UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2018
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _________ to _________
Commission File Number: 001-16577
(Exact name of registrant as specified in its charter).
Michigan | 38-3150651 | |
(State or other jurisdiction of | (I.R.S. Employer | |
Incorporation or organization) | Identification No.) | |
5151 Corporate Drive, Troy, Michigan | 48098-2639 | |
(Address of principal executive offices) | (Zip code) | |
(248) 312-2000
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and formal fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ¨ | Accelerated filer | ý |
Non-accelerated filer | o | Smaller reporting company | ¨ |
Emerging growth company | ¨ | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act ¨.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý.
As of November 1, 2018, 57,627,630 shares of the registrant’s common stock, $0.01 par value, were issued and outstanding.
FLAGSTAR BANCORP, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2018
TABLE OF CONTENTS
Item 1. | ||
Consolidated Statements of Financial Condition – September 30, 2018 (unaudited) and December 31, 2017 (unaudited) | ||
Consolidated Statements of Operations – For the three and nine months ended September 30, 2018 and 2017 (unaudited) | ||
Consolidated Statements of Comprehensive Income – For the three and nine months ended September 30, 2018 and 2017 (unaudited) | ||
Consolidated Statements of Stockholders’ Equity – For the nine months ended September 30, 2018 and 2017 (unaudited) | ||
Consolidated Statements of Cash Flows – For the nine months ended September 30, 2018 and 2017 (unaudited) | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 1. | ||
Item 1A. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. | ||
2
GLOSSARY OF ABBREVIATIONS AND ACRONYMS
The following list of abbreviations and acronyms are provided as a tool for the reader and may be used throughout this Report, including the Consolidated Financial Statements and Notes:
Term | Definition | Term | Definition | |||
AFS | Available for Sale | HELOC | Home Equity Lines of Credit | |||
Agencies | Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and Government National Mortgage Association, Collectively | HELOAN | Home Equity Loan | |||
ALCO | Asset Liability Committee | HOLA | Home Owners Loan Act | |||
ALLL | Allowance for Loan & Lease Losses | Home equity | Second Mortgages, HELOANs, HELOCs | |||
AOCI | Accumulated Other Comprehensive Income (Loss) | HTM | Held to Maturity | |||
ASU | Accounting Standards Update | LIBOR | London Interbank Offered Rate | |||
Basel III | Basel Committee on Banking Supervision Third Basel Accord | LHFI | Loans Held-for-Investment | |||
C&I | Commercial and Industrial | LHFS | Loans Held-for-Sale | |||
CDARS | Certificates of Deposit Account Registry Service | LTV | Loan-to-Value Ratio | |||
CET1 | Common Equity Tier 1 | Loan Beta | The change in the annualized yield of our LHFI portfolio, compared to the change in the Federal Reserve discount rate | |||
CFPB | Consumer Financial Protection Bureau | Management | Flagstar Bancorp’s Management | |||
CLTV | Combined Loan to Value Ratio | MBIA | MBIA Insurance Corporation | |||
Common Stock | Common Shares | MBS | Mortgage-Backed Securities | |||
CRE | Commercial Real Estate | MD&A | Management's Discussion and Analysis | |||
DCB | Desert Community Bank | MSR | Mortgage Servicing Rights | |||
Deposit Beta | The change in the annualized cost of our deposits, compared to the change in the Federal Reserve discount rate | N/A | Not Applicable | |||
DFAST | Dodd-Frank Stress Test | NYSE | New York Stock Exchange | |||
DOJ | United States Department of Justice | OCC | Office of the Comptroller of the Currency | |||
DTA | Deferred Tax Asset | OTTI | Other-Than-Temporary-Impairment | |||
EVE | Economic Value of Equity | QTL | Qualified Thrift Lending | |||
Fannie Mae | Federal National Mortgage Association | REO | Real estate and other nonperforming assets, net | |||
FASB | Financial Accounting Standards Board | RWA | Risk Weighted Assets | |||
FDIC | Federal Deposit Insurance Corporation | SEC | Securities and Exchange Commission | |||
FHA | Federal Housing Administration | SFR | Single Family Residence | |||
FHLB | Federal Home Loan Bank | TARP Preferred | Troubled Asset Relief Program Fixed Rate Cumulative Perpetual Preferred Stock, Series C | |||
FICO | Fair Isaac Corporation | TDR | Trouble Debt Restructuring | |||
FRB | Federal Reserve Bank | UPB | Unpaid Principal Balance | |||
Freddie Mac | Federal Home Loan Mortgage Corporation | U.S. Treasury | United States Department of Treasury | |||
FTE | Full Time Equivalent Employees | VIE | Variable Interest Entities | |||
GAAP | United States Generally Accepted Accounting Principles | XBRL | eXtensible Business Reporting Language | |||
3
PART I. FINANCIAL INFORMATION
ITEM 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following is Management's Discussion and Analysis of the financial condition and results of operations of Flagstar Bancorp, Inc. for the third quarter of 2018, which should be read in conjunction with the financial statements and related notes set forth in Part I, Item 1 of this Form 10-Q and Part II, Item 8 of Exhibit 99.1 to our June 1, 2018 Form 8-K Report.
Certain statements in this Form 10-Q, including but not limited to statements included within Management’s Discussion and Analysis of Financial Condition and Results of Operations, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. These statements are based on the current beliefs and expectations of our management. Actual results may differ from those set forth in forward-looking statements. See Forward-Looking Statements on page 34 of this Form 10-Q and Part I, Item 1A, Risk Factors of Flagstar Bancorp, Inc.'s 2017 Annual Report on Form 10-K for the year ended December 31, 2017. Additional information about Flagstar can be found on our website at www.flagstar.com.
Where we say "we," "us," "our," the "Company," "Bancorp" or "Flagstar," we usually mean Flagstar Bancorp, Inc. However, in some cases, a reference will include our wholly-owned subsidiary Flagstar Bank, FSB (the "Bank"). See the Glossary of Abbreviations and Acronyms on page 3 for definitions used throughout this Form 10-Q.
Introduction
We are a savings and loan holding company founded in 1993. Our business is primarily conducted through our principal subsidiary, the Bank, a federally chartered stock savings bank founded in 1987. We provide commercial and consumer banking services and we are the 5th largest bank mortgage originator and the 7th largest sub-servicer of mortgage loans nationwide. At September 30, 2018, we had 3,496 full-time equivalent employees. Our common stock is listed on the NYSE under the symbol "FBC."
We have a relationship-based business model which leverages our full-service Bank’s capabilities with our national mortgage platform to create and build financial relationships with our customers. At September 30, 2018, we operated 108 full service banking branches that offer a full set of banking products to consumer, commercial, and government customers. Our banking footprint spans throughout Michigan and contiguous states as well as the high desert region of California.
In the first quarter of 2018, we closed the purchase of the mortgage loan warehouse business from Santander Bank, which added $499 million in outstanding warehouse loans and we completed the acquisition of eight Desert Community Bank branches in San Bernardino County, California, with $614 million in deposits and $59 million in loans.
