Flagstar Bank, National Association 2026 Q3 Earnings Call

Sal, please go ahead. Thank you, Holly, and good morning, everyone.

Welcome to our third quarter 2026 earnings conference call. This morning, our Executive Chairman and CEO, Joseph Otting, along with the company's Co-President, Co-Chief Operating Officer, and Chief Banking Officer, Rich Raffetto, and Co-President, Co-Chief Operating Officer, and Chief Financial Officer, Lee Smith, will discuss our results for the quarter. During the call, we will be referring to a presentation which provides additional detail on our quarterly results and operating performance. Both the earnings presentation and the press release can be found on the investor relations section of our company website, ir.flagstar.com. Also, before we begin, I'd like to remind everyone that certain comments made today by the management team of Flagstar Bank may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements we may make are subject to the safe harbor rules.

Please review the forward-looking disclaimer and safe harbor language in today's press release and presentation for more information about risks and uncertainties which may affect us. In addition, when discussing our results, we will reference certain non-GAAP measures which exclude certain items from reported results. Please refer to today's earnings release for reconciliation of these non-GAAP measures. With that, I would now like to turn the call over to Mr. Otting.

Joseph? Yeah. Thank you, Sal, and good morning, everyone.

We appreciate you joining the call today. I'd like to begin on slide 3 by providing updates to factors affecting our business and updates around the financial forecast. We continue to make meaningful progress in strengthening our core business and advancing our strategic priorities. Net interest income increased, the net interest margin expanded, and pre-provision net revenue improved compared to the previous quarter. We also grew our C&I loan portfolio and deposits while reducing our exposure to commercial real estate loans this quarter. However, several variables pressured credit costs during the third quarter, including the effects of higher interest rates, actions related to the New York City rent regulations, and persistent inflationary pressures. At the same time, a competitive deposit environment continues to impact deposit pricing and growth expectations.

Our success as a company will be determined by our ability to continue to reduce our New York rent-regulated exposure, which we did during the quarter, and attract deposits in an economic manner and expand the balance sheet through C&I loan growth. We are still on track towards achieving our strategic objectives and with our plan to diversify our balance sheet. However, given a higher for longer interest rate environment, the full realization of our transformation has shifted to 2028 from 2027. As a result, we are adjusting our guidance from what we previously outlined to reflect the impact of higher interest rates, the rate environment on credit quality, less deposit growth and corresponding C&I loan growth, and the net interest margin, which Lee will discuss in more detail shortly.

Moving to slide 4, I'd like to discuss some of our third quarter highlights in each of our key focus areas. First, in terms of our earnings, both our net interest income and margin increased compared to the prior quarter, while PPNR also continued to improve. Second, a key part of our balance sheet diversification strategy is growing our C&I loan portfolio. This quarter, we delivered another $2 billion of net C&I loan growth, which resulted in about $1 billion of net loan portfolio growth during the quarter. On average, the average loan in that portfolio we added was about $28 million in loan outstanding, and it was roughly 75 relationships. Third, another key component of our balance sheet diversification strategy is reducing our overall commercial real estate exposure. During the quarter, our CRE par payoffs totaled $1.2 billion, of which 35% were rated substandard.

The decline in the overall CRE portfolio was slightly less as we funded approximately $375 million of new high-quality relationship-based CRE loans on commitments of over $700 million. In our forecast, we project CRE to decline net $1 billion per quarter. And fourth, we continue to apply a prudent approach to credit quality. During the quarter, we had net charge-offs of $74 million, or 49 basis points of average loans, down $25 million compared to the prior quarter, while non-accrual loans were relatively stable. Now I'd like to turn it over to our Chief Financial Officer, Lee Smith, who can provide more color on our revised guidance, asset quality, and third quarter trends. Lee, I'll hand it over to you.

Thank you, Joseph, and good morning, everyone.

As you just heard, the turnaround story of Flagstar is very much on track. However, certain macroeconomic headwinds, especially from higher interest rates, have pushed back the timing of us achieving peer-like metrics by approximately 12 months. The last few months have seen a significant shift in interest rates. The 5-year treasury had increased 75 basis points over the last 3 months as of October 14th, and 111 basis points over the last 6 months. Two quarters ago, the forward curve assumed two rate cuts in 2026, and as recently as June 18th of this year, the forward curve had shifted to one rate hike in October. Fast-forward to September 18th, and the current forward curve has four rate hikes in September, December, March, and June. We are also seeing extended inflationary pressures as a result of higher energy prices.

This change in interest rates and inflationary pressures have impacted our New York City rent-regulated multifamily portfolio in particular. When we use the forward curve with four rate hikes and include inflationary pressures, it has had the following effects. Increased cap rates on rent-regulated buildings, particularly in the Bronx, increased operating expenses at a time when rents have been frozen for up to 2 years, put pressure on debt service coverage ratios, increased the risk that more loans migrate to criticized and classified status. These events have caused an increase in our provision expense to $76 million in the third quarter. Turning now to slide 5.

Given what I have just outlined and our commitment to transparent reporting on the impact of any change to our forecast, we have adjusted our guidance downward for both 2026 and 2027, predominantly the result of higher provision costs in Q4 and full year 2027, for the reasons I just mentioned. The higher interest rates have also resulted in a more competitive deposit environment. While we expect to grow deposits quarter-over-quarter, it is at a reduced level than previously anticipated. Less deposit growth also results in a smaller balance sheet. We expect the balance sheet to grow on average approximately $1 billion a quarter in 2027 and 2028, driven by net new loan growth of $2 billion, funded approximately 50% with deposit growth and 50% with CRE runoff as we continue to diversify the balance sheet and improve the mix of C&I loans in particular.

The higher rate environment is also resulting in lower mortgage originations impacting both interest income and non-interest income, and nonaccruals declining at a slower rate than previously anticipated. EPS for 2026 is now forecast to be in the $0.10-$0.15 range, and EPS for 2027 is forecast to be in the $0.85-$0.95 range. We are also including a full-year 2028 forecast where EPS is expected to be $1.60-$1.70 on top of where we previously expected full-year 2027 EPS to be. I would note that our goal to return Flagstar to profitability metrics similar to our peers is on track to occur in 2028. The inflection point is 2027 for the following reasons. Between October 1st, 2026 and December 31st, 2027, we have $12 billion of low coupon, less than 3.9% CRE multifamily loans either resetting or maturing.