we preserve variable cost model that we've put in place, and so right now we're getting paid for that retail volume in a pretty favorable fashion given the margins there. And so we're comfortable with the growth that we've seen there. With respect to recapture I'm going to just let Lee answer that part of it.

Yes. Thanks Sandro. Thanks for the question Bose. So on the retail side, we've seen just really good growth, both from a distributed retail point of view and in our consumer direct channel. Now, the margins in the consumer direct channel are a little less when you factor in the recapture as you can imagine, but the margins are still pretty robust at the moment given the current market, and the margins are very, very strong on the distribute retail side, but we've seen healthy growth across all of our retail channels.

Okay. Great. Thanks a lot.

Thank you, Bose.

Our next question comes from Daniel Tamayo of Raymond James.

Hi, Dan.

Hey. Good morning guys. Congratulations on the strong quarter.

Thank you.

So I guess just staying on the gain on sale quickly here. You mentioned $100 million plus so far in July. What is the spread look like in July relative to what you saw in the second quarter?

Well, given what we've told you on the gain on sale, I think I'm comfortable in saying that the spread has held up pretty well this month.

Okay. Longer term, I think you guys have talked about as we see is healthy profit margins in the business and certainly strong volumes that would invite increased competition over time. Are you seeing that yet. And how long until you think that starts to impact spreads?

Competition in the mortgage business?

Right.

Yes. I don't -- yes, I think capacity is what's going to drive what happens to margin. So I think whether there is new entrants to the business or not, I think a lot of mortgage originators have continued to build capacity. What we try to do to offset that a bit and I think it's been successful is manage the capacity in a very disciplined fashion and look for where the best opportunities were to grab business with the best margins that that we could do by not adding a lot of fixed expenses. So right now it's working really well. How long we can continue to do that? Again that's anybody's guess, but the mortgage market certainly looks like it's going to continue to be strong through the rest of this year. The 30 year rate what is that 2.9%, something like that. The housing market is very strong. The year-over-year purchase activity is up. If you look at our builder portfolio, only one small credit and that's for a payment deferral. So people are still building houses, buying houses. So I think the fact that we didn't have, what was that some price increase, we don't have a bubble that we're dealing with here in the real estate world. So, but that's still real optimistic about the opportunity for continued strong volume in mortgage for the rest of this year. Margins is a big question, and we'll see how that goes. But pretty comfortable with that. Guys anyone want to add anything to that.

Yes, I mean, I think you're exactly right, Sandro. I think the only thing I would add is, I mean, look, when you look at the latest forecast from the agencies and the MBA, they are forecasting $2.9 trillion for 2020, and will probably go about $3 trillion. I think in the first half of this year there was $1.5 trillion of originations. So there's a good runway here. They are forecasting $2.2 trillion for 2021 right now, and it is all about capacity, but as Sandro said, we managed volume to capacity and optimize through product and channel mix, so that we're maximizing returns and we want to ensure consistent quality customer experience and we'll continue to do that.

All right, great. Thank you for all the color. And if I could sneak one more in on the mortgage warehouse yields. So, obviously you've been successful with the floors there and keeping those yields relatively high and they are higher than your C&I and CRE yields. So given the duration of these loans in the floor, do you have in place -- is it sustainable for those yields to remain above the CRE and C&I books do you think?

Well, I think there's a good chance and it's sustainable, sorry to say for sure. The yields are enhanced as I said in my prepared remarks by the draw fees, and so if the activity continues and the number of draws that we've seen in the last quarter continues in this current quarter, I think there is a really good chance that we could continue to sustain that level of yield. I certainly don't see it declining very much. So I think it's a yield that's very much protected given the floors that we have in that portfolio. And as I say, coupled with the draw fee. So it's a business I love being in right now. It's got very, very little credit risk as both Jim and I noted, less than $5 million in losses over the last 12 years that through a economic recession by the way. And I'll share another little story with you if I could. We had a -- we made a decision in late March that we were going to stop accepting non-QM and jumbo product as collateral for our warehouse lines. And at the time we had about $300 million of that collateral and we were able to work together with our clients. We didn't have very many investors at that point in time to wind that collateral down to literally nothing today, and we did that without experiencing any loss. So I think that tells you a lot about how strong that business is and if you the manage the quality of the collateral properly, how there's very little risk. And I remind you, we had an originator last year Live Well that abruptly closed their doors. I think it was a $20 million line outstanding to them at that time and within 45 days we rounded down and actually collected more than what was on the line. So it really is a very safe business. So to be able to grow our commercial loans in this environment and grow our yields in our net interest income, I mean, I couldn't be more pleased.