In the second quarter 2018, we signed a definitive agreement to acquire 52 Wells Fargo branches in Indiana, Michigan, Wisconsin and Ohio. We expect to close this transaction at the beginning of December 2018.
We originate mortgages through a wholesale network of brokers and correspondents in all 50 states, and our own loan officers from 81 retail locations in 27 states and two call centers, which includes our direct-to-consumer lending team. Flagstar is also a leading national servicer of mortgage loans and provides complementary ancillary offerings including, MSR lending, servicing advance lending and recapture services. Servicing and subservicing of loans provides fee income and generates a stable long-term source of funding through custodial deposits.
Operating Segments
Our operations are conducted through our three operating segments: Community Banking, Mortgage Originations, and Mortgage Servicing. For additional information, please see MD&A - Operating Segments and Note 18 - Segment Information.
4
Selected Financial Ratios
(Dollars in millions, except share data)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||||
(In millions and percentages) | |||||||||||||||
Selected Mortgage Statistics: | |||||||||||||||
Mortgage rate lock commitments (fallout-adjusted) (1) | $ | 8,290 | $ | 8,898 | $ | 25,024 | $ | 23,896 | |||||||
Mortgage loans originated | 9,199 | 9,572 | 26,125 | 24,659 | |||||||||||
Mortgage loans sold and securitized | 8,423 | 8,924 | 24,930 | 22,397 | |||||||||||
Selected Ratios: | |||||||||||||||
Interest rate spread (2) | 2.57 | % | 2.58 | % | 2.57 | % | 2.56 | % | |||||||
Net interest margin | 2.93 | % | 2.78 | % | 2.85 | % | 2.74 | % | |||||||
Return on average assets | 1.04 | % | 0.99 | % | 1.00 | % | 0.94 | % | |||||||
Return on average equity | 12.80 | % | 11.10 | % | 12.10 | % | 10.23 | % | |||||||
Equity-to-assets ratio (average for the period) | 8.13 | % | 8.95 | % | 8.23 | % | 9.16 | % | |||||||
Efficiency ratio | 74.6 | % | 73.5 | % | 76.2 | % | 73.9 | % | |||||||
Effective tax provision rate | 20.0 | % | 32.4 | % | 20.1 | % | 32.3 | % | |||||||
Average Balances: | |||||||||||||||
Average interest-earning assets | $ | 16,786 | $ | 14,737 | $ | 16,050 | $ | 13,709 | |||||||
Average interest-paying liabilities | 13,308 | 12,297 | 13,150 | 11,481 | |||||||||||
Average stockholders' equity | 1,514 | 1,471 | 1,468 | 1,412 | |||||||||||
September 30, 2018 | December 31, 2017 | September 30, 2017 | |||||||||
(In millions, except per share data and percentages) | |||||||||||
Selected Statistics: | |||||||||||
Book value per common share | $ | 26.34 | $ | 24.40 | $ | 25.38 | |||||
Tangible book value per share (3) | $ | 25.13 | $ | 24.04 | $ | 25.01 | |||||
Number of common shares outstanding | 57,625,439 | 57,321,228 | 57,181,536 | ||||||||
Common equity-to-assets ratio | 8.12 | % | 8.27 | % | 8.60 | % | |||||
Tangible common equity to assets ratio (3) | 7.74 | % | 8.15 | % | 8.47 | % | |||||
Capitalized value of mortgage servicing rights | 1.43 | % | 1.16 | % | 1.15 | % | |||||
Bancorp Tier 1 leverage (to adjusted avg. total assets) (4) | 8.36 | % | 8.51 | % | 8.80 | % | |||||
Bank Tier 1 leverage (to adjusted avg. total assets) (4) | 8.77 | % | 9.04 | % | 9.38 | % | |||||
Number of bank branches | 108 | 99 | 99 | ||||||||
Number of FTE employees | 3,496 | 3,525 | 3,495 | ||||||||
(1) | Fallout adjusted refers to mortgage rate lock commitments which are adjusted by a percentage of mortgage loans in the pipeline that are not expected to close based on previous historical experience and the impact of changes in interest rates. |
(2) | Interest rate spread is the difference between the annualized yield earned on average interest-earning assets for the period and the annualized rate of interest paid on average interest-bearing liabilities for the period. |
(3) | Excludes goodwill and intangibles of $70 million, $21 million, and $21 million at September 30, 2018, December 31, 2017, and September 30, 2017, respectively. See Non-GAAP Financial Measures for further information. |
(4) | The Basel III transitional phase-in rules were applicable to December 31, 2017 and September 30, 2017. |
5
Overview
The third quarter of 2018 resulted in net income of $48 million, or $0.83 per diluted share, up $8 million or $0.13 per diluted share compared to the third quarter of 2017. The increase in net income was primarily due to $21 million, or 20 percent, higher net interest income in the third quarter of 2018 compared to the same period a year ago, driven by growth in interest earning assets and net interest margin expansion.
Through the nine months ended September 30, 2018, consistent earnings performance demonstrated the strength of our Community Banking segment. When comparing the nine months ended September 30, 2018 to the same period in 2017, average commercial loans have increased $1.4 billion, or 42 percent, with broad based growth across all portfolios and average retail and government deposits have grown $955 million, or 13 percent. Additionally, the pending acquisition of 52 branches from Wells Fargo will provide us with over $2 billion of additional high quality, low cost deposits which we will use to fund balance sheet growth.
We continue to build the Mortgage Servicing segment, increasing the number of loans serviced 49 percent over the last 12 months and ending the third quarter of 2018 servicing nearly 620,000 accounts. We are positioned to continue to add scale to our servicing business which provides both stable deposits and a reliable source of fee income.
The mortgage market continued to be challenging through the third quarter 2018. Net gain on loan sales decreased $32 million, primarily driven by a 33 basis point decrease in net gain on loan sale margin in the three months ended September 30, 2018, compared to the same period in 2017. This loss was partially offset by stronger valuations and lower prepayments on our mortgage servicing assets, which improved $7 million.
