Orig­i­na­tion

Flagstar has sur­vived — now it must rein­vent it­self

National Mortgage News - - Contents - By jackie ste­wart

flagstar ban­corp in troy, mich., is con­tin­u­ing to find ways to put its tu­mul­tuous past be­hind it.

Lead­ing up to the fi­nan­cial cri­sis, the $ 16.8 bil­lion- as­set com­pany re­lied heav­ily on na­tional mort­gage bank­ing. That strat­egy proved to be dis­as­trous when the mort­gage-backed se­cu­ri­ties mar­ket col­lapsed.

Flagstar re­mained deeply trou­bled, los­ing more than $1.4 bil­lion from 2007 to 2011.

Over that time, the com­pany was weighed down by non­per­form­ing as­sets, hit with a reg­u­la­tory con­sent or­der tied to com­pli­ance and risk man­age­ment and un­der­went man­age­ment changes.

Re­cent years have been prof­itable, af­ford­ing Flagstar more room to rein­vent it­self by mak­ing more com­mer­cial-and-in­dus­trial loans and di­ver­si­fy­ing its real es­tate book. Now the com­pany is buy­ing eight Cal­i­for­nia branches from East West Ban­corp to gain cheap de­posits to sup­port its loan growth.

De­spite the im­prove­ments, Flagstar’s fu­ture is far from cer­tain. In­vestors re­main skep­ti­cal of a busi­ness model that re­mains heav­ily re­liant on mort­gages. Its largest share­holder is a pri­vate eq­uity firm that could view the com­pany’s sale as a chance to exit the in­vest­ment.

For now, man­age­ment is fo­cused on im­prov­ing per­for­mance.

“The past is way in our rearview mir­ror,” said Alessan­dro DiNello, Flagstar’s pres­i­dent and CEO.

“We have to con­vince in­vestors that we can run a com­pany with the level of ex­po­sure to the mort­gage busi­ness that we have and not have the volatil­ity that most mort­gage or­ga­ni­za­tions have,” DiNello added. “Our plan is to keep do­ing what we’re do­ing and show we know how to man­age this within the bank struc­ture.”

Flagstar’s lat­est deal — the pur­chase of Desert Com­mu­nity Bank, a di­vi­sion of East West — in­cludes $70 mil­lion in loans and $600 mil­lion in de­posits in South­ern Cal­i­for­nia. The de­posits should pro­vide liq­uid­ity to a bal­ance sheet with dou­ble-digit loan growth. Desert Com­mu­nity will re­tain its brand un­der Flagstar.

Flagstar “is work­ing to­ward build­ing its com­mer­cial bank­ing busi­ness,” said Scott Beury, an an­a­lyst at Boen­ning & Scat­ter­good. Desert Com­mu­nity “is an at­trac­tive de­posit trans­ac­tion that adds strong core fund­ing. It will give them more of a pres­ence in an eco­nom­i­cally sound mar­ket and they can build their brand and ex­pand their de­posit fran­chise there.”

Con­sol­i­da­tion in Cal­i­for­nia could open up more op­por­tu­ni­ties for Flagstar, said Mitch Ra­zook, pres­i­dent and chief op­er­at­ing of­fi­cer of RLR Man­age­ment Con­sult­ing. The num­ber of banks based in the state is down 38% from the end of 2010, ac­cord­ing to data from the Fed­eral De­posit In­sur­ance Corp.

“There could be an op­por­tu­nity for a rel­a­tively lo­cal bank if they wanted to grow that area,” Ra­zook said. “But the down­side of that is, if Desert Com­mu­nity is owned by Flagstar will peo­ple still con­sider that lo­cal?”

While ex­pand­ing in Cal­i­for­nia had been on DiNello’s radar, the com­pany wasn’t lim­it­ing it­self to that state, he said.

All of the com­pany’s branches are in Michi­gan, though some busi­nesses, such as ware­house lend­ing, on a na­tional scale.

Flagstar pur­chased the mort­gage lender Opes Ad­vi­sors in Cu­per­tino, Calif., and Res­i­den­tial Mort­gage

Del­e­gated Cor­re­spon­dent Lend­ing from Stearns Lend­ing in Santa Ana, Calif., last year. Other than Michi­gan, Cal­i­for­nia gen­er­ates the most rev­enue for Flagstar, DiNello said.

The com­pany will take an op­por­tunis­tic view of M&A, though DiNello said it doesn’t need a merger to make more money.

“My pref­er­ence is to con­tinue to grow as much as we can or­gan­i­cally, but if the right op­por­tu­nity presents it­self we will look at it,” DiNello said.

In M&A, Flagstar may be con­strained by its stock price. Its stock, while up roughly 35% in 2017, still trades be­low re­gional bank peers. Beury said Flagstar is trad­ing at about 13 times Boen­ning’s 2018 earn­ings es­ti­mates, while other banks with $15 bil­lion to $30 bil­lion in as­sets are trad­ing at 15 times this year’s fore­casts.

That gap could close if Flagstar pro­vides con­sis­tent re­sults. Mort­gage deal­ings, how­ever, usu­ally lead to volatile re­sults, in­dus­try ex­perts said.

“I think they have an in­ter­est­ing bal­ance,” said Bose Ge­orge, an an­a­lyst at Keefe, Bruyette & Woods. “They’re a very good mort­gage com­pany and the ac­qui­si­tions they have done are good from an earn­ings stand­point. But bank in­vestors don’t like sig­nif­i­cant mort­gage earn­ings. It is a trade-off.”

There is also a ques­tion of how the pri­vate eq­uity firm MatlinPat­ter­son, which owns more than 60% of Flagstar, will han­dle its in- vest­ment. An in­crease to the $50 bil­lion as­set thresh­old for sys­tem­i­cally im­por­tant fi­nan­cial in­sti­tu­tions could make Flagstar a more at­trac­tive tar­get, said Je­sus Bueno, an an­a­lyst at Com­pass Point Re­search & Trad­ing.

One buyer could be Fifth Third Ban­corp in Cincin­nati, though it is cur­rently deal­ing with a com­pli­ance is­sue tied to the Com­mu­nity Rein­vest­ment Act.

While Flagstar’s fo­cus on mort­gages may scare off other po­ten­tial buy­ers, Fifth Third may find it to be a good fit.

For in­stance, Flagstar re­cently launched a no-down-pay­ment mort­gage prod­uct that is sim­i­lar to some­thing that Fifth Third has.

A Fifth Third spokesman de­clined to com­ment. A call to MatlinPat­ter­son was not re­turned.

“I think the endgame is a sale,” Bueno said. “I would not be shocked if in the next two or three years they sell the bank. Grow­ing the com­mer­cial bank is geared to­ward im­prov­ing the val­u­a­tion and pre­par­ing it for an even­tual sale.”

While MatlinPat­ter­son may look for an exit in the next one to three years, DiNello said he didn’t be­lieve a sale was in­evitable. The in­vestor could also cash out through a sec­ondary of­fer­ing. “Our job is to get the stock trad­ing where it should be, then that pro­vides op­tions to MatlinPat­ter­son,” DiNello said. “We’re try­ing to de­velop a strong, in­de­pen­dent bank.”

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