Thanks everyone for joining us this afternoon. We are pleased to have Flagstar Bank here today joining us. Joseph Otting, the Executive Chairman, Chief Executive Officer; Lee Smith, Co-President, Co-Chief Operating Officer, and Chief Financial Officer; and Rich Raffetto, also Co-President, Co-Chief Operating Officer, and Chief Banking Officer. Thanks a lot, guys.
Thank you, Jared.
Appreciate you joining us. I know you did not have too far to travel to get here. It is good to have you all here. Maybe just starting off, the commercial banking build-out has become the primary growth engine of the company. What allows Flagstar to win so many new relationships today, and how have you differentiated yourself from peers who are pursuing the same clients?
Great. First of all, Jared, thank you very much for the invitation to the conference. The Barclays conference, year after year, is a highlight for our organization and for the people that are attending. The ability to sit down and talk with investors in a one-on-one basis, almost like speed dating, has built a lot of solid relationships. Thank you for you and the organization putting this together. When we joined the company in March of 2024, we laid out a plan that we really wanted to diversify the balance sheet, and we wanted the risk to look like a third in commercial real estate, a third in consumer cash flows, and we put mortgage-backed securities into that bucket, and a third in C&I. To build a relationship commercial banking business, which really was not a part of the DNA of the legacy organizations.
We were fortunate to hire Rich Raffetto to come in and lead that effort for us. Both Rich and I really spent the majority of our careers in the C&I kind of business banking, corporate banking, middle market space. We really had a vision that we could build something out that could be really special, where we could be customer-centric, be responsive to the customers. But the real ingredient that was really important is that we recruited really top-notch talent into the bank. As Rich and I laugh every once in a while, those early days, it was a bit of a hat trick to get people that knew us to join the company. But the momentum started, and today Rich has done an amazing job of hiring over 400 banking professionals. This covers relationship management, product areas, credit underwriting.
I think the core, not only that the senior management is committed to this space, we think it's a big part of the future of the bank, but that we brought people in who knew the owners and leaders and executives of companies that we wanted to bank. While we brought credibility from Flagstar, they created credibility for Flagstar in the eyes of the customers. So now, we're generating $2.8 billion- $3 billion of new loan outstanding a quarter. We're doing that one relationship at a time. We're generating about 75 relationships per quarter. We really think the future is very bright for Flagstar. We're in a unique position where people are looking for regional banks to play a role.
As some of our brethren at Silicon Valley Bank, First Republic Bank, Union Bank, and Signature Bank have gone away, it's really opened up a really good vortex for us to be able to step in and fill that void.
You talked about now and you've talked in the past about building a relationship-based bank rather than simply growing loans. As these newer relationships mature, how should we think about the opportunity for deposits, treasury management, capital markets, and wealth management revenues?
It's really a wide-open opportunity for us. Rich quotes the number that over the last six months, we've boarded $4.4 billion in new loans in the commercial bank and in the private bank and $2.4 billion of deposits. We have expectations, depending upon the vertical and the business and the industry, and we're going to get a full relationship with these customers. Frequently, you have to use your balance sheet that gives you the fishing license to start the process. About half of our relationships now are single bank or one or two bank where we're the lead on that, and half of those are coming where we're a participant with other banks. But we have full expectations that not only fee income and deposits will come with those relationships, and our short-term success has proved that.
As you said, the growth has come from that combination of geographic expansion and specialized industry verticals. Which verticals and markets have exceeded expectations? Where do you see the largest opportunity over the next few years?
We're really excited because across the United States, Flagstar Bank has retail banking presence in California, Arizona, Florida, New York, New Jersey, Ohio, Indiana, and Michigan. Really solid markets. But we didn't have commercial banking operations, and so we've developed a strategy in those markets and others to put commercial bankers to coexist with our brand in those markets. We've had really good success at penetrating the middle and lower corporate market with that. Then we also felt specialized business brings a unique ability for relationship managers to understand the needs of owners in certain industries. For us, we've seen really great growth in oil and gas and in healthcare, entertainment, sports specialty. We're also seeing a lot of great momentum in renewable energy right now, a lot of that.
We've opened up this year a couple of new ones in food, and other things where all those kind of parallel into large chunks of GDP in the economy. Again, starting from zero and being able to gain market share allows us to show significant growth in all of those areas.
