Flagstar's move to diversify beyond mortgages pays off

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Despite an overall weak mortgage originations market, Flagstar Bancorp's third-quarter earnings grew 20%, due in large part to its ongoing efforts to diversify operations.

Flagstar had net income of $48 million for the quarter, compared with $50 million in the second quarter and $40 million for the third quarter of 2017.

"A common theme all three quarters this year has been the softness in the mortgage market, not just for Flagstar but for all originators," Sandro DiNello chief executive officer, said during a conference call with analysts. "Yet our story every quarter has been that despite the mortgage challenge, we have posted strong consistent earnings. It is now clear that our banking business is carrying the day. We have grown that business to the point where we don't need to rely on the mortgage business to produce strong returns on assets and equity."

Net interest income totaled $124 million, up from $115 million in the prior quarter and $103 million one year ago. There was a 5% quarter-to-quarter increase in average earning assets, while the net interest margin grew by 7 basis points compared with the second quarter and 19 basis points from 2017's third quarter to 2.93%.

Earnings were also affected by $1.2 million of pretax expenses related to the pending acquisition of 52 branches from Wells Fargo, which is expected to take place in December.

In other events during the quarter, the Federal Reserve lifted its supervisory agreement.

Flagstar originated $9.2 billion of mortgages in the third quarter, compared with $9 billion in the second quarter and $9.6 billion for the third quarter of 2017. Purchases made up 71% of the third-quarter volume, up from 55% one year prior.

But the net gain-on-sale margin of 51 basis points for the third quarter was 20 basis points lower than the second quarter and 33 basis points lower than the third quarter of 2017.

Net gain-on-loan sales of $43 million was down 32% from $63 million in the second quarter and 42% from $75 million in the third quarter 2017.

"We saw actions we took early this year in response to expected softness in the mortgage market fully take shape," DiNello said.

"While we also suffered secondary margin compression, our channel margin decline resulted in large part from a shift from retail to bulk production." But on the other hand, purchasing loans through the delegated correspondent channel has lower expenses for Flagstar than retail.

"Mortgage gain-on-sale revenue came in as low as we've experienced since the second quarter of 2011," Jim Ciroli, chief financial officer, said during the conference call. "However, since we've transformed the earnings power of the bank, our net interest income is now nearly two and one half times since it was then."

Flagstar's return on mortgage servicing rights was up 44% from the second quarter and 117% year-over-year to $13 million. But that was not enough to make up for the decline on gain in sale, leading to a quarter-to-quarter decline of 22% and a year-over-year drop of 31% in mortgage revenue to $56 million.

The increase reflected the growth in the mortgage servicing rights portfolio and a $1.9 million fair value gain associated with the pending sale of a $4.7 billion portfolio that is expected to close in the current quarter.

At the end of the quarter, Flagstar serviced (including loans it subservices) 619,000 units, up 16% from the second quarter and 49% from the previous year.

It services $136 billion, including $8 billion for itself, $22 billion for others and $106 billion of subservicing. On Sept. 30, 2017, Flagstar had a $91 billion portfolio, made up of $7 billion of its own loans, $21 billion serviced for others and $62 billion of subservicing.

Since 2014, Flagstar sold the MSRs it created to investors and retain the subservicing function. It is also adding subservicing on loans it didn't originate.

In the fourth quarter it is adding 200,000 units of non-Flagstar loan servicing rights, said Chief Operating Officer Lee Smith during the conference call, which should push the loan count "comfortably" over 800,000 units by year-end.

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