Flagstar Bank, National Association Q1 FY2024 Earnings Call

Hello, and thank you for joining us. My name is Regina and I will be your conference operator today. I would like to welcome everyone to the New York Community Bancorp, Inc. First Quarter 2024 Earnings Conference Call. I will now turn the conference over to Sal DiMartino, Director of Investor Relations. Please proceed.

Thank you, Regina, and good morning, everyone. Thank you for joining the management team of New York Community Bancorp on short notice for today's conference call. Today's discussion of the company's first quarter 2024 results will be led by President and CEO, Joseph Otting, joined by the company's Chief Financial Officer, Craig Gifford. Before the discussion begins I would like to remind everyone that our quarterly earnings press release and investor presentation can be found on the Investor Relations section of our company website at ir.mynycb.com. Additionally, certain comments made today by the management team may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements we may make are subject to the safe harbor rules. Please review the forward-looking disclaimer and safe harbor language in today's press release and presentation for more information about risks and uncertainties, which may affect us. Also, when discussing our results, we will reference certain non-GAAP measures, which exclude certain items from reported results. Please refer to today's earnings release for reconciliations of these non-GAAP measures. And now I would like to turn the call over to Ms. Otting. Joseph?

Thank you, Sal, and good morning, everybody, and thank you for joining us today. Before I go into my prepared remarks, I'd like to offer my apologies for the late notification for today's earnings call. Clearly, this is not the standard we intend to operate by in the future. We will notify you in a timely manner in the future quarters. However, we made some big promises for this meeting when we met on March 7, which was a tall order. Being a new management team, not only did we have to obtain and analyze information, but we had to ensure we had both controls and processes and completed the credit review that we had indicated we would conduct. As I indicated, we first got together on March 7, I had three overarching items that I wanted to focus on in my first 12 weeks. The first was to reevaluate and get our forecast accurate and formulate strategies around the businesses. We wanted to conduct a review and understand our credit risk in the portfolio. It was very important for us to engage with our regulators and develop relationships because they are vital to our overall organization and building our risk framework. We think these were critical components. We believe we've done a tremendous amount of work on that, and you'll find through the slide presentation today that we made significant progress in the last four weeks since the new team has come together. Now turning to the first quarter. During the quarter, the company took several actions designed to lay down the groundwork for a return to long-term sustainable profitability in line with our regional bank peers. First and foremost, we successfully completed just over $1 billion equity raise anchored by Liberty Strategic Capital, a firm led by former Treasury Secretary, Stephen Mnuchin, along with Hudson Bay Capital Management, Reverence Capital Partners, and Citadel Global Equities. The completion of this equity raise significantly strengthens our capital and liquidity position and demonstrates the confidence that the new investors have in the turnaround currently underway at the company. Second, we bolstered our Board of Directors and executive management team. In conjunction with the capital raise, we reduced the size of our board to nine members and added five new directors, all of whom bring extensive banking and turnaround experience to the bank. I've known them for a long time and can attest to them being independent thinkers who will challenge management appropriately as very strong board members. More recently, we announced the appointment of four senior leaders to our executive management team, each with deep industry knowledge and extensive backgrounds in their respective fields. When you think about the characteristics of the people that have joined us, they all come from