Earnings Performance Highlights
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
2018 | 2017 | Change | 2018 | 2017 | Change | ||||||||||||||||||
(Dollars in millions, except share data) | |||||||||||||||||||||||
Net interest income | $ | 124 | $ | 103 | $ | 21 | $ | 345 | $ | 283 | $ | 62 | |||||||||||
Provision (benefit) for loan losses | (2 | ) | 2 | (4 | ) | (3 | ) | 4 | (7 | ) | |||||||||||||
Total noninterest income | 107 | 130 | (23 | ) | 341 | 346 | (5 | ) | |||||||||||||||
Total noninterest expense | 173 | 171 | 2 | 523 | 465 | 58 | |||||||||||||||||
Provision for income taxes | 12 | 20 | (8 | ) | 33 | 52 | (19 | ) | |||||||||||||||
Net income | $ | 48 | $ | 40 | $ | 8 | $ | 133 | $ | 108 | $ | 25 | |||||||||||
Income per share | |||||||||||||||||||||||
Basic | $ | 0.84 | $ | 0.71 | $ | 0.13 | $ | 2.32 | $ | 1.90 | $ | 0.42 | |||||||||||
Diluted | $ | 0.83 | $ | 0.70 | $ | 0.13 | $ | 2.28 | $ | 1.86 | $ | 0.42 | |||||||||||
Comparison to Prior Year Quarter
• | Net income increased $8 million, or $0.13 per diluted share, to $48 million, or $0.83 per diluted share. |
• | Net interest income increased $21 million, primarily driven by $2.0 billion higher average interest-earnings assets and a 15 basis point increase in net interest margin. |
• | Noninterest income decreased $23 million, primarily due to lower gains on loan sales, partially offset by higher returns on MSRs. |
• | Noninterest expense increased $2 million, primarily a result of organic growth and acquisitions, partially offset by a decrease in volume related expenses. |
Comparison to Prior Year to Date
• | Net income increased $25 million, or $0.42 per diluted share, to $133 million, or $2.28 per diluted share. |
• | Net interest income increased $62 million, primarily driven by 17 percent higher average interest-earning assets and net interest margin expansion of 11 basis points. |
• | The $7 million change in the provision for loan losses was driven by continued minimal net charge-offs and low levels of delinquencies. |
• | Noninterest expense increased $58 million, primarily resulting from growth initiatives and volume driven expenses. |
6
Net Interest Income
The following tables present, on a consolidated basis, interest income from average assets and liabilities, expressed in dollars and yields:
Three Months Ended September 30, | |||||||||||||||||
2018 | 2017 | ||||||||||||||||
Average Balance | Interest | Annualized Yield/ Rate | Average Balance | Interest | Annualized Yield/ Rate | ||||||||||||
(Dollars in millions) | |||||||||||||||||
Interest-Earning Assets | |||||||||||||||||
Loans held-for-sale | $ | 4,393 | $ | 52 | 4.69 | % | $ | 4,476 | $ | 45 | 3.99 | % | |||||
Loans held-for-investment | |||||||||||||||||
Residential first mortgage | 3,027 | 27 | 3.63 | % | 2,594 | 22 | 3.32 | % | |||||||||
Home equity | 695 | 9 | 5.12 | % | 486 | 6 | 5.11 | % | |||||||||
Other | 128 | 2 | 5.54 | % | 26 | — | 4.52 | % | |||||||||
Total consumer loans | 3,850 | 38 | 3.96 | % | 3,106 | 28 | 3.61 | % | |||||||||
Commercial real estate | 2,106 | 29 | 5.37 | % | 1,646 | 19 | 4.43 | % | |||||||||
Commercial and industrial | 1,330 | 18 | 5.28 | % | 1,073 | 13 | 4.77 | % | |||||||||
Warehouse lending | 1,586 | 21 | 5.10 | % | 978 | 12 | 4.82 | % | |||||||||
Total commercial loans | 5,022 | 68 | 5.26 | % | 3,697 | 44 | 4.63 | % | |||||||||
Total loans held-for-investment (1) | 8,872 | 106 | 4.70 | % | 6,803 | 72 | 4.16 | % | |||||||||
Loans with government guarantees | 292 | 3 | 4.20 | % | 264 | 3 | 4.58 | % | |||||||||
Investment securities | 3,100 | 21 | 2.81 | % | 3,101 | 20 | 2.58 | % | |||||||||
Interest-earning deposits | 129 | 1 | 2.38 | % | 93 | — | 1.23 | % | |||||||||
Total interest-earning assets | 16,786 | 183 | 4.32 | % | 14,737 | 140 | 3.77 | % | |||||||||
Other assets | 1,825 | 1,702 | |||||||||||||||
Total assets | $ | 18,611 | $ | 16,439 | |||||||||||||
Interest-Bearing Liabilities | |||||||||||||||||
Retail deposits | |||||||||||||||||
Demand deposits | $ | 727 | $ | 3 | 1.62 | % | $ | 489 | $ | — | 0.14 | % | |||||
Savings deposits | 3,229 | 7 | 0.90 | % | 3,838 | 7 | 0.76 | % | |||||||||
Money market deposits | 252 | — | 0.62 | % | 276 | — | 0.57 | % | |||||||||
Certificates of deposit | 2,150 | 10 | 1.78 | % | 1,182 | 4 | 1.19 | % | |||||||||
Total retail deposits | 6,358 | 20 | 1.27 | % | 5,785 | 11 | 0.78 | % | |||||||||
Government deposits | |||||||||||||||||
Demand deposits | 283 | 1 | 0.59 | % | 250 | — | 0.43 | % | |||||||||
Savings deposits | 564 | 2 | 1.48 | % | 362 | 1 | 0.71 | % | |||||||||
Certificates of deposit | 327 | 1 | 1.52 | % | 329 | 1 | 0.89 | % | |||||||||
Total government deposits | 1,174 | 4 | 1.28 | % | 941 | 2 | 0.70 | % | |||||||||
Wholesale deposits and other | 537 | 3 | 2.03 | % | 35 | — | 1.49 | % | |||||||||
Total interest-bearing deposits | 8,069 | 27 | 1.32 | % | 6,761 | 13 | 0.78 | % | |||||||||
Short-term Federal Home Loan Bank advances and other | 3,465 | 18 | 2.10 | % | 3,809 | 11 | 1.17 | % | |||||||||
Long-term Federal Home Loan Bank advances | 1,280 | 7 | 2.11 | % | 1,234 | 6 | 1.99 | % | |||||||||
Other long-term debt | 494 | 7 | 5.62 | % | 493 | 7 | 5.09 | % | |||||||||
Total interest-bearing liabilities | 13,308 | 59 | 1.75 | % | 12,297 | 37 | 1.19 | % | |||||||||
Noninterest-bearing deposits (2) | 3,267 | 2,244 | |||||||||||||||
Other liabilities | 522 | 427 | |||||||||||||||
Stockholders’ equity | 1,514 | 1,471 | |||||||||||||||
