Flagstar Bank, National Association Q3 FY2025 Earnings Call

Hello, and welcome to the Flagstar Bank NA Third Quarter 2020 Earnings Call. I would now like to turn the conference over to Sal DiMartino, Director of Investor Relations. You may begin.

Thank you, Sarah, and good morning, everyone. Welcome to Flagstar Bank's Third Quarter 2025 Earnings Call. This morning, our Chairman, President and CEO, Joseph Otting; along with the company's Senior Executive Vice President and Chief Financial Officer, Lee Smith, who will discuss our results for the quarter and the outlook. During this call, we will be referring to a presentation which provides additional detail on our quarterly results and operating performance. Both the earnings presentation and the press release can be found on the Investor Relations section of our company website at irflagstar.com. Also, before we begin, I'd like to remind everyone that certain comments made today by the management team may include forward-looking statements within the meanings of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements we may make are subject to the safe harbor rules. Please refer to 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. 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 a reconciliation of these non-GAAP measures. And with that, I would now like to turn it to Mr. Otting. Joseph?

Thank you, Sal, and good morning, everybody, and welcome to our first quarterly earnings as Flagstar NA. We are very pleased with the operating results this quarter. Our third quarter performance provides further tangible evidence that we are successfully executing on all our strategic priorities. Our operating results improved significantly throughout the year and during the quarter as many of our key metrics continue to trend positively. From an earnings perspective, our adjusted net loss of $0.07 per diluted share narrowed substantially compared to the second quarter, while our pre-provision net revenue continues to trend higher, putting us on a path to profitability. In addition to the improvement in earnings, we had several other positives during the quarter, highlighted by this was a breakout quarter in our C&I business as we originated $1.7 million in new loan outstandings and realized overall net loan growth of $448 million in the C&I portfolio. Our net interest margin expanded for the third consecutive quarter, up 10 basis points to 1.91% compared to the second quarter. And our operating expenses remained well controlled and were down year-over-year $800 million on an annualized basis, significantly ahead of our plan. Criticized and classified assets continued to decline, down $600 million or 5% on a linked quarter basis and $2.8 billion or 20% year-to-date, while nonaccrual loans were relatively stable. We had another strong quarter of multifamily and CRA payoffs of $1.3 billion, and this has continued the trend over the last couple of quarters where we've been above our forecast on real estate payoffs. And our provision for loan losses decreased 41%, while our net charge-offs declined 38%. Now turning to Slide 3 of the presentation. We have highlighted the key management areas that we have focused on and how we have performed in each category. First, to improve our earnings, we have reported smaller net loss every quarter for the past year due to a combination of factors, including margin expansion and cost reductions. Lee has a slide later on that he'll cover this in detail, but the trend line on this lines up very well with what we've communicated about a return to profitability for the company. Second, we continue to implement our commercial lending and private banking strategy, which I will discuss in more detail shortly. And third, we proactively managed our multi-family and commercial real estate portfolio to continue to reduce our CRE concentration. And fourth, our credit quality profile, which has resulted in net charge-offs as we are starting to see signs of stabilization in the loan portfolio. The next several slides highlight the tremendous progress we've made in our C&I business. Starting on Slide 4, this was a breakout quarter for our C&I lending. Our strategy in the C&I space really began after the June 2024 strategy as we hired Rich Repetto to come in and lead our commercial, private banking and commercial banking strategy. This strategy focuses on 2 primary businesses, specialized industries and corporate and regional commercial banking. Both of those gained momentum in the third quarter, driving C&I loan growth up nearly $450 million or 3% versus the second quarter. This was the first positive growth quarter since early last year. Our 2 strategic focus areas led the growth with total loan growth of $1.1 billion, up 28% compared to the prior quarter. On the next slide, you will see the positive trends in new commitments and new loan originations over the past 5 quarters. Compared to the second quarter, new commitments increased 26% to $2.4 billion, while originations grew 41% to $1.7 billion. More importantly, you can see that the contribution to this growth from our 2 strategic focus areas was quite impressive. Specialized Industries and corporate and regional commercial banking experienced a 57% or almost a $750 million increase in commitments to $2.1 billion versus the prior quarter. Originations in these 2 areas increased 73% or nearly $600 million to $1.4 billion. Both areas have seen a consistent upward trend since the third quarter of last year, reflecting steady pipeline growth and a high success rate in converting opportunities. Just as important as our C&I pipeline, which currently stands at $1.8 billion on commitments, up 51% compared to the $1.2 billion at this time last quarter, providing strong momentum for the fourth quarter C&I loan growth. Also important is the number of new relationships we've added. Year-to-date, we've added 99 relationships to the bank, including 41 just in the third quarter. I believe these 2 data points reflect the industries we chose to focus on and the talented individuals we brought into the company, most of whom are mid-career bankers with 25 to 35 years of experience in their respective industries and have impressive Rolodexes. So far in 2025, we have doubled the number of relationship bankers and support staff in our 2 main focus areas to 124 and plan to add another 20 in the fourth quarter. Turning to Slide 6. This provides an overview of our specialized industry business and the growth trends both in commitments and originations over the past 5 quarters. You can see they had strong growth in both commitments and originations during the third quarter. Slide 7 provides a similar overview of the corporate and regional banking business. This business also had a very strong quarter in both total commitments and originations. We believe it has reached an inflection point after successfully building out 4 new segments and reinvigorating legacy businesses, showing that our relationship-based strategy is yielding positive results. We expect to see further growth in the C&I business as existing bankers continue to deepen their banking relationships and the addition of new bankers. Additionally, we see potential opportunities from recent merger activity. Many of these are right in our core markets to selectively add talented bankers as well as winning new business relationships. The next slide lays out the roadmap we employed to solidify the balance sheet and reposition the bank for growth. This is a little bit of a down history lane, but we have increased our CET1 capital ratio by nearly 350 basis points, ranking us among the highest, best capitalized regional banks amongst our peers. We also fortified our ECL through a rigorous credit review process where we reviewed virtually every single multi-family and commercial real estate loan. We significantly enhanced our liquidity position and we reduced our reliance on wholesale funding, including flub advances and brokered deposits nearly $20 billion year-over-year, lowering our cost of funds and boosting our net interest margin. And in addition to what the items are identified on this slide, there could be many more. Obviously, our expenses, our deposit costs and our risk governance are other areas that we're heavily focused on. Now turning to Slide 9. You can see the impact on our adjusted EPS from the balance sheet improvements I just talked about on the previous slide. Our adjusted diluted loss per share has consistently and significantly narrowed over the past 5 quarters, including a 50% quarter-over-quarter reduction in the third quarter loss to $0.07. Now with that, I'd like to turn it over to Lee to review our financials.