strong organizations with backgrounds from institutions like U.S. Bank, Bank of America, and most of us have worked together either at one of those institutions or at OneWest Bank. We understand the culture and the type of risk organization that we want to collectively build and we all came from organizations that were viewed in the industry as high-performing. I'm confident together with the newly reconstructed Board we'll be able to drive our strategic initiatives forward and solidify our position as the leading regional bank. We've done this before, and we feel we can do it again. Third, we completed an in-depth due diligence process of our multifamily and commercial real estate portfolios, including the office portfolio, performed both by the bank and separately by an independent third party. We increased our credit loss reserves as a result of information from this review and other analyses we conducted during the quarter. Now I'll take you through the earnings presentation beginning with Slide 2. Slide 2 highlights our strategy. We've bolstered management and the Board, we've developed what we think is a realistic operating plan to get the organization to the end of 2026 at or above industry standards for performance. We have achievable capital and earnings forecasts. We have now implemented a rigorous credit risk management process and have strengthened talent in the credit risk process while maintaining sufficient liquidity, as we will discuss. Our future targets are to be a strong, diversified regional bank producing a return on average assets of 1%, a return on average total TCE of 11% or 12%, and a CET1 ratio of 11% or 12%. We'll walk you through those later today. The goal is to create long-term meaningful shareholder value. 2024 will be a transition year to a more normalized 2025 and 2026. On Page 3, it highlights that seven of the 10 people are new to the company within the last five months and adjunct three important individuals who were legacy NYCB and Flagstar members who have joined the organization. Slide 4 gives a quick overview of the Board members and the depth of knowledge they bring to the organization. On Slide 5, we outline our path to profitability. We believe we have multiple levers to accomplish that. Firstly, as the industry faces rapid rising interest rates, many loans that were fixed rates with either three, five, or seven interest rate resets, are starting to come forward for repricing, which will benefit net interest income and NIM. Secondly, we focus on the workout of problem loans, bringing in resources to strengthen talent in dealing with workouts. This will lead to long-term reductions in our NPAs. Thirdly, we'll begin to build a more robust middle market relationship banking franchise. Currently, we have roughly $20 billion in C&I loans outstanding. We foresee this business growing to over $30 billion in the next three to five years. I have spent most of my career in this space, successfully growing similar businesses at U.S. Bank and OneWest Bank, and I am confident we can replicate that success here. Fourthly, we will fully integrate all three banks. Currently, in 2024, we integrated the Flagstar NYCB onto a single platform called Fiserv, while the signature legacy is on FIS. We will transition to one platform in the future, as this is a costly proposition when operating on two different systems. Fifthly, the efficiency ratio tells the story. We operate with an 80% efficiency ratio, a standard we learned at U.S. Bank under Jerry Grundhofer's teachings on efficiency. It is in our culture, and we will aggressively scrutinize our cost structure to align with industry standards. Regarding medium-term targets, we will diversify our loan portfolio; our commercial real estate portfolio is currently around $47 billion, and we aim to reduce that to around the $30 billion range. We will enhance funding by growing core deposits and increasing fee income through deeper cross-selling into existing businesses. Lastly, we are reviewing our portfolio for non-strategic assets. We have identified an opportunity that could close quickly for $5 billion at par minus a transaction fee, potentially finalized within the next 60-70 days. We've initiated a strategic review of which assets fit our long-term goals. Now, I will turn it over to Craig Gifford, our newly appointed CFO.