Maybe we can talk a little bit about the balance sheet transformation and what has gone on since you all have come on board. The pace of CRE reduction continues to exceed, I think, what you originally expected, with another $1.1 billion payoffs in the second quarter and a meaningful portion coming from the criticized asset portfolio. How has your thinking evolved around the speed of the transformation, and how much is left to do?
So if you go back to the third, a third, a third. Today, we sit at about 48% of the loan book is in commercial real estate as a whole. That includes owner-occupied and real estate across the nation. About 28% is in what we consider consumer cash flows, and roughly 26% in C&I. You are right. A transformation into that much more diversified balance sheet has occurred much more rapidly than we thought. When we originally got there, 70% of the book or more was in commercial real estate. We had a lot of discussions with customers of the bank that basically said we did not want to renew or extend any real estate loans. We are now at a position where we are excited about being able to do new real estate transactions because that exposure has shrunk.
But I think when we get to the beginning of 2028, we are going to feel pretty good that we are in the geography of the range that we were hoping to get to. That builds, I think, a much more durable, diversified institution.
As the pace of that runoff remains elevated and you have some more capacity under your CRE concentration, how do you determine when it is worth to retain a CRE relationship versus running off at this point? Has that framework changed as the balance sheet has become stronger?
Initially, we wanted to reduce our commercial real estate exposure with limited exceptions. We really communicated. Today, we've now graduated to the point where if someone has a strong non-credit relationship with the bank, we will make exceptions. As we pursue markets in California, Arizona, Florida, Chicago, Michigan, and Ohio, we're looking for where people want and need commercial real estate, either construction financing, transition financing, or mini- perm financing. We'll expect and have to have a depository relationship with them. If it doesn't, then we're probably going to pass on those relationships.
Maybe we shift a little bit to margin and NII. The market has spent a lot of time focusing on near-term NII pressure from the CRE runoff. As you think about the next several years, what are the biggest building blocks that get Flagstar from today's earnings profile towards the profitability targets that you've outlined?
This is where I hand the baton to Lee.
Thank you, Joseph. Thanks for having us. It's always nice to be here, as Joseph said. I think when you look at 2027, I think in terms of NIM expansion, the three biggest drivers are in 2027 alone, we have $9 billion of low coupon multifamily loans that are resetting or maturing. When I say low coupon, less than 3.9%. So they will either reset at a market rate, and we will keep them, or they will pay off, and we will give Rich that liquidity to continue to originate and build the C&I portfolio. So we're going to get a lift from those resets, because those resets are contractual. They're just going to happen as they hit those dates. So we get a big lift, which is somewhat mechanical, just by letting that play through.
I think the second item is as we grow the C&I book and the balance sheet. As we said in Q2, Rich brought on net growth $2+ billion of C&I loans at an average spread to SOFR of 225 basis points. So you're looking at an all-in coupon of just around 6%. Our cost of interest-bearing deposits in the second quarter was 3.05%. The spot rate of our deposit costs when you include non-interest bearing are around 2.52%. So if we can sort of keep deposit costs somewhat consistent, maybe they increase a couple of basis points, but we're putting on loans at those spreads and those coupons, then we're going to continue to drive NIM expansion and interest income expansion. The third main driver is bringing those non-accrual loans down.
We have $2.8 billion of non-accruals today, 40% of which I want to point out are performing and current. We're very punitive on how we classify non-accruals. But that is dead capital, dead earnings because they're 150% risk-weighted, and they're not doing anything for interest income or NIM. As we bring those non-accruals down, it's automatically going to be accretive from an earnings point of view. So if you're thinking of the NIM expansion, those are the three main drivers.
Since the original plan was developed, the rate outlook CRE payoff activity in the deposit environment evolved. How do you think about the balance between loan yields, deposit costs, multifamily repricing, and balance sheet growth as drivers going forward?
Look, I think as I mentioned, the resets are a big deal for us, and that's going to obviously help the NIM expansion. Coming back to what Joseph said earlier, we're trying to limit the sort of CRE multifamily runoff to somewhere between $800 million and $1 billion a quarter. We think that Rich can originate what we saw in Q2, which is about net C&I growth of $2+ billion a quarter. We think we can sort of continue that going forward. On the loan side, you've got the C&I growth. Some of that is going to be funded by CRE runoff. So you're looking to fund the remainder of the C&I growth with incremental deposit growth.