Thank you, Joseph, and good morning, everyone. During the third quarter, we continued to execute on our strategic vision to make Flagstar one of the best-performing regional banks in the country. We achieved net interest margin expansion of 10 basis points quarter-over-quarter, paid off another $2 billion of high-cost brokered deposits as we further reduced our funding costs and continued to demonstrate excellent cost controls, continuing the surgical approach to cost optimization of the last 9 months. Our unadjusted pre-provision net revenue improved by $14 million quarter-over-quarter, while our adjusted pre-provision net revenues improved $6 million versus the second quarter. On the credit side, multi-family and CRE payoffs were again elevated at $1.3 billion, of which 42% was substandard. And criticized and classified loans declined about $600 million or 5% during the quarter and 19% or $2.8 billion on a year-to-date basis. Net charge-offs decreased $44 million and the provision decreased $24 million, both compared to the second quarter. And we ended Q3 with a CET1 capital ratio of 12.45%. As Joseph previously mentioned, we had net C&I loan growth during Q3 of approximately $450 million following the origination of $2.4 billion of new C&I commitments, of which $1.7 billion was funded. We're very pleased with the performance of our C&I businesses. We've surpassed our target of $1.5 billion of funded C&I loans per quarter and believe we can fund $1.75 billion to $2 billion per quarter going forward assuming no change in market conditions. We will also start originating new CRE loans in the fourth quarter that are of high credit quality and geographically diverse. We've also started to experience growth in our health investment residential portfolio, which increased $100 million on a net basis. We're doing exactly what we said we would do, and I want to complement the entire Flagstar team on another successful quarter. Now turning to the slides and specifically Slide 10. This morning, we reported a net loss attributable to common stockholders of $0.11 per diluted share. We had the following notable items in the third quarter. First, we had a $21 million fair value gain on a legacy investment in Figure Technologies following its September IPO. Second, we recorded a $14 million increase in litigation reserves related to the settlement of 2 legacy cyber matters dating back to 2021 and 2022, 1 of which involved a third-party vendor. And third, we had $8 million in severance costs related to FTE reductions. Therefore, on an adjusted basis, after also excluding merger expenses, we reported a net loss of $0.07 per diluted share, significantly better than last quarter and in line with consensus. On Slide 11, we provide our updated forecast through 2027. We tweaked our 2025 noninterest income assumptions resulting in full year 2025 adjusted diluted EPS and in a range of minus $0.36 to minus $0.41 per diluted share. Our guidance for both 2026 and 2027 remains unchanged. One of the highlights this quarter was the double-digit increase in net interest margin. Slide 12 shows the trends in our NIM over the past several quarters which expanded 10 basis points quarter-over-quarter to 1.91% and has now increased for 3 consecutive quarters. In September, our NIM was 1.94% compared to 1.91% for the third quarter, and we expect to see margin improvement going forward, driven by a lower cost of funds as we manage our cost of funding lower low-yielding multifamily loans paying off a path or if they remain with Flagstar resetting at higher rates, ongoing growth in the C&I and other portfolios and a reduction in nonaccrual loans. Turning to Slide 13. Another highlight this quarter was the decline in noninterest expenses. Our noninterest expenses remained well controlled as they declined another $3 million in the third quarter and are down 30% year-over-year or approximately $800 million on an annualized basis. Slide 14 shows the growth in our capital over the past 5 quarters and the strength of our CET1 ratio. At 12.45%, our CET1 ratio ranks amongst the best relative to our regional bank peers. We will continue to prioritize reinvesting our capital into growing the C&I and other portfolios as we remain focused on diversifying the balance sheet and growing earnings. Slide 15 is our deposit overview. Similar to last quarter, we further deleveraged the balance sheet by paying down $2 billion of brokered deposits at a weighted average cost of 5.08%. Going back to the third quarter of 2024, we have now paid down almost $20 billion of flub advances and brokered deposits. In addition, approximately $5.6 billion of retail CDs matured during the quarter at a weighted average cost of 4.50%. We retained approximately 85% of these CDs and they moved into other CD products that were approximately 30 to 35 basis points lower than the maturing product. In the fourth quarter, we have another $5.4 billion in retail CDs maturing with a weighted average cost of 4.30%. These deleveraging actions, CD maturities and other deposit management strategies have allowed us to reduce deposit costs by 13 basis points quarter-over-quarter and liability costs by 10 basis points. We also saw an increase in interest-bearing deposits of $1.5 billion as a result of increased commercial, private bank and mortgage escrow balances. We continue to actively manage our cost of deposits and are targeting a 55% to 60% deposit beta on all interest-bearing deposits with the Fed rate cuts.

