Flagstar Bank, National Association (FLG) Earnings Call Transcript & Summary

[Audio Gap] And we really had a vision that we could build something out that could be really special where we could be customer-centric, be responsive to the customers. But the real ingredient that was really important is that we recruited really top-notch talent into the bank. And as Rich and I laugh every once a while in those early days, it was a bit of a hat trick to get people that knew us to join the company, but the momentum started. And today, Rich has done an amazing job of hiring over 400 banking professionals. This covers relationship management, product areas, credit underwriting. And I think the core, not only that the senior management is committed to this space, we think it's a big part of the future of the bank, but that we brought people in who knew the owners and leaders and executives of companies that we wanted to bank. And while we bought credibility from Flagstar, they created credibility for Flagstar in the eyes of the customers. And so now we're generating $2.8 billion to $3 billion of new loan outstandings a quarter. We're doing that one relationship at a time. We're generating about 75 relationships per quarter. And we really think the future is very bright for Flagstar. And we're in a unique position where people are looking for regional banks to play a role. And as some of our brethren at Silicon Valley and First Republic and Union and Signature have gone away, it's really opened up a really good vortex for us to be able to step in and fill that void.

You often -- you talked about now and you talked in the past about building a relationship-based bank rather than simply growing loans. As these newer relationships mature, how should we think about the opportunity for deposits, treasury management, capital markets and wealth management revenues?

Yes. It's really a wide open opportunity for us. Rich quotes the number that over the last 6 months, we've boarded $4.4 billion in new loans in the commercial bank and in the Private Bank and $2.4 billion of deposits. And so we have expectations depending upon the vertical and the business and the industry, and we're going to get a full relationship with these customers. Frequently, you have to use your balance sheet that gives you the fishing license to start the process. But about half of our relationships now are single bank or 1 or 2 banks, we were the lead on that, and half of those are coming where we're a participant with other banks. But we have full expectations that not only fee income and deposits will come with those relationships and our short-term successes prove that.

As you said, the growth has come from that combination of geographic expansion and specialized industry verticals, which verticals and markets have exceeded expectations? And where do you see the largest opportunity over the next few years?

Yes. So we're really excited because across the United States, Flagstar has retail banking presence in California and Arizona, in Florida, New York, New Jersey, Ohio, Indiana and Michigan, really solid, solid markets. But we didn't have commercial banking operations. And so we've developed a strategy in those markets and others to put commercial bankers to coexist with our brand in those markets. We've had really, really good success at penetrating the middle and lower corporate market with that. And then we also felt specialized business brings a unique ability for relationship managers to understand the needs of owners in certain industries. And for us, we've seen really great growth in oil and gas and in health care, entertainment, sports specialty, we're also seeing a lot of great momentum in renewable energy right now, a lot of that. And we've opened up this year a couple of new ones in food and other things where all those kind of parallel into large chunks of GDP in the economy. And so again, starting from 0 and being able to gain market share allows us to show significant growth in all of those areas.

Maybe we can talk a little bit about the balance sheet transformation and what's gone on since you all have come on board, the pace of CRE reduction continues to exceed, I think, what you originally expected with another $1.1 billion payoffs in second quarter and a meaningful portion coming from the criticized asset portfolio. How has your thinking evolved around the speed of the transformation and how much is left to do?

Yes. So if you go back to the 1/3, 1/3, 1/3, today, we sit at about 48% of the loan book is in commercial real estate as a whole. That includes owner-occupied and really real estate across the nation. About 28% is in what we consider consumer cash flows in roughly $26 million in C&I. And so you're right, that transformation into that much more diversified balance sheet has occurred much more rapidly than we thought. And when we originally got there, the book or more was in commercial real estate. We had a lot of discussions with customers of the bank that basically said we did not want to renew or extend any real estate loans. We're now in a position where we're excited about being able to do new real estate transaction because that exposure has shrunk. But I think when we get to the beginning of 2028, we're going to feel pretty good that we're in the geography of the range that we were hoping to get to. And that builds, I think, a much more durable, diversified institution.