We expect that to come from the commercial relationships that we're bringing in every quarter with the new C&I growth and the private bank growing its deposits as well. The question is, what is the incremental cost of the deposits that we're bringing in to fund that new C&I growth? If we can bring that in at the right cost, and we think we can, then you're going to achieve earnings accretion for the bank. Two other points that I just want to make on what I previously said. If you think about the $9 billion of CRE loans that are resetting in 2027, they're on our balance sheet today. We're already funding those. We don't have to go and get incremental funding.
We're just going to get the pickup in the improved spreads or coupons that we get on those loans, whether they reset, pay off, and we use the liquidity for C&I. The non-accrual loans that are on the balance sheet today of $2.8 billion, we're already funding that. We don't need incremental funding for those two big drivers of net interest expansion. Where we have to go and get some additional liquidity is to fund the C&I growth that isn't being funded by the CRE runoff.
Maybe just sticking with the multifamily portfolio for a minute. You did a lot of deep work on evaluating credit over the last two years with that. At this point last year, the expectation was that we're going into a lower rate environment. Now, we're going into a higher rate environment. How do you see maybe some of those criticized and classified but non-performing loans reacting with a reset that's potentially higher with the backdrop in New York still pretty rough for those owners?
I'll talk about non-accruals at the end. I think what we have consistently seen over the last several quarters is of the $1+ billion of par payoffs each quarter, 40%-50% of those par payoffs have been substandard. Again, that's because we've been very punitive in the way we've risk-rated the book. We do not see that changing, at least in the near term. We've seen those loans that are paying off going to the agency, Fannie Mae, Freddie Mac, and obviously going to other lending institutions. For those regulated buildings that are more than 50%, some of those other institutions do get CRA benefits for financing those loans. We think that is a part of what we've seen. There's a lot of liquidity out there for this asset class. We've consistently brought down our criticized and classified, and we think that will continue.
I think if there's one area where we think the higher rate environment might slow us down a little bit, it's the speed and the pace with which we can reduce the non-accrual loans.
Rich, maybe you've done a lot of work over the last few years bringing in new people and really growing the C&I base in an environment where there's a lot of banks out there looking to hire good C&I lenders. What's the value proposition as you pitch it to people to come over to Flagstar and help build out that commercial business?
Well, thanks, Jared. I think it's a very relevant question. As Joseph mentioned, the commercial banking build out was one of the great opportunities that our new management team, that's not new to the industry, but when we arrived at Flagstar, it was one of the glaring, obvious opportunities for the company. Since then, we're pretty proud that we've onboarded over 400 new bankers to build out this commercial banking platform and to deepen our existing platform in private banking. We've been very gratified by the quality of the professionals who we've brought on board. Frankly, one of the attractive things is that we've got Joseph in the corner office, having grown up as a commercial banker. I can count on one hand how many commercial bankers are serving as Chairman and CEO of a top 30 bank in this country.
I think that really does resonate. In addition, the opportunity to build something and make a big impact in an environment where you know that C&I and commercial banking is going to be core to the strategy of the new management team. That's been certainly a tailwind for us in bringing on new talent. The quality of the people that have come from much bigger institutions that are now building out the platform at Flagstar has also been a draw. We're pretty proud to note that we've only used an executive search firm on a couple of bespoke hiring opportunities. Most of the people that we're attracting to the franchise are through that network effect of people that we've worked with and trusted over the years, and they're trusting us to come over to build something special together.
It is in an environment where we are a bank that is big enough to matter in terms of the ability to provide capital to their clients as they come over. They are not 10 layers down from the CEO, and they know they can make a big impact. We are not burdened with a legacy of being overweight from a credit exposure perspective in really any of our C&I subsectors that we are building out. As Joseph mentioned, it is a two-pronged strategy to cover specialized industries with experienced bankers, as well as to fill in our geographies around the country with geographically- focused commercial bankers that are networked in that community and can really make a big impact. We are pleased with the progress that we are making, and I think those factors are continuing to be a tailwind as we continue to onboard talent.
I would describe this as we are in the top of the fourth inning in a nine-inning game, but you are starting to see it now with the quarter-over-quarter C&I loan growth and the fact that we are onboarding 70- 80 new relationships each quarter on the commercial side of our book, that the loan is only the beginning of that relationship in a relationship-focused strategy. We can go deeper with treasury management, capital markets, private banking, and wealth management. Connecting those dots in a tight-knit organization is how we are executing.