Total liabilities and stockholders' equity | $ | 18,611 | $ | 16,439 | |||||||||||||
Net interest income | $ | 124 | $ | 103 | |||||||||||||
Interest rate spread (3) | 2.57 | % | 2.58 | % | |||||||||||||
Net interest margin (4) | 2.93 | % | 2.78 | % | |||||||||||||
Ratio of average interest-earning assets to interest-bearing liabilities | 126.1 | % | 119.9 | % | |||||||||||||
(1) | Includes nonaccrual loans. For further information on nonaccrual loans, see Note 4 - Loans Held-for-Investment. |
(2) | Includes noninterest-bearing custodial deposits that arise due to the servicing of loans for others. |
(3) | Interest rate spread is the difference between rates of interest earned on interest-earning assets and rates of interest paid on interest-bearing liabilities. |
(4) | Net interest margin is net interest income divided by average interest-earning assets. |
7
Nine Months Ended September 30, | |||||||||||||||||
2018 | 2017 | ||||||||||||||||
Average Balance | Interest | Annualized Yield/ Rate | Average Balance | Interest | Annualized Yield/ Rate | ||||||||||||
(Dollars in millions) | |||||||||||||||||
Interest-Earning Assets | |||||||||||||||||
Loans held-for-sale | $ | 4,265 | $ | 142 | 4.44 | % | $ | 4,014 | $ | 119 | 3.96 | % | |||||
Loans held-for-investment | |||||||||||||||||
Residential first mortgage | 2,893 | 76 | 3.52 | % | 2,497 | 62 | 3.34 | % | |||||||||
Home equity | 681 | 26 | 5.13 | % | 453 | 17 | 5.04 | % | |||||||||
Other | 71 | 3 | 5.37 | % | 26 | 1 | 4.52 | % | |||||||||
Total consumer loans | 3,645 | 105 | 3.86 | % | 2,976 | 80 | 3.61 | % | |||||||||
Commercial real estate | 2,026 | 79 | 5.12 | % | 1,482 | 47 | 4.15 | % | |||||||||
Commercial and industrial | 1,269 | 51 | 5.26 | % | 929 | 33 | 4.71 | % | |||||||||
Warehouse lending | 1,312 | 51 | 5.08 | % | 840 | 30 | 4.70 | % | |||||||||
Total commercial loans | 4,607 | 181 | 5.15 | % | 3,251 | 110 | 4.45 | % | |||||||||
Total loans held-for-investment (1) | 8,252 | 286 | 4.58 | % | 6,227 | 190 | 4.05 | % | |||||||||
Loans with government guarantees | 288 | 8 | 3.86 | % | 300 | 10 | 4.41 | % | |||||||||
Investment securities | 3,127 | 64 | 2.74 | % | 3,093 | 59 | 2.55 | % | |||||||||
Interest-earning deposits | 118 | 2 | 1.95 | % | 75 | 1 | 1.08 | % | |||||||||
Total interest-earning assets | 16,050 | 502 | 4.15 | % | 13,709 | 379 | 3.68 | % | |||||||||
Other assets | 1,784 | 1,697 | |||||||||||||||
Total assets | $ | 17,834 | $ | 15,406 | |||||||||||||
Interest-Bearing Liabilities | |||||||||||||||||
Retail deposits | |||||||||||||||||
Demand deposits | $ | 660 | $ | 4 | 0.89 | % | $ | 502 | $ | 1 | 0.16 | % | |||||
Savings deposits | 3,376 | 21 | 0.85 | % | 3,899 | 22 | 0.76 | % | |||||||||
Money market deposits | 235 | 1 | 0.54 | % | 264 | 1 | 0.49 | % | |||||||||
Certificates of deposit | 1,927 | 24 | 1.64 | % | 1,116 | 9 | 1.12 | % | |||||||||
Total retail deposits | 6,198 | 50 | 1.09 | % | 5,781 | 33 | 0.76 | % | |||||||||
Government deposits | |||||||||||||||||
Demand deposits | 256 | 1 | 0.54 | % | 228 | 1 | 0.41 | % | |||||||||
Savings deposits | 512 | 5 | 1.29 | % | 410 | 2 | 0.59 | % | |||||||||
Certificates of deposit | 369 | 4 | 1.34 | % | 314 | 1 | 0.73 | % | |||||||||
Total government deposits | 1,137 | 10 | 1.14 | % | 952 | 4 | 0.59 | % | |||||||||
Wholesale deposits and other | 325 | 5 | 1.99 | % | 16 | — | 1.21 | % | |||||||||
Total interest-bearing deposits | 7,660 | 65 | 1.13 | % | 6,749 | 37 | 0.74 | % | |||||||||
Short-term Federal Home Loan Bank advances and other | 3,713 | 50 | 1.81 | % | 3,028 | 23 | 1.01 | % | |||||||||
Long-term Federal Home Loan Bank advances | 1,283 | 21 | 2.15 | % | 1,211 | 17 | 1.92 | % | |||||||||
Other long-term debt | 494 | 21 | 5.53 | % | 493 | 19 | 5.06 | % | |||||||||
Total interest-bearing liabilities | 13,150 | 157 | 1.58 | % | 11,481 | 96 | 1.12 | % | |||||||||
Noninterest-bearing deposits (2) | 2,721 | 2,098 | |||||||||||||||
Other liabilities | 495 | 415 | |||||||||||||||
Stockholders’ equity | 1,468 | 1,412 | |||||||||||||||
Total liabilities and stockholders' equity | $ | 17,834 | $ | 15,406 | |||||||||||||
Net interest income | $ | 345 | $ | 283 | |||||||||||||
Interest rate spread (3) | 2.57 | % | 2.56 | % | |||||||||||||
Net interest margin (4) | 2.85 | % | 2.74 | % | |||||||||||||
Ratio of average interest-earning assets to interest-bearing liabilities | 122.1 | % | 119.4 | % | |||||||||||||
(1) | Includes nonaccrual loans. For further information on nonaccrual loans, see Note 4 - Loans Held-for-Investment. |
(2) | Includes noninterest-bearing custodial deposits that arise due to the servicing of loans for others. |
(3) | Interest rate spread is the difference between rates of interest earned on interest-earning assets and rates of interest paid on interest-bearing liabilities. |
(4) | Net interest margin is net interest income divided by average interest-earning assets. |
8
Rate/Volume Analysis
The following tables present the dollar amount of changes in interest income and interest expense for the components of interest-earning assets and interest-bearing liabilities. The table distinguishes between the changes related to average outstanding balances (changes in volume while holding the initial rate constant) and the changes related to average interest rates (changes in average rates while holding the initial balance constant). The rate/volume variances are allocated to rate.