The next slide shows our multi-family and CRE par payoffs for the quarter. We continued to witness significant par payoffs of approximately $1.3 billion, of which 42% or about $540 million were rated substandard. Approximately $195 million of this quarter's payoffs were multi-family greater than 50% rent regulated. We continue to witness strong market interest for these loans from other banks and from the GSEs. The par payoffs are also leading to a substantial reduction in overall CRE balances and in our CRE concentration ratio. Total CRE balances have declined $9.5 billion or 20% since year-end 2023 to about $38 billion, aiding our strategy to diversify the loan portfolio to a mix of 1/3 CRE, 1/3 C&I and 1/3 consumer. In addition, the payoffs have led to a 95 percentage point decline in the CRE concentration ratio to 407% since year-end 2023. The next slide is an overview of our multi-family portfolio, which has declined 13% or $4.3 billion on a year-over-year basis. Our reserve coverage on the overall multi-family portfolio of 1.83% remains strong and is the highest relative to other multifamily focused lenders in the Northeast. Furthermore, the reserve coverage on those multifamily loans where 50% or more of the units are regulated is 3.05%. Currently, we have about $14.3 billion of multi-family loans that are either resetting or contractually maturing between now and year-end '27, with a weighted average coupon of less than 3.70%. If these loans pay off, we will reinvest the proceeds in our C&I or other portfolios or pay down wholesale borrowings. And if they stay with Flagstar, the reset rate is significantly higher than the existing rate, which provides a NIM benefit. On Slide 18, we've once again provided significant additional information on our New York City multi-family loans where 50% or more units are rent regulated. This tranche of the multi-family portfolio totals $9.6 billion compared to $10 billion last quarter with an occupancy rate of 99% and a current LTV ratio of 70%. Approximately 55% or $5.3 billion of the $9.6 billion are pass-rated and the remaining 45% or $4.3 billion are criticized or classified, meaning they are either special mention, substandard or nonaccrual. Of the $4.3 billion, $2 billion are nonaccrual and have already been charged off to 90% of appraisal value, meaning $370 million or 16% has been charged off against these nonaccrual loans. Furthermore, we also have an additional $40 million or 2% of ACL reserves against this nonaccrual population. Of the remaining $2.3 billion that are special mention and substandard loans between reserves and charge-offs, we have 7% or $165 million of loan loss coverage. We believe we're adequately reserved for charged these loans off to the appropriate levels and with excess capital of $1.7 billion before tax we think we're more than covered were there to be any further degradation in this portion of the portfolio. Slide 19 details the ACL coverage by category. The ACL declined $34 million compared to the second quarter to $1.128 billion, a result of lower HFI loan balances and stabilization in property values and borrower financials. The overall ACL coverage ratio, including unfunded commitments was 1.80%, broadly in line with last quarter at 1.81%. On Slide 20, we provide additional details around our asset quality trends. Criticized and classified loans continued to decline, down approximately $600 million compared to the second quarter. On a year-to-date basis, we have made tremendous progress in reducing these loans as they are down $2.8 billion or 19% since the beginning of the year. Our net charge-offs decreased $44 million or 38% compared to the prior quarter to $73 million, and the net charge-off ratio improved 26 basis points to 0.46%. Nonaccrual loans, including those held for sale, were $3.2 billion, relatively stable compared to the prior quarter. I would add that approximately 41% or $1.3 billion of nonaccrual loans are performing. The 1 borrower we moved to nonaccrual status in the first quarter who subsequently filed for bankruptcy remains in the bankruptcy process, but there is an auction in progress that we hope conclude sometime in early 2026, which will allow us to resolve our position sometime during the first half of next year. With respect to the 30- to 89-day delinquencies at quarter end, approximately $274 million of the $535 million were driven by 1 borrower who typically pay subsequent to month end and has done so again. As of October 20, $166 million of their delinquent loans have been brought current. More importantly, after quarter end, we sold approximately $254 million of these borrowers' loans above our book value, thereby reducing our exposure to this borrower. Finally, we continue to review the 2024 annual financial statements for all borrowers. And today, we've completed the review on the majority of them. I'm pleased to report that the vast majority have stayed consistent compared to the prior year, indicating an overall stable trend for our borrowers. We continue to deliver on our strategic plan and are excited about the journey we are on and the value we will create over the next 2 years. With that, I will now turn the call back to Joseph. Thanks, Lee. Before moving to Q&A, I'm also happy to share that last Friday, we closed on our holding company reorganization after receiving all necessary regulatory and shareholder approvals. As a result of this reorganization, Flagstar Financial, Inc. was ultimately merged with Flagstar Bank NA, with Flagstar Bank NA as the surviving entity. As I mentioned on last quarter's call, this reorganization simplifies our corporate structure, reduces our regulatory burden and lowers operating expenses by approximately $15 million. As always, we remain extremely focused on executing our strategic plan, including transforming Flagstar into a top-performing regional bank, creating a more customer-centric relationship-based culture and effectively managing risk to drive long-term value. Now we would be happy to answer your questions. Operator, please open the line for questions.