You brought on the people with the relationships. They have to bring over their own relationships and onboard the new customers. Similarly, what is that value proposition to get somebody to leave the bank that they are banking with today and to come to Flagstar Bank, which may be relatively new on the scene for this type of banking?
Sure. Having been a commercial banker myself for about 35 years, I can tell you that most of the client- engagement team are pretty entrepreneurial in spirit. Building something is something that is very attractive to folks in the marketplace. As you can imagine, with a number of institutions either full up in different segments or going through strategic shifts, it might be M&A integration. We have seen a number of regional banks get taken out either in M&A or following 2023. There is an opportunity that we at Flagstar Bank are grabbing to take market share where there are bankers that are looking for a platform like ours where they know they can make a really big difference. They know that commercial banking is core to building out the platform.
They know we've got capacity across commercial and private banking to be relevant in different industry sectors, and they know that we need to be more impactful in the communities where our brand is already known in four big geographies around the country. And they're going to work with people who know what good looks like from other institutions at large, top 10 banks in the country. I think that those things are resonating, and they know that they can be impactful, and they know they have an executive management team, including the three people up on stage today, that are happy to jump on an airplane or come across town and meet with a business owner who's trying to decide between us or another institution.
I think that's the formula that we put into the mixing bowl that's resulting in really good relationship growth. Over time, we will drive higher returns on those relationships as we go deeper with additional products beyond credits only at the beginning. We go to deposits and then the fee-generating services. That's the model that we're executing.
Lee, you mentioned a little bit about the need for funding growth as well to support this loan growth. What are you seeing in terms of deposit pricing out there in the market today and the likely rate hike or expected rate hike tomorrow? How are you expecting to see deposit pricing trends through the rest of the year?
It's undoubtedly competitive. There's no doubt about it. That's what we're seeing. But I think as I mentioned earlier, what we're trying to accomplish is, and we've done this in the first two quarters of the year, w e've grown deposit balances, but we've been able to reduce our cost of interest-bearing deposits at the same time. I think we're at an inflection point where can we continue to grow deposits but keep the cost of the deposits relatively flat. So maybe it goes up a couple of basis points, but you don't see a big jump in the cost of deposits. That's what we're trying to aim for. We are seeing banks that have savings promos, CDs out there that are north of 4% in some instances. We've got our own promo on the website, 3.75% APY.
But at the same time, we're leveraging the commercial relationships and the private bank relationships to bring in some non-interest bearing. We'd like to bring in more, but also low interest-bearing deposits so that you're bringing that overall cost of deposits, keeping it relatively stable. As we think about the funding side of the balance sheet, generally, if we can keep the cost of deposits sort of in a very tight zip code, then we'll continue to chip away at the FHLB advances, and that's how we'll sort of continue to reduce funding costs.
Great. Maybe shifting to the spend side and some of the technology spend in AI. AI is obviously a big theme this year. You've talked increasingly about modernizing the technology stack at the bank. Where are you seeing the most tangible benefits today, and where do you think some of the biggest opportunities are still out there?
When we first arrived, we had six technology centers. Each legacy bank had two. Really through the course of this year, we've converted. We've closed those six and opened up really two co-location centers. So we went down six, up two is the way I would look at. We made that transition rather smoothly. There was no disruption, both at the bank or with our customers. The next big transition is we currently operate on two cores. We'll be converting down to one core in June of next year. So those all have kind of allowed us to build what we call the S2 Platform in our organization. Simple and sophisticated is what we've really focused on. But also bringing forth that the legacy banks did not have the ability to invest in the technology spend.
We've been able to drive the cost down substantially by a number of these moves and use those dollars to reinvest in our technology platform. So that includes products and services, the way we process things, using external resources, using some international resources to drive the cost down. So we've actually lowered our cost while dramatically improving the technology that's available. We also were an early user and adapter of AI technology in the company. We have StarIQ, which is kind of a proprietary system that is based upon the Claude that is actually used within the company. So it's a closed-loop system where we make AI available to all our employees, and we're constantly doing lots of education now about how people can use AI to further advance their efficiency, effectiveness in their work environment.
We are really excited not only about where our technology has come under Chris Higgins and Jason Pope's leadership, but really what we have available to yet to get done in creating the efficiencies.