Three Months Ended September 30, | |||||||||||
2018 Versus 2017 Increase (Decrease) Due to: | |||||||||||
Rate | Volume | Total | |||||||||
(Dollars in millions) | |||||||||||
Interest-Earning Assets | |||||||||||
Loans held-for-sale | $ | 8 | $ | (1 | ) | $ | 7 | ||||
Loans held-for-investment | |||||||||||
Residential first mortgage | 2 | 3 | 5 | ||||||||
Home equity | — | 3 | 3 | ||||||||
Other | 1 | 1 | 2 | ||||||||
Total consumer loans | 3 | 7 | 10 | ||||||||
Commercial real estate | 5 | 5 | 10 | ||||||||
Commercial and industrial | 2 | 3 | 5 | ||||||||
Warehouse lending | 1 | 8 | 9 | ||||||||
Total commercial loans | 8 | 16 | 24 | ||||||||
Total loans held-for-investment | 11 | 23 | 34 | ||||||||
Investment securities | 1 | — | 1 | ||||||||
Interest-earning deposits and other | 1 | — | 1 | ||||||||
Total interest-earning assets | $ | 21 | $ | 22 | $ | 43 | |||||
Interest-Bearing Liabilities | |||||||||||
Interest-bearing deposits | $ | 11 | $ | 3 | $ | 14 | |||||
Short-term Federal Home Loan Bank advances and other | 8 | (1 | ) | 7 | |||||||
Long-term Federal Home Loan Bank advances | 1 | — | 1 | ||||||||
Total interest-bearing liabilities | 20 | 2 | 22 | ||||||||
Change in net interest income | $ | 1 | $ | 20 | $ | 21 | |||||
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Nine Months Ended September 30, | |||||||||||
2018 Versus 2017 Increase (Decrease) Due to: | |||||||||||
Rate | Volume | Total | |||||||||
(Dollars in millions) | |||||||||||
Interest-Earning Assets | |||||||||||
Loans held-for-sale | $ | 15 | $ | 8 | $ | 23 | |||||
Loans held-for-investment | |||||||||||
Residential first mortgage | 4 | 10 | 14 | ||||||||
Home equity | 1 | 8 | 9 | ||||||||
Other | — | 2 | 2 | ||||||||
Total consumer loans | 5 | 20 | 25 | ||||||||
Commercial real estate | 15 | 17 | 32 | ||||||||
Commercial and industrial | 6 | 12 | 18 | ||||||||
Warehouse lending | 4 | 17 | 21 | ||||||||
Total commercial loans | 25 | 46 | 71 | ||||||||
Total loans held-for-investment | 30 | 66 | 96 | ||||||||
Loans with government guarantees | (1 | ) | (1 | ) | (2 | ) | |||||
Investment securities | 5 | — | 5 | ||||||||
Interest-earning deposits and other | 1 | — | 1 | ||||||||
Total interest-earning assets | $ | 50 | $ | 73 | $ | 123 | |||||
Interest-Bearing Liabilities | |||||||||||
Interest-bearing deposits | $ | 22 | $ | 6 | $ | 28 | |||||
Short-term Federal Home Loan Bank advances and other | 22 | 5 | 27 | ||||||||
Long-term Federal Home Loan Bank advances | 3 | 1 | 4 | ||||||||
Other long-term debt | 2 | — | 2 | ||||||||
Total interest-bearing liabilities | 49 | 12 | 61 | ||||||||
Change in net interest income | $ | 1 | $ | 61 | $ | 62 | |||||
Comparison to Prior Year Quarter
Net interest income increased $21 million, or 20 percent, for the three months ended September 30, 2018, compared to the same period in 2017. This increase was primarily driven by growth in average interest-earning assets, led by continued growth in the commercial loan portfolio.
Net interest margin for the three months ended September 30, 2018 was 2.93 percent, as compared to 2.78 percent for the three months ended September 30, 2017. The increase in net interest margin was primarily due to growth in our commercial loan portfolio, partially offset by higher average rates on deposits. Loans held-for-investment, driven by higher yielding commercial loans, saw a 54 basis point increase in average rates. This change in rates represents a loan beta of 54 percent, which is the change in the annualized yield of our LHFI portfolio, compared to the change in the Federal Reserve discount rate. Our deposit costs increased 36 basis points, representing a deposit beta of only 36 percent, primarily driven by holding a higher percentage of certificates of deposits, offset by lower cost deposits acquired from the DCB branch acquisition. The higher loan beta when compared to our deposit beta indicates that the yield on our LHFI portfolio is more responsive to changes in market rates than our deposit costs, driving a higher interest rate spread. In addition, average deposit growth of $2.3 billion allowed us to reduce higher cost FHLB borrowings, further benefiting margin expansion.
Average interest-earning assets increased $2.0 billion for the three months ended September 30, 2018, compared to the three months ended September 30, 2017, primarily due to an increase in both commercial and consumer LHFI average balances. The commercial loan portfolio increased $1.3 billion from broad based growth in warehouse, commercial real estate and C&I loans driven by organic growth and the acquisition of the Santander warehouse business from the first quarter of 2018. Additionally, we experienced growth of $744 million in our consumer loan portfolio as we continued to portfolio mortgage loan production and grow our indirect lending business.
Average interest-bearing liabilities increased $1.0 billion for the three months ended September 30, 2018, compared to the three months ended September 30, 2017. This increase was primarily due to the DCB branch acquisition as well as organic growth in retail certificates of deposit partially offset by a decline in retail savings deposits. Additionally, we experienced an increase in wholesale deposits to bridge funding needs to December when these funds will be replaced with lower cost, more
10
stable branch deposits from the Wells Fargo acquisition. As a result of deposit growth, average short term FHLB borrowings were reduced $344 million.
Comparison to Prior Year to Date
Net interest income increased $62 million, or 22 percent, for the nine months ended September 30, 2018, compared to the same period in 2017. This increase was primarily driven by growth in average interest-earnings assets, led by continued growth in the commercial loan portfolio.
Our net interest margin for the nine months ended September 30, 2018 was 2.85 percent, as compared to 2.74 percent for the nine months ended September 30, 2017. Margin expansion was primarily a driven by a 53 basis point increase in yields on our LHFI portfolios, which outweighed a 27 basis point increase in average costs of deposits. The increase in deposit costs was driven by a shift in mix to longer duration certificates of deposits, partially offset by the low cost deposits acquired from the DCB branch acquisition.
Average interest-earning assets increased $2.3 billion for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017, primarily due to broad based growth in the commercial loan portfolio of $1.4 billion, partially driven by the Santander warehouse business acquisition, and increases in residential mortgage loans and HELOCs of $669 million.
Average interest-bearing liabilities increased $1.7 billion for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017. Interest-bearing deposits increased $911 million, primarily driven by the DCB branch acquisition along with higher retail and wholesale deposits. Additionally, to fund balance sheet growth, average short term FHLB advances increased $685 million.
Provision for Loan Losses
The provision for loan losses was a benefit of $2 million and $3 million for the three and nine months ended September 30, 2018, respectively, compared to a provision of $2 million and $4 million for the three and nine months ended September 30, 2017, respectively. The improvement in the provision reflects our continued strong credit quality with continued low levels of charge-offs, offset by growth of the portfolio in areas we believe to pose lower levels of credit risk.
For further information on the provision for loan losses see MD&A - Credit Quality.