As the pace of that runoff remains elevated and you have some more capacity under your CRE concentration. How do you determine when it's worth to retain a CRE relationship versus running off at this point? And has that framework changed as the balance sheet become stronger?

Yes. It -- initially, it was we wanted to reduce our commercial real estate exposure with limited exceptions. We really communicated. And today, we've now graduated to the point where if someone has a strong noncredit relationship with the bank, we will make exceptions. And then as we pursue markets in California and Arizona and Florida and Chicago, Michigan and Ohio. We're looking for -- where people want and need commercial real estate, either construction financing, transition financing or mini perm financing, but we'll expect and have to have depository relationship with that. And if it doesn't, then we're probably going to pass on those relationships.

Maybe shift a little bit to margin and NII. The market has spent a lot of time focusing on near-term NII pressure from the CRE runoff. As you think about the next several years, what are the biggest building blocks that get Flagstar from today's earnings profile towards the profitability targets that you've outlined?

This is where I hand the baton to Lee.

Thank you, Joe. Thanks for having us. It's always going to be here, as Joseph said, I think when you look -- I mean, just looking at '27, I think in terms of NIM expansion, I think the 3 biggest drivers are we have -- in '27 alone, we have $9 billion of low coupon PAUSE multifamily loans that are resetting or maturing. And when I say low coupon, less than 3.9%. So they will either reset at the market rate, and we will keep them or they will pay off, and we will give rich that liquidity to continue to originate and build the C&I portfolio. So we're going to get a lift from those resets because those resets are contractual. They're just going to happen as they hit those dates. So we get a big lift, which is somewhat mechanical just by letting that play through. I think the second item is as we grow the C&I book and the balance sheet, if we're -- as we said in Q2, Rich brought on net growth, $2 billion of C&I loans at an average spread to sofa of 225. So you're looking at an all-in coupon of just around 6%. Our cost of interest-bearing deposits in the second quarter was 3.05%. The spot rate of our deposit cost when you include noninterest-bearing are around 252. So if we can sort of keep deposit costs somewhat consistent, maybe they increased a couple of basis points, but we're putting on loans at that -- at those spreads. Then those coupons, then we're going to continue to drive NIM expansion and interest income expansion. And then the third main driver is bringing those nonaccrual loans down. We have $2.8 billion of nonaccruals today which I want to point out are performing in current. We're very punitive on how we classify nonaccruals, but that is debt capital, debt earnings because they're 150% risk weighted and they're not doing anything for interest income or NIM. So as we bring those nonaccruals down, it's automatically going to be accretive from an earnings point of view. So if you're thinking of the NIM expansion, those are the 3 main drivers.

Since the original plan was developed, the rate outlook CRE payoff activity in the deposit environment have evolved. How do you think about the balance between loan yields, deposit costs, multifamily repricing and balance sheet growth as drivers going forward?

Yes. I mean, look, I think the -- as I mentioned, the resets are a big deal for us, and that's going to obviously help the NIM expansion. But we'll typically see going back to what Joseph said earlier, we're trying to limit the sort of CRE multifamily runoff to somewhere between $800 million and $1 billion a quarter. We think that reach can originate what we saw in Q2, which is about net C&I growth of $2-plus billion a quarter. We think we can sort of continue that going forward. And so on the loan side, you've got the C&I growth some of that is going to be funded by CRE runoff. And so you're looking to fund the remainder of the C&I growth with incremental deposit growth. We expect that to come from the commercial relationships that we're bringing in every quarter with the new C&I growth and then the Private Bank growing its deposits as well. So the question is what is the incremental cost of the deposits that we're bringing in to fund that new C&I growth. And if we can bring that in at the right cost, then -- and we think we can, then you're going to achieve earnings accretion for the bank. Two of the points that I just want to make on what I previously said. If you think about the $9 billion of CRE loans that are resetting in '27, they're on our balance sheet today. We're already funding those. We don't have to go and get incremental funding. We're just going to get the pickup in the improved spreads or coupons that we get on those loans, whether they reset, pay off, and we use the liquidity for C&I. And the nonaccrual loans that are on the balance sheet today of $2.8 billion. We're already funding that. We don't need incremental funding for those 2 big drivers of net interest expansion. Where we have to go and get some additional liquidity is to fund the C&I growth that isn't being funded by the CRE runoff.

