Earnings Call Transcript - FLG Q4 2020

Operator, Operator

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

Ken Schellenberg, Investor Relations

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

Sandro DiNello, President and Chief Executive Officer

Thanks, Ken, and good morning to everyone listening in. I hope all of you and your loved ones have been able to stay safe and healthy through these most unusual times. I’m joined this morning by Jim Ciroli, our Chief Financial Officer; Lee Smith, our President of Mortgage; and Reggie Davis, our President of Banking. I’m going to start by providing a high-level view of our performance for the quarter and the year, then I’ll turn the call over to Jim for details on our financial results. Reggie will follow with an update on the Community Bank; then Lee will handle the Mortgage segment, including Servicing, and then we’ll open up the line for questions. 2020 brought many challenges and few companies ended the year stronger than when they started it. But Flagstar, it’s the opposite. We kept getting better throughout the year as we adapted to a new normal and finished the year extremely strong. This is a testament to how we built our business model, to have diverse revenue streams and a flexible balance sheet that provides us optionality and less volatile earnings during changes in economic environments. You recall in 2018, the mortgage business was challenging, where we said, grew earnings as the rest of the company stepped up to contribute. Then in 2019, declining interest rates put pressure on our spread income, but we were able to temper this by capitalizing on favorable conditions in the mortgage market and that carried into 2020. Today we are looking at an exceptionally strong fourth quarter, a period which I consider to be the most successful year in our history. As reported, we posted net income of $154 million or $2.83 per share, up a phenomenal 183% from the same quarter last year. For the year, we achieved net income of $538 million, or $9.52 per diluted share, topping the result for the full year 2019 by 151%. In fact, our earnings for this quarter alone are roughly three quarters of what we earned in all of 2019. Mortgage continued to lead the way in the fourth quarter, as it has for most of the year, but the contributions from our banking and servicing businesses should not be overlooked. We believe the relationships with our customers strengthened through adversity. That is true in our banking business, where our team focused all year on supporting our borrowers and helping them navigate the challenging conditions brought on by the pandemic. We want our borrowers to remember that we stood by them every step of the way. It’s times of adversity that build the kind of long-lasting relationships we want to be our hallmark. At the same time, banking produced steady results, again led by the warehouse business, which is now the third largest in the nation. On to mortgage, what an incredible year. The mortgage team delivered amazing results throughout the year, as they took advantage of an extraordinary mortgage market, while maintaining pricing and expense discipline. As always, we managed the volume to maintain industry-leading service levels, while producing margin and revenue we haven't seen in a very long time. And our servicing business kept delivering consistent results, supporting our mortgage business, providing efficient funding, adding fee income and keeping the number of loans we service or sub-service steady, even in the face of historically high payoffs related to the robust refinance market. We couldn’t be more pleased with how we ended the year and the many milestones we achieved as well as the investment grade rating from Moody’s. This further validates the strength of our balance sheet and the earnings power of the business model. It has been a long and winding road, but I believe we are a very special company with a very bright future. We move into 2021 with a healthy net interest margin, the power to generate strong non-interest income and a fortress balance sheet. We are ready to take on whatever 2021 throws our way. With that, let me now turn it over to Jim.