Noninterest Income
The following tables provide information on our noninterest income along with other mortgage metrics:
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
2018 | 2017 | Change | 2018 | 2017 | Change | ||||||||||||||||||
(Dollars in millions) | |||||||||||||||||||||||
Net gain on loan sales | $ | 43 | $ | 75 | $ | (32 | ) | $ | 166 | $ | 189 | $ | (23 | ) | |||||||||
Loan fees and charges | 23 | 23 | — | 67 | 58 | 9 | |||||||||||||||||
Deposit fees and charges | 5 | 5 | — | 15 | 14 | 1 | |||||||||||||||||
Loan administration income | 5 | 5 | — | 15 | 16 | (1 | ) | ||||||||||||||||
Net return on mortgage servicing rights | 13 | 6 | 7 | 26 | 26 | — | |||||||||||||||||
Other noninterest income | 18 | 16 | 2 | 52 | 43 | 9 | |||||||||||||||||
Total noninterest income | $ | 107 | $ | 130 | $ | (23 | ) | $ | 341 | $ | 346 | $ | (5 | ) | |||||||||
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Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
2018 | 2017 | Change | 2018 | 2017 | Change | ||||||||||||||||||
(Dollars in millions) | |||||||||||||||||||||||
Mortgage rate lock commitments (fallout-adjusted) (1) | $ | 8,290 | $ | 8,898 | $ | (608 | ) | $ | 25,024 | $ | 23,896 | $ | 1,128 | ||||||||||
Net margin on mortgage rate lock commitments (fallout-adjusted) (1)(2) | 0.51 | % | 0.84 | % | (0.33 | )% | 0.66 | % | 0.79 | % | (0.13 | )% | |||||||||||
Mortgage loans sold and securitized | 8,423 | 8,924 | (501 | ) | 24,930 | 22,397 | 2,533 | ||||||||||||||||
(1) | Fallout adjusted refers to mortgage rate lock commitments which are adjusted by a percentage of mortgage loans in the pipeline that are not expected to close based on our historical experience and the impact of changes in interest rates. |
(2) | Gain on loan sale volume is based on net gain on loan sales to fallout-adjusted mortgage rate lock commitments. |
Comparison to Prior Year Quarter
Total noninterest income decreased $23 million during the three months ended September 30, 2018, compared to the same period in 2017.
Net gain on loan sales decreased $32 million during the three months ended September 30, 2018, compared to the three months ended September 30, 2017, primarily due to a 33 basis point decrease in net gain on loan sale margin and $608 million decrease in fallout-adjusted rate lock volume. The mortgage market has seen a decrease in production and continued over capacity during the third quarter of 2018 compared to the same quarter a year ago. The decrease in gain on sale margin was primarily due to secondary margin compression and a shift in the channel mix toward lower margin, but lower cost delegated correspondent channel.
Net return on MSRs, including the impact of hedges, increased $7 million during the three months ended September 30, 2018, compared to the three months ended September 30, 2017. The increase was primarily due to higher net return from the MSR asset resulting from lower prepayments and stronger valuations, along with a higher average MSR balance.
Other noninterest income increased $2 million during the three months ended September 30, 2018, compared to the three months ended September 30, 2017. The increase was primarily due to higher FHLB stock dividend income attributable to an increase in FHLB stock holdings and higher rental income driven by growth within the equipment finance operating lease portfolio.
Comparison to Prior Year to Date
Total noninterest income decreased $5 million during the nine months ended September 30, 2018, compared to the same period in 2017.
Net gain on loan sales decreased $23 million during the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017, primarily due to a 13 basis point decrease in net gain on loan sale margin driven by secondary margin compression and a mix shift toward the lower margin, but lower cost delegated correspondent channel, partially offset by securitizations. Margin compression was partially offset by a 5 percent increase in fallout-adjusted rate locks, boosted by our 2017 mortgage acquisitions.
Loan fees and charges increased $9 million during the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017, primarily due to an increase in mortgage loan closings, boosted by our 2017 mortgage acquisitions, and shift in the channel mix from third party originations to retail channels.
Other noninterest income increased $9 million during the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017. The increase was primarily due to higher FHLB stock dividend income attributable to an increase in FHLB stock holdings and a supplemental dividend from the FHLB received in the first quarter of 2018, higher rental income driven by growth within the equipment finance operating lease portfolio, and higher investment and insurance income.
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Noninterest Expense
The following table sets forth the components of our noninterest expense:
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
2018 | 2017 | Change | 2018 | 2017 | Change | ||||||||||||||||||
(Dollars in millions) | |||||||||||||||||||||||
Compensation and benefits | $ | 76 | $ | 76 | $ | — | $ | 236 | $ | 219 | $ | 17 | |||||||||||
Occupancy and equipment | 31 | 28 | 3 | 91 | 75 | 16 | |||||||||||||||||
Commissions | 21 | 23 | (2 | ) | 64 | 49 | 15 | ||||||||||||||||
Federal insurance premiums | 6 | 5 | 1 | 18 | 12 | 6 | |||||||||||||||||
Loan processing expense | 14 | 15 | (1 | ) | 43 | 41 | 2 | ||||||||||||||||
Legal and professional expense | 7 | 7 | — | 19 | 22 | (3 | ) | ||||||||||||||||
Other noninterest expense | 18 | 17 | 1 | 52 | 47 | 5 | |||||||||||||||||
Total noninterest expense | $ | 173 | $ | 171 | $ | 2 | $ | 523 | $ | 465 | $ | 58 | |||||||||||
Efficiency ratio | 74.6 | % | 73.5 | % | 1.1 | % | 76.2 | % | 73.9 | % | 2.3 | % | |||||||||||
Average number of FTE | 3,570 | 3,500 | 70 | 3,617 | 3,233 | 384 | |||||||||||||||||
Comparison to Prior Year Quarter
Noninterest expense increased $2 million during the three months ended September 30, 2018, compared to the three months ended September 30, 2017.
Occupancy and equipment increased $3 million during the three months ended September 30, 2018, compared to the three months ended September 30, 2017. The increase was primarily due to a higher average depreciable asset base resulting from technology upgrades and software.
Commissions decreased $2 million and loan processing expense decreased $1 million, during the three months ended September 30, 2018, compared to the three months ended September 30, 2017, primarily due to a decrease in loan originations.
Comparison to Prior Year to Date
Noninterest expense increased $58 million during the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017.
Compensation and benefits increased $17 million during the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017, primarily due to 12 percent higher average FTE, driven by acquisitions and growth in our overall business, partially offset by cost reduction initiatives and lower incentive compensation.
Occupancy and equipment increased $16 million during the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017. The increase was primarily due to a higher average depreciable asset base and an increase in vendor services supporting business growth.
Commissions increased $15 million during the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017. The increase is primarily due to the acquisition of Opes in May of 2017, which has increased our retail mortgage originations versus our predominately third party origination model, and $1.4 billion higher loan originations in the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017.
FDIC insurance premiums increased $6 million during the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017, primarily due to growth in our total assets.
Other noninterest expense increased $5 million during the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017, primarily due to advertising expense to raise brand awareness.
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Provision for Income Taxes
Our provision for income taxes for the three and nine months ended September 30, 2018 was $12 million and $33 million, respectively, compared to a provision of $20 million and $52 million for the three and nine months ended September 30, 2017, respectively. These decreases are primarily due to the reduction in the statutory corporate tax rate from 35 percent to 21 percent as a result of the Tax Cuts and Jobs Act.
Our effective tax provision rate for the three and nine months ended September 30, 2018 was 20.0 percent and 20.1 percent, respectively, compared to 32.4 percent and 32.3 percent for the three and nine months ended September 30, 2017, respectively. Our effective tax provision rate differs from the combined federal and state statutory tax rate primarily due to non-taxable bank owned life insurance and other tax-exempt earnings, partially offset by nondeductible expenses.