Thank you, Joseph, and thanks to all those who were able to join the call today. I look forward to meeting many of you in the near future. Over the next few slides, I'll take you through how we think about our forecast, our loan portfolio, our credit risk, and our deposit base and liquidity. If you turn to Slide 6, you can see a summary of the next three years' expectations for our financial performance. Initially, we expect our diluted EPS (earnings per share) to grow from our current level to about $0.65 to $0.75 by the end of 2026. As Joseph mentioned, we expect to reduce our efficiency ratio to peer levels through the integration of previous mergers and a close examination of overlapping cost structures. Our capital ratios have been bolstered by the recent infusion discussed by Joseph, and we foresee this moving towards peer levels over the next two years, driven by earnings power and retention into capital. Our return on assets is expected to improve through rebalancing our asset mix and loan repricing. Our return on equity will benefit from these initiatives, driving a projected tangible book value in the $7 range by the end of 2026. These forecasts reflect the strategies Joseph outlined earlier. Turning to Page 7, this is where the details become relevant. Starting with our income statement, our net interest income will benefit from the repricing of loans over the next couple of years. We predict around $4 billion annually over the next three years will be repriced. We are currently relatively neutral in interest rate risk, having exited positions that left us in a neutral state. Our net interest margin decreased this quarter primarily due to a shift to more expensive wholesale funding. We anticipate improvements in the next two years due to the repricing of our portfolio. Following a detailed examination of our credit portfolio considering current market conditions, we increased our loan loss reserves for the quarter. We expect elevated levels of provisioning throughout the year as market conditions may impact borrowers. However, we anticipate returning to normalized levels of losses thereafter. Noninterest income expectations remain flat, but upside is possible as we enhance our customer mix. We expect a reduction in noninterest expenses by 10% to 15% through efficiencies from merger activities. If you move to Slide 8, our current position shows that the equity infusion in March has us at a 10.1% CET1 ratio, and the reserve increase brings us to a 1.58% allowance for loan loss relative to total loans. Importantly, 84% of our deposits are insured, showcasing a low level of uninsured deposits compared to peers. On Slide 9, we detail our loan portfolio regarding credit reviews of various high-risk positions. A significant number of loans and the percentage of the total portfolio have undergone deep dives involving internal analysis and third-party appraisals, confirming potential credit losses previously disclosed. As detailed, we covered approximately 75% of our office portfolio and around 30% of our multi-family portfolio during this deep dive analysis. Slide 10 shows details on our office portfolio, which totals $3 billion with a cumulative 10.3% allowance relative to total office loans. The deep dive review has focused on loans valued above $50 million, as they exhibit different risk factors compared to smaller loans, which average around $5 million. Slide 11 elaborates on our multi-family portfolio, the largest segment at $36.9 billion, of which 36% underwent thorough credit review. Our allowance for total loan coverage in this segment stands at 1.3%. We anticipate around $2.6 billion of our multi-family loans to reset in 2024 as part of the extensive portfolio review that has yielded strong performance data to date. Slide 12 presents our diversified $7.4 billion non-office portfolio, largely free of credit concentrations. Page 13 breaks down our allowance for loan losses, noting a 1.3% allowance in the multi-family portfolio, while the office category remains high at 10.3%. In terms of liquidity, our deposit base has proven stable since our capital infusion, with healthy growth observed. Our unique 555 product has gained traction, drawing new deposits without drastically impacting overall margins. Slide 15 reflects our position with respect to uninsured deposits—only $12.4 billion is uninsured. Overall, we have over 200% of uninsured deposits in liquidity, supporting our current strategies. Slide 16 summarizes our first-quarter financial highlights, including a net loss of $335 million related primarily to provisioning and merger costs. This noise aside, we see a base operational net income in the first quarter, which we will now return to Joseph for closing remarks.

Thank you, Craig. First of all, I appreciate your patience. Since this is really our first opportunity to get together with all of you, we believed it was important to go through the deck instead of merely reading opening comments, enabling you to gain context and details about where the organization stands today and how we envision its transformation moving forward. I hope you found this helpful and insightful. Craig and I look forward to meeting many of you and having discussions in further detail about areas of interest from the packet today. One area we assess is the upside for the company, currently trading at roughly 0.42 of a fully converted tangible book value of $6.33, compared to about 1.5x for Category 4 banks and approximately 1.4x for regional banks. We believe this valuation gap will significantly narrow as we execute our transformation plan. We are an experienced team familiar with navigating this journey, clear on what steps are necessary to execute, and our optimism backs our confidence to deliver on this plan. We acknowledge the hard work it will entail, but our team, with their diverse backgrounds, is up for the challenge. I would like to extend my gratitude to all our team members for their dedication and effort on behalf of the bank and our customers. I appreciate being here for almost eight weeks, and Craig for about two and a half weeks. It has been paramount for us to meet with you as soon as possible to provide an overview of the organization, and we now look forward to fielding any questions from the group. Operator, please take over.

Our first question will come from Ebrahim Poonawala at Bank of America.