Your first question comes from Manan Gosalia of Morgan Stanley.

So I wanted to focus on the NII guide for the year. If I take the guide for the full year, relative to the progress year-to-date, it implies that NII should be up about 5% to 15% Q-on-Q next quarter. You're making good progress on the C&I loan growth side, NIM has been rising consistently and you should benefit from additional rate cuts from here. But at the same time, earning assets have also been shrinking as you pay down some of those broker deposits. So can you talk about how we should think of each of these spots next quarter and into the first half of next year?

Yes, definitely. First, regarding the balance sheet, it only saw a decline of $500 million even after we paid off another $2 billion in brokered deposits. We anticipate that Q4 will likely be the low point for us. The total assets will be between $90 billion and $91 billion, and we expect the balance sheet to begin growing as we progress through 2026. I want to emphasize that we foresee further expansion in our net interest margin (NIM) going forward, supported by several strategies. As I previously mentioned, the multi-family loans are either being paid off or reaching their reset dates, with a weighted average coupon below 3.7%. If borrowers continue with Flagstar, our pricing reset will align with a 5-year flub plus 300 or prime plus 2.75, which would benefit us. Should they pay off, we will reinvest those proceeds into commercial and industrial (C&I) growth, pay down high-cost broker deposits, or reduce flub advances. On the C&I side, we are demonstrating strong growth; in the third quarter, the average spread to SOFR on new loan originations was 242 basis points, indicating robust returns from our new C&I loans. As mentioned by Joseph regarding the pipeline, we believe this growth trajectory will persist. We also plan to initiate new commercial real estate (CRE) loans, focusing on high-quality, geographically diverse properties outside of rent-regulated New York City, particularly in the Midwest, California, and South Florida. We're beginning to see improvements in our mortgage health investment portfolio, which we expect to enhance further in a lower rate environment. We've effectively managed our funding costs by paying down expensive broker deposits and flub advances, and we've also lowered core deposit costs without requiring Fed cuts. Should the Fed cut rates, we project a beta of 55 to 60, which remains a focus on our liability side. Lastly, as we reduce our nonaccrual loans—something we expect to see in Q4—that will further contribute to our NIM. I realize that was quite an extensive response, but there are many factors at play here.

That was great. That was the detail I was looking for. As a follow-up to your comments on the commercial and industrial side, the originations were clearly very strong this quarter. Can you discuss whether this is a sustainable rate for the next few quarters? Should we expect it to accelerate from here? Also, could you elaborate on how you are managing risk during this rapid expansion, considering the macro uncertainty?

Thank you. We believe that we will continue to experience growth beyond what we achieved this quarter. We estimate our run rate to be between $1.7 billion and $2.2 billion per quarter going forward. It’s important to note that many of our new team members have only been with us for 3 to 6 months, and they are still acclimating and creating new opportunities for the company. We view ourselves as an engine currently operating at about half capacity, and we have the potential to enhance our overall performance in the coming quarters. Additionally, we plan to hire 20 more employees in the fourth quarter and around 100 in 2026, demonstrating our commitment to growth. Our strategy focuses on a specialized industry approach with 12 verticals, led by experienced bankers who bring extensive knowledge in those areas. For risk underwriting, we have the credit products team embedded as the first line of defense, conducting independent underwriting and due diligence separate from the relationship managers. Recommendations from this team go through a credit approval process that is overseen by our Chief Credit Officer. We are confident that our structure provides solid checks and balances to ensure adherence to our credit standards without significant deviations from our underwriting policies.

And Manan, one thing I would add, again, just looking at Q3, if you look at the average loan size of the new originations, it was just over $30 million. So as we've said before, we are not taking outsized positions in any 1 name or industry. We're diversified in terms of the size of the positions we're taking. We've said before, our sweet spot is maybe $50 million to $75 million. But in Q3, the average new loan commitment size was a little over $30 million, and that gives us comfort as well.

And I will leave it at a good point. On Slide 4, it does highlight the other businesses like Flagstar Financial and leasing and the MSR lending and a couple of others where actually, we thought the exposures to a number of individual borrowers were too high. And so we brought down in those portfolios significant amounts of high individual company exposure, and that's resulted in some of the declines year-to-date in those portfolios. We do think that will start to stabilize now as we've made our way through those portfolios in 2025.

That's great. And just a clarification, the $1.7 billion to $2.2 billion that you mentioned, that's originations, correct?

That is correct.

The next question comes from Dave Rochester with Cantor.

On the $1.7 billion to $2.2 billion that you just talked about in C&I production, when do you think you ultimately hit that? Is that a 1Q timing on that or further into next year? And then given that and the restart of the CRE originations and what you're doing on the resi production front, at what point do you expect total loans will start to grow again next year? And then with the 100 people or so that you're planning on hiring for next year, are there any new verticals contemplated in that?

I will address the first part of your question. As I mentioned to Manan, we believe that the lowest point for the balance sheet will be in the fourth quarter, which we expect to be around $90 billion to $91 billion. We anticipate that we will begin to see some modest growth in the balance sheet during the first quarter of 2026, followed by more significant growth in the second, third, and fourth quarters of next year. This outlines our expectations for balance sheet growth and its turning point.

