UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2018 |
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number: 001-16577
(Exact name of registrant as specified in its charter)
Michigan | 38-3150651 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
5151 Corporate Drive, Troy, Michigan | 48098-2639 | |
(Address of principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code: (248) 312-2000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, par value $0.01 per share | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes No ý
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 every Interactive Data File required to be submitted 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 such files). Yes ý No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
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 definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer | ý | Accelerated Filer | o | Smaller Reporting Company | o | ||
Non-Accelerated Filer | o | Emerging growth company | o | ||||
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 13(a) of the Exchange Act ¨.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No ý
The estimated aggregate market value of the voting common stock held by non-affiliates of the registrant, computed by reference to the closing sale price ($34.26 per share) as reported on the New York Stock Exchange on June 30, 2018, was approximately $1 billion. The registrant does not have any non-voting common equity shares.
As of February 26, 2019, 56,442,315 shares of the registrant’s common stock, $0.01 par value, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement relating to the 2019 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report on Form 10-K.
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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 | GNMA | Government National Mortgage Association | |||
Agencies | Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and Government National Mortgage Association, Collectively | HELOAN | Home Equity Loans | |||
ALCO | Asset Liability Committee | HELOC | Home Equity Lines of Credit | |||
ALLL | Allowance for Loan & Lease Losses | HFI | Held for Investment | |||
AOCI | Accumulated Other Comprehensive Income (Loss) | HOLA | Home Owners Loan Act | |||
ASR | Accelerated Share Repurchase | Home Equity | Second Mortgages, HELOANs, HELOCs | |||
ASU | Accounting Standards Update | HPI | Housing Price Index | |||
Basel III | Basel Committee on Banking Supervision Third Basel Accord | H.R.1. | House of Representatives 1 - Tax Cuts and Jobs Act | |||
BSA | Bank Secrecy Act | HTM | Held to Maturity | |||
C&I | Commercial and Industrial | LHFI | Loans Held-for-Investment | |||
CAMELS | Capital, Asset Quality, Management, Earnings, Liquidity and Sensitivity | LHFS | Loans Held-for-Sale | |||
CDARS | Certificates of Deposit Account Registry Service | LIBOR | London Interbank Offered Rate | |||
CD | Certificates of Deposit | LTV | Loan-to-Value Ratio | |||
CET1 | Common Equity Tier 1 | Management | Flagstar Bancorp’s Management | |||
CLTV | Combined Loan to Value | MBIA | MBIA Insurance Corporation | |||
Common Stock | Common Shares | MBS | Mortgage-Backed Securities | |||
CRE | Commercial Real Estate | MD&A | Management's Discussion and Analysis | |||
CFPB | Consumer Financial Protection Bureau | MP Thrift | MP Thrift Investments, L.P. | |||
DCB | Desert Community Bank | MSR | Mortgage Servicing Rights | |||
Deposit Beta | The change in the annualized cost of our deposits, divided by the change in the Federal Reserve discount rate | N/A | Not Applicable | |||
DIF | Deposit Insurance Fund | NASDAQ | National Association of Securities Dealers Automated Quotations | |||
DOJ | United States Department of Justice | NYSE | New York Stock Exchange | |||
DTA | Deferred Tax Asset | OCC | Office of the Comptroller of the Currency | |||
EVE | Economic Value of Equity | OCI | Other Comprehensive Income (Loss) | |||
ExLTIP | Executive Long-Term Incentive Program | OTTI | Other-Than-Temporary-Impairment | |||
Fannie Mae | Federal National Mortgage Association | QTL | Qualified Thrift Lending | |||
FASB | Financial Accounting Standards Board | Regulatory Agencies | Board of Governors of the Federal Reserve, Office of the Comptroller of the Currency, U.S. Department of the Treasury, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, Securities and Exchange Commission | |||
FBC | Flagstar Bancorp | RMBS | Residential Mortgage-Backed Securities | |||
FDIC | Federal Deposit Insurance Corporation | RSU | Restricted Stock Unit | |||
Federal Reserve | Board of Governors of the Federal Reserve System | RWA | Risk Weighted Assets | |||
FHA | Federal Housing Administration | SEC | Securities and Exchange Commission | |||
FHFA | Federal Housing Finance Agency | SOFR | Secured Overnight Financing Rate | |||
FHLB | Federal Home Loan Bank | SFR | Single Family Residence | |||
FICO | Fair Isaac Corporation | TARP | Troubled Asset Relief Program | |||
FRB | Federal Reserve Bank | TDR | Trouble Debt Restructuring | |||
Freddie Mac | Federal Home Loan Mortgage Corporation | TILA | Truth in Lending Act | |||
FTE | Full Time Equivalent | UPB | Unpaid Principal Balance | |||
GAAP | Generally Accepted Accounting Principles | U.S. Treasury | United States Department of Treasury | |||
Ginnie Mae | Government National Mortgage Association | VIE | Variable Interest Entity | |||
GLBA | Gramm-Leach Bliley Act | XBRL | eXtensible Business Reporting Language | |||
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FORWARD-LOOKING STATEMENTS
Certain statements in this Form 10-K, including but not limited to statements included within the 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. In addition, we may make forward-looking statements in our other documents filed with or furnished to the Security and Exchange Commission (SEC), and our management may make forward-looking statements orally to analysts, investors, representatives of the media, and others.
Generally, forward-looking statements are not based on historical facts but instead represent management’s current beliefs and expectations regarding future events and are subject to significant risks and uncertainties. Such statements may be identified by words such as believe, expect, anticipate, intend, plan, estimate, may increase, may fluctuate, and similar expressions or future or conditional verbs such as will, should, would, and could. Our actual results and capital and other financial conditions may differ materially from those described in the forward-looking statements depending upon a variety of factors, including without limitation the precautionary statements included within each individual business’ discussion and analysis of our results of operations and the risk factors listed and described in Item 1A. to Part I, Risk Factors.
Other than as required under United States securities laws, we do not undertake to update the forward-looking statements to reflect the impact of circumstances or events that may arise after the date of the forward-looking statements.
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PART I
ITEM 1. | BUSINESS |
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-K.
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 savings bank founded in 1987. We provide commercial and consumer banking services and we are the 5th largest bank mortgage originator in the nation and the 6th largest sub-servicer of mortgage loans nationwide. At December 31, 2018, we had 3,938 full-time equivalent employees. Our common stock is listed on the NYSE under the symbol "FBC."
Our relationship-based business model leverages our full-service bank’s capabilities and our national mortgage platform to create and build financial solutions for our customers. At December 31, 2018, we operated 160 full service banking branches that offer a full set of banking products to consumer, commercial, and government customers. Our banking footprint spans throughout Michigan, Indiana, California, Wisconsin, Ohio and contiguous states.
We originate mortgages through a wholesale network of brokers and correspondents in all 50 states, and our own loan officers from 75 retail locations in 24 states and two call centers, which include 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.
Recent Acquisitions
In the first quarter of 2018, we closed on 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 fourth quarter of 2018, we closed on the purchase of 52 branches in Indiana, Michigan, Wisconsin and Ohio, from Wells Fargo, with $1.8 billion in deposits and $107 million in loans. For further information, see Note 2 - Acquisitions.
Operating Segments
Our operations are conducted through our three operating segments: Community Banking, Mortgage Originations and Mortgage Servicing. For further information, see MD&A - Operating Segments and Note 23 - Segment Information.
Competition
We face substantial competition in attracting deposits and generating loans. Our most direct competition for deposits has historically come from other savings banks, commercial banks and credit unions in our banking footprint. Money market funds, full-service securities brokerage firms, and financial technology companies also compete with us for these funds. We compete for deposits by offering a broad range of high quality customized banking services at competitive rates. From a lending perspective, there are many institutions including commercial banks, national mortgage lenders, local savings banks, credit unions, and commercial lenders offering consumer and commercial loans. We compete by offering competitive interest rates, fees, and other loan terms through efficient and customized service.
Subsidiaries
We conduct business primarily through our wholly-owned bank subsidiary. In addition, the Bank has wholly-owned subsidiaries through which we conduct non-bank business or which are inactive. The Bank and its wholly owned subsidiaries comprised 99.7 percent of our total assets at December 31, 2018. For further information, see Note 1 - Description of Business, Basis of Presentation, and Summary of Significant Accounting Standards, Note 8 - Variable Interest Entities and Note 24 - Holding Company Only Financial Statements.
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Regulation and Supervision
The Bank is a federally chartered savings bank, subject to federal regulation and oversight by the OCC. We are also subject to regulation and examination by the FDIC, which insures the deposits of the Bank to the extent permitted by law and the requirements established by the Federal Reserve. The Bank is also subject to the supervision of the CFPB which regulates the offering and provision of consumer financial products or services under the federal consumer financial laws. The OCC, FDIC and the CFPB may take regulatory enforcement actions if we do not operate in accordance with applicable regulations, policies and directives. Proceedings may be instituted against us, or any "institution-affiliated party," such as a director, officer, employee, agent or controlling person, who engages in unsafe and unsound practices, including violations of applicable laws and regulations. The FDIC has additional authority to terminate insurance of accounts, if after notice and hearing, we are found to have engaged in unsafe and unsound practices, including violations of applicable laws and regulations. The federal system of regulation and supervision establishes a comprehensive framework of activities in which to operate and is intended primarily for the protection of depositors and the FDIC's Deposit Insurance Fund rather than our shareholders.
As a savings and loan holding company, we are required to comply with the rules and regulations of the Federal Reserve. We are required to file certain reports and we are subject to examination by the enforcement authority of the Federal Reserve. Under the federal securities laws, we are also subject to the rules and regulations of the Securities and Exchange Commission.
Any change to laws and regulations, whether by the FDIC, OCC, CFPB, SEC, the Federal Reserve, or Congress, could have a material adverse impact on our operations.
Holding Company Regulation
Acquisition, Activities and Change in Control. Flagstar Bancorp, Inc. is a unitary savings and loan holding company. We may only conduct, or acquire control of companies engaged in, activities permissible for a unitary savings and loan holding company pursuant to the relevant provisions of the Home Owners' Loan Act and relevant regulations. Further, we generally are required to obtain Federal Reserve approval before acquiring directly or indirectly, ownership or control of any voting shares of another bank or bank holding company (or savings associations or savings and loan holding company) if, after such acquisition, we would own or control more than 5 percent of the outstanding shares of any class of voting securities of the bank or bank holding company (or savings association or savings and loan holding company). Additionally, we are prohibited from acquiring control of a depository institution that is not federally insured or retaining control of a savings association subsidiary for more than one year after the date that such subsidiary becomes uninsured.
We may not be acquired by a company, unless the Federal Reserve approves such transaction. In addition, the GLBA generally restricts a company from acquiring us if that company is engaged directly or indirectly in activities that are not permissible for a savings and loan holding company or financial holding company.
Volcker Rule. Section 619 of the Dodd-Frank Act required the federal financial regulatory agencies to adopt rules that prohibit banking entities, including federal savings associations and their and affiliates, from engaging in proprietary trading and investing in and/or sponsoring certain "covered funds," In 2013, the agencies adopted rules to implement section 619. These rules, collectively with section 619, are commonly referred to as the "Volcker Rule." Compliance with the Volcker Rule generally has been required since July 21, 2015. Pursuant to the requirements of the Volcker Rule, we have established a standard compliance program based on the size and complexity of our operations.
Capital Requirements. The Bank and Flagstar are currently subject to the regulatory capital framework and guidelines reached by Basel III as adopted by the OCC and Federal Reserve. The OCC and Federal Reserve have risk-based capital adequacy guidelines intended to measure capital adequacy with regard to a banking organization’s balance sheet, including off-balance sheet exposures such as unused portions of loan commitments, letters of credit, and recourse arrangements.
The Bank and Flagstar have been subject to the capital requirements of the Basel III rules since January 1, 2015. On October 27, 2017, the agencies published a proposed rule which would simplify certain aspects of the capital rules, including the capital treatment for items covered by the rule. The agencies expect that the capital treatment and transition provisions for items covered by Basel III rules will change once the proposal is finalized and effective. On November 21, 2017, in preparation for forthcoming rules that would simplify regulatory capital requirements to reduce regulatory burden, federal banking regulators approved the extension of the existing transitional capital treatment for certain regulatory capital deductions and risk weights. For additional information, see Note 20 - Regulatory Capital.
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Source of Strength. The Dodd-Frank Act codified the Federal Reserve’s "source of strength" doctrine and extended it to savings and loan holding companies. Under the Dodd-Frank Act, the prudential regulatory agencies are required to promulgate joint rules requiring savings and loan holding companies, such as us, to serve as a source of financial strength for any depository institution subsidiary by maintaining the ability to provide financial assistance to such insured depository institution in the event that it suffers financial distress.