Operating Segments
Our operations are conducted through three operating segments: Community Banking, Mortgage Originations, and Mortgage Servicing. The Other segment includes the remaining reported activities. The operating segments have been determined based on the products and services offered and reflect the manner in which financial information is currently evaluated by management. Each of the operating segments is complementary to each other and because of the interrelationships of the segments, the information presented is not indicative of how the segments would perform if they operated as independent entities.
For detail on each segment's objectives, strategies, and priorities, please read this section in conjunction with Note 18 - Segment Information.
Community Banking
Our Community Banking segment services commercial, governmental and consumer customers in our banking footprint which spans throughout Michigan and contiguous states as well as the high desert region of California. We also serve home builders, correspondents, and commercial customers on a national basis. The Community Banking segment originates loans, and provides deposit and fee based services to consumer, business, and mortgage lending customers.
Our commercial customers are from a diversified range of industries including financial, insurance, service, manufacturing, and distribution. We offer financial products to these customers for use in their normal business operations and financing of working capital needs, capital investments, and equipment purchases and leases. Additionally, our commercial real estate business supports income producing real estate and home builders. The Community Bank also offers warehouse lines of credit to other mortgage lenders.
Our Community Banking segment has seen continued growth, both organically and through strategic acquisitions, and our transformation into a commercial bank continues to be a key component in our overall business model. Our commercial loan portfolio has grown 25 percent in the last twelve months, to $5.0 billion, at September 30, 2018, boosted by the Santander warehouse business acquisition. Additionally, the DCB branch acquisition expanded our banking footprint and drove an increase in deposits in the Community Banking segment. Average deposits, for the nine month ended September 30, 2018, have increased to $8.6 billion, compared to $7.4 billion, for the same period in 2017.
In the second quarter 2018, we signed a definitive agreement to acquire 52 Wells Fargo branches in Indiana, Michigan, Wisconsin and Ohio. These branches will provide us with over $2 billion of high-quality, low-cost deposits, allowing for balance sheet growth and further expansion of our banking footprint. We estimate post-closing deposit run-off of approximately 17 percent and anticipate fourth quarter 2018 integration costs to be approximately $10 million. The acquisition is expected to be moderately accretive to 2019 earnings per share with a payback period of less than five years. We expect to close this transaction at the beginning of December 2018.
14
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
Community Banking | 2018 | 2017 | Change | 2018 | 2017 | Change | |||||||||||||||||
(Dollars in millions) | |||||||||||||||||||||||
Summary of Operations | |||||||||||||||||||||||
Net interest income | $ | 81 | $ | 63 | $ | 18 | $ | 231 | $ | 171 | $ | 60 | |||||||||||
Provision benefit for loan losses | (1 | ) | (1 | ) | — | (2 | ) | (3 | ) | 1 | |||||||||||||
Net interest income after (provision) benefit for loan losses | 80 | 62 | 18 | 229 | 168 | 61 | |||||||||||||||||
Net gain (loss) on loan sales | (3 | ) | (4 | ) | 1 | (10 | ) | (7 | ) | (3 | ) | ||||||||||||
Other noninterest income | 10 | 8 | 2 | 27 | 22 | 5 | |||||||||||||||||
Total noninterest income | 7 | 4 | 3 | 17 | 15 | 2 | |||||||||||||||||
Compensation and benefits | (17 | ) | (15 | ) | (2 | ) | (51 | ) | (46 | ) | (5 | ) | |||||||||||
Other noninterest expense and directly allocated overhead | (27 | ) | (25 | ) | (2 | ) | (81 | ) | (67 | ) | (14 | ) | |||||||||||
Total noninterest expense | (44 | ) | (40 | ) | (4 | ) | (132 | ) | (113 | ) | (19 | ) | |||||||||||
Income before indirect overhead allocations and income taxes | 43 | 26 | 17 | 114 | 70 | 44 | |||||||||||||||||
Overhead allocations | (9 | ) | (10 | ) | 1 | (29 | ) | (30 | ) | 1 | |||||||||||||
Provision for income taxes | 7 | 6 | 1 | 18 | 14 | 4 | |||||||||||||||||
Net income | $ | 27 | $ | 10 | $ | 17 | $ | 67 | $ | 26 | $ | 41 | |||||||||||
Key Metrics | |||||||||||||||||||||||
Efficiency Ratio | 51.2 | % | 59.7 | % | (8.5 | )% | 53.5 | % | 60.8 | % | (7.3 | )% | |||||||||||
Return on average assets | 1.2 | % | 0.6 | % | 0.6 | % | 1.1 | % | 0.6 | % | 0.5 | % | |||||||||||
Average number of FTE employees | 846 | 725 | 121 | 811 | 705 | 106 | |||||||||||||||||
Comparison to Prior Year Quarter
The Community Banking segment reported net income of $27 million for the three months ended September 30, 2018, compared to $10 million for the three months ended September 30, 2017. The $17 million increase in net income was primarily due to an $18 million increase in net interest income driven by higher average commercial loans. Average commercial loans increased $1.3 billion for the three months ended September 30, 2018 compared to the three months ended September 30, 2017, due to organic growth and our 2018 acquisitions of Desert Community Bank branches and the Santander warehouse business. This increase was partially offset by a $4 million increase in noninterest expense primarily due to higher compensation and benefits driven by an increase in FTE to support growth initiatives and an increase in FDIC premiums primarily due to higher total assets.
Comparison to Prior Year to Date
The Community Banking segment reported net income of $67 million for the nine months ended September 30, 2018, compared to $26 million for the nine months ended September 30, 2017. The $41 million increase in net income was primarily due to a $60 million increase in net interest income driven by average commercial loan growth of $1.4 billion for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017. This average commercial loan growth was due to organic growth and our 2018 acquisitions of Desert Community Bank branches and the Santander warehouse business. The increase in net interest income was partially offset by a $19 million increase in noninterest expense driven by growth initiatives, which include higher compensation and benefits, commissions, occupancy and equipment expense, along with an increase in community reinvestment programs and FDIC premiums primarily due to higher total assets.
Mortgage Originations
We are a leading national originator of residential first mortgages. Our Mortgage Origination segment originates and acquires one-to-four family residential mortgage loans primarily to sell or in some instances to hold in our LHFI portfolio in the Community Banking segment. We utilize diversified channels to originate or acquire mortgage loans including more than 1,100 correspondent partners, more than 800 broker relationships and we operate 81 retail lending locations.
