Flagstar Bancorp, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Flagstar Bancorp, Inc. is a diversified financial services company that primarily operates as a bank with a retail mortgage and commercial lending focus. It also has a strong focus on specialty servicing and certain niche market businesses.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Flagstar Bancorp is structured into three segments: 1. Community Banking: This segment includes all of the company’s traditional banking operations. This includes generating loans, and also gathering deposits and is focused on retail and commercial clients, primarily in the Northeast and Midwest regions of the United States. 2. Mortgage: This segment consists of residential loan origination, and sale, where most loans are purchased through secondary mortgage markets, such as FHLB. The Company also services approximately $365 billion in mortgage loans. 3. Operations and Corporate: This segments encompasses core functions such as enterprise risk, IT, human resources, legal, marketing and corporate functions. They also have a small but profitable unit that manages and sells the Company’s real estate assets.

Revenue Distribution: The bank’s revenue is a mixture of interest and noninterest income, with net interest income from loans making up the bigger portion. In 2023, 62.1 percent of revenues were generated by Net interest income from loans and other interest earning assets, while Noninterest income comprised the remaining 37.9 percent.

Industry Trends: The financial services industry is facing significant shifts, including increased competition from nonbank financial companies (like fintechs), higher regulatory requirements, and changing consumer preferences for digital banking. Traditional banks, like Flagstar, are now forced to invest heavily into their technology infrastructure to avoid losing out to faster growing competitors. In the mortgage market, which is a big part of Flagstar’s business, market activity is tied closely to interest rates and macro trends in the housing market.

Margins: The bank operates with a relatively thin net interest margin, which means they need high volumes to achieve decent profits. As of their most recent earnings, the net interest margin was 2.61%.

Competitive Landscape: Flagstar Bancorp operates in an industry with intense competition, especially with respect to retail and commercial banking. Smaller regional players like Flagstar, compete with large money-center banks, regional banks, credit unions, and other lenders on the basis of customer service, competitive rates, and product offerings. They also face competition from non-bank financial companies in various areas of business.

What Sets Flagstar Apart? They have a unique combination of local and national presence. They have a good amount of branches in the Northeast and Midwest of the U.S., but at the same time they have one of the largest servicing portfolios in the whole U.S., with a growing national mortgage banking platform. The Company has specialized expertise in their niche lending businesses that may give them a competitive advantage.

Financials: * Revenue Growth: Revenues grew from 2.8 billion in 2021 to 4.9 billion in 2022 mainly due to the acquisitions, but are estimated to fall slightly for 2023. * Net Income: Net income increased significantly from $189.3 million in 2021 to $2.0 billion in 2022. However, it’s predicted to drop in 2023 by a large amount because of significant credit risk provisions.

Key Financial Highlights from September 30 2023 Earnings Release: * Third quarter loss was $234 million or 1.72 a share. * Net interest margin decreased to 2.61 percent, down from 2.82 percent in the previous quarter. * Reported a provision for credit losses of $276 million, compared to $144 million in the prior quarter. * Commercial real estate loan originations decreased to $2.1 billion in the quarter. * Mortgage loan production decreased to $8.0 billion in the quarter * Total revenue fell to $997 million in the quarter. * Non-performing assets increased to $873 million by end of the quarter, a sharp increase. * Book value has remained almost steady since June 30 2023, decreasing by ~0.17% but remains elevated compared to 2022 levels.

Moat Assessment (2 / 5): Flagstar has some elements of a moat, mainly due to its established presence in the mortgage servicing sector and due to local ties in select markets. However, the banking industry is very competitive, with low barriers of entry and strong competition in most of its areas of business. It has no real tangible advantages over its competitors, including high switching costs or network effects. Moreover, as an increasingly large amount of mortgage originations are being handled by non-bank mortgage brokers, this means the Company’s competitive position has become more fragile.

Risks and Resilience:

Interest Rate Risk: Rising interest rates increase funding costs for the Company, while also slowing down mortgage originations. At the same time, falling interest rates may encourage borrowers to refinance, reducing value from existing loans.
Credit Risk: A large portion of the bank’s assets comes from mortgages, which are highly susceptible to defaults in the event of a recession or economic contraction. This is exacerbated by the company’s current reliance on floating rate mortgages.
Regulatory Risk: Regulatory changes may force the bank to make costly changes, or otherwise change business fundamentals, such as capital ratios and reserve requirements.
Competition: The extremely competitive landscape in the financial sector makes it tough for any player to gain a competitive advantage and maintain it over the long term, thus putting downward pressure on prices and revenues.
Economic Conditions: Changes in macro economic conditions such as GDP, employment and housing markets are directly related to Flagstar’s financial performance, which can lead to large swings in revenues and profitability.
Technological Disruption: Fintech companies and other disrupters, can force established companies to lower prices, margins, and even lose out in market share as consumers prefer more modern offerings.

Despite these risks, the company has shown itself to be reasonably resilient, withstanding multiple economic conditions. The Company is a large lender in the mortgage sector with a good servicing operation. Also, the Company has a well-established presence in select regional markets, and has a diverse line of business that should provide stability. However, the company is currently facing strong headwinds due to high interest rates and a tough economic environment, which could hurt profitability.

Understandability (3 / 5): The Company’s core banking and lending businesses are easily understood. However, a larger portion of revenue coming from non-traditional sources like mortgage servicing and also derivatives adds a bit of complexity. Analyzing the nuances of their financials, and their impact on the Company’s value, also requires specific industry knowledge, which may be difficult for the average investor.

Balance Sheet Health (4 / 5): The Company’s capital position appears to be strong, with a leverage ratio of 8.7. However, their debt to tangible equity ratio at 10x is on the higher side for a bank, indicating moderate leverage. The company has a lot of non-performing assets in 2023, but there have been provisions set aside that should help with these concerns. These points are still a concern, and could indicate a risk to company solvency if the market worsens significantly. The company also has a large amount of goodwill and intangibles, which could affect the balance sheet, but we have made a suitable adjustment to account for these in the ROIC calculation above. Also, it would be better to monitor the financial position of their acquired entities as their operating conditions may vary from what was originally projected.

Recent Concerns/Controversies/Problems:

The company has seen a sharp increase in credit loss provision to $276 million from $144 million in the previous quarter. This could indicate that they are seeing an increasing risk of loan defaults due to the macro economic situation.
Non-performing assets have increased quite substantially in the most recent quarter. Although they are provisioned to be recovered, there is a risk that the recoveries may not come through. The company also saw a decrease in their loan origination rates, which will likely hurt revenues and profit in the future.
These issues are expected to continue in the short term as interest rates and inflation are expected to stay high in the near future, as said by the Federal Reserve.

Management Perspective: The management has noted that they are actively working to reduce expenses, and improve margins, which should improve value for shareholders. They are focusing more on stable lines of business. They have said their credit quality remains strong. And they also believe that economic growth will lead to an increase in interest rates, but also will improve employment for those holding mortgages. However, they note that they are also working to better their management practices to make the business better able to weather economic instability. The company claims to be focused on achieving growth while being cost-conscious, and they are focused on making changes to their lending guidelines to be in line with economic trends.