Jim Ciroli, Chief Financial Officer

Thanks Sandro. Turning to Slide 6, net income this quarter was $154 million, $2.83 per share. This compared to $222 million, $3.88 per share last quarter. The decrease on a linked-quarter basis was largely due to the extraordinary levels of gain on sale revenue last quarter. Increases in net interest income and a lower credit provision this quarter partially offset the lower mortgage revenue. For the year, we had net income of $538 million or $9.52 per share compared to $218 million or $3.80 per share that we earned in 2019. Current year earnings represent a 2% return on assets and a 28% return on equity. Diving deeper into this quarter’s performance our pre-tax, pre-provision earnings were $207 million compared to $327 million last quarter. Net interest income increased $9 million or 5% as average earning assets grew $1.4 billion while the net interest margin was flat at 2.78%. Excluding loans with government guarantees that have not been repurchased, the net interest margin actually increased 4 basis points. This performance was primarily driven by the strength of our warehouse business that has rate floors in place to protect from margin compression and our core deposits which benefited from high custodial balances and also from the maturity of higher cost CDs and the expiration of promotional rates on savings accounts. We will review these numbers in a couple of slides. Mortgage revenues were $232 million, a decrease of $126 million compared to the very strong number we reported last quarter. During the quarter we saw gain on sale margins decrease from last quarter’s record levels. Asset quality remained strong. Net charge-offs were 4 basis points. Early-stage delinquencies were only 22 basis points of total loans. Non-performing loans were $57 million, up $12 million as a result of two commercial borrowers being put on non-accrual status during the quarter. Our allowances for credit losses remained flat to the prior quarter at $280 million and our coverage ratio, excluding warehouse, increased to 3.2% from 3.1% at the end of the third quarter. We’ll provide more details when we get to the asset quality slide and take a deeper dive into CECL. Capital also remained solid. Total risk-based capital was 11.9% at December 31st. Our CET1 ratio was 9.1% and our Tier 1 leverage ratio was 7.7%. We repurchased $115 million of stock which caused our capital ratios to decline. This was more than offset by our earnings and total assets grew $1.6 billion causing our CET1 and Tier 1 leverage ratios to decline slightly. Total risk-based capital increased due to the subordinated debt we issued during the quarter to fund the stock buyback. Finally, we continued to demonstrate significant capital generation with growth in our tangible book value per share of $38.80 at year end, up $3.20 from September 30 and $10.23 from one year ago, a 36% increase. So let’s turn to Slide 7 and dive deeper into the income statement. Net interest income increased $9 million to $189 million this quarter, up 5% from last quarter. Average earning assets grew $1.4 billion led by warehouse lending. Deposit costs came down 15 basis points on average; retail banking and customer deposit balances increased $0.3 billion and $1.2 billion respectively. We’ll dive deeper into net interest income and our interest rate position on the next slide. Non-interest income decreased to $115 million from $337 million due to lower mortgage revenues and non-interest expense was $319 million, up $14 million from the prior quarter. Finally, our effective tax rate was 24.8% this quarter. This is the result of $2 million in additional state level taxes that resulted from MatlinPatterson’s exit and certain non-deductible expenses including FDIC insurance and incentive compensation. We expect that the effective tax rate in 2021 will be approximately 23%. Turning to Slide 8, average earning assets increased $1.4 billion from last quarter. This resulted from a $1.3 billion increase in warehouse loans and a $0.4 billion increase in the loans with government guarantees that have not been repurchased. The increase in warehouse loans resulted from continued success in bringing on new customers. Declines in securities and in mortgage loans held for investment were due to faster prepayments that partially offset the balance sheet growth. C&I balances also declined by $200 million primarily driven by the full quarter impact of the sale of the PPP loan portfolio in the third quarter. Balances of the loans with government guarantees peaked at the end of last quarter; the balance declined only slightly throughout the fourth quarter resulting in an average balance increase. We expect to see balances gradually decline through 2021. As we’ve stated previously, we do not believe there's significant downside to holding these loans either by buying them or through this accounting close-up. If we were to repurchase these loans, we can pledge the loans for FHLB