Collins Amendment. The Collins Amendment to the Dodd Frank Act established minimum Tier 1 leverage and risk-based capital requirements for insured depository institutions, depository institution holding companies, and non-bank financial companies that are supervised by the Federal Reserve. The minimum Tier 1 leverage and risk-based capital requirements are determined by the minimum ratios established by the federal banking agencies that apply to insured depository institutions under the prompt corrective action regulations. The amendment states that certain hybrid securities, such as trust preferred securities, may be included in Tier 1 capital for bank holding companies that had total assets below $15 billion as of December 31, 2009. As we were below $15 billion in assets as of December 31, 2009, the trust preferred securities classified as long term debt on our balance sheet are included as Tier 1 capital while they are outstanding, unless we complete an acquisition of a depository institution holding company and we report total assets greater than $15 billion at the end of the quarter in which the acquisition occurs. At our present size, with total assets of $18.5 billion at December 31, 2018, an acquisition of a depository holding company would likely cause our trust preferred securities totaling $247 million at December 31, 2018 to no longer be included in Tier 1 capital and would therefore be included in Tier 2 capital.
Banking Regulation
We must comply with a wide variety of banking, consumer protection and securities laws, regulations and supervisory expectations and are regulated by multiple regulators, including the Federal Reserve, the Office of the Comptroller of the Currency of the U.S. Department of the Treasury, the Consumer Financial Protection Bureau, and the Federal Deposit Insurance Corporation.
FDIC Insurance and Assessment. The FDIC insures the deposits of the Bank and such insurance is backed by the full faith and credit of the U.S. government through the DIF. The FDIC maintains the DIF by assessing each financial institution an insurance premium. The FDIC defined deposit insurance assessment base for an insured depository institution is equal to the average consolidated total assets during the assessment period, minus average tangible equity.
All FDIC-insured financial institutions must pay an annual assessment based on asset size to provide funds for the payment of interest on bonds issued by the Financing Corporation ("FICO bonds"), a federal corporation chartered under the authority of the Federal Housing Finance Board. The last of the remaining FICO bonds will mature in September 2019. The Federal Housing Finance Agency (FHFA) projects that the last FICO assessment will be collected in the first half of 2019.
In 2016, the FDIC adopted a rule in accordance with the provisions of Dodd-Frank that requires large institutions to bear the burden, through an imposed surcharge, of raising the DIF reserve ratio. As of September 30, 2018, the DIF has exceeded the required ratio and therefore the surcharge imposed on large banks ended as of that date. We expect the elimination of the surcharge to decrease FDIC insurance premiums approximately $3 million for the full year 2019.
Affiliate Transaction Restrictions. The Bank is subject to the affiliate and insider transaction rules applicable to member banks of the Federal Reserve as well as additional limitations imposed by the OCC. These provisions prohibit or limit the Bank from extending credit to, or entering into certain transactions with principal stockholders, directors and executive officers of the banking institution and certain of its affiliates. The Dodd-Frank Act imposed further restrictions on transactions with certain affiliates and extension of credit to executive officers, directors and principal stockholders.
Limitation on Capital Distributions. The OCC and FRB regulate all capital distributions made by the Bank, directly or indirectly, to the holding company, including dividend payments. The Bank must receive approval from the OCC and FRB to pay dividends to the Bancorp if, after paying those dividends, the Bank would fail to meet the required minimum levels under risk-based capital guidelines and the minimum leverage and tangible capital ratio requirements. Payment of dividends by the Bank also may be restricted at any time at the discretion of the OCC if it deems the payment to constitute an unsafe and unsound banking practice.
Loans to One Borrower. Under the Home Owners Loan Act (HOLA), loans to one borrower may not be in excess of 15 percent of Tier 1 and Tier 2 capital plus any portion of the allowance for loan losses not included in Tier 2 capital. This limit was $256 million as of December 31, 2018. For further information, see MD&A - Risk Management.
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Bank Secrecy Act and Anti-Money Laundering. The Bank is subject to the BSA and other anti-money laundering laws and regulations, including the USA PATRIOT Act. The BSA requires all financial institutions to, among other things, establish a risk-based system of internal controls reasonably designed to prevent money laundering and the financing of terrorism. The BSA includes various record keeping and reporting requirements such as cash transaction and suspicious activity reporting as well as due diligence requirements. The Bank is also required to comply with U.S. Treasury’s Office of Foreign Assets Control imposed economic sanctions that affect transactions with designated foreign countries, nationals, individuals, entities and others.
The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018
On May 24, 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (“Economic Growth Act”) was enacted, which repealed or modified several provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”). Certain key aspects of the Economic Growth Act that have the potential to affect the Company’s business and results of operations include:
• | Raising the total asset threshold from $10 billion to $250 billion at which bank holding companies are required to conduct annual company-run stress tests mandated by the Dodd-Frank Act. |
• | Revising the definition of high volatility commercial real estate loans to ease the regulatory burden associated with the identification of loans that meet qualifying criteria. |
• | Providing that certain reciprocal deposits shall not be considered brokered deposits, subject to certain limitations. |
• | Entitling federal savings associations, such as the Bank, with less than $20 billion in total assets as of December 31, 2017, an option to elect to operate as covered savings associations (similar to a national bank) without changing their charter. |
Consumer Protection Laws and Regulations
The Bank is subject to a number of federal consumer protection laws and regulations. These include, among others, the Truth in Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Servicemembers Civil Relief Act, the Expedited Funds Availability Act, the Community Reinvestment Act, the Real Estate Settlement Procedures Act, electronic funds transfer laws, redlining laws, predatory lending laws, laws prohibiting unfair, deceptive or abusive acts or practices in connection with the offer, or sale of consumer financial products or services, and the GLBA regarding customer privacy and data security.
The Bank is subject to supervision by the CFPB, which has responsibility for enforcing federal consumer financial laws. The CFPB has broad rulemaking authority to administer and carry out the provisions of the Dodd-Frank Act with respect to financial institutions that offer covered financial products and services to consumers, including prohibitions against unfair, deceptive abusive acts or practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service including regulations related to the origination and servicing of residential mortgages. The Bank is subject to the CFPB’s supervisory, examination and enforcement authority with respect to consumer protection laws and regulations. As a result, we could incur increased costs, potential litigation or be materially limited or restricted in our business, product offerings or services in the future.
Due to regulatory focus on compliance with consumer protection laws and regulations, portions of our lending operations which most directly deal with consumers, including mortgage and consumer lending, may pose particular challenges. Further, the CFPB continues to propose new rules and to amend existing rules. While we are not aware of any material compliance issues related to our mortgage and consumer lending practices, the focus of regulators and the changes to regulations may increase our compliance risks. Despite the supervision and oversight we exercise in these areas, failure to comply with these regulations could result in the Bank being liable for damages to individual borrowers or other imposed penalties.
Additionally, the Equal Credit Opportunity Act and the Fair Housing Act prohibit financial institutions from engaging in discriminatory lending practices. The Department of Justice, CFPB, and other agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution's performance under fair lending laws in class action litigation. A successful challenge to the Bank's performance under the fair lending laws and regulations could adversely impact the Bank's rating under the Community Reinvestment Act and result in a wide variety of sanctions or penalties or limit certain revenue channels.
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Regulatory Matters
Supervisory Agreement. The Supervisory Agreement originally dated January 27, 2010, was lifted by the Federal Reserve on August 14, 2018. For further information and a complete description of all of the terms of the Supervisory Agreement, please refer to the copy of the Supervisory Agreement filed with the SEC as an exhibit to our 2016 Form 10-K for the year ended December 31, 2016.
Consent Order with CFPB. On September 29, 2014, the Bank entered into a Consent Order with the CFPB. The Consent Order relates to alleged violations of federal consumer financial laws arising from the Bank’s residential first mortgage loan loss mitigation practices and default servicing operations dating back to 2011. Under the terms of the Consent Order, the Bank paid $28 million for borrower remediation and $10 million in civil money penalties. The settlement did not include an admission of wrongdoing on the part of the Bank or its employees, directors, officers, or agents. For further information and a complete description of all of the terms of the Consent Order, please refer to the copy of the Consent Order filed with the SEC as an exhibit to our Current Report on Form 8-K filed on September 29, 2014.
Incentive Compensation
The U.S. bank regulatory agencies issued comprehensive guidance on incentive compensation policies intended to ensure that the incentive compensation policies of U.S. banks do not undermine safety and soundness by encouraging excessive risk-taking. The U.S. bank regulatory agencies review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of U.S. banks that are not "large, complex banking organizations." These reviews are tailored to each bank based on the scope and complexity of the bank’s activities and the prevalence of incentive compensation arrangements.
Additional Information
Our executive offices are located at 5151 Corporate Drive, Troy, Michigan 48098, and our telephone number is (248) 312-2000. Our stock is traded on the NYSE under the symbol "FBC."
We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act available free of charge on our website at www.flagstar.com, under "Investor Relations," as soon as reasonably practicable after we electronically file such material with the SEC. These reports are also available without charge on the SEC website at www.sec.gov.
ITEM 1A. RISK FACTORS
Our financial condition and results of operations may be adversely affected by various factors, many of which are beyond our control. In addition to the factors identified elsewhere in this Report, we believe the most significant risk factors affecting our business are set forth below.
Market, Interest Rate, Credit and Liquidity Risk
Economic and general conditions in the markets in which we operate may adversely affect our business.
Our business and results of operations are affected by economic and market conditions, political uncertainty and social conditions, factors impacting the level and volatility of short-term and long-term interest rates, inflation, home prices, unemployment and under-employment levels, bankruptcies, household income, consumer spending, fluctuations in both debt and equity capital markets and currencies, liquidity of the financial markets, the availability and cost of capital and credit, investor sentiment and confidence in the financial markets, and the sustainability of economic growth. Deterioration of any of these conditions could adversely affect our business segments, the level of credit risk we have assumed, our capital levels, liquidity, and our results of operations.
Domestic and international fiscal and monetary policies also affect our business. Central bank actions, particularly those of the Federal Reserve, can affect the value of financial instruments and other assets, such as investment securities and MSRs, and their policies can affect our borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in fiscal and monetary policies are beyond our control and difficult to predict but could have an adverse impact on our capital requirements and the cost of running our business.
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Changes in interest rates could adversely affect our financial condition and results of operations including our net interest margin, mortgage related assets, and our investment portfolio.
Our results of operations and financial condition could be significantly affected by changes in interest rates. Our financial results depend substantially on net interest income, which is the difference between the interest income that we earn on interest-earning assets and the interest expense we pay on interest-bearing liabilities. Net interest income represented 53 percent of our total revenue for the full year ended December 31, 2018.
Changes in interest rates may affect the expected average life of our mortgage LHFI and mortgage backed securities and, to a lesser extent, our commercial loans. Decreases in interest rates can trigger an increase in unscheduled prepayments of our loans and mortgage backed securities as borrowers refinance to reduce their own borrowing costs. Conversely, increases in interest rates may decrease loan refinance activity.
The fair value of our fixed-rate financial instruments, including certain LHFI, LHFS, and investment securities is affected by changes in interest rates. If interest rates increase, the fair value of our fixed-rate financial instruments will generally decline and, therefore, have a negative effect on our financial results. We use derivatives to provide a level of protection against interest rate risks, but no hedging strategy will offset this risk completely.
Additionally, the fair value of our MSRs is highly sensitive to changes in interest rates and changes in market implied interest rate volatility. Decreases in interest rates can trigger an increase in actual repayments and market expectation for higher levels of repayments in the future which have a negative impact on MSR fair value. Conversely, higher rates typically drive lower repayments which result in an increase in the MSR fair value. We utilize derivatives to manage the impact of changes in the fair value of the MSRs. Our risk management strategies, which rely on assumptions or projections, may not adequately mitigate the impact of changes in interest rates, interest rate volatility, credit spreads or prepayment speeds, and as a result, the change in the fair value of MSRs may negatively impact earnings.
Changes in the method of determining the London Inter-Bank Offered Rate (LIBOR), or the replacement of LIBOR with an alternative reference rate, may adversely affect interest income or expense.
On July 27, 2017, the United Kingdom Financial Conduct Authority, which oversees LIBOR, formally announced that it could not assure the continued existence of LIBOR in its current form beyond the end of 2021, and that an orderly transition process to one or more alternative benchmarks should begin. In June 2017, the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions organized by the Federal Reserve, announced that it had selected a modified version of the unpublished Broad Treasuries Financing Rate as the preferred alternative reference rate for U.S. dollar obligations. This rate, now referred to as the Secured Overnight Financing Rate (SOFR), is based on actual transactions in certain portions of overnight repurchase agreement markets for certain U.S. Treasury obligations, and was first published during the first half of 2018.