So appreciate everything that you outlined around business strategy and credit. Maybe first question, I guess, both of you wrote this better than most. We are in a tough interest rate backdrop. Just talk to us when you talk about growing the core deposit franchise, which is extremely tough right now for even the best of banks in terms of the nuts and bolts of how you can execute that without undue pressure on deposit costs? And also, if you don't mind addressing there's been a fair amount of challenge about talent leaving NYB over the last few weeks? Like how impactful would that be? And how much of that is baked into your forecast and outlook from here?

Thank you very much. The first question is when you look at the legacy organization, it was kind of a monoline business focused on multifamily and then they raised high money market and CD rates to fund that. The evolution with Flagstar brought more relationship deposits into the fold, and then the Signature bank joined through the FDIC-assisted transaction. We've been able to navigate this to where, as Craig showed on the chart, 41% of our deposits are now in noninterest-bearing and interest-bearing accounts, which are transactional. If you ask most people who their bank is, even if they have significant funds elsewhere, they usually identify by their checking account. We have a strong retail franchise to grow from those relationships. As we expand into the C&I business, being important to the customer means acquiring relationship products, leading to deposits, cash management, and other financial services. Therefore, our focus is on cultivating talent in this space. We already have robust businesses in C&I that can help drive less interest-sensitive clients. Regarding the Signature Bank departures, our goal is to anchor our C&I business on those teams. They've been successful in lucrative markets, though the integration has had challenges. Some legacy clients didn't meet our BSA standards and have moved on, leading to around 200 departures. We monitor these changes and have retained a significant portion of those deposits. We have been able to successfully assign existing team members to engage clients, leading to strong retention. Although we anticipate some migration, overall, we've experienced good growth in deposits and continue to see that into April.

As Joseph mentioned, there's been very little deposit departures since the press related to the advisers that left, with only about $200 million seen vacating. This occurred in the first two weeks, and since then it's been a trickle, which is a very positive sign.

Ebrahim, in addition to this, many teams have left for smaller banks, and clients find it challenging to be serviced by these smaller institutions. They may shift parts of their relationships, but fully integrating them into the small banks is complicated. Therefore, it's likely we will develop split relationships going forward, but we remain optimistic as we've retained substantial deposits and maintained robust engagement from our retail and private banking arms.

That's great color. And if I can have one quick follow-up. I appreciate all the deep dive you've done on the office and multi-family. When all this began, there was a lot of concern around New York City stabilized multi-family book. I appreciate there's more to do in terms of the deep dive review. Just give us a sense—like for the longest time, I've covered the bank; it felt like the loss content in that book should be minimal. I would love to hear your thoughts in terms of the rents stabilizing in New York City multi-family and your view on the loss content?

Well, a couple of things. We are aware of the 2019 legislative changes and the lack of movement in the Supreme Court that would have benefitted the market's outlook. Currently, we might have reached a low point with tax abatements now being explored. Our review of large multi-family entities indicates steady revenue, with high occupancy rates. However, the operating expenses have surged, like HVAC repairs costing 30-40% more than two years ago. Our portfolio has demonstrated resilience in payments with very few clients becoming delinquent. We have seen some owners leveraging personal family resources to sustain their properties, ensuring they can manage them effectively.

On Page 8, regarding our past due loan metrics, we have 26% of total loans past due 30 to 89 days versus 64% for Category 4 and 29% for $50 billion to $100 billion portfolios. This indicates our portfolio has held up well, even though there are potential risks in terms of defaults.

Congrats on getting all this together in such a short period of time. It's very impressive. Just following up on your comments on the $6 billion in deposits. Can you share what's the mix of that $6 billion that's remaining? What portion of that is DDA versus interest-bearing or higher-rate CDs? Additionally, could you provide insight on how many of those teams are remaining at the bank?