and they’re 20% risk-weighted assets. Further, if we do repurchase the loans, we could resell those at a later date, which is attractive for us and they remain government guaranteed. Average deposits increased $1.5 billion from last quarter. Custodial deposits drove $1.2 billion of this increase. We also saw growth of $311 million in DDA and savings account balances, a 5% increase from last quarter and $188 million seasonal increase from government deposits. Overall, we managed deposit costs lower by 15 basis points as deposits continued to reprice into the new current environment providing support for our net interest margin expansion. We continue to believe that our interest rate risk position is in a good place due to the actions we’ve taken in this lower interest rate environment. We feel that we can protect our net interest income and net interest margin and believe that our net interest margin should be relatively flat where it’s been in the past three quarters. There are interest rate floors in place on a large portion of our commercial loan book and these floors help protect us against further margin compression. The actions we took earlier this year to lock $2 billion of lower rate funding remains in place. While this has made us more asset sensitive in our structural balance sheet, our mortgage origination business is naturally liability sensitive. So we believe the combination positions us well for future success regardless of where rates are. We continue to have a strong liquidity position driven by the strength of our deposit base and access to multiple sources of liquidity built on-balance sheet with our high-quality securities portfolio and off-balance sheet with our undrawn FHLB facilities. At December 31, we had ready liquidity at $4.5 billion not including the ample access we have to borrow at the discount window. Let’s now turn to Slide 9, which details our non-interest income and non-interest expenses. Non-interest income decreased $115 million due to the extraordinary levels of mortgage revenue in the prior quarter. Our gain on sale revenue of $232 million represented a decrease of $114 million. Fallout-adjusted locks decreased 20% to $12.0 billion and the gain on sale margin was 193 basis points. Channel margins continue to come down gradually and Lee will provide more insight in the gain on sale revenues later. The net return on mortgage servicing rights declined $12 million from the prior quarter. Prepayment continued to be elevated resulting in higher one-off items. The capitalization of our MSRs remained relatively flat at 86 basis points of UPB at the end of the quarter, up only 1 basis point from the prior quarter. We would observe that the MSR market continues to show signs of improvement, as shown with the bulk and flow sales that we executed during the quarter. Non-interest expense increased to $319 million for the fourth quarter, compared to $305 million last quarter, primarily reflecting a $7 million loss recognized on the early extinguishment of our senior notes and $2 million of extra charitable contributions we made to Flagstar Foundation in support of its efforts to help those in greatest need in the communities we serve. Both of these items will not recur next quarter. We saw a $7 million increase in mortgage expenses which was driven by efforts to expand capacity along with the higher retail channel mix. Lee will provide more insight into the mortgage expenses later. We expect non-interest expense of $295 million to $305 million and an efficiency ratio in the low 60s for the first quarter of 2021. So, let’s now turn to asset quality on Slide 10. Credit quality and the loan portfolio remained strong. Early-stage delinquencies continued to be relatively low as early-stage consumer loan delinquencies as of December 31st were flat and early-stage commercial loan delinquencies increased driven by one commercial loan that is beyond its maturity date which we haven’t renewed yet, but which remains current with respect to interest payments. Total early-stage delinquencies were $36 million at December 31st and were only 22 basis points of total loans held for investment. Commercial deferrals were only $22 million at December 31st. We continue to be pleased with how well the portfolio is holding up despite what the economy has done this past year. Non-performing loans picked up slightly as we added two small commercial credits to non-accrual status. Our allowances for credit losses of $280 million covered 1.7% of total HFI loans, excluding warehouse loans from the denominator given their relatively clean credit loss history and considering that substantially all of these loans are collateralized with agency or government-backed loans. Our coverage ratio stands among the best in the industry at 3.2%. On Slide 11, we can see that we ended the quarter with $280 million of allowances for credit losses consisting of $252 million of allowance for loan losses and $28 million in the reserve for