It is unclear whether, or in what form, LIBOR will continue to exist after 2021. If LIBOR ceases to exist or if the methods of calculating LIBOR change from current methods for any reason, interest rates on our floating rate loans, deposits, obligations, derivatives, and other financial instruments tied to LIBOR rates, as well as the revenue and expenses associated with those financial instruments, may be adversely affected. Additionally, whether or not SOFR attains market traction as a replacement to LIBOR remains in question and it remains uncertain at this time what the impact of a possible transition to SOFR may have on our business, financial result and operations.
Rising interest rates and adverse changes in mortgage market conditions could reduce mortgage revenue.
In 2018, approximately 47 percent of our revenue was derived from our Mortgage Origination segment which includes activities related to the origination and sales of residential mortgages. The residential real estate mortgage lending business is sensitive to changes in interest rates. Declining interest rates generally increase the volume of mortgage originations while higher interest rates generally cause that volume to decrease. Historically, mortgage origination volume and sales for the Bank and for other financial institutions have risen and fallen in response to these and other factors. An increase in interest rates and/or a decrease in our mortgage production volume could have a material adverse effect on our operating results. During 2018, average 10 year U.S. Treasury rates, on which we base our pricing of our 30 year mortgages, was 2.91 percent, 58 basis points higher than average rates experienced during 2017. The sustained higher rates experienced throughout 2018 negatively impacted the mortgage market including loan origination volume and refinancing activity.
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In addition to being affected by interest rates, the secondary mortgage markets are also subject to investor demand for residential mortgage loans and investor yield requirements for these loans. These conditions may fluctuate or worsen in the future. Adverse market conditions, including increased volatility and reduced market demand, could result in greater risk in retaining mortgage loans pending their sale to investors. A prolonged period of secondary market illiquidity may result in a reduction of our loan mortgage production volume and could have a material adverse effect on our financial condition and results of operations.
Our mortgage origination business is also subject to the cyclical and seasonal trends of the real estate market. Cyclicality in our industry could lead to periods of strong growth in the mortgage and real estate markets followed by periods of sharp declines and losses in such markets. Seasonal trends have historically reflected the general patterns of residential and commercial real estate sales, which typically peak in the spring and summer seasons. One of the primary influences on our mortgage business is the aggregate demand for mortgage loans, which is affected by prevailing interest rates, housing supply and demand, residential construction trends, and overall economic conditions. If we are unable to respond to the cyclicality of our industry by appropriately adjusting our operations or relying on the strength of our other product offerings during cyclical downturns, our business, financial condition and results of operations could be adversely affected.
To effectively manage our MSR concentration risk we may have to sell our MSRs when market conditions are not optimal or hold MSRs at a level which is punitive to our Common Equity Tier 1 capital (CET1) under Basel III.
We are subject to capital standards requirements, including requirements of the Dodd-Frank Act and those developed by the Bank's regulators based on the Basel Committee on Banking Supervision, commonly referred to as Basel III. Basel III established a qualifying criteria for regulatory capital, including limitations on the amount of DTAs and MSRs that may be held without triggering higher capital requirements. Basel III currently limits the amount of MSRs and DTAs each to 10 percent of CET1, individually, and 15 percent of CET1, in the aggregate.
As of December 31, 2018, we had $290 million in MSRs and a MSR to Common Equity Tier 1 Capital ratio of 23.0 percent. We produced, on average, approximately $89 million of new MSRs per quarter in 2018 and we expect to continue to generate MSRs going forward. Considering the volume of MSRs that we generate, we must continually sell MSRs to manage the concentration of this asset. In 2018, we sold $371 million in MSRs and as of December 31, 2018, we had pending MSR sales with a fair value of $44 million which closed during the first quarter of 2019. While our established plan to manage our MSR concentration incorporates our production volumes and required sales, no assurance can be given that we will be able to do so. Additionally, to manage our MSR concentration, we may have to sell our MSRs at a price less than their fair value due to market constraints present at the time of sale which could have an adverse effect on our financial condition and results of operations.
On October 27, 2017, the agencies issued a notice of proposed rulemaking (NPR) which would simplify certain aspects of the Basel III capital rules. The agencies expect that the capital treatment and transition provisions for items covered by this final rule will change once the simplification proposal is finalized and effective. Specifically, the proposal would increase the limit on MSRs to 25 percent of CET1 and eliminate the aggregate 15 percent CET1 deduction threshold for MSRs and temporary difference DTAs. The increase in the limit on MSRs would allow us to hold up to $347 million in MSRs without being punitive to our capital ratios. The regulators have not yet issued their final rule.
In preparation for the NPR, the Basel III implementation phase-in has been halted for the treatment of MSRs and certain DTAs. The agencies issued a final rule that will maintain the capital rules’ 2017 transition provisions for several regulatory capital deductions and certain other requirements that are subject to multi-year phase-in schedules in the regulatory capital rules. Specifically, the final rule will maintain the capital rules’ 2017 transition provisions at 80 percent for the regulatory capital treatment of the following items: (i) MSRs, (ii) DTAs arising from temporary differences that could not be realized through net operating loss carrybacks, (iii) investments in the capital of unconsolidated financial institutions, and (iv) minority interests. As of December 31, 2018, we had $290 million on MSRs, $48 million in DTAs arising from temporary differences and no material investments in unconsolidated financial institutions or minority interest. This final rule will maintain the 2017 transition provisions for certain items for non-advanced approach banks, such as the Bank.
Our ALLL could be too low to sufficiently cover future credit losses. As of December 31, 2018, our ALLL was $128 million, covering 1.4 percent of total loans held-for-investment. Our estimate of the inherent losses is imperfect and based on management judgment.
Our ALLL, which reflects our estimate of such losses inherent in the loan portfolio at December 31, 2018, may not be adequate to cover actual credit losses. If this allowance is insufficient, future provisions for credit losses could adversely affect
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our financial condition and results of operations. We attempt to limit the risk that borrowers will fail to repay loans by carefully underwriting our loans, but losses nevertheless occur in the ordinary course of business. Our ALLL is based on historical experience as well as our evaluation of the risks inherent in the loan portfolio at December 31, 2018. The determination of an appropriate level of loan loss allowance is a subjective process that requires significant management judgment, including estimates of loss and the loss emergence period, estimates and judgments about the collectability of our loan portfolio including but not limited to the creditworthiness of our borrowers and the value of real estate or other collateral backing the repayment of loans. New information regarding existing loans, identification of additional problem loans, failure of borrowers and guarantors to perform in accordance with the terms of their loans, and other factors, both within and outside of our control, may require an increase in the ALLL. Moreover, our regulators, as part of their supervisory function, periodically review our ALLL and may recommend or require us to increase the amount of our ALLL, based on their judgment, which may be different from that of our management. Any increase in our loan losses would have an adverse effect on our earnings and financial condition.
Concentration of loans held-for-investment in certain geographic locations and markets may increase the magnitude of potential losses should defaults occur.
Our residential mortgage loan portfolio is geographically concentrated in certain states, including California and Michigan, which comprise approximately 52 percent of the portfolio. In addition, our commercial loan portfolio has a concentration of Michigan lending relationships. Approximately 44 percent of our CRE loans are collateralized by properties in Michigan and 29 percent of our C&I borrowers are located in Michigan. These concentrations have made, and will continue to make, our loan portfolio particularly susceptible to downturns in the local economies and the real estate and mortgage markets in these areas. Adverse conditions that are beyond our control may affect these areas, including unemployment, inflation, recession, natural disasters, declining property values, municipal bankruptcies and other factors which could increase both the probability and severity of defaults in our loan portfolio, reduce our ability to generate new loans and negatively affect our financial results.
In 2018, we continued to grow our commercial portfolio to $5.0 billion at December 31, 2018. As a part of that, CRE and C&I loans grew to $3.6 billion and comprised 39 percent of our total LHFI portfolio. Additionally, our home builder finance program reached $718 million in outstanding loans at December 31, 2018. The home builder lending portfolio contains secured and unsecured loans and our lending platform originates loans throughout the U.S. with regional offices in Houston and Denver. The growth of our home builder lending business may be impacted by overall economic conditions in the areas builders operate as well as new home construction rates and trends.
Commercial loans, excluding our warehouse loans, generally expose us to a greater risk of nonpayment and loss than residential real estate loans due to the more complex nature of underwriting. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans. At December 31, 2018, our largest CRE and C&I borrowers had loans of $71 million and $70 million, respectively. Further, we have commitments up to $100 million in our CRE and C&I portfolios. As such, a default by one of our larger borrowers could result in a significant loss relative to our ALLL. Additionally, secured loans, including residential and commercial real estate, may experience changes in the underlying collateral value due to adverse market conditions which could result in increased charge-offs in the event of a loan default.
At December 31, 2018, our adjustable-rate warehouse lines of credit granted to other mortgage lenders was $3.8 billion, of which $1.5 billion was outstanding. There may be risks associated with the mortgage lenders that borrow from the Bank, including credit risk, inadequate underwriting, and potential external fraud. At December 31, 2018, our largest borrower had an outstanding advance of $80 million. A default by one of our larger warehouse borrowers could result in a large loss. Additionally, adverse changes to industry competition, mortgage demand and the interest rate environment may have a negative impact on warehouse lending.
Liquidity risk may affect our ability to meet obligations and impact our ability to grow our business.
We require substantial liquidity to repay our customers' deposits, fulfill loan demand, meet borrowing obligations as they come due, and fund our operations under both normal operating environments and unforeseen circumstances causing liquidity stress. Our liquidity could be impaired by our inability to access the capital markets or unforeseen outflows of deposits. Our access to liquidity, including deposits, as well as the cost of that liquidity, is dependent on various factors, a number of which could make funding more difficult, more expensive or unavailable on any terms. These factors include: losses or declining financial results, material changes to operating margins, financial leverage on an absolute basis or relative to peers, changes within the organization, specific events that impact our financial condition or reputation, disruptions in the capital
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markets, specific events that adversely impact the financial services industry, counterparty availability, the corporate and regulatory structure, balance sheet and capital structure, geographic and business diversification, interest rate fluctuations, market share and competitive position, general economic conditions and the legal, regulatory, accounting and tax environments governing funding transactions. Many of these factors are beyond our control. A material deterioration in any one or a combination of these factors could result in a downgrade of our credit or servicer standing with counterparties or a decline in our reputation within the marketplace, and could result in higher cash outflows requiring additional access to liquidity, having a limited ability to borrow funds, maintain or increase deposits (including custodial deposits from our agency servicing portfolio) or to raise capital on commercially reasonable terms or at all. If we are unable to maintain and grow certain of these financing arrangements, are restricted from accessing certain funding sources by our regulators, are unable to arrange for new financing on acceptable terms, or if we default on any of the covenants imposed upon us by our borrowing facilities, then we may have to limit our growth, reduce the number of loans we are able to originate or take actions that could have other negative effects on our operations.
We are a holding company and are, therefore, dependent on the Bank for funding of obligations.
As a holding company with no significant assets other than the capital stock of the Bank and cash on hand, our ability to service our debt, including interest payments on our senior notes and trust preferred securities, pay dividends, repurchase shares of our common stock, pay for certain services we purchase from the Bank and cover operating expenses, depend upon available cash on hand and the receipt of dividends from the Bank. The holding company had cash and cash equivalents of $201 million at December 31, 2018, or approximately 3.2 years of future cash outflows, dividend payments, share repurchases and debt service coverage when excluding the redemption of $250 million of senior notes which mature on July 15, 2021. On January 29, 2019, our Board of Directors approved an accelerated share repurchase ("ASR") agreement with Wells Fargo, N.A. to repurchase up to $50 million of the Company's common stock. Operating expenses, which include costs paid to the Bank, totaled $34 million for the year ended December 31, 2018. The declaration and payment of dividends by the Bank on all classes of its capital stock is subject to the discretion of the Bank's Board of Directors and to applicable regulatory and legal limitations. If the Bank, does not, or cannot, make sufficient dividend payments to us, we may not be able to service our debt, which could have a material adverse effect on our financial condition and results of operations or could cause us to take other actions which could be materially detrimental.
Regulatory Risk
We are highly dependent on the Agencies to buy mortgage loans that we originate. Changes in these entities or their current roles could adversely affect our business, financial condition and results of operations.