On capital, you obviously have plenty of capital. You announced the $250 million share repurchase in the second quarter, which I think was expected, but it certainly resonated with investors. What does that say about management's confidence in the transformation in core earnings trajectory. Should we think about that as more of an introductory start to capital management? And where ultimately you see capital ratios settling out for you?
We have had, what, 12 meetings today, and that is the first time that has come up. First of all, the three things that both management and the board has really focused on is building those core earnings up. We publicly said, look, we want to continue to see the path on core earnings. That is probably the most important thing for the company. The second is cleaning up the loan portfolio as we have it today. Then the third is really how much capital will we deploy, in which is C&I build. I think the management recommended and the board supported the stock buyback. I would say that was earlier than I think most people thought. I think most people were thinking that was going to be perhaps a September or October event, and we announced it earlier. We just think that is a way for us to demonstrate with the bank's excess capital.
As long as those three other variables come along, we are going to continue to look at that and see what is the best option for our investors. We are confident that those three items are going to continue to improve. C&I is going to grow. We are going to continue to see real positive core earnings growth. We are really highly focused on reducing the substandard and non-accruals on the bank's balance sheet.
Great. Any questions from the audience? Happy to open it up. Well, I think, if we are sitting here next year at the same time and get you guys to join us, and the stock is resonating with investors, what do you think the main drivers of that change would be between now and a year from now?
I think that we continue down the path of growing and building our C&I franchise. That we have transformed the real estate portfolio, that now we are recognized as someone who is a provider of debt and relationship banking into the commercial real estate. We are also transforming our retail banking group to be a little bit more sales-oriented and outward-focused. We have a retail banking franchise with about $36 billion in deposits that we want to really turn it into a deposit origination machine. That we can serve both local consumers and small businesses through that 360- branch network.
We continue to hear and see that Flagstar plays an important role as a bank in America, and that people can rely upon us, and we can provide great quality relationship managers who offer solutions to our clients where we can add value to the client. I think we are well on the path of doing that across America.
I would add, Jared, that the talent piece of the equation continues to be critically important, particularly as we expand in these markets. While we have planted the flag in different industry segments and in geographies, and we have retooled and invested in product capabilities to match competitors of our size and complexity, c ontinuing to attract bankers to the platform is key. We talked about adding 40- 60 new bankers to our platform over the course of 2026 in the C&I space. We are well on that path and feel really good about getting to that number, probably the higher end of that number by the end of the calendar year. That momentum we expect to carry over into 2027 as well.
The other piece of the equation that is now different, now that we have very purposefully managed down the commercial real estate exposure as a percent of capital at the company, we are selectively reopening for business in the CRE space. Our new originations in the third quarter will be markedly improved from very little activity in the new origination space in commercial real estate in prior quarters under this management team. Our home builder finance group that is based down in Houston, and our non-New York centric commercial real estate business based out in Detroit and in other markets. We are starting to add commercial real estate originations-focused bankers and credit underwriting professionals in markets like Southern California, Chicago, Dallas, Mid-Atlantic, and South Florida, where we simply have not had them before.
I think our momentum on our overall commercial businesses, including commercial real estate, you will see this point of inflection continue where the C&I momentum continues to build. We will go deeper in these relationships, driving more deposits and fees. Commercial real estate , t hey are joining the party two years late. Now, they are moving back into more traditional BAU mode while we continue to work down the concentration that we have in the New York area with legacy New York rent regulated. It is a nice transition, but kind of moving more into the middle innings, if I were to describe it.
Looking forward a year, I think we've been one of the most transparent banks in the country. You go back a couple of years, we put a three-year plan out there, and we've continued to put that guidance out there through the end of 2027. A lot of backup information in terms of how we're going to get there. As Joseph said, the strategy hasn't changed. We are very much on the rails. I think I would just emphasize that don't underestimate the power of $9 billion of low coupon multifamily loans resetting in 2027. Obviously, it's cumulative quarter- over- quarter. As you move through the year, the impact is only going to increase. Reducing those non-accruals that are doing nothing for us today, and then obviously continuing to grow that C&I portfolio.
If you actually do the calculation, only $3 million of interest income can move our NIM 4 basis points. It's very sensitive. When you have those three levers, it can be meaningful.
Great. Well, thank you very much.
Thanks, Jared. Thanks, Barclays.
Thanks everybody for joining us today.
Thank you.
Thank you.