unfunded loan commitments. As we did last quarter, we used three different Moody’s forecasts of the next two years to guide our allowance levels: an S1 growth forecast weighted at 30%, a baseline forecast weighted at 40%, and an S3 adverse forecast weighted at 30%. All forecasts used December releases. The resulting composite forecast for this quarter was slightly better than the composite forecast we used last quarter. Unemployment increases only slightly in 2021 and begins recovering in 2022. GDP recovers slightly by the end of the year from current levels. It does not return to near pre-COVID levels until 2024. HPI decreases 1% throughout 2021. While there are positive economic signs, we continue to be cautious and are not confident about the recovery until we see more evidence that the recovery will sustain. Accordingly, we have qualitative reserves of $77 million primarily in our commercial real estate and C&I portfolios guided by the CECL allowance model output using the Moody’s adverse scenarios to provide coverage for industries and customers that we believe could be more exposed to stressful conditions in our forecast. We feel very comfortable about the strength of credit in the portfolio. It’ll be difficult to provide future guidance. We’ve provided a portfolio-by-portfolio breakdown of the resulting ACL coverage ratios in our appendix. On Slide 12, we’ve updated our exposure to those industries we believe are more likely to be most impacted. In total, we have $1.0 billion of outstanding loans in this category representing 6% of our total loan portfolio. It’s interesting to note we have almost no loans in deferral in these portfolios today. In our commercial and industrial loan portfolio, the COVID-impacted loans totaled $0.3 billion. You can see that the exposure here is relatively low, especially as there are no deferrals and only one $10 million C&I loan is non-performing. We have no oil and gas exposure. In our commercial real estate portfolio, we have $0.7 billion outstanding in the areas most impacted by COVID, including commercial real estate loans secured with hotels, retail properties and senior housing. Of loans in this category, our average pre-COVID LTV was 55%, and our average pre-COVID debt service coverage ratio was 1.6 times. We still don’t have any loans in these portfolios that we believe will default. While we believe that we will have losses, we continue to see strong borrower support across the portfolio. We feel good about our credit risk in this portfolio, as we’re starting from a position of strength from our carefulness about who we lend to, to the disciplined underwriting of those credits, and the pre-COVID LTVs and debt service coverage ratios in the CRE portfolio. Turning to Slide 13, our capital ratios remain solid and nicely above our stress buffers. At December 31st, our total risk-based capital was 11.9%. Our CET1 ratio was 9.1%, and our Tier 1 leverage ratio was 7.7%. As I mentioned before, we repurchased $150 million of stock which caused our capital ratios to decline. This was more than offset by our earnings and total assets grew $1.6 billion causing our CET1 and Tier 1 leverage ratios to decline slightly. The total risk-based capital increased as a result of the subordinated debt we issued during the quarter to fund the stock buyback. As we pointed out with our warehouse loan portfolio, loans held for sale and loans with government guarantees, we have more than half of our balance sheet and over 1,100 basis points of risk-based capital dedicated to these three asset categories that have very little risk content. Warehouse loans are secured with recently originated first mortgage loans and turn over every 10 to 15 days. Loans held for sale turn over every one to two months and this portfolio was carried at fair value. The portfolio of loans with government guarantees has no real downside, and perhaps a modest upside. When you take all of this into consideration, we believe that we are operating at strong capital levels, given our low-risk balance sheet composition. If we just weighted our warehouse loans at 50% rather than 100% under current risk-based capital rules, you’ll see that our capital ratios compare favorably to most other mid-sized banks. This makes sense as the loans are fully collateralized by 50% risk-weighted assets and those assets remain under our custody while the loans are on our lines. Further there is even an outstanding proposal from the mortgage bankers’ associations to make a distinction in risk-weighted capital rules, a proposal we wholeheartedly support. So, adjusting the risk weighting on the warehouse loans, our total risk-based capital would be 14.0% — over 200 basis points higher — which would put that ratio above the average for all mid-sized banks. Our CET1 ratio would be 10.7%. So that provides the rationale behind our belief that we have solid — I’d even say strong — capital ratios. I’ll now turn it over to Reggie to cover Community Banking.