We generate mortgage revenues primarily from gains on the sale of single-family residential loans pursuant to programs currently offered by Fannie Mae, Freddie Mac, Ginnie Mae and other investors. These entities account for a substantial portion of the secondary market in residential mortgage loans. During the year ended December 31, 2018, we sold approximately 50 percent of our mortgage loans to Fannie Mae and Freddie Mac. Any future changes in these programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, result in a lower volume of corresponding loan originations or other administrative costs which may materially adversely affect our results of operations or could cause us to take other actions that would be materially detrimental.
Fannie Mae and Freddie Mac remain in conservatorship and a path forward for them to emerge from conservatorship is unclear. Their roles could be reduced, modified or eliminated as a result of regulatory actions and the nature of their guarantees could be limited or eliminated relative to historical measurements. The elimination or modification of the traditional roles of Fannie Mae or Freddie Mac could create additional competition in the market and significantly and adversely affect our business, financial condition and results of operations.
Changes in the servicing, origination, or underwriting guidelines or criteria required by the Agencies could adversely affect our business, financial condition and results of operations.
We are required to follow specific guidelines or criteria that impact the way that we originate, underwrite, or service. Agency loans, including guidelines with respect to credit standards for mortgage loans, our staffing levels and other servicing practices, the servicing and ancillary fees that we may charge, our modification standards and procedures and the amount of non-reimbursable advances.
We cannot negotiate these terms with the Agencies and they are subject to change at any time. A significant change in these guidelines which decreases the fees we charge or requires us to expend additional resources in providing mortgage
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services could decrease our revenues or increase our costs, which would adversely affect our business, financial condition and results of operations.
In addition, changes in the nature or extent of the guarantees provided by Fannie Mae and Freddie Mac or the insurance provided by the FHA could also have broad adverse market implications. The fees that we are required to pay to the Agencies for these guarantees have changed significantly over time and any future increases in these fees would adversely affect our business, financial condition and results of operations.
We depend upon having FDIC insurance to raise deposit funding at reasonable rates. Future changes in deposit insurance premiums and special FDIC assessments could adversely affect our earnings.
The Dodd-Frank Act required the FDIC to substantially revise its regulations for determining the amount of an institution's deposit insurance premiums. Consequently, the FDIC has defined the deposit insurance assessment base for an insured depository institution as average consolidated total assets during the assessment period, minus average Tier 1 Capital. Our assessment rate is determined by use of a scorecard that combines our CAMELS ratings with certain other financial information. Changes in the level and mix of these financial components in the scorecard may result in a higher assessment rate. The FDIC may determine that we present a higher risk to the DIF than other banks due to various factors. These factors include significant risks relating to interest rates, loan portfolio and geographic concentration, concentration of high credit risk loans, increased loan losses, regulatory compliance, existing and future litigation and other factors. As a result, we could be subject to higher deposit insurance premiums and special assessments in the future that could adversely affect our earnings. The Bank’s deposit insurance premiums and special assessments in the future also may be higher than competing banks may be required to pay. For the years ended December 31, 2018, 2017 and 2016, our FDIC insurance expense premiums totaled $22 million, $16 million and $11 million, respectively.
Operational Risk
Our recent acquisition of bank branches from Wells Fargo involves integration and other risks.
Bank branch acquisitions involve a number of challenges including, the ability to integrate new business into operations, internal controls and regulatory functions. There is no assurance we will be able to limit the outflow of deposits held by our new customers in the acquired branches or attract new deposits and generate new interest-earning assets in geographic areas we did not previously serve. There is no guarantee that the acquired branches will achieve results in the future similar to those achieved by our existing banking business; that we will compete effectively in the market areas served by acquired branches; or that we will manage any growth resulting from the transaction effectively. We face the additional risk that the anticipated benefits of the acquisition may not be realized fully or at all, or within the time period expected.
A failure of our information technology systems, or those of any of our key third party vendors or service providers, could cause operational losses and damage our reputation.
Our businesses are increasingly dependent on our ability to process, record and monitor a large number of complex transactions and data. If our internal information technology systems fail, we may be unable to conduct business for a period of time, which may impact our financial results if that interruption is sustained. In addition, our reputation with our customers or business partners may suffer, which could have a further, long-term impact on our financial results.
Because we conduct part of our business over the Internet and outsource a significant number of our critical functions to third parties, our operations depend on our third-party service providers to maintain and operate their own technology systems. To the extent these third parties’ systems fail, despite our monitoring and contingency plans, we may be unable to conduct business or provide certain services, and we may face financial and reputational losses as a result.
We face operational risks due to the high volume and the high dollar value of transactions we process.
We rely on the ability of our employees and systems to process a wide variety of transactions. Many of the transactions we process may be of high dollar value, such as those related to mortgage lending and warehouse advances. In 2018, we originated a total of $32.5 billion in residential mortgage loans and processed $33.9 billion of warehouse lending advances. We face operational risk from, but not limited to, the risk of fraud by employees or persons outside our company, the execution of unauthorized transactions, errors relating to transaction processing and technology, breaches of our internal control systems or failures of those of our suppliers or counterparties, compliance failures, cyber-attacks, technology failures, or unforeseen problems related to system implementations or upgrades, business continuation and disaster recovery issues, and other external
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events. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. The occurrence of any of these events could result in a financial loss, regulatory action or damage to our reputation.
We may lose market share to our competitors if we are not able to respond to technological change and introduce new products and services.
Financial products and services have become increasingly technologically driven. We may not be able to respond to technological innovations as quickly as our competitors do. Certain of our competitors are making significantly greater investments and allocating significantly more in financial resources toward technological innovations than we historically have. Our ability to meet the needs of our customers and introduce competitive products in a cost-efficient manner depends on our responsiveness to technological advances, investment in new technology as it becomes available, and obtaining and maintaining related essential personnel. Furthermore, the introduction of new technologies and products by financial technology companies and platforms may adversely affect our ability to maintain our customer base, obtain new customers or successfully grow our business. The failure to respond to the product demands of our customers, due to cost, proficiency or otherwise, could have a material adverse impact on our business and therefore on our financial condition and results of operations.
We collect, store and transfer our customers’ personally identifiable information. Any cybersecurity attack or other compromise to the security of that information could adversely impact our business and financial condition.
Cybersecurity related attacks are attempted on an ongoing basis which pose a risk of data breaches relative to the processing of consumer transactions that contain customers’ personally identifiable information. As a part of conducting business, we receive, transmit and store a large volume of personally identifiable information and other user data either on our network or in the cloud.
Cybersecurity risks for banking institutions have increased significantly in recent years due to new technologies, the reliance on technology to conduct financial transactions and the increased sophistication of organized crime and hackers. A cybersecurity attack or information security breach could adversely impact our ability to conduct business due to the potential costs for remediation, protection and litigation and reputational damage with customers, business partners and investors.
There are myriad federal, state, local and international laws regarding privacy and the storing, sharing, use, disclosure and protection of personally identifiable information and user data. We have policies and processes in place that are intended to meet the requirements of those laws, including security systems to prevent unauthorized access to that information. Nevertheless, those processes and systems may be inadequate. Also, to the extent we rely upon third parties to handle personally identifiable data on our behalf, we may be responsible if such data is compromised or subject to a cybersecurity attack while in the custody and control of those third parties.
Privacy laws are continually evolving and many state and local jurisdictions have laws that differ from federal law or privacy policies, further some of those policies or laws may conflict. If we fail to comply with applicable privacy policies or federal, state, local or international laws and regulations or experience any compromise of security that results in the unauthorized release of personally identifiable information or other user data, those events could damage the reputation of our business, and discourage potential users from utilizing our products and services. In addition, we may have to bear the cost of mitigating identity theft concerns, and may be subject to fines or legal proceedings by governmental agencies or consumers. Any of these events could adversely affect our business and financial condition.
We may be terminated as a servicer or subservicer or incur costs, liabilities, fines and other sanctions if we fail to satisfy our servicing obligations, including our obligations with respect to mortgage loan foreclosure actions.
Servicing revenue makes up approximately 11 percent of our total revenue and contributed approximately $1.8 billion in average custodial deposits during 2018. At December 31, 2018, we had relationships with 7 owners of MSRs, excluding ourselves, in which we act as servicer or subservicer for the mortgage loans they own. Due to the limited number of relationships, discontinuation of existing agreements with any of those third parties or adverse changes in contractual terms could have a significant negative impact to our mortgage servicing revenue. The terms and conditions in which a master servicer may terminate subservicing contracts are broad and, in some instances, could be exercised at the discretion of the master servicer without requiring cause. Additionally, the master servicer directs the oversight of custodial deposits associated with serviced loans and, to the extent allowable, could choose to transfer the oversight of the Bank's custodial deposits to another depository institution. Further, as servicer or subservicer of loans, we have certain contractual obligations, including foreclosing on defaulted mortgage loans or, to the extent applicable, considering alternatives to foreclosure. If we commit a
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material breach of our obligations as servicer, we may be subject to termination if the breach is not cured within a specified period of time following notice, causing us to lose servicing income.
We may be required to repurchase mortgage loans, pay fees or indemnify buyers against losses.
When mortgage loans are sold by us, we make customary representations and warranties to purchasers, guarantors and insurers, including the Agencies, about the mortgage loans, and the manner in which they were originated. Whole loan sale agreements require us to repurchase or substitute mortgage loans, or indemnify buyers against losses, in the event we breach these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of early payment default of the borrower or we may be required to pay fees. We also are subject to litigation relating to these representations and warranties which may result in significant costs. With respect to loans that are originated through our broker or correspondent channels, the remedies we have available against the originating broker or correspondent, if any, may not be as broad as the remedies available to purchasers, guarantors and insurers of mortgage loans against us. We also face further risk that the originating broker or correspondent, if any, may not have the financial capacity to perform remedies that otherwise may be available. Therefore, if a purchaser, guarantor or insurer enforces its remedies against us, we may not be able to recover losses from the originating broker or correspondent. If repurchase and indemnity demands increase and such demands are valid claims, our liquidity, results of operations and financial condition may also be adversely affected.
For certain investors and/or certain transactions, we may be contractually obligated to repurchase a mortgage loan or reimburse the investor for credit or other losses incurred on the loan as a remedy for servicing errors with respect to the loan. If we have increased repurchase obligations because of claims for which we did not satisfy our obligations, or increased loss severity on such repurchases, we may have a significant reduction to noninterest income or an increase to noninterest expense. We may incur significant costs if we are required to, or if we elect to, re-execute or re-file documents or take other action in our capacity as a servicer in connection with pending or completed foreclosures. We may incur litigation costs if the validity of a foreclosure action is challenged by a borrower. Any of these actions may harm our reputation or negatively affect our servicing business and, as a result, our profitability.
Our representation and warranty reserve, which is based on an estimate of probable future losses, was $7 million at December 31, 2018. This may not be adequate to cover losses for loans that we have sold or securitized for which we may be subsequently required to repurchase, pay fines or fees, or indemnify purchasers and insurers because of violations of customary representations and warranties. Our regulators, as part of their supervisory function, periodically review our representation and warranty reserve for losses. Our regulators may recommend or require us to increase our reserve, based on their judgment, which may differ from that of our management. The repurchase demand pipeline was $9 million UPB at December 31, 2018.
We utilize third party mortgage originators which subjects us to strategic, reputation, compliance and operational risk.
In 2018, approximately 86 percent of our residential first mortgage volume depended upon the use of third party mortgage originators, i.e. mortgage brokers and correspondent lenders, who are not our employees. These third parties originate mortgages and provide services to many different banks and other entities. Accordingly, they may have relationships with or loyalties to such banks and other parties that are different from those they have with or to us. Failure to maintain good relations with such third party mortgage originators could have a negative impact on our market share which would negatively impact our results of operations.
We rely on third party mortgage originators to originate and document the mortgage loans we purchase or originate. While we perform due diligence on the mortgage companies with whom we do business and review the loan files and loan documents we purchase to attempt to detect any irregularities or legal noncompliance, we have less control over these originators than employees of the Bank.
Due to regulatory scrutiny, our third party mortgage originators could choose or be required to either reduce the scope of their business or exit the mortgage origination business altogether. The TILA-RESPA Integrated Disclosure Rule issued by the CFPB establishes comprehensive mortgage disclosure requirements for lenders and settlement agents in connection with most closed-end consumer credit transactions secured by real property. The rule requires certain disclosures to be provided to consumers in connection with applying for and closing on a mortgage loan. The rule also mandates the use of specific disclosure forms, timing of communicating information to borrowers and certain record keeping requirements. The ongoing administrative burden and the system requirements associated with complying with these rules or potential changes to these rules could impact our mortgage volume and increase costs. In addition, these arrangements with third party mortgage originators and the fees payable by us to such third parties could be subject to regulatory scrutiny and restrictions in the future.