Currently, there are about 100 teams remaining at the bank. Initially, there were roughly 130. We have instituted a cash payment plan over a year and two years, along with an equity-based retention structure. However, it's vital to facilitate strong customer service to retain these bankers rather than just relying on financial incentives. If we can streamline operations effectively, it would markedly improve retention and satisfaction.

As for the deposits, of the remaining $5.8 billion, only about $250 million is in CDs. The majority comprises transactional accounts which underpin the stability due to established relationships.

What do you believe is the timeline for resolving the service issues?

We've made these service issues a personal initiative. Our team has worked to align approval levels back to what they were previously and have focused on enhancing credit approvals.

I wondered if you could share with us what you're assuming for the balance sheet size in your modeling?

We are not assuming any significant reduction in the balance sheet size in our modeling. While we are looking at strategic transactions, we do not have a balance sheet reduction as our principal target. Our intention is focused on making strategic moves that align with the overall business model.

Secondly, I think your lead independent director suggested on CNBC that the company could be utilized as a roll-up vehicle for more FDIC deals. When do you think that could happen? Is any of that included in your plans through 2026?

That is not part of our plan. With my background as a comptroller of the currency, I understand the importance of having robust risk management infrastructure. We need to focus on cleaning up our house before considering any acquisitions. Our primary intention is to work collaboratively with our regulators as we establish and enhance our risk structure because it is essential for our advancement.

Additionally, the necessary financial implications for that risk infrastructure have been included in our financial forecasts. We anticipate that the efficiencies derived from our operations will be reinvested into strengthening our risk management capability.

Would you consider selling a part of the branch franchise? Are there areas where you see an opportunity for consolidation?

At this point, no. We're enthusiastic about our current branch structure and the deposits they produce. Our focus lies in enhancing products and services to expand that success further.

Can you share your target loan-to-deposit ratio over the next 2 to 3 years?

The loan-to-deposit ratio is expected to remain relatively consistent over the next 24 months. Although improvements might occur as a result of strategic transactions, we don’t anticipate significant transitions in the ratio during this timeframe.

So it will stay elevated?

Correct. As we consider strategic transactions, there may be a reduction in loans that would lead to a decreased loan-to-deposit ratio to enhance liquidity and operational efficiency.

Overall, we need to review our current business relationships and decide the future of those that don’t fit well with our strategy. Today’s market does show a demand for those types of products. Hence, any strategic transactions will be carefully weighed with our liquidity in mind.

Regarding the $5 billion transaction you mentioned, can you share which asset class that pertains to?

I cannot disclose specific details at this moment, but we are in the deciding phase for that transaction and it is our intention to proceed accordingly.

That transaction will positively impact our capital ratios and diminish our overall capital demands without adversely affecting our earnings potential.

Can you discuss your approach to complying with long-term debt rules proposed last year?

With respect to rating agencies, they require a reliable path toward earnings that reflects our grasp on credit risk. While not immediate, we believe opportunities will arise to demonstrate our business understanding and financial performance for potential future rating upgrades.

Sure, great. Can you elaborate on bringing down the commercial real estate concentration in your portfolios?

Our most significant concentration is in the multi-family sector. For any significant reductions, we would need to narrow exposure within that segment. We intend to decrease our office portfolio due to observed stress levels and the evolving workplace dynamics affecting its future viability.

We prefer managing relationships effectively over divesting portfolios outright, as we want to maintain connections with our clients.

Ultimately, our focus is to keep beneficial relationships and only move away from financing when it no longer aligns with our strategic aims.

I know you gave a good amount of information on individual categories in your CRE book. Can you clarify if there is an intention for a full 100% review, or did you start with the larger accounts to ensure adequate reserve levels?

We began with larger accounts to ensure thorough coverage with fewer overall loans. The loan decisioning parameters differ between larger and smaller loans, hence it was necessary to start here. However, we will adapt our approach to reviewing smaller loans over time.

The next phase involves assessing large borrowers in our verticals, specifically those with a collective loan above $10 million, and reviewing them by June 30. Our goal is to enhance our comfort level with risk assessments and reserve allocations.