Reggie Davis, President of Banking

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

Lee Smith, President of Mortgage

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

Operator, Operator

Our first question comes from Bose George with KBW.

Bose George, Analyst (KBW)

I wanted to ask first about the net interest margin guidance. You noted that it’s going to be roughly flat in the next few quarters. Just what are your thoughts there in terms of expectation for the warehouse? So it’s obviously been very supportive to the margin, how do you think that sort of plays into that guidance?

Jim Ciroli, Chief Financial Officer

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

Reggie Davis, President of Banking

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

Jim Ciroli, Chief Financial Officer

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

Reggie Davis, President of Banking

And we’re still investing in that business and we’re improving the technology platform to drive greater efficiency there. So, we really like that business.

Bose George, Analyst (KBW)

Okay, great thanks, that’s helpful. And then actually I wanted to go back to Lee’s comments just on forbearance, on the GSE forbearance side. Can you remind us what the deadline is for that? Is there a clear deadline for when that ends? You guys still doing forbearances there, how does that program play out?

Lee Smith, President of Mortgage

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

Bose George, Analyst (KBW)

Okay. But are new forbearances being offered now, so can a borrower enter a new forbearance currently?

Lee Smith, President of Mortgage

Yes, they could call and request forbearance, correct.

Bose George, Analyst (KBW)

Okay, perfect. Thank you.

Operator, Operator

Our next question comes from Scott Siefers with Piper Sandler.

Scott Siefers, Analyst (Piper Sandler)

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

Lee Smith, President of Mortgage

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

Jim Ciroli, Chief Financial Officer

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

Scott Siefers, Analyst (Piper Sandler)

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

Lee Smith, President of Mortgage

Yes, it is an emerging issue Scott. Because it’s the cash window it doesn’t affect us. We obviously operate at scale and so I think that it’s going to affect the smaller originators. It’s not going to affect as much or at all the big originators who are operating at scale like ourselves and some of the other large names. In terms of opportunities, I need to think about that more. But I think the effect is going to be on the smaller originator set.

Sandro DiNello, President and Chief Executive Officer

Which should be a positive for our TPO business, particularly our business with small correspondents. As you know, historically Flagstar’s bread and butter was the small correspondents and frankly as many could not get into the cash window, I don’t even think it’s a book space that had an impact on us. So, it remains to be seen where that goes but it could be a benefit to those mortgage originators that have a strong third-party business.

Scott Siefers, Analyst (Piper Sandler)

Yes, okay. Perfect. Thank you guys very much.

Operator, Operator

Our next question comes from Daniel Tamayo with Raymond James.

Daniel Tamayo, Analyst (Raymond James)

Just a question on the expenses first for Lee. Specifically, on the mortgage side, you mentioned in the release and talked about it being driven by the efforts to expand capacity as well as a higher retail mix. It sounds like that higher retail mix will continue to be the case. So, I’m expecting that you would say the mortgage expense per closing would be a little bit higher than what you were thinking prior — how are you thinking about that number going forward?

Lee Smith, President of Mortgage

Yes, I would actually say slightly — I think that it will be in the same zip code. I think the retail mix will sort of be similar to what you’ve seen in the last couple of quarters and I think that the 1.18% result, I would expect to be in a similar zip code next quarter. So that’s how I would think about it.

Jim Ciroli, Chief Financial Officer

Danny, back to my earlier comment about managing to the revenue: we really manage net revenue when it’s all said and done. So if you’re generating business from a higher expense category or delivery channel then you’re going to need more revenue to support that and I think we’ve shown our ability to tie the revenue changes to the expense changes and that will continue to be the case. So, if the mix of retail went way up which caused our expenses to go way up, that probably would mean the revenue guidance should be more than what we guided you to. I just want to be clear about this: we’re very careful in terms of how we’re managing net revenue in the business.

Daniel Tamayo, Analyst (Raymond James)

No, that’s great. And you certainly have proven that. And then I guess on the non-mortgage side maybe for Reggie here. How do you think about the expenses on that side of the business where perhaps anticipating a shift on the balance sheet — is there any efficiency ratio or profitability target that you use to govern there or is it just too tough to pin down given all the moving parts?