Got it. So you're also considering whether total loans will stabilize next quarter, or is that just the initial point before stabilization?

That's right. That's exactly right. Yes.

And then regarding your question on the $2.4 billion and the $1.7 billion, we do expect growth on those numbers both this quarter and going forward. So I mean that number clearly can get north of $2 billion on a pretty consistent basis.

That's great. And then just on the elimination of the holding company, I know that that exempts you from annual stress tests whenever you cross over $100 billion or whatever that threshold is at that point. Any other regulatory relief you get from that as well? I know you save on the cost front, but anything else that you'd point to?

Yes. I mean in a lot of instances, you have examinations that cover the same thing from the OCC to the Fed. So you eliminate that, you also eliminate a lot of staff interaction with the Fed. So there's also caution you can't exactly quantify but frees up resources in time. So we obviously think it's the right thing to do. And for us, we do not do today nor do we plan to do non-admitted activities. So it was a logical step for us as an organization.

The next question comes from Ebrahim Poonawala with Bank of America.

So I guess, maybe a question around, from an expense standpoint. So you talked about all the hiring over the coming year. When you look at the adjusted expenses, about $450 million in your outlook for next year. It seems like expenses are kind of flatlining at this run rate. Just talk to us in terms of incrementally like what's the cost save opportunity left within the expense base to invest and like the puts and takes around why they could be higher versus lower than what you have forecasted?

Sure, Ebrahim. I want to take a moment to acknowledge the entire Flagstar team for their outstanding work. As Joseph and I mentioned, comparing the Q3 '24 and Q3 '25 run rates shows an $800 million reduction in noninterest expenses, which required significant effort. The team has truly excelled in cutting down these expenses. Looking ahead, our current run rate is approximately $450 million per quarter, which aligns with the upper end of our 2026 expense guidance of $1.8 billion. We see opportunities for further savings in three main areas. First, we can keep reducing FDIC expenses through various strategies we've already initiated. We've made progress in optimizing our liquidity by decreasing wholesale borrowings and broker deposits, and we aim to continue that momentum while also focusing on profitability, asset quality, and regulatory relations. Second, we believe there is potential to further lower vendor costs; we've made strides in the last nine months, but there's still more to do. Finally, we have significant technology projects in progress that will help us achieve greater efficiencies and cost reductions as we move into 2016 and beyond.

Just to address Lee's question about technology, we previously operated 6 data centers within the company, with 2 designated for each legacy organization. Last quarter, we reduced that number to 4, and our goal is to ultimately consolidate to 2 sites. Transitioning from 6 outdated legacy data centers to a new platform will enable us to significantly reduce costs in this process.

Got it. That's helpful. I have a separate question regarding noninterest-bearing deposits. It seems like the balances may be stabilizing, and I understand that it takes time for loan relationships to convert into core deposits. Can you provide us with an outlook on NIB deposit growth, either in terms of dollar amounts or as a percentage of the overall mix? How do you see that trend developing? Also, what is the estimated timeline for the lending relationships brought on by your bankers to translate into core deposit growth?

Yes, yes. So it does take a little bit of time, and we're seeing some traction. But obviously, as we move forward, we think we'll see a lot more traction. And so as we think of the noninterest-bearing deposit growth, I think it really comes from 3 areas, and you've touched on one. As we bring on all of these new C&I relationships, we certainly want to leverage those relationships to bring on more deposits, including operating accounts ultimately and those noninterest-bearing deposits. We also see growth on the noninterest-bearing deposit side coming from our private bank. As we mentioned on the last call, we've hired Mark to run the private bank. He has done a nice job of reorganizing the private bank and making sure that all the right product sets are in place. So we look like a real sort of private wealth bank. And so we think that we'll be able to leverage the private bank and those products to drive noninterest-bearing deposits as we move forward. And then obviously, our 360 bank branches, they play an important role in continuing to grow noninterest-bearing deposits with our existing customer base and bringing in new customers as well. So that's how we see the noninterest-bearing deposit growth, where it's coming from.

The next question comes from Jared Shaw with Barclays.

Maybe starting on the credit side. Should we think that as we move forward and as you see the runoff in multi-family and CRE, maybe the loans that don't run off tend to have the weaker characteristics. So should we expect to see maybe a continued growth in CRE NPLs, but not corresponding growth in provision like we saw this quarter that you feel like those marks are adequate and sufficient?

Yes, we experienced a significant decrease in nonperforming loans during the second quarter. Recently, it remained relatively stable as we worked on a large portfolio sale. However, for the fourth quarter, we anticipate reductions of around $400 million in nonperforming loans, potentially increasing to $500 million. We have also established a dedicated team focused on nonperforming loans that are still being paid, which make up about 42% to 43% of our total nonperforming loans. A substantial portion of these loans continues to receive payments, but our analysis shows that their cash flows from single source or repayment properties are insufficient. As a result, borrowers are relying on their cash reserves to keep these loans up to date. We are concentrating on this area, and we are noticing a downward trend in nonperforming assets. While our classified loans decreased and our nonperforming assets remained nearly unchanged this quarter, we do observe a declining trend overall.