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Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
Mortgage Originations | 2018 | 2017 | Change | 2018 | 2017 | Change | |||||||||||||||||
(Dollars in millions) | |||||||||||||||||||||||
Summary of Operations | |||||||||||||||||||||||
Net interest income | $ | 36 | $ | 34 | $ | 2 | $ | 100 | $ | 96 | $ | 4 | |||||||||||
Provision for loan losses | — | (1 | ) | 1 | (1 | ) | (3 | ) | 2 | ||||||||||||||
Net interest income after provision benefit for loan losses | 36 | 33 | 3 | 99 | 93 | 6 | |||||||||||||||||
Net gain on loan sales | 46 | 79 | (33 | ) | 176 | 196 | (20 | ) | |||||||||||||||
Other noninterest income | 30 | 27 | 3 | 76 | 77 | (1 | ) | ||||||||||||||||
Total noninterest income | 76 | 106 | (30 | ) | 252 | 273 | (21 | ) | |||||||||||||||
Compensation and benefits | (26 | ) | (28 | ) | 2 | (83 | ) | (72 | ) | (11 | ) | ||||||||||||
Other noninterest expense and directly allocated overhead | (41 | ) | (49 | ) | 8 | (129 | ) | (114 | ) | (15 | ) | ||||||||||||
Total noninterest expense | (67 | ) | (77 | ) | 10 | (212 | ) | (186 | ) | (26 | ) | ||||||||||||
Income before indirect overhead allocations and income taxes | 45 | 62 | (17 | ) | 139 | 180 | (41 | ) | |||||||||||||||
Overhead allocation | (16 | ) | (15 | ) | (1 | ) | (51 | ) | (46 | ) | (5 | ) | |||||||||||
Provision for income taxes | 6 | 16 | (10 | ) | 18 | 47 | (29 | ) | |||||||||||||||
Net income | $ | 23 | $ | 31 | $ | (8 | ) | $ | 70 | $ | 87 | $ | (17 | ) | |||||||||
Key Metrics | |||||||||||||||||||||||
Efficiency Ratio | 59.1 | % | 55.0 | % | 4.1 | % | 60.1 | % | 50.4 | % | 9.7 | % | |||||||||||
Return on average assets | 1.6 | % | 2.2 | % | (0.6 | )% | 1.7 | % | 2.2 | % | (0.5 | )% | |||||||||||
Mortgage rate lock commitments (fallout-adjusted) (1) | $ | 8,290 | $ | 8,898 | $ | (608 | ) | $ | 25,024 | $ | 23,896 | $ | 1,128 | ||||||||||
Average number of FTE employees | 1,464 | 1,618 | (154 | ) | 1,575 | 1,381 | 194 | ||||||||||||||||
(1) | Fallout adjusted refers to mortgage rate lock commitments which are adjusted by a percentage of mortgage loans in the pipeline that are not expected to close based on our historical experience and the impact of changes in interest rates. |
Comparison to Prior Year Quarter
The Mortgage Originations segment reported net income of $23 million for the three months ended September 30, 2018, compared to $31 million for the three months ended September 30, 2017. The decrease in net income, was primarily due to a $33 million lower net gain on loan sales driven by a 33 basis point decrease in net gain on loan sale margin and $608 million lower fallout adjusted locks. Secondary margin compression and a mix shift toward lower margin, but lower cost delegated correspondent channel, drove margin compression. The decrease in net interest income was partially offset by a $10 million decrease in noninterest expense due to lower volume related expenses and a decrease in compensation and benefits resulting from lower headcount, in addition to a $7 million increase in net return on MSRs primarily driven by lower prepayments and stronger valuations, along with a higher average UPB MSR balance.
Comparison to Prior Year to Date
The Mortgage Originations segment reported net income of $70 million for the nine months ended September 30, 2018, compared to $87 million for the nine months ended September 30, 2017. The decrease was primarily due to $20 million decrease in net gain on loan sales driven by a 13 basis point decrease in net gain on loan sale margins, partially offset by $1.1 billion higher fallout adjusted locks driven by 2017 acquisitions. The increase in mortgage volumes drove a $13 million increase in commission expense and a partially offsetting $2 million favorable impact on loan fees and charges. Additionally, an increase in headcount, primarily driven by acquisitions, resulted in $11 million higher compensation and benefits.
Mortgage Servicing
The Mortgage Servicing segment services loans, in which we hold the MSR asset, and subservices mortgage loans for others through a scalable servicing platform on a fee for service basis. We may also collect ancillary fees and earn income through the use of noninterest bearing escrows. The loans we service generate custodial deposits which provide a stable funding source. Revenue for those serviced and subserviced loans is earned on a contractual fee basis, with the fees varying based on our responsibilities and the delinquency status of the underlying loans. The Mortgage Servicing segment also services residential mortgages for our LHFI portfolio in the Community Banking segment and our own MSR portfolio in the Mortgage Originations segment for which it earns intersegment revenue.
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Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
Mortgage Servicing | 2018 | 2017 | Change | 2018 | 2017 | Change | |||||||||||||||||
(Dollars in millions) | |||||||||||||||||||||||
Summary of Operations | |||||||||||||||||||||||
Net interest income (1) | $ | 2 | $ | 4 | $ | (2 | ) | $ | 5 | $ | 9 | $ | (4 | ) | |||||||||
Provision for loan losses | — | — | — | — | — | — | |||||||||||||||||
Net interest income after provision for loan losses | 2 | 4 | (2 | ) | 5 | 9 | (4 | ) | |||||||||||||||
Total noninterest income | 24 | 14 | 10 | 65 | 47 | 18 | |||||||||||||||||
Compensation and benefits | (4 | ) | (4 | ) | — | (13 | ) | (12 | ) | (1 | ) | ||||||||||||
Other noninterest expense and directly allocated overhead | (18 | ) | (13 | ) | (5 | ) | (49 | ) | (45 | ) | (4 | ) | |||||||||||
Total noninterest expense | (22 | ) | (17 | ) | (5 | ) | (62 | ) | (57 | ) | (5 | ) | |||||||||||
Income (loss) before indirect overhead allocations and income taxes | 4 | 1 | 3 | 8 | (1 | ) | 9 | ||||||||||||||||
Overhead allocations | (5 | ) | (6 | ) | 1 | (15 | ) | (17 | ) | 2 | |||||||||||||
Provision (benefit) for income taxes | — | (1 | ) | 1 | (2 | ) | (6 | ) | 4 | ||||||||||||||
Net income (loss) | $ | (1 | ) | $ | (4 | ) | $ | 3 | $ | (5 | ) | $ | (12 | ) | $ | 7 | |||||||
Key Metrics | |||||||||||||||||||||||
Efficiency Ratio | 86.9 | % | 94.4 | % | (7.5 | )% | 88.6 | % | 101.8 | % | (13.2 | )% | |||||||||||
Return on average assets | (14.5 | )% | (53.3 | )% | 38.8 | % | (24.5 | )% | (44.4 | )% | 19.9 | % | |||||||||||
Average number of residential loans serviced | 591,769 | 401,792 | 189,977 | 515,292 | 397,558 | 117,734 | |||||||||||||||||
Average number of FTE employees | 238 | 197 | 41 | 221 | 197 | 24 | |||||||||||||||||
(1) | Includes intersegment interest earned, net of interest paid on custodial deposits. |
The following table presents residential loans serviced and the number of accounts associated with those loans.
September 30, 2018 | December 31, 2017 | ||||||||||||
Unpaid Principal Balance (1) | Number of accounts | Unpaid Principal Balance (1) | Number of accounts | ||||||||||