Reggie Davis, President of Banking

I don’t have an explicit overhead efficiency target. But we’re trying to basically keep expenses flat. We are looking for opportunities where we think that the spend can be optimized in certain channels and businesses and we’re also looking for opportunities to move expenses from non-growth areas where we think we have less growth — things like technology and other areas that ultimately drive the overhead efficiency ratio. So that’s kind of the mode that we’re in. It’s hard to pick a number right now.

Daniel Tamayo, Analyst (Raymond James)

No, I understand that. And then finally I guess given the stronger warehouse business and really taking share there with the demand you’ve mentioned, how does the more traditional commercial lending fit in — CRE and C&I especially since C&I has been kind of declining over the last year or so understandably. How do you think about the growth of that business given what we’ve seen and what you’re expecting in the warehouse business going forward?

Reggie Davis, President of Banking

That’s a great question. Having benefited from the warehouse business in past experiences, it’s a wonderful thing because what it does is it takes the pressures off of us on the commercial side and so we’re being really selective about the things that we’re looking at, focusing on prior existing clients whom we know extremely well. But we’re looking at external opportunities where we have very strong sponsorship, very strong projects and we’re kind of cherry-picking, for lack of a better term, and we’re not feeling any undue pressure because of the benefit of the warehouse business to do anything other than that.

Sandro DiNello, President and Chief Executive Officer

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

Daniel Tamayo, Analyst (Raymond James)

All right, great. That’s all I had. Thanks for all the color.

Operator, Operator

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

Steve Moss, Analyst (B. Riley Securities)

On the reserve ratio here - you continue to maintain a very strong allowance, just kind of curious what you want to see for reserve releases going forward here?

Sandro DiNello, President and Chief Executive Officer

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

Steve Moss, Analyst (B. Riley Securities)

Okay, that’s fair. On capital here obviously very strong and looking another good quarter here. Just kind of wondering when the appetite for additional repurchases or acquisitions?

Sandro DiNello, President and Chief Executive Officer

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

Steve Moss, Analyst (B. Riley Securities)

Okay, that’s helpful. And then in terms of just the loan fees here. I know there are elevated fees for loss mitigation and forbearance — just kind of wondering how sustainable that is when you think about that? Is it more like things come off in April perhaps that will pull back a bit, any color there would be helpful?

Lee Smith, President of Mortgage

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

Steve Moss, Analyst (B. Riley Securities)

Okay, thank you very much. Good quarter.

Operator, Operator

Our next question comes from Giuliano Bologna with Compass Point.

Giuliano Bologna, Analyst (Compass Point)

Turning back to topics around the warehouse line side. You’ve obviously done an incredible job growing the warehouse lending business and as you’ve alluded to there’s a lot of demand out there. I’m curious what the pipeline looks like because you’re obviously managing at the capital and there which implies that there are other opportunities out there that you could take advantage of if capital wasn’t the constraint. What I’m trying to figure out is what magnitude of the opportunity you might be turning away because that could be relevant when the mortgage cycle does cool down eventually in terms of your ability to take more share going forward.

Sandro DiNello, President and Chief Executive Officer

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

Reggie Davis, President of Banking

No, I think that’s right. We don’t — it’s impossible to forecast. We thought we might see some degradation of the client base toward the end of the year but honestly the business has continued to be really strong and so we’re open for business.

Giuliano Bologna, Analyst (Compass Point)

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

Jim Ciroli, Chief Financial Officer

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

Reggie Davis, President of Banking

I think that’s absolutely right. I think the opportunity and that channel is significant and I think we’ve got the right leadership there and so I’m optimistic about our opportunities there.

Giuliano Bologna, Analyst (Compass Point)

Makes a lot of sense. I’m perhaps curious what kind of asset growth potential there might be out there or how you think about the roll forward in terms of assets versus capital in the next couple of quarters? Obviously you might have some growth — it’s hard to tell outside of that.