Yes. And again, Jared, as you know, when we did the credit review in '24, we were deliberately punitive on ourselves. And the other point I would add to what Joseph mentioned, and I mentioned this in my prepared remarks, you've got 1 borrower that is in bankruptcy that is $500 million of those nonaccrual loans. And as I said, that's moving into an auction process. And so once that moves through the process and concludes, we feel that we'd be able to deal with a large chunk of those nonaccruals in the early part of 2026. That's in addition to the $400 million pipeline that Joseph mentioned.

Great. So those are two separate components. That's good information. As we consider guidance and your comments about assets potentially reaching a low point in the fourth quarter, what should we anticipate regarding total asset growth or total loan growth as we look ahead to year-end 2026 and 2027 in relation to that guidance?

Yes. No problem. So as I mentioned, at the end of '25, we think the balance sheet will be sort of $90 billion to $91 billion. We think that at the end of '26, our balance sheet will be around high $96 billion to sort of high $97 billion, right around that range. And then in '27, we think we get it to about $108 billion, $108 billion, $109 billion.

The next question comes from Mark Fitzgibbon with Piper Sandler.

I wondered if you could share with us of the $1.7 billion of C&I originations you had in the third quarter, what percentage was participations? And also curious if you had any tricolor or first brand exposure because I did see a little uptick in nonaccruals in the C&I bucket?

Yes, that was one credit. We're running 50% to 60% of our loans as participations. However, the key difference is that the individuals joining our company who bring these opportunities have direct relationships with management. We do not purchase participations unless we are directly interacting with the company's management, which sets us apart from simply having a trading desk that buys loan participations. All these are active relationships that have been ongoing. In our documents, we require the relationship manager to create a relationship model detailing what we expect to achieve in both fee income and deposits from each relationship. Therefore, we maintain a high standard for our expectations before getting involved in any credit.

Just to confirm, we had no exposure to first brands or Tricolor or any of the other names that have been mentioned this quarter and obviously, we're pleased about that. We've looked at that. We do have a very, very small MDF book. A big portion of that is our MSR lending. So we feel good about that and no exposure to any of the names that have been disclosed previously.

I have a separate question. What does the note sale market look like today for moderately challenged New York multifamily loans? Is there significant depth to that market? Where can these notes currently be sold? Can you provide any insight on that?

I believe that despite the concerns emerging over the past few months regarding New York City rent regulation, we still achieved $1.3 billion in par payoffs during Q3, with 42% of that being substandard. Instead of seeing a lack of payoffs, there's still significant demand for this asset class from other lenders and the GSEs, as I mentioned earlier. This is positive, and in a declining interest rate environment, we can expect more par payoffs moving forward. This will help us reach our goal of a diversified balance sheet of one-third in each category even faster.

The next question comes from Bernard Von Gizycki with Deutsche Bank.

Lee, in your prepared remarks, I believe you mentioned that $195 million of the par payoffs of the $1.3 million were regulated over 50%. And I think that total portfolio declined almost $1 billion. Just wondering, were there any asset sales in that particular portfolio? And any updates you can provide on how we should think about the size of this book going forward in the next 6, 12 months?

Yes, I believe we will continue to see a decline, primarily due to the par payoffs we experience each quarter. Joseph mentioned that from a nonaccrual perspective, we currently have an active pipeline of $400 million that we expect to close in the fourth quarter. This is how I view the movement in the rent-regulated book moving forward. We provide these numbers because we are not observing any adverse selection; instead, we see par payoffs across all commercial real estate asset classes, whether they are market-based, rent-regulated under 50%, or rent-regulated over 50%. Our expectation is that par payoffs and reductions will persist across all multifamily asset classes.

Okay. Tying the payoffs with loan yields, I know they increased by 3 basis points in the second quarter. We've noticed that tick up. Given the paydowns of the nonaccruals and the shift from multifamily to commercial and industrial, along with the anticipated growth in commercial and industrial, should we expect a more significant change in yields? Or are these par payoffs at higher yields holding that back a bit? I just want to understand the expansion of loan yields moving forward.

Yes. The par payoffs do not include everything below 3.7%. Some of these are loans that have already reset. Looking at the blended weighted average coupon of the $1.3 billion that paid off in Q3, it was 5.7%. This reflects a combination of low coupon loans and loans that have already reset, which is what you are referring to.

And some of the payoffs also were coming out of some of the legacy C&I businesses, where we're reducing the exposures down in those credits where they're in the LIBOR plus, on average, 240 range. So some of those payoffs have some impact on that.

The next question comes from David Chiaverini with Jefferies.

Your paydown activity has been very strong over the past couple of quarters. Do you have any insights on the anticipated total paydown activity for the fourth quarter, especially regarding the $400 million in non-performing loans? Additionally, how much of that could fall under the substandard category?

I think we have expectations for a similar range of $1 billion to $1.3 billion in the fourth quarter. So I would say that's been somewhat unabated, so to speak, of especially in the market of the regulated New York multi-family. Surprisingly, as Lee commented, that continues to be a robust refinance by the agencies and a couple of the large banks who continue to add to their portfolios. So we don't see any material change. We had originally modeled at the start of the year, somewhere between $700 million and $800 million a quarter, and that just continued to accelerate in the second quarter. Obviously, the third quarter was the strongest at $1.5 billion. But I think those numbers paying somewhere in that range of $1 billion to $1.5 billion in the fourth quarter.

Great. And then could you refresh us with thoughts on Mamdani and the impact his potential election win could have on provisioning looking out to next year?