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The Equal Credit Opportunity Act and the Fair Housing Act, prohibit discriminatory lending practices by lenders, including financial institutions. Mortgage and consumer lending practices raise compliance risks resulting from the detailed and complex nature of mortgage and consumer lending laws regulations imposed by federal regulatory agencies, and the relatively independent and diverse operating channels in which loans are originated. As we originate loans through various channels, we, and our third party mortgage originators, are especially impacted by these laws and regulations and are required to implement appropriate policies and procedures to help ensure compliance with fair lending laws and regulations and to avoid lending practices that result in the disparate treatment of or disparate impact to borrowers across our various locations under multiple channels. Failure to comply with these laws and regulations, by us or our third party mortgage originators, could result in the Bank being liable for damages to individual borrowers or other imposed penalties.
General Risk Factors
MP Thrift, an entity managed and controlled by MatlinPatterson, owns 47.8 percent of our common stock. Future issuance of Flagstar’s common stock in the public market, or as a result of actions taken by MP Thrift, could adversely affect the trading price of Flagstar’s common stock.
As of December 31, 2018, MP Thrift owned 47.8 percent of the Company’s common stock. Sales of a substantial number of shares of Flagstar’s common stock in the public market, or the perception that these sales might occur, may cause the market price of Flagstar’s common stock to decline. Further, a large quantity of our shares introduced into the market, either at once or over time, could increase the supply of Flagstar common stock, thereby putting pressure on our stock price. Pricing pressure could further be exacerbated by low trading volumes and market conditions, both of which may impact the extent of time it may take for pricing to rationalize.
We are subject to various legal or regulatory investigations and proceedings.
At any given time, we are involved with a number of legal and regulatory examinations as a part of the routine reviews conducted by regulators and other parties which may involve consumer protection, employment, tort, and numerous other laws and regulations. Proceedings or actions brought against us may result in judgments, settlements, fines, injunctions, business improvement orders, consent orders, supervisory agreements, restrictions on our business activities, or other results adverse to us, which could materially and negatively affect our business. If such claims and other matters are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services, as well as impact customer demand for those products and services. Some of the laws and regulations to which we are subject may provide a private right of action that a consumer or class of consumers may pursue to enforce these laws and regulations. We have been, and may be in the future, subject to stockholder derivative actions, which could seek significant damages or other relief. Any financial liability or reputational damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations. Claims asserted against us can be highly complicated and slow to develop, making the outcome of such proceedings difficult to predict or estimate early in the process. As a participant in the financial services industry, it is likely that we will be exposed to a high level of litigation and regulatory scrutiny relating to our business and operations.
In 2018, the Ninth Circuit Federal Court of Appeals held that California state law requiring mortgage servicers to pay interest on certain mortgage escrow accounts was not, as a matter of law, preempted by the National Bank Act (Lusnak v. Bank of America). This ruling goes against the position that regulators, national banks and other federally-chartered financial institutions have taken regarding the preemption of state-law mortgage escrow interest requirements. The opinion issued by the Ninth Circuit Federal Court of Appeals is legal precedent only in certain parts of the western United States. If the Ninth’s Circuit’s holding is more broadly adopted by other Federal Circuits, including those covering states that currently have or in the future may enact statutes requiring the payment of interest on escrow balances or if we would be required to retroactively apply interest on escrows, the Company’s earnings could be adversely affected.
Although we establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated, we do not have accruals for all legal proceedings where we face a risk of loss. Due to the inherent subjectivity of the assessments and unpredictability of the outcome of legal and regulatory proceedings, amounts accrued may not represent the ultimate loss to us from the legal and regulatory proceedings in question. As a result, our ultimate losses may be significantly higher than the amounts accrued for legal loss contingencies. For further information, see Note 21 - Legal Proceedings, Contingencies and Commitments.
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Loss of certain personnel, including key members of the Corporation's management team, could adversely affect the Corporation.
We are and will continue to be dependent upon our management team and other key personnel. Losing the services of one or more key members of our management team or other key personnel could adversely affect our operations.
In addition, we are subject to regulations that allow us to make severance payments only in limited circumstances. Our named executive officers may be entitled to certain severance and change in control benefits. Although we follow certain leading practices with respect to executive compensation including the elimination of supplemental executive retirement plans (SERPs) or other nonqualified plans for executives and avoiding severance payments for "cause" terminations or voluntary resignations, we may be subject to certain legal or regulatory risks associated with previous employment agreements or retirement plans which could impact our liabilities and results of operations related to these matters.
Other Risk Factors
The above description of risk factors is not exhaustive. Other risk factors are described elsewhere herein as well as in other reports and documents that we file with or furnish to the SEC. Other factors that could also cause results to differ from our expectations may not be described herein or in any such report or document.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Flagstar's headquarters is located in Troy, Michigan at 5151 Corporate Drive and we operate a regional office in Jackson, Michigan. We own both the headquarters and regional office buildings.
At December 31, 2018, we operated 160 bank branches in the following states:
Owned | Leased | Total | Free-Standing Office Building | In-Store Banking Center | Buildings with Other Tenants | Total | |||||||||||||||
Michigan | 87 | 27 | 114 | 90 | 2 | 22 | 114 | ||||||||||||||
Indiana | 27 | 6 | 33 | 31 | — | 2 | 33 | ||||||||||||||
California | 8 | — | 8 | 8 | — | — | 8 | ||||||||||||||
Wisconsin | 3 | 1 | 4 | 3 | — | 1 | 4 | ||||||||||||||
Ohio | 1 | — | 1 | 1 | — | — | 1 | ||||||||||||||
Total | 126 | 34 | 160 | 133 | 2 | 25 | 160 | ||||||||||||||
We also have 75 retail mortgage locations, 4 wholesale lending offices, and 9 commercial lending offices. These locations are primarily leased and located in 25 states.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is party to legal proceedings incident to its business. For further information, see Note 21 - Legal Proceedings, Contingencies and Commitments.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
18
PART II
ITEM 5. | MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS |
Our common stock trades on the NYSE under the trading symbol FBC. At December 31, 2018, there were 57,749,464 shares of our common stock outstanding held by 11,746 stockholders of record.
Dividends
We had not paid dividends on our common stock since the fourth quarter 2007. On January 29, 2019, our Board of Directors declared a quarterly cash dividend which will commence in the first quarter of 2019. The declaration and payment of future dividends, if any, will be considered by our Board of Directors in its discretion and will depend on a number of factors, including our financial condition, liquidity, earnings and prospective earnings.
Sale of Unregistered Securities
We made no unregistered sales of our equity securities during the fiscal year ended December 31, 2018.
Issuer Purchases of Equity Securities
Period | Total Number of Shares Purchased | Average Price per Share | Total Number of Shares Purchases as Part of Publicly Announced Plan | Maximum Number of Shares that May Yet Be Purchased Under the Plan | |||||||||
October 1, 2018 to October 31, 2018 | — | — | — | — | |||||||||
November 1, 2018 to November 30, 2018 | — | — | — | — | |||||||||
December 1, 2018 to December 31, 2018 | 4,709 | $ | 31.51 | 4,709 | 28,919 | ||||||||
On October 16, 2018, the Board approved the offer to repurchase common stock from beneficial owners of 99 or fewer shares of common stock, commonly referred as an odd-lot buyback. This repurchase offer is complete and expired on January 11, 2019. All repurchased shares are authorized and will be accounted for as treasury stock in the Consolidated Statements of Financial Condition.
On January 31, 2019, our Board of Directors announced an accelerated share repurchase ("ASR") agreement with Wells Fargo, N.A. to repurchase up to $50 million of the Company's common stock. The ASR program commenced on February 1, 2019. Under the terms of the ASR, the Company received an initial delivery of approximately 1.3 million shares which represents 82 percent of the total number of shares expected to be repurchased pursuant to the ASR program, based on the closing price of $30.85 on January 31, 2019. The total number of shares to be repurchased will be based on the average of the Company’s daily volume-weighted average stock price, less a discount, during the term of the ASR program, which is expected to be completed by the end of the second quarter of 2019.
Equity Compensation Plan Information
For information with respect to securities to be issued under our equity compensation plans, see Part III, Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, which information is hereby incorporated by reference.
19
Performance Graph
CUMULATIVE TOTAL STOCKHOLDER RETURN
COMPARED WITH PERFORMANCE OF SELECTED INDICES
DECEMBER 31, 2013 THROUGH DECEMBER 31, 2018
Flagstar Bancorp | Nasdaq Financial | Nasdaq Bank | S&P Small Cap 600 | Russell 2000 | |||||
December 31, 2013 | 100 | 100 | 100 | 100 | 100 | ||||
December 31, 2014 | 80 | 102 | 103 | 104 | 104 | ||||
December 31, 2015 | 118 | 106 | 110 | 101 | 98 | ||||
December 31, 2016 | 137 | 130 | 148 | 126 | 117 | ||||
December 31, 2017 | 191 | 147 | 153 | 141 | 132 | ||||
December 31, 2018 | 135 | 132 | 126 | 127 | 116 | ||||
20
ITEM 6. SELECTED FINANCIAL DATA
For the Years Ended December 31, | |||||||||||||||||||
2018 (1) | 2017 (2) | 2016 (3) | 2015 | 2014 (4) | |||||||||||||||
(In millions, except share data and percentages) | |||||||||||||||||||
Summary of Consolidated Statements of Operations | |||||||||||||||||||
Net interest income | $ | 497 | $ | 390 | $ | 323 | $ | 287 | $ | 247 | |||||||||
Provision (benefit) for loan losses | (8 | ) | 6 | (8 | ) | (19 | ) | 132 | |||||||||||
Noninterest income | 439 | 470 | 487 | 470 | 372 | ||||||||||||||
Noninterest expense | 712 | 643 | 560 | 536 | 590 | ||||||||||||||
Provision (benefit) for income taxes | 45 | 148 | 87 | 82 | (34 | ) | |||||||||||||
Net income (loss) | 187 | 63 | 171 | 158 | (69 | ) | |||||||||||||
Preferred stock dividends/accretion | — | — | — | — | (1 | ) | |||||||||||||
Net income (loss) from continuing operations | $ | 187 | $ | 63 | $ | 171 | $ | 158 | $ | (70 | ) | ||||||||
Income (loss) per share: | |||||||||||||||||||
Basic | $ | 3.26 | $ | 1.11 | $ | 2.71 | $ | 2.27 | $ | (1.72 | ) | ||||||||
Diluted | $ | 3.21 | $ | 1.09 | $ | 2.66 | $ | 2.24 | $ | (1.72 | ) | ||||||||