Thanks for all the color. That's all I have.

And our next question comes from Steve Moss of B. Riley, FBR.

Hi, good morning. In terms of just following upon capacity within the retail business. You guys mentioned adding a couple more originators. Just kind of curious with the mortgage loan being strong, how much more could we see in terms of volume for you guys?

Well, look, I think you got to be careful, right. So while we continue to add capacity to take advantage of the opportunity that we've been presented with, as I said, we're being really careful not to do it in such a way as to increase long-term fixed expenses in any way. So we can get hold of your skis in this business and get excited and add a lot of capacity internally that is hard to get rid of when the volumes go the other way. So we're leaning on our people to work as much over time as they are willing to work. We are paying them stifs to work longer hours, to get more work done. We're leaning on our third-party vendors to do as much as possible for us. Everybody is working in nights and weekends. So we are stretching this thing out as far as we can stretch. But I'm not going to go chase another couple of hundred million dollars of business a day and then a year from now explain in July, our expenses are too high. We are just not going to let that happen. So, hey, if we can do what we're doing and here in July we are sitting here on today 28th of July with over $100 million through last Friday, I got to say, I think we're managing this thing pretty well.

Right. Absolutely. And then in terms of the -- just on the margin here, I think the guidance was for relatively stable this quarter. Just kind of looking at the dynamics. Mortgage warehouse yields are up. Funding costs are coming down. It looks like there's some pretty good room. Just kind of curious what else could be a little bit of an offset here?

So Steve, as you think it. The primary, secondary spreads come in. I am looking at how low can that overall mortgage yield go. I don't think there is a lot of risk of that moving meaningfully below 3%, but we fund that portfolio that held for sales portfolio short. So right now it's accretive to NIM, but if that mortgage yield were to fall a lot, say going to 2.5%, which I think it's just absolutely crazy, then we could see some pressure on the NIM from that portfolio. In response to that we would shorten - we would shorten our turn times. But we fell that's just a function of how long we went out on the balance sheet, what the average balances are? Did that answer your question, I wasn't sure.

Yes.

I meant net interest margin.

Jim, got it. And then, so just on credit here. You had $170 million in downgrades from the -- $170 million downgrades. I'm just kind of wondering what portfolio, that's -- what portfolio those downgrades were from?

These were predominantly in the CRE portfolio. As you look at, where are bigger concerns are, it's hotel, it's retail, I mean, keep in mind, a big piece of our retail, our single-tenant buildings or what we call neighborhood centers and numerous centers are all that predominantly anchored by a grocery store. So single-tenant buildings, neighborhood centers are doing fine. But as you move up into bigger boxed anchored type structures then those are experiencing some stress. So we don't see any weakness. We've got strong borrower support across the portfolio, but we thought it merited downgrade to that watch status in the quarter.

Okay. That's helpful. And then last question from me. Just on hotels, kind of curious as to, if you have any data to what activity you are seeing -- off to the activity you're seeing within those portfolios?

Hotel portfolio specifically.

Yes, I'm sorry.

Yes. So hotel is obviously the most difficult piece of the hospitality portfolio. We are watching it very closely. Fortunately, we do have very, very strong sponsors in the hotel space and so far so good. They are hanging in there. There has been some deferrals as we've shared with you. But at this point, we haven't got any feedback from anybody that they're thinking about throwing in the panel. So everything looks like it's holding up right now and they all tell me and a number of them I had the opportunity to speak to myself regularly. They are in this for the long haul. They think it's going to come back and they are going to do what it takes to stay out there in that business and one in particular I talked to recently, they've said they are going to have a capital cost for their partners, so they can put more money into the project. And so far, we feel pretty good about the way our sponsors are handling their obligations.

All right. Well, thank you very much.