Yes. One of his stated items was that he would freeze the rent regulated rate increases for four years. The first impact of that decision will be made mid-next year by the commission regarding those freezes, so there’s likely going to be a bit of a delay. However, we approach that entire portfolio by reviewing 97% of the financials. We conduct a property-by-property analysis of the cash flows, and if the cash flows are inadequate, we perform appraisals on the properties. Overall, we feel we have a solid understanding. This year, as Lee mentioned, we have nearly completed our review of that portfolio and have not observed any material changes. This is primarily due to significant factors affecting those properties, such as insurance costs rising by 30% to 50%, along with increased labor and HVAC rates; however, we did not see these lead to further increases this year. Thus, when modeling, you can assume flat revenues, but it’s essential to focus on the expense side, as that will determine whether these properties generate positive cash flow.

I think a couple of other things I would just add to what Joseph said, I mean rent increases for the next 12 months have just gone into effect. So the 3% for 1 year, 4.50% for 2 years. that runs through September of 2026. But I think what will have a bigger impact on these owners are reductions in interest rates. I think that's going to be a big advantage for them. And again, we said this previously, a lot of these owners have benefited from the 1031 tax rules. So they have low tax basis in these properties as well.

The next question comes from Chris McGratty with KBW.

The margin improvement on Slide 11 over the next 2 years roughly 90 to 100 basis points. How much of it is the resolution of credit? Like how much is the margin being suppressed from nonaccruals right now, give a ballpark?

To provide some clarity, nonaccrual loans do not contribute to earnings or capital because they carry a 150% risk weight. By reducing these loans, we release capital. Even if we transfer them to assets with a 100% risk weight, we would still free up 50 basis points. However, they aren't generating earnings. If we were to decrease nonaccruals by $1 and replace that with cash, it could earn approximately 4%. If we then invest this in commercial and industrial loans, where we have a spread of SOFR plus 242 basis points, that would result in an even greater improvement. Therefore, addressing nonaccruals is a central part of our strategy. Looking ahead to 2026, we believe we can reduce nonaccruals by up to $1 billion, with $500 million of that linked to one borrower in bankruptcy, which we aim to resolve in the early part of '26. We anticipate being able to decrease an additional $500 million throughout the rest of the year. This will significantly influence our net interest margin improvement. Additionally, we must consider other factors, such as the ongoing adjustment of low coupon multifamily loans, expanding our C&I book, and increasing other portfolios on our balance sheet. We are starting to originate new commercial real estate loans, and there are opportunities in our mortgage and residential securities portfolio. Moreover, managing our core deposits and reducing wholesale borrowings will all contribute to net interest margin expansion.

That's helpful. Joseph, over the last 1.5 years, you have successfully focused on optimizing the balance sheet, capital, and liquidity, and you're also making great progress on expenses. What do you think the conversation will be like a year from now? Do you expect it to shift in terms of the strategic use of capital? Any insights on how we should think about capital allocation between growth, buybacks, and other strategic options?

We haven't discussed that at the Board level yet. As we move into 2026 and demonstrate significant progress with the nonperforming loans in our portfolio, we will have a clearer picture of the potential growth from our business activities. This will allow the Board to meet midyear and evaluate what to do with any excess capital. Our Board is very focused on being shareholder-friendly, concentrating on earnings growth and using capital efficiently.

Perfect. And then, Lee, if I could, on the earning asset, the asset discussion. What's the embedded thoughts on the cash levels and the security balances in the next 1 to 2 years?

Yes. I believe that in the fourth quarter, you will likely see an increase in securities due to our excess cash. Our securities balances are expected to rise by approximately $1 billion during this period. It seems probable that we will maintain that level of securities into 2026. Additionally, I would estimate that our cash will remain in the range of $7 billion to $8 billion as we progress through 2026.

Okay. So to get to those asset totals, it's contingent really on the loan growth, continuing the momentum. Got it.

That's exactly what's driving the growth on the balance sheet, correct?

The next question comes from Christopher Marinac with Janney.

Lee and Joseph, I just want to circle back on deposits from the commercial C&I growth that you obviously had a great quarter. Are there any goals on deposits these next several quarters? I'm thinking more next year than next quarter, but just curious to flesh that out further.

We are expecting around $6 billion in new deposits from our commercial and industrial group, which will come from our lending relationships. Additionally, we have created a deposit-only group that will concentrate on specific sectors such as title, HOA, escrow, and the traditional insurance industry. This team is dedicated to high deposit categories, so we are optimistic about gaining significant momentum on the deposit front.

Yes. And I would just add, as well as the $6 billion that Joseph mentioned, we do have sort of $2.5 billion that's tied to the CRE book. And so as we start originating new CRE loans, again, our strategy is about relationship banking. It's not us just giving the balance sheet away. We want to establish much deeper relationships, whether that be through deposits or being able to create fee income opportunities. And so that's the model that we're deploying across all businesses within the bank, not just the C&I piece, but with the private bank and the loans that they're originating, particularly the mortgages.

The next question comes from Anthony Elian with JPMorgan.

The reduction in nonaccruals you expect in Q4 and through '26, is all of that occurring organically outside of the 1 in auction? Or does that include any asset sales as well?

Most of it will be organic.

Okay. And that includes... Go ahead. Go ahead, Lee.

Yes. It's organic, but we deploy a number of strategies. Joseph mentioned but there's work out, some could be through sales. So it's organic, but it's us working the various options and strategies that we can deploy against that nonaccrual book.