Weighted average shares outstanding: | |||||||||||||||||||
Basic | 57,520,289 | 57,093,868 | 56,569,307 | 56,426,977 | 56,246,528 | ||||||||||||||
Diluted | 58,322,950 | 58,178,343 | 57,597,667 | 57,164,523 | 56,246,528 | ||||||||||||||
(1) | Net interest income includes $29 million of pre-tax hedging gains reclassified from AOCI. Noninterest expense includes $15 million of pre-tax acquisition-related expenses related to the Wells Fargo branch acquisition. |
(2) | Provision for income taxes includes $80 million non-cash charge resulting from the revaluation of the Company's net deferred tax asset (DTA) at a lower statutory rate as a result of the Tax Cuts and Jobs Act. |
(3) | Noninterest income includes $24 million of pre-tax benefit due to the reduction of the DOJ settlement liability. |
(4) | Provision for loan losses includes $96 million charge due to changes in estimates related to the loss emergence period on residential loans and the evaluation of risk associated with interest-only loans. Noninterest expense includes $38 million related to CFPB litigation settlement expense. |
December 31, | |||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||
(In millions, except per share data and percentages) | |||||||||||||||||||
Summary of Consolidated Statements of Financial Condition | |||||||||||||||||||
Total assets | $ | 18,531 | $ | 16,912 | $ | 14,053 | $ | 13,715 | $ | 9,840 | |||||||||
Loans receivable, net | 13,221 | 12,165 | 9,465 | 9,226 | 6,523 | ||||||||||||||
Total deposits | 12,380 | 8,934 | 8,800 | 7,935 | 7,069 | ||||||||||||||
Total short-term and long-term Federal Home Loan Bank advances | 3,394 | 5,665 | 2,980 | 3,541 | 514 | ||||||||||||||
Long-term debt | 495 | 494 | 493 | 247 | 331 | ||||||||||||||
Stockholders' equity (1) | 1,570 | 1,399 | 1,336 | 1,529 | 1,373 | ||||||||||||||
Book value per common share | 27.19 | 24.40 | 23.50 | 22.33 | 19.64 | ||||||||||||||
Tangible book value per share (2) | 23.90 | 24.04 | 23.50 | 22.33 | 19.64 | ||||||||||||||
Number of common shares outstanding | 57,749,464 | 57,321,228 | 56,824,802 | 56,483,258 | 56,332,307 | ||||||||||||||
(1) | Includes preferred stock totaling $267 million for the years ended December 31, 2015 and December 31, 2014. |
(2) | Excludes goodwill and intangibles of $190 million and $21 million for the years ended December 31, 2018 and December 31, 2017, respectively. See Non-GAAP Financial Measures for further information. |
21
At or For the Years Ended December 31, | |||||||||||||||||||
2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||
(In millions, except share data and percentages) | |||||||||||||||||||
Average Balances: | |||||||||||||||||||
Average interest-earning assets | $ | 16,136 | $ | 14,130 | $ | 12,164 | $ | 10,436 | $ | 8,440 | |||||||||
Average interest paying liabilities | 13,124 | 11,848 | 9,757 | 8,305 | 6,780 | ||||||||||||||
Average stockholders’ equity | 1,488 | 1,433 | 1,464 | 1,486 | 1,406 | ||||||||||||||
Selected Ratios: | |||||||||||||||||||
Interest rate spread (1) | 2.81 | % | 2.56 | % | 2.45 | % | 2.58 | % | 2.80 | % | |||||||||
Adjusted interest rate spread (1)(2) | 2.58 | % | 2.56 | % | 2.45 | % | 2.58 | % | 2.80 | % | |||||||||
Net interest margin | 3.07 | % | 2.75 | % | 2.64 | % | 2.74 | % | 2.91 | % | |||||||||
Adjusted net interest margin (2) | 2.89 | % | 2.75 | % | 2.64 | % | 2.74 | % | 2.91 | % | |||||||||
Return (loss) on average assets | 1.04 | % | 0.40 | % | 1.23 | % | 1.32 | % | (0.71 | )% | |||||||||
Return (loss) on average equity | 12.58 | % | 4.41 | % | 11.69 | % | 10.63 | % | (4.97 | )% | |||||||||
Return (loss) on average common equity | 12.6 | % | 4.4 | % | 13.0 | % | 10.5 | % | (6.1 | )% | |||||||||
Equity-to-assets ratio | 8.47 | % | 8.27 | % | 9.50 | % | 11.14 | % | 13.95 | % | |||||||||
Common equity-to-assets ratio | 8.47 | % | 8.27 | % | 9.50 | % | 9.20 | % | 11.24 | % | |||||||||
Tangible common equity-to-assets ratio (3) | 7.45 | % | 8.15 | % | 9.50 | % | 9.20 | % | 11.24 | % | |||||||||
Equity/assets ratio (average for the period) | 8.28 | % | 9.05 | % | 10.52 | % | 12.43 | % | 14.22 | % | |||||||||
Efficiency ratio | 76.0 | % | 74.8 | % | 69.2 | % | 70.9 | % | 95.4 | % | |||||||||
Bancorp Tier 1 leverage (to adjusted avg. total assets) (4) | 8.29 | % | 8.51 | % | 8.88 | % | 11.51 | % | N/A | ||||||||||
Bank Tier 1 leverage (to adjusted avg. total assets) (4) | 8.67 | % | 9.04 | % | 10.52 | % | 11.79 | % | 12.43 | % | |||||||||
Effective tax provision rate (5) | 19.4 | % | 70.1 | % | 33.7 | % | 34.2 | % | 32.9 | % | |||||||||
Selected Statistics: | |||||||||||||||||||
Mortgage rate lock commitments (fallout-adjusted) (6) | $ | 30,308 | $ | 32,527 | $ | 29,372 | $ | 25,511 | $ | 24,007 | |||||||||
Mortgage loans originated | $ | 32,465 | $ | 34,408 | $ | 32,417 | $ | 29,368 | $ | 24,585 | |||||||||
Mortgage loans sold and securitized | $ | 32,076 | $ | 32,493 | $ | 32,033 | $ | 26,307 | $ | 24,407 | |||||||||
Number of bank branches | 160 | 99 | 99 | 99 | 107 | ||||||||||||||
Number of FTE employees | 3,938 | 3,525 | 2,886 | 2,713 | 2,739 | ||||||||||||||
(1) | Interest rate spread is the difference between the yield earned on average interest-earning assets for the period and the rate of interest paid on average interest-bearing liabilities. |
(2) | The year ended December 31, 2018, excludes $29 million of hedging gains reclassified from AOCI to net interest income in conjunction with the payment of long-term FHLB advances. See Non-GAAP Financial Measures for further information. |
(3) | Excludes goodwill and intangibles of $190 million and $21 million for the years ended December 31, 2018 and December 31, 2017, respectively. See Non-GAAP Financial Measures for further information. |
(4) | Basel III transitional. |
(5) | The year ended December 31, 2017 includes an $80 million, non-cash charge to the provision for income taxes resulting from the revaluation of the Company's net deferred tax asset (DTA) at a lower statutory rate as a result of the Tax Cuts and Jobs Act. |
(6) | Fallout-adjusted mortgage rate lock commitments are adjusted by a percentage of mortgage loans in the pipeline that are not expected to close based on previous historical experience, the level of interest rates and other factors. |
22
ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
23
The following is an analysis of our financial condition and results of operations. This should be read in conjunction with our Consolidated Financial Statements and related notes filed with this report in Part II, Item 8. Financial Statements and Supplementary Data.
Overview
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 savings bank founded in 1987. We provide a range of commercial, small business, and consumer banking services and we are the 5th largest bank mortgage originator in the nation. We distinguish ourselves by crafting specialized solutions for our customers, local delivery, high quality customer service and competitive product pricing. For additional details and information on each of our lines of business, see MD&A - Operating Segments and Note 23 - Segment Information.
The year ended December 31, 2018 resulted in net income of $187 million, or $3.21 per diluted share, and adjusted net income of $176 million, or $3.02 per diluted share, when excluding Wells Fargo branch acquisition expenses of $13 million, and related hedging gains of $24 million, both net of taxes. When comparing full year 2018 to full year 2017, net income increased $124 million, or $1.57 per diluted share. Excluding the Wells Fargo branch acquisition expenses and related hedging gains from 2018, and an $80 million charge to the provision for income taxes in 2017 resulting from tax reform, adjusted net income increased $33 million, or $0.55 per diluted share. During 2018, we continued to grow the community bank, strengthened our balance sheet with high quality interest earning assets and stable liquidity, and continued to diversify our earnings.
Three strategic banking acquisitions in 2018 further strengthened the community bank. In the first quarter we acquired eight branches of Desert Community Bank and the mortgage loan warehouse business from Santander Bank, followed by the acquisition of 52 branches from Wells Fargo in the fourth quarter. These acquisitions expanded our banking footprint and added $2.2 billion of deposits and $760 million of loans to our balance sheet as of December 31, 2018.
As a result of our acquisitions and continued organic growth, average interest-earning assets increased $2.0 billion, with broad based growth in both our commercial and consumer loan portfolios, which increased $1.2 billion and $704 million, respectively. The acquired low-cost deposits were the primary driver of the $2.5 billion increase in retail and government deposits in 2018, which provides ample liquidity to fund future balance sheet growth. The increase in earning-assets, along with consistent expansion of our net interest margin reflecting higher yielding loans and low-cost deposits, drove up adjusted net interest income less the hedging gains, $78 million, or 20 percent. Net interest income accounted for 52 percent of total revenues in 2018, compared to 45 percent in 2017.
Our mortgage servicing business continued to gain scale and we ended the year servicing nearly 827,000 accounts, representing an 87 percent increase from the prior year. During 2018, we had $29 billion in MSR sales with subservicing retained on 100 percent of these sales, strengthening our national position as the 6th largest subservicer. This business continues to provide both stable deposits and a reliable, predictable source of fee income.
The mortgage market continued to be challenging throughout 2018 as the national mortgage origination market experienced an 8 percent decline in volume from the prior year. As a result, our mortgage origination volume declined 6 percent to $32 billion, contributing to a $68 million decrease in net gain on loan sales. This loss was partially offset by stronger valuations and lower prepayments on our mortgage servicing assets, which improved $14 million.
24
Earnings Performance Highlights
For the Years Ended December 31, | |||||||||||||||||||
2018 | 2017 | 2016 | Change 2018 vs. 2017 | Change 2017 vs. 2016 | |||||||||||||||
(Dollars in millions) | |||||||||||||||||||
Net interest income | $ | 497 | $ | 390 | $ | 323 | $ | 107 | $ | 67 | |||||||||
Provision (benefit) for loan losses | (8 | ) | 6 | (8 | ) | (14 | ) | 14 | |||||||||||
Total noninterest income | 439 | 470 | 487 | (31 | ) | (17 | ) | ||||||||||||
Total noninterest expense | 712 | 643 | 560 | 69 | 83 | ||||||||||||||
Provision for income taxes | 45 | 148 | 87 | (103 | ) | 61 | |||||||||||||
Net income | $ | 187 | $ | 63 | $ | 171 | $ | 124 | $ | (108 | ) | ||||||||
Adjusted net income (1) | $ | 176 | $ | 143 | $ | 155 | $ | 33 | $ | (12 | ) | ||||||||
Income per share: | |||||||||||||||||||
Basic | $ | 3.26 | $ | 1.11 | $ | 2.71 | $ | 2.15 | $ | (1.60 | ) | ||||||||
Diluted | $ | 3.21 | $ | 1.09 | $ | 2.66 | $ | 2.12 | $ | (1.57 | ) | ||||||||
Adjusted diluted (1) | $ | 3.02 | $ | 2.47 | $ | 2.38 | $ | 0.55 | $ | 0.09 | |||||||||
(1) | For further information, see MD&A - Use of Non-GAAP Financial Measures. |
2018 Compared to 2017
• | Net income increased $124 million, or $2.12 per diluted share, to $187 million, or $3.21 per diluted share. |
• | Adjusted net income increased $33 million, or $0.55 per diluted share, to $176 million, or $3.02 per diluted share, when excluding an $80 million charge due to tax reform in 2017 and Wells Fargo branch acquisition expenses of $13 million, net of tax, and related hedging gains of $24 million, net of tax, in 2018. |
• | Net interest income increased $107 million, or $78 million, when excluding hedging gains of $29 million which were reclassified from AOCI. The increase in net interest income was primarily driven by 14 percent higher average interest-earning assets, led by commercial loan growth, and net interest margin expansion of 14 basis points. |
• | The provision for loan losses decreased $14 million, primarily driven by minimal net charge-offs and low levels of delinquencies. |
• | Noninterest income decreased $31 million, primarily due to a $68 million decrease in net gain on loan sales, partially offset by a $14 million increase in net return on MSRs. |