But with that -- yes, okay. Thank you.

[Operator Instructions] And we'll go next to Henry Coffey of Wedbush.

Hi, Henry.

Good morning everyone. Good morning and great quarter. I won't torment you about mortgage anymore. It sounds like you're queued up for a pretty good second half. But...

Henry it wouldn't be right if you're going to ask us about mortgage.

Well, I mean, the Fannie Mae's at $3.1 trillion, so that's where all the real estates are going. It's pretty transparent. When we go back to a couple of issues. One, in terms of reserve build, how do you manage around the Moody's forecast, if that's what you're using. It's kind of like the price of oil, they get to change it, whenever they change it. And then your models have to react to it. Is there a way to minimize that impact. So any future reserve builds are more a function of actual credit metrics?

Well, I'll let Jim get into the detail. Here's what I would tell you about how I view the reserve. Build in a reserve, what the right reserve is it's not a fund, but we are being pretty true to the model. And as you noted, it is heavily swayed by the Moody's economic forecasts. We do apply qualitative judgments to the model output, and we try to do that and what we believe is a conservative room. So we want to be in the best place we possibly can be. And I think that we feel like we're in the right place, and again if anything moved a little bit on the higher side. But it's -- you may recall, I started my career has an examiner or maybe part of that training never left me. I really believe that's the right way to manage the overall reserve for credit losses and that's the way we're doing it here. We always have, and during my tenure as CEO. Now to the specifics of Moody's, let me, let our CFO handle that.

Hey, thanks. I point you to - I'd point you to Slide 12. When you look at Slide 12, you see that the forecast changes drove $31 million of the increase and our judgment changes drove $63 million, more than two times what the forecast did. So we're pretty much as Sandro said, conservative when it comes to doing what is necessary to protect the balance sheet. Lee has made the reference about fortress balance sheet a couple of times in his prepared remarks, but well, I've seen some people take the Moody's forecast down qualitatively, we've actually taken it up, and so there's a lot of room in that number to have Moody's catch up to where we think our conservative meaning puts us.

I'm sorry.

Go ahead.

Have you thought about selling any of these commercial real estate assets. You've got a good book. Its performing well. Maybe the answer is to offload some of the risk given how much strength you have in your other businesses?

No. We really haven't. There hasn't been a capital discussion at all and maybe that's because we know these borrowers as well, and we speak to them regularly, and we just feel that they're going to be okay. So as Jim said in his prepared remarks, we know there is going to be lots of but knowing exactly where they're going to be, I don't know whether exactly where they're going to be. So at this point, I think hanging in there with them, working with them is the best long-term long-term results for us.

Great. Thank you for answering my questions and congrats on a great quarter.

Thank you.

And with no further questions in the queue, I'd like to turn the call back over to Mr. Sandro DiNello for any additional or closing remarks.

Thank you. Well, while Flagstar was busy having a spectacular quarter, the world around us erupted in social unrest. We used to be there so we could keep the office in the world outside pretty much in separate compartments, but I don't think that's an option today. When we started our diversity and inclusion journey, our focus was on Flagstar and making it a workplace where everyone would feel comfortable in their authentic selves. I now know that we can't build a wall between our company and the outside world. We're all part of the larger community. We are bringing the outside in and vice versa and as a company, we need to do our part to make things better. That's why when killing of George Floyd sent shockwaves around the world, I felt it was important to speak out and start a dialog with our employees. Since then we've probably stopped talking and hopefully never will. And one of the first things we did was to add the word equity to our discussion around diversity and inclusion. And I'm really proud of the way our employees have suggested and embraced opportunities to engage of social justice issues. Here are some of the things we did. We held, let's talk about it panel discussions with external leaders in diversity and inclusion. We pulled our advertising from Facebook in July to support the staff aid for profit initiatives. We held the June team celebration. We communicated to employees and held a discussion about the Supreme Court's recent rulings on Daca and equal rights for LGBT workers. We publicly supported a ballot proposal in Michigan to ban LGBTQ discrimination. We celebrated pride month with virtual events and speakers, and we introduced a learning module for all our employees and the International Day…

And this does conclude today’s call. Thank you for your participation. And you may now disconnect.+