Just a quick follow-up. I know you gave guidance on elevated loan loss provisions, but can you clarify if this will be driven from allowance building or from charge-offs?

We're anticipating elevated charge-offs overall due to specific stress situations in our office loans. Charge-offs and reserve builds will correlate since both reflect underlying credit loss metrics within our portfolios.

Regarding your Category 4 bank status, you noted potential expenses to develop enhanced systems. You are optimistic about driving down expenses while revamping risk management infrastructure, but could you clarify how these pressures and efficiencies balance out?

Expectations show between a 10-15% reduction in our expense ratios, but some unavoidable costs exist. We merged three full sets of infrastructure, providing us ample opportunity for efficiency and savings. The chart on Page 7 provides a clear framework for our derived efficiency forecasts.

Could you elaborate on the situation you inherited? Essential details show prior reliance on manual spreadsheets with a lack of visibility. Can you confirm what you found?

The primary indicator was the lack of insight into market stress factors influencing credit assessments. The previous management team struggled to stay ahead in recognizing these developments, which ultimately affected reserves. We've made significant strides in recent weeks to overcome deficiencies to date, but we still have room for improvement.

As mentioned, we have onboarded experienced talent to lead and improve our risk processes. We're initiating several action plans to enhance our forecasting and charge-off evaluations, applying our expertise to refine how we gather and analyze data.

Following the reviews of troubled exposures in your loan portfolio, can you provide context on expected price declines? What's the current pricing landscape for your products looking forward?

The pricing outlook varies. In office categories, we've modeled a 42% decline, while multi-family pricing has seen approximately 30%. These values shape our reserve expectations going forward.

Regarding your CRE concentration, can you detail how this might evolve on a flat balance sheet, considering the $10 billion opportunity for C&I growth?

Over the next 2-3 years, we expect natural balance shifts related to resets and maturities of our loans. Focus on retaining quality credits with broader relationships is essential, allowing for reductions in those primarily using our balance sheet.

The baseline in our model reflects a flat steady state; however, with prospective reductions in the multi-family space, we aim to ensure we align with our concentration targets. The goal is to achieve approximately 25-30% in CRE and increase our C&I targets.

What’s the current outlook on liquidity expectations considering anticipated guidance here?

Liquidity on our balance sheet is currently ample. Post-transactions, we expect the bulk of the liquidity to remain on balance sheet. The securities portfolio will mainly be short-term with no significant extensions planned.

Can you provide your loan accretion figures for the quarter?

The accretion figures aren’t available at the moment.

Given the flat balance sheet context, how should we anticipate overall deposits to sustain at the $75 billion level through 2026?

While conservative in our forecasting approach, we've allowed entities for potential upside through deeper customer relationships, which we’re optimistic about cultivating further over the remaining year.

As you wind down the CRE loans, what's the timeline you're projecting for that? Expecting overall loan growth in 2025 and 2026?

Our model doesn't fundamentally change to accommodate for loan growth, but resets will contribute around $4 billion per year from portfolio gradually over the next three years.

Besides the charge-offs witnessed in Q1, can you detail the expectations around due multifamily and CRE loans moving forward?

We've had about $2 billion of loans that reset in the past year, with 25% completely paying off and 75% having successfully refinanced with strong performance metrics.

Could you outline the trends observed in criticized and classified loans this quarter?

Critically classified loans increased by around $2 billion quarter over quarter due to the sensitivity of loans influenced by the interest rate curve. I apologize for an omission earlier regarding average share counts. On a fully converted basis, we can look forward to an increase in share count due to the preferred stock conversions predicted to take place in Q2.

To summarize, I want to express gratitude for your participation today. It was crucial for us to convey our progress and aspirations for the company. The path forward will be demanding, but we are confident our strategies will be executed successfully. Thank you for your ongoing support.

That will conclude today's call. Thank you all for joining. You may now disconnect.