• | Noninterest expense increased $69 million, primarily resulting from organic growth and acquisitions which drove higher compensation and benefits, along with an increase in occupancy and equipment expenses. |
• | Provision for income taxes decreased $103 million, primarily resulting from the revaluation of our DTAs as a result of the new tax legislation in the fourth quarter of 2017 and a lower corporate tax rate throughout 2018. |
2017 Compared to 2016
• | Net income decreased $108 million, or $1.57 per diluted share, to $63 million, or $1.09 per diluted share. |
• | Adjusted net income decreased $12 million, or $0.09 per diluted share, to $143 million, or $2.47 per diluted share, when excluding a $16 million, net of tax, decrease in the fair value of the DOJ settlement in 2016 and an $80 million charge due to tax reform in 2017. |
• | Net interest income increased $67 million, due to interest earning asset growth of $2.0 billion led by higher average LHFS resulting from extending turn times and accumulation of loans in support of residential mortgage backed securitization and commercial lending growth. |
• | The provision for loan losses increased $14 million, primarily due to 2016 sales of consumer loans which resulted in a gain and increases in the provision in 2017 driven by loan growth. |
• | Noninterest income decreased $17 million, primarily due to a $48 million decrease in net gain on loan sales and a $24 million decrease in the fair value of the DOJ liability settlement in 2016, partially offset by a $48 million increase in the net return on MSRs. |
• | Noninterest expense increased $83 million, primarily driven by growth initiatives, including our 2017 acquisitions, as well as higher mortgage volume related expenses. |
25
Net Interest Income
The following table presents on a consolidated basis interest income from average assets and liabilities, expressed in dollars and yields:
For the Years Ended December 31, | ||||||||||||||||||||||||||
2018 | 2017 | 2016 | ||||||||||||||||||||||||
Average Balance | Interest | Average Yield/ Rate | Average Balance | Interest | Average Yield/ Rate | Average Balance | Interest | Average Yield/ Rate | ||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||
Interest-Earning Assets | ||||||||||||||||||||||||||
Loans held-for-sale | $ | 4,196 | $ | 190 | 4.52 | % | $ | 4,146 | $ | 165 | 3.99 | % | $ | 3,134 | $ | 113 | 3.62 | % | ||||||||
Loans held-for-investment | ||||||||||||||||||||||||||
Residential first mortgage | 2,949 | 105 | 3.56 | % | 2,549 | 85 | 3.35 | % | 2,328 | 74 | 3.16 | % | ||||||||||||||
Home Equity | 690 | 36 | 5.21 | % | 471 | 24 | 5.06 | % | 475 | 24 | 5.17 | % | ||||||||||||||
Other | 111 | 6 | 5.73 | % | 26 | 1 | 4.51 | % | 29 | 1 | 4.73 | % | ||||||||||||||
Total Consumer loans | 3,750 | 147 | 3.93 | % | 3,046 | 110 | 3.62 | % | 2,832 | 99 | 3.52 | % | ||||||||||||||
Commercial Real Estate | 2,063 | 109 | 5.23 | % | 1,579 | 68 | 4.25 | % | 1,004 | 35 | 3.46 | % | ||||||||||||||
Commercial and Industrial | 1,288 | 69 | 5.32 | % | 981 | 47 | 4.73 | % | 631 | 27 | 4.22 | % | ||||||||||||||
Warehouse Lending | 1,318 | 69 | 5.14 | % | 890 | 43 | 4.73 | % | 1,346 | 58 | 4.22 | % | ||||||||||||||
Total Commercial loans | 4,669 | 247 | 5.23 | % | 3,450 | 158 | 4.51 | % | 2,981 | 120 | 3.97 | % | ||||||||||||||
Total loans held-for-investment (1) | 8,419 | 394 | 4.65 | % | 6,496 | 268 | 4.09 | % | 5,813 | 219 | 3.75 | % | ||||||||||||||
Loans with government guarantees | 303 | 11 | 3.53 | % | 290 | 13 | 4.30 | % | 435 | 16 | 3.59 | % | ||||||||||||||
Investment securities | 3,094 | 86 | 2.76 | % | 3,121 | 80 | 2.57 | % | 2,653 | 68 | 2.56 | % | ||||||||||||||
Interest-bearing deposits | 124 | 2 | 1.83 | % | 77 | 1 | 1.15 | % | 129 | 1 | 0.50 | % | ||||||||||||||
Total interest-earning assets | 16,136 | $ | 683 | 4.21 | % | 14,130 | $ | 527 | 3.71 | % | 12,164 | $ | 417 | 3.42 | % | |||||||||||
Other assets | 1,844 | 1,716 | 1,743 | |||||||||||||||||||||||
Total assets | $ | 17,980 | $ | 15,846 | $ | 13,907 | ||||||||||||||||||||
Interest-Bearing Liabilities | ||||||||||||||||||||||||||
Retail deposits | ||||||||||||||||||||||||||
Demand deposits | $ | 764 | $ | 7 | 0.93 | % | $ | 514 | $ | 1 | 0.19 | % | $ | 489 | $ | 1 | 0.18 | % | ||||||||
Savings deposits | 3,300 | 29 | 0.87 | % | 3,829 | 29 | 0.76 | % | 3,751 | 29 | 0.78 | % | ||||||||||||||
Money market deposits | 288 | 2 | 0.49 | % | 255 | 1 | 0.50 | % | 278 | 1 | 0.44 | % | ||||||||||||||
Certificates of deposit | 2,015 | 34 | 1.70 | % | 1,187 | 14 | 1.18 | % | 990 | 10 | 1.05 | % | ||||||||||||||
Total retail deposits | 6,367 | 72 | 1.12 | % | 5,785 | 45 | 0.78 | % | 5,508 | 41 | 0.76 | % | ||||||||||||||
Government deposits | ||||||||||||||||||||||||||
Demand deposits | 259 | 1 | 0.57 | % | 222 | 1 | 0.45 | % | 228 | 1 | 0.39 | % | ||||||||||||||
Savings deposits | 535 | 8 | 1.41 | % | 406 | 3 | 0.68 | % | 442 | 2 | 0.52 | % | ||||||||||||||
Certificates of deposit | 355 | 5 | 1.44 | % | 329 | 2 | 0.82 | % | 382 | 2 | 0.40 | % | ||||||||||||||
Total government deposits | 1,149 | 14 | 1.23 | % | 957 | 6 | 0.67 | % | 1,052 | 5 | 0.45 | % | ||||||||||||||
Wholesale deposits and other | 401 | 8 | 2.02 | % | 23 | — | 1.35 | % | — | — | — | % | ||||||||||||||
Total interest-bearing deposits | 7,917 | 94 | 1.18 | % | 6,765 | 51 | 0.77 | % | 6,560 | 46 | 0.71 | % | ||||||||||||||
Short-term FHLB advances and other | 3,521 | 68 | 1.93 | % | 3,356 | 37 | 1.09 | % | 1,249 | 5 | 0.44 | % | ||||||||||||||
Long-term FHLB advances | 1,192 | (4 | ) | (0.32 | )% | 1,234 | 24 | 1.92 | % | 1,584 | 27 | 1.72 | % | |||||||||||||
Less: Swap gain reclassified out of OCI (5) | — | 29 | — | % | — | — | — | % | — | — | — | % | ||||||||||||||
Adjusted long-term FHLB advances (5) | 1,192 | 25 | 2.12 | % | 1,234 | 24 | 1.92 | % | 1,584 | 27 | 1.72 | % | ||||||||||||||
Other long-term debt | 494 | 28 | 5.56 | % | 493 | 25 | 5.08 | % | 364 | 16 | 4.34 | % | ||||||||||||||
Adjusted total interest-bearing liabilities (5) | 13,124 | 215 | 1.63 | % | 11,848 | 137 | 1.15 | % | 9,757 | 94 | 0.97 | % | ||||||||||||||
Noninterest-bearing deposits (2) | 2,858 | 2,142 | 2,202 | |||||||||||||||||||||||
Other liabilities | 510 | 423 | 484 | |||||||||||||||||||||||
Stockholders’ equity | 1,488 | 1,433 | 1,464 | |||||||||||||||||||||||
Total liabilities and stockholders' equity | $ | 17,980 | $ | 15,846 | $ | 13,907 | ||||||||||||||||||||
Adjusted net interest income (5) | $ | 468 | $ | 390 | $ | 323 | ||||||||||||||||||||
Adjusted interest rate spread (3) (5) | 2.58 | % | 2.56 | % | 2.45 | % | ||||||||||||||||||||
Adjusted net interest margin (4) (5) | 2.89 | % | 2.75 | % | 2.64 | % | ||||||||||||||||||||
Ratio of average interest-earning assets to interest-bearing liabilities | 122.9 | % | 119.3 | % | 124.7 | % | ||||||||||||||||||||
(1) | Includes nonaccrual loans, for further information relating to nonaccrual loans, see Note 1 - Description of Business, Basis of Presentation, and Summary of Significant Accounting Policies. |
(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. |
(5) | The year ended December 31, 2018, excludes $29 million of hedging gains reclassified from AOCI in conjunction with the payment of long-term FHLB advances. See Non-GAAP Financial Measures for further information. |
26
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.
For the Years Ended December 31, | |||||||||||||||||||||||
2018 Versus 2017 Increase (Decrease) Due to: | 2017 Versus 2016 Increase (Decrease) Due to: | ||||||||||||||||||||||
Rate | Volume | Total | Rate | Volume | Total | ||||||||||||||||||
(Dollars in millions) | |||||||||||||||||||||||
Interest-Earning Assets | |||||||||||||||||||||||
Loans held-for-sale | $ | 23 | $ | 2 | $ | 25 | $ | 15 | $ | 37 | $ | 52 | |||||||||||
Loans held-for-investment | |||||||||||||||||||||||
Residential first mortgage | 7 | 13 | 20 | 5 | 6 | 11 | |||||||||||||||||
Home equity | 2 | 10 | 12 | — | — | — | |||||||||||||||||
Other | 1 | 4 | 5 | — | — | — | |||||||||||||||||
Total Consumer loans | 10 | 27 | 37 | 5 | 6 | 11 | |||||||||||||||||
Commercial Real Estate | 20 | 21 | 41 | 13 | 20 | 33 | |||||||||||||||||
Commercial and Industrial | 8 | 14 | 22 | 5 | 15 | 20 | |||||||||||||||||
Warehouse Lending | 6 | 20 | 26 | 4 | (19 | ) | (15 | ) | |||||||||||||||
Total Commercial loans | 34 | 55 | 89 | 22 | 16 | 38 | |||||||||||||||||
Total loans held-for-investment | 44 | 82 | 126 | 27 | 22 | 49 | |||||||||||||||||
Loans with government guarantees | (3 | ) | 1 | (2 | ) | 2 | (5 | ) | (3 | ) | |||||||||||||
Investment securities | 7 | (1 | ) | 6 | — | 12 | 12 | ||||||||||||||||
Interest-earning deposits | — | 1 | 1 | — | — | — | |||||||||||||||||
Total interest-earning assets | $ | 71 | $ | 85 | $ | 156 | $ | 44 | $ | 66 | $ | 110 | |||||||||||
Interest-Bearing Liabilities | |||||||||||||||||||||||
Interest-bearing deposits | $ | 34 | $ | 9 | $ | 43 | $ | 3 | $ | 3 | $ | 6 | |||||||||||
Short-term FHLB advances and other | 30 | 1 | 31 | 22 | 9 | 31 | |||||||||||||||||
Long-term FHLB advances (1) | 2 | (1 | ) | 1 | 2 | (5 | ) | (3 | ) | ||||||||||||||
Other long-term debt | 2 | 1 | 3 | 4 | 5 | 9 | |||||||||||||||||
Total interest-bearing liabilities (1) | 68 | 10 | 78 | 31 | 12 | 43 | |||||||||||||||||
Change in net interest income (1) | $ | 3 | $ | 75 | $ | 78 | $ | 13 | $ | 54 | $ | 67 | |||||||||||
(1) | The year ended December 31, 2018, excludes $29 million of hedging gains reclassified from AOCI in conjunction with the payment of long-term FHLB advances. See Non-GAAP Financial Measures for further information. |
2018 Compared to 2017
For the year ended December 31, 2018, net interest income increased $107 million, or $78 million when excluding a $29 million hedging gain, compared to the same period in 2017. The increase was primarily driven by growth in average interest earning assets, led by increases in our higher yielding commercial loan portfolio, and a 14 basis point increase in net interest margin.
Our net interest margin for the year ended December 31, 2018 was 2.89 percent, compared to 2.75 percent for the year ended December 31, 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 saw a 56 basis point increase in average yield, primarily due to higher yields on our commercial loans, driven by increases in LIBOR rates during 2018. In comparison, our interest bearing deposit costs increased 41 basis points, representing a deposit beta of 41 percent, which is the change in the annualized rate of our deposits divided by the change in the Federal Reserve discount rate. The average yield on our LHFI portfolio, influenced by our variable rate commercial loan portfolio, was more responsive to changes in market rates than our deposit costs. Deposit costs increased due to higher rates and an increase in use of wholesale deposits. Wholesale deposits,
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which experienced a rate increase of 61 basis points, were primarily utilized as an additional funding source prior to the acquisition of the deposits from Wells Fargo.
Average interest-earnings assets increased $2.0 billion for the year ended December 31, 2018, compared to the same period in 2017, primarily due to growth in the LHFI portfolio. Average commercial loans increased $1.2 billion with broad based growth across CRE, C&I, and the warehouse loan portfolios. We continued to grow CRE and C&I loans, and the acquisition of the Santander warehouse lending business in the first quarter of 2018 increased average warehouse loans $493 million during the year. The consumer loan portfolio increased $704 million, primarily due to the addition of residential first mortgages and HELOCs to the LHFI portfolio.
Average interest-bearing liabilities increased $1.3 billion for the year ended December 31, 2018, compared to the full year in 2017, primarily due to a $1.2 billion increase in interest bearing deposits. The increase in average deposits is primarily attributable to the acquisition of deposits from DCB, which impacted the full year average by $478 million, and one month of Wells Fargo deposits, which impacted the full year average by $147 million. Average wholesale deposits increased $378 million, primarily to provide additional funding prior to the acquisition of the Wells Fargo deposits.