Yes. Our approach in what I think we found is you can sell those pools, you, in today's market, take a sizable discount to move that. And who we sell those to are going to do the same things that we would do, which is pick up the phone and see if we can work something out with the borrower. I'll remind you, in a lot of instances, low 40% of those borrowers have never missed a payment with us. So in their mind, they're performing at the terms and conditions of the loan. So we also have a pretty good track record that when we've sold assets or negotiated our way out of those loans, we've generally had a slight gain on the resolutions of those credits, which I think reflects that for the most part, we have those loans marked pretty close to where we're exiting the transactions.

And then on credit quality more broadly. I know you mentioned in the prepared remarks you don't have exposure to tricolor or any of the other names that have come up, but I'm curious if you've done any reviews on procedures or policies, particularly on the asset-based lending vertical within specialized industries after the recent credit events that have surfaced over the past several weeks.

Yes, that's a great question. We have ensured that we do not have exposure to any of the names mentioned in recent press. We assessed our NDFI portfolio, which totals around $2.3 billion, with $1.1 billion allocated to MSR lending. We primarily lend to the largest mortgage REITs and originators in the country, and we are confident in that segment. On the lender finance side, we have commitments of about $1 billion, with $600 million already drawn. We conducted a thorough review of that book and feel very positive about it as well. Given the recent events in other areas of the industry, we performed a detailed evaluation.

The next question comes from Matthew Breese with Stephens Inc.

I wanted to go back to the NIM. What percentage of loans today are pure floating rate? And then second, if you have it, what was the spot cost of deposits either today or at quarter end?

Yes. When you examine our balance sheet today, the commercial and industrial loans are primarily floating. The residential loans we have are generally adjustable-rate mortgages with 5-, 7-, or 10-year terms, which adjust only after those specific periods. So there's some floating there. Additionally, we have cash and some securities. As for our spot rate, it was at 2.82 a couple of days ago, Matt.

Great. I appreciate that. And then the second one, within the updated guidance, there was a change in the tangible book value outlook. It now includes the warrants. What drove that change? And could you help us out with the average diluted versus common share outstanding expectations for the fourth quarter and early 2026? I also think there was some thinking, and I was curious on this as well that you'll be profitable in the fourth quarter. I was curious if that holds up as well?

So that is what's driving it. It's the warrants. So the warrants kick in, in Q4, the share count goes from about 416 million to 480 million and then that carries through in '26 and '27. We've also adjusted the total book value on the guidance slide for the warrants as well. So that's what you see, Matt, exactly right.

And that will impact average diluted as well as common shares outstanding?

Yes, that's correct.

Okay. And then on profitability, is the expectation still that you'll be profitable in 4Q?

We expect to be, but there's a lot of moving parts. And I think, again, I'll just point to the progress that we've made quarter-over-quarter for the last few quarters.

The next question comes from David Smith with Truth Securities.

Technical 1 on capital. After the holdco got consolidated down to the bank, I think there were some preferreds that got moved down. Is there any difference in how those are going to qualify for Tier 1 treatment now?

No. No change at all in how they will qualify.

The next question comes from Jon Arfstrom with RBC Capital Markets.

On the CRE pricing, you mentioned earlier, Lee, is that market or acceptable pricing on renewals? Just curious if you're losing deals on pricing? Or is that not really the case?

So I would say, and this is why we're seeing a significant amount of par payoffs that borrowers are able to get better deals at other institutions or the agencies. So we've been very rigid in not moving off the 5-year flub plus 300 or prime plus 375. The reason being, as you know, we are overly concentrated in CRE, and we are looking to reduce that concentration. And so I think the reason that you've seen the heightened payoffs that we've experienced is we're being very rigid and sticking to that sort of knitting. And I think other lenders are leaning into the space and those borrowers are able to get better deals than what I just mentioned, and that's what's driving the par payoffs. And we're okay with that because, again, we're trying to reduce our exposure to CRE and multifamily and get to that diversified balance sheet structure.

Okay. Good. I appreciate that. And then, Joseph, for you, maybe kind of a simple question. But when I look at the credit stats, they're kind of flat to down. And I know it's not linear, but in your mind, is there anything new in the legacy credit book relative to a quarter ago? Or is it basically you know where the issues are and it's just timing for these numbers to fall?

Yes. There's nothing new. We reviewed the entire multi-family portfolio again and outlined on Slide 18 where the perceived risk lies within the bank, particularly in the regulated segment above 50%. I believe we are on track to address the credit issues, and we have a structured plan in place to resolve them.

This concludes the question-and-answer session. I'll turn the call to Mr. Otting for closing remarks.

Well, thank you, everybody, and I'd like to personally thank our Board and especially our Lead Director, Secretary Steven Mnuchin. The work and commitment has been really important. And the leadership team at the bank has really valued the Board. I think maybe over the last 12 to 15 months, we probably set a record for Board and committee meetings in a bank. And it really shows in the results. I'd also like to thank the executive leadership team of the bank and the women and men of the company. We really are focused on building a great company. And I thank you for all your work, dedication to the bank and very much important to our customers. And then as a final note, I'd like to thank the Federal Reserve and especially Mona Johnson and her team. While we no longer be regulated by the Fed, she was a source of knowledge and assistance as we navigated our challenges. So thank you again for taking the time to join us this morning and your interest in Flagstar Bank.

This concludes today's call. Thank you for joining. You may now disconnect.