And maybe just looking -- sticking with the multifamily portfolio for a minute. You did a lot of deep work on evaluating credit over the last 2 years with that. At this point last year, the expectation was that we're going into a lower rate environment, now we're going into a higher rate environment. How do you see maybe some of those criticized and classified but not nonperforming loans, reacting with a reset that's potentially higher with the backdrop in New York still pretty rough for those owners?

Yes. I think -- and I will -- I'll talk about nonaccruals at the end. But I think what we have consistently seen over the last several quarters is of the $1 billion plus of par payoffs each quarter, 40% to 50% of those par payoffs have been substandard. And again, that's because we've been very punitive in the way we've risk rated the book. We do not see that changing at least in the near term. I mean we've seen those loans that are paying off going to the agency Spann Freddie and obviously, going to other lending institutions. For those rent-regulated buildings that are more than 50%, some of those other institutions do get CRE benefits for financing those loans. So we think that is a part of what we've seen. But there's a lot of liquidity out there for this asset class. And so we've consistently brought down our criticized and classified, and we think that will continue. I think if there's one area where we think the higher rate environment might slow us down a little bit, it's the speed and the pace with which we can reduce the nonaccrual loans.

Rich, maybe you've done a lot of work over the last few years, bringing in new people and really growing the C&I space in an environment where there's a lot of banks out there looking to hire good C&I lenders. What's sort of the value proposition as you pitch it to people to come over to Flagstar and help build out that commercial business?

Well, thanks, Jared. I think it's a very relevant question. As Joseph mentioned, the Commercial Banking build-out was one of the great opportunities that our new management team. That's not new to the industry, but when we arrived at Flagstar, it was one of the glaring obvious opportunities for the company. And since then, we're pretty proud that we've onboarded over 400 new bankers to build out this commercial banking platform and to deepen our existing platform in private banking. And we've been very gratified by the quality of the professionals that we've brought on board. And frankly, one of the attractive things is that we've got Joseph in the corner office, having grown up as a commercial banker. I can count on one hand how many commercial bankers are serving as Chairman and CEO of the top 30 bank in this country. And I think that really does resonate. In addition, the opportunity to build something and make a big impact in an environment where you know that C&I and commercial banking is going to be core to the strategy of the new management team. That's been certainly a tailwind for us in bringing on new talent and the quality of the people that have come from much bigger institutions that are now building out the platform at Flagstar has also been a draw. We're pretty proud to note that we've only used an executive search firm on a couple of bespoke hiring opportunities. Most of the people that we're attracting to the franchise are through that network effect of people that we've worked with and trusted over the years, and they're trusting us to come over to build something special together, and it's in an environment where a bank that's big enough to matter in terms of the ability to provide capital to their clients as they come over. And -- but they're not 10 layers down from the CEO, and they know they can make a big impact. And we're not burdened with a legacy of being overweight from a credit exposure perspective in really any of our C&I subsectors that we're building out. And as Joseph mentioned, it's a two-pronged strategy to cover specialized industries with experienced bankers as well as to fill in our geographies around the country with geographically focused commercial bankers that are networked in that community and can really make a big impact. So we're pleased with the progress that we're making. And I think those factors are continuing to be a tailwind as we continue to onboard talent. And I would describe this as we're in the top of the fourth inning in a 9-inning game, but you're starting to see it now with the quarter-over-quarter C&I loan growth and the fact that we're onboarding 70 to 80 new relationships each quarter on the commercial side of our book, that the loan is only the beginning of that relationship. In a relationship-focused strategy, and we can go deeper with treasury management, capital markets, private banking and wealth management and connecting those dots in a tightened organization is how we're executing.

What about when you're -- so you brought on the people with the relationships. They have to bring over their own relationships and onboard the new customers. What's the -- similarly, what's that value proposition to get somebody to leave the bank that they're banking with today and to come to Flagstar, which may be relatively new in the -- on the scene for this type of banking.