2017 Compared to 2016
Net interest income increased $67 million for the year ended December 31, 2017, compared to the same period in 2016. The increase was primarily driven by growth in average interest-earning assets of 16 percent, led by higher average LHFS balances and growth of our higher yielding commercial LHFI portfolios.
Our net interest margin for the year ended December 31, 2017 was 2.75 percent, as compared to 2.64 percent for the year ended December 31, 2016. The increase in net interest margin was driven by a higher average yield on interest earning assets due to the growth in our commercial loan portfolio. This was partially offset by an increase in interest expense resulting from a full year of interest on our long-term senior debt which was issued in July 2016.
Average interest-earnings assets increased $2.0 billion for the year ended December 31, 2017, compared to the same period in 2016. The increase was due to a $1.0 billion increase in LHFS due to extending turn times and accumulation of loans in support of residential mortgage backed securitization. The CRE and C&I portfolios increased $925 million, or 57 percent, as we continued to focus our efforts on building a broad-based, higher yielding commercial loan portfolio.
Average interest-bearing liabilities increased $2.1 billion for the year ended December 31, 2017, compared to the full year in 2016, primarily due to an increase in FHLB advances used to fund balance sheet growth in excess of deposit growth. Average interest-bearing deposits increased $205 million, or 3 percent, for the year ended December 31, 2017, compared to the same period in 2016, driven by higher average retail deposits, partially offset by lower average government deposits. Our costs remained well managed in a rising interest rate environment, despite a slight extension of duration due to a higher percentage of certificates of deposit.
Provision (Benefit) for Loan Losses
2018 Compared to 2017
The provision for loan losses was a benefit of $8 million for the year ended December 31, 2018, compared to a provision of $6 million for the year ended December 31, 2017. The improvement in the provision reflects our continued strong credit quality with consistently low levels of charge-offs, low delinquencies, and growth of the portfolio in areas we believe to pose lower levels of credit risk.
2017 Compared to 2016
The provision for loan losses increased $14 million to $6 million for the year ended December 31, 2017, compared to a benefit of $8 million for the year ended December 31, 2016. The increase was primarily due to loan growth of $1.6 billion in our commercial and consumer portfolios. The benefit in 2016 resulted from the sale of consumer loans with a UPB of $1.3 billion, of which $110 million were nonperforming.
For further information, see MD&A - Credit Risk.
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Noninterest Income
The following tables provide information on our noninterest income along with other mortgage metrics:
For the Years Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
(Dollars in millions) | |||||||||||
Net gain on loan sales | $ | 200 | $ | 268 | $ | 316 | |||||
Loan fees and charges | 87 | 82 | 76 | ||||||||
Net return (loss) on mortgage servicing rights | 36 | 22 | (26 | ) | |||||||
Loan administration income | 23 | 21 | 18 | ||||||||
Deposit fees and charges | 21 | 18 | 22 | ||||||||
Other noninterest income | 72 | 59 | 81 | ||||||||
Total noninterest income | $ | 439 | $ | 470 | $ | 487 | |||||
For the Years Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
(Dollars in millions) | |||||||||||
Mortgage rate lock commitments (fallout-adjusted) (1) | $ | 30,308 | $ | 32,527 | $ | 29,372 | |||||
Net margin on mortgage rate lock commitments (fallout-adjusted) (1) (2) | 0.65 | % | 0.82 | % | 1.02 | % | |||||
Net margin on loans sold and securitized | 0.62 | % | 0.82 | % | 0.94 | % | |||||
(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 level of interest rates. |
(2) | Gain on sale margin is based on net gain on loan sales (excludes net gain on loan sales of $2 million, $1 million, and $15 million from loans transferred from HFI for the years ended December 31, 2018, December 31, 2017 and December 31, 2016, respectively) to fallout-adjusted mortgage rate lock commitments. |
2018 Compared to 2017
Total noninterest income decreased $31 million during the year ended December 31, 2018 from the year ended December 31, 2017, primarily due to the following:
• | Net gain on loan sales decreased $68 million. Lower mortgage origination volume and pricing competition experienced in the mortgage market throughout 2018 impacted both net gain on loan sale margin, which decreased 17 basis points, and fall-out adjusted lock volume which decreased $2.2 billion. The lower margin was primarily driven by secondary margin compression and a shift in channel mix toward the lower margin, but lower cost delegated correspondent channel, partially offset by an improvement in securitization performance. The full year 2018 saw the benefit of our 2017 delegated correspondent lending and retail lending related acquisitions, which provided a boost to fall-out adjusted lock volume in those channels. Our total fall-out adjusted lock volume decreased 6.8 percent, despite the 8.3 percent decline in the overall mortgage origination market experienced during 2018. |
• | Net return on MSRs, including the impact of hedges, increased $14 million, 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 $13 million, 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 within the equipment finance operating lease portfolio, an increase in investment and insurance income and a gain from the sale of our wealth management business. |
2017 Compared to 2016
Total noninterest income decreased $17 million during the year ended December 31, 2017 from the year ended December 31, 2016, primarily due to the following:
• | Net gain on loan sales decreased $48 million. Market conditions impacted the net gain on loan sales margin which decreased 12 basis points with fallout adjusted lock yields decreasing 20 basis points to 0.82 percent. As a result of our 2017 mortgage acquisitions, the decrease in margin was partially offset by a 10.7 percent increase in fallout adjusted mortgage rate lock volume. Despite the 14 percent decline in the overall mortgage origination market experienced in 2017, we maintained our market share. In addition, the decrease in net gain on loan sales was partially attributable to |
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extending turn times on sales of certain LHFS, which shifts earnings from net gain on loan sales to net interest income as well as the sale of nonperforming LHFI that occurred in 2016 which resulted in a $14 million gain.
• | Net return on MSRs, including the impact of hedges, increased $48 million primarily driven by a more stable prepayment environment as a result of higher market interest rates, partially offset by a decrease in servicing fee income resulting from a lower MSR balance and higher transaction costs due to MSR sales that occurred in 2017. |
• | Other noninterest income decreased $22 million primarily due to a $24 million reduction in the DOJ settlement liability that occurred in the third quarter of 2016 and a $6 million decrease in the representation and warranty benefit driven by lower recoveries. These decreases were partially offset by increased rental income attributable to growth in operating leases, and higher investment and insurance revenues. |
Noninterest Expense
The following table sets forth the components of our noninterest expense:
For the Years Ended December 31, | |||||||||||||||||||
2018 | Wells Fargo Branch Acquisition Expenses | Adjusted 2018 (1) | 2017 | 2016 | |||||||||||||||
(Dollars in millions) | |||||||||||||||||||
Compensation and benefits | $ | 318 | $ | 3 | $ | 315 | $ | 299 | $ | 269 | |||||||||
Occupancy and equipment | 127 | 3 | 124 | 103 | 85 | ||||||||||||||
Commissions | 80 | — | 80 | 72 | 55 | ||||||||||||||
Loan processing expense | 59 | — | 59 | 57 | 55 | ||||||||||||||
Legal and professional expense | 28 | 3 | 25 | 30 | 29 | ||||||||||||||
Federal insurance premiums | 22 | — | 22 | 16 | 11 | ||||||||||||||
Intangible asset amortization | 5 | — | 5 | — | — | ||||||||||||||
Other noninterest expense | 73 | 6 | 67 | 66 | 56 | ||||||||||||||
Total noninterest expense (1) | $ | 712 | $ | 15 | $ | 697 | $ | 643 | $ | 560 | |||||||||
(1) | See Non-GAAP Financial Measures for further information. |
For the Years Ended December 31, | ||||||||
2018 | 2017 | 2016 | ||||||
Efficiency ratio | 76.0 | % | 74.8 | % | 69.2 | % | ||
Average number FTE | 3,655 | 3,303 | 2,850 | |||||
2018 Compared to 2017
Total noninterest expense increased $69 million during the year ended December 31, 2018, compared to the year ended December 31, 2017. Expenses related to the 2018 Wells Fargo branch acquisition totaled $15 million and primarily included costs related to integration, marketing, legal and consulting. Excluding these expenses, adjusted noninterest expense increased $54 million during the year ended December 31, 2018, compared to the year ended December 31, 2017, primarily due to the following:
• | Compensation and benefits expense increased $16 million, primarily due to a higher headcount resulting from acquisitions and growth in our community bank, partially offset by cost management and lower incentive compensation. |
• | Occupancy and equipment increased $21 million, primarily due to a higher average depreciable asset base resulting from technology upgrades and software, along with increases in vendor services to support business growth. |
• | Commission expense increased $8 million, primarily due to an increase in originations in the higher commission earning retail channel, driven from the acquisition of Opes in 2017. |
• | Legal and professional expense decreased $5 million, primarily due to fewer significant legal matters in 2018 and higher acquisition related expenses in 2017. |
• | FDIC insurance premiums increased $6 million, primarily driven by growth in our total assets. |
• | Intangible asset amortization increased to $5 million, primarily due to the amortization of the intangible assets associated with our 2018 banking acquisitions. |
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• | Other noninterest expense increased $1 million, primarily due to increases in advertising expense to raise brand awareness and charitable contributions, primarily offset by a reduction in the value of a contingent consideration liability. |
2017 Compared to 2016
Total noninterest expense increased $83 million during the year ended December 31, 2017 from the year ended December 31, 2016, primarily due to the following:
• | Compensation and benefits expense increased $30 million, primarily due to higher headcount resulting from acquisitions and additions to the Community Banking segment to support growth in both our C&I and CRE portfolios. Our average full-time equivalent employees increased overall by 16 percent from December 31, 2016 to a total average of 3,303 full-time equivalent employees at December 31, 2017, of which 444 were Opes average full-time equivalent employees. |
• | Occupancy and equipment increased $18 million, primarily due to a higher average depreciable asset base and increased utilization of vendor services to support the needs of our growing business. |
• | Commission expense increased $17 million, primarily due to higher loan originations and a shift in channel mix to delegated retail channels with higher commission rates resulting from our mortgage acquisitions. |
• | FDIC insurance premiums increased $5 million, primarily driven by growth in our commercial portfolios. |
• | Other noninterest expense increased $10 million, primarily due to an increase in advertising expenses due to direct mail and brand awareness campaigns that were launched to drive deposit growth. The remaining increase is attributable to higher business development costs related to acquisitions and an increase in charitable activities. |
Provision for Income Taxes
The H.R.1, originally known as the Tax Cuts and Jobs Act, which was signed in December 2017, included various changes to the U.S. tax code that had an impact on us, including, but not limited to, the following:
• | Reduction in the statutory corporation tax rate from a maximum rate of 35 percent to a flat rate of 21 percent effective January 1, 2018 |
• | Repeal of the corporate alternative minimum tax (“AMT”) |
• | Immediate expensing of capital investments |
• | Modifications to the provisions of future generated net operating losses |
• | Additional limitations on the deductibility of performance-based compensation for named executive officers. |
2018 Compared to 2017
Our provision for income taxes for the year ended December 31, 2018 was $45 million, compared to a provision of $148 million for the year ended December 31, 2017. The decrease in the provision for income taxes was primarily due to the change related to the revaluation of deferred tax assets during the fourth quarter of 2017, resulting from the passage of the new tax legislation. The Company's effective tax rate for the year ended December 31, 2018 was 19.4 percent. Our effective tax rate differs from the combined federal and state statutory rate primarily due to a change in our valuation allowance for net deferred tax assets at the state level, higher tax exempt earnings, and stock based compensation.
2017 Compared to 2016
Our provision for income taxes for the year ended December 31, 2017 was $148 million, compared to a provision of $87 million for the year ended December 31, 2016. The increase in the provision for income taxes was primarily due to the charge to the provision for income taxes of approximately $80 million from the revaluation of our DTAs as a result of the new tax legislation. Excluding this charge, the Company’s adjusted effective tax rate was 32.1 percent. This adjusted effective tax rate differs from the combined federal and state statutory rate primarily due to benefits from tax-exempt earnings and stock-based compensation.
For further information, see Note 19 - Income Taxes.
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Fourth Quarter Results
The following table sets forth selected quarterly data:
Three Months Ended | |||||||||||
December 31, 2018 | September 30, 2018 | December 31, 2017 | |||||||||
(Unaudited) | (Unaudited) | (Unaudited) | |||||||||
(Dollars in millions) | |||||||||||
Net interest income | $ | 152 | $ | 124 | $ | 107 | |||||
Provision (benefit) for loan losses | (5 | ) | (2 | ) | 2 | ||||||
Total noninterest income | 98 | ||||||||||