Sandro DiNello, President and Chief Executive Officer

You’ve been following the company and our history is that we’re comfortable in this capital area. So we’re going to maximize the reinvestment of our capital the way we always have, we’re going to find ways to grow the balance sheet to match the growth and capital, and if we can’t then — to go back to a previous question — we look for different ways to invest our capital. So it’s hard to give you a target growth for the balance sheet, but we’re going to grow as much as we can while still maintaining proper capital levels.

Giuliano Bologna, Analyst (Compass Point)

That’s good. I really appreciate the time and I’ll jump back in the queue.

Operator, Operator

And our next question comes from Henry Coffey with Wedbush.

Henry Coffey, Analyst (Wedbush)

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

Sandro DiNello, President and Chief Executive Officer

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

Lee Smith, President of Mortgage

Thanks Sandro. Morning, Henry. So, let me talk about the market first. I’m very bullish on the mortgage market in 2021. If you look at the agencies and MBA forecasters and the MBA updated yesterday — this is fresh — and you average them out we’re looking at a $3.3 trillion market, that’s the second biggest mortgage market in years after 2020 and I think it’s going to be strong on both the refi and the purchase side. On the refi side, there’s been a couple of studies in the last six weeks or so — there are still 19 million good borrowers out there that could save 75 basis points if they were to refinance at current rates. Good borrowers meaning minimum FICO code 720 and at least 20% equity in their homes. That was confirmed by one of the major investment banks over the holidays — 80% of mortgages are in the money for the tune of 50 basis points if they were to refinance at current rates. So I think the refi wave has room to run here which I think is positive. In terms of purchase mortgages, the low rates are making homeownership much more affordable particularly for first-time homebuyers and the low rates are offsetting some of the home price increases that we’re seeing. Homebuilders are saying that home starts are going to increase 16% year-over-year which is going to put inventory into the market and then I mentioned COVID earlier — people are much more flexible in their work-life balance and so we’re seeing a lot of movement because of that. And then the final point on purchases: the MBA themselves have said they expect this year to be the strongest purchase market ever. I feel very bullish on the mortgage market in 2021. Based on what Sandro commented on, we have proven our ability to optimize and maximize revenue. So, we will look because we have the benefit of a diversified mortgage business. We will look to see where the opportunities are and we will focus resources there and we’ve done that and you’ve seen us do that in our result. I would emphasize again, we don’t see channel conflict; we offer great service to all of our customers.

Reggie Davis, President of Banking

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

Henry Coffey, Analyst (Wedbush)

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

Reggie Davis, President of Banking

I think it’s time I let Jim talk. We can’t really get into that without Jim commenting.

Jim Ciroli, Chief Financial Officer

Henry, just to go back to my prepared comments: what I’m saying is, I think we’re as asset sensitive as we’ve ever been as a company in terms of our asset sensitivity. We took actions to lengthen liability duration in this low interest rate environment. So even if the curve were to steepen further, I think that’s only going to accrue to our benefit. Certainly, if we see something move on the short end of the curve that will immediately accrue to our benefit. But even on the longer end, if we had a steeper curve I think there are things that we can take advantage of that environment that will help our net interest income. The other thing I’ll say: with the payoff of the senior notes that we have, keep in mind those notes cost us over 6% and we’re going to effectively replace that funding at something that’s around or maybe a little bit less than 25 basis points. That alone in 2021 will give us about $3.5 million of lower interest expense per quarter and if you look at Q4’s interest expense that’s about 15% of our total interest expense in just that one move. So again, I feel pretty confident about where net interest margin is and our ability to maintain it.

Sandro DiNello, President and Chief Executive Officer

Our company with the mortgage business makes all the sense in the world so we’re comfortable with the strategic position that we’ve taken.

Henry Coffey, Analyst (Wedbush)

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

Sandro DiNello, President and Chief Executive Officer

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

Henry Coffey, Analyst (Wedbush)

Great, thank you very much.

Operator, Operator

We have no further questions at this time. I’d like to turn the conference back to Sandro DiNello.

Sandro DiNello, President and Chief Executive Officer

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

Operator, Operator

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