Apr 28, 2015
Executives
David Urban - Director, Investor Relations Sandro DiNello - President and CEO Jim Ciroli - Chief Financial Officer Lee Smith - Chief Operating Officer Steve Figliuolo - Chief Risk Officer
Analysts
Brendan Nosal - Sandler O'Neill Bose George - KBW Kevin Barker - Compass Point Paul Miller - FBR Capital Markets
Operator
Please standby, we are about to begin. Good day.
And welcome to the Flagstar Bank First Quarter 2015 Earnings Conference Call. Today’s conference is being recorded.
At this time, I would like to turn the conference over to Mr. David Urban.
Please go ahead, sir.
David Urban
Thank you, Jennifer, and good morning. Welcome to the Flagstar first quarter 2015 earnings call.
This is David Urban, Director of Investor Relations. Before we begin, I would like to remind you that the presentation today may contain forward-looking statements regarding both our financial condition and our financial and operating results.
These statements involve certain risks that may cause actual results in the future to be different from our current expectations. For non-exhaustible list of such factors, please see our 2014 Form 10-K and as well as the legal disclaimer on slide one of our first quarter 2015 earnings call slides that we have posted today on our Investor Relations site at flagstar.com.
During the call, you may also discuss -- we may also discuss non-GAAP financial measures regarding our financial performance. A non-GAAP financial measure is a metric that is not presented in accordance with U.S.
GAAP. We believe that our use of these non-GAAP financial measures in addition to the GAAP results can provide investors with additional information that is useful in assessing the results of Flagstar’s operations on a run rate basis.
In today’s presentation, in the press release we issued this morning and in our subsequent SEC filings, we identify these non-GAAP financial measures as adjusted measures, which modify for significant items. We are providing a reconciliation of these measures to similar GAAP measures in the tables to our press release that we issued this morning or in the appendix to our earnings call slides.
With that, I’d like to now turn the call over to Sandro DiNello, our President and Chief Executive Officer.
Sandro DiNello
Thanks, Dave, and thank you everyone for joining us today. Let me first apologize in advance for my voice, I am a little under the weather today.
In addition to Dave, I am joined this morning by Jim Ciroli, our Chief Financial Officer; Lee Smith, our Chief Operating Officer; and Steve Figliuolo, our Chief Risk Officer. I would like to take a moment to describe the order of the call.
First, I am going to highlight the key items and actions we undertook during the first quarter. After my remarks, Jim will review the consolidated quarterly financial performance.
Lee will then provide a more detailed review of our business segments and strategic initiatives. Following this, I will conclude with a view of our 2015 second quarter and then open the call for questions-and-answers.
With that, let’s begin. We reported net income of $31.5 million or $0.43 per diluted share for the first quarter of 2015, as compared to $11.1 million or $0.07 per diluted share in the fourth quarter of 2014.
That’s the significant rise in profitability that resulted from a 15% increase in revenue, coupled with 2% decrease in expenses. This positive operating leverage is what we have been working hard to achieve.
While we are pleased with these results, we are even more pleased with the fundamentals behind the numbers as we continue to improve in all key operating areas, net interest income, credit cost, non-interest income and operating expenses. First, our Mortgage business had a very strong quarter.
Mortgage originations were up 10%, locks were up 17%, gain on sale margin was up 46%, again on sale income was up 71%. These numbers reflect the power of our national origination platform and provide concrete evidence that our efforts to reposition our mortgage franchise are working.
With these results, we have outpaced the performance of virtually every other mortgage originator who has released Q1 results to-date. Second, net interest income continue to grow on the strength of an 8% increase in average earning assets for Q1, driven by growth in loans held for sale and in the investment portfolio.
The loan growth was led by 15% increase in warehouse lending. We believe we are increasing market share in warehouse as our operating model has fundamentally changed, where once we were the primary purchaser of loans funded by our warehouse lending now loans purchase but other investors represent the majority of our fundings.
Take a look at how this business has change over the last year. At March 31, 2014, we have $409 million in outstanding warehouse lines with 31% funded loans purchased by other investors.
At March 31, 2015, we had $1.1 billion in outstanding warehouse lines with 60% funded loans purchased by other investors. As these numbers show, we have successfully reengineered this business in a very positive fashion.
Third, we substantially improve credit quality, primarily via loan sales, performing TDRs declined by 69% and nonperforming loans were down 30% from the fourth quarter of 2014. NPLs are now comfortably below $100 million, a level Flagstar has not seen since 2006.
And finally, in the phase of rising business levels throughout the company, we reduced operating expenses. This management team is focused on improving efficiency and will continue to be relentless in pursuing that goal.
Now let’s take a deeper dive into the mortgage business, so you can get a better picture of the dynamics of our results. We were able to capitalize on a drop in the 10-year treasury rate, as well as FHA's mortgage insurance premium reduction that created an attractive refinance environment.
We were very focused and proactive in pursuing the window that open for us and refis, and conducted a direct marketing campaign to bring in the business. We are further encouraged by the benefit we are seeing from the operational changes we made to our Mortgage Origination business.
For example, we’ve become smarter in working with the third-party originators. We are doing more business and better business with fewer TPOs, with no reduction in market share.
We’ve also adjusted spans of control in the sales organization, which we believe has produced improved performance. And not only did we increase originations and locks significantly, we also maintained service levels throughout a period of high volume.
In fact, we carefully managed volume through pricing to ensure we met our customers’ service expectations. As I said before, we are fully committed to building our mortgage business and this entire bank on the foundation of industry-leading service.
Another positive for the quarter was the growth of our balance sheet, beyond the $10 billion threshold. As we said last quarter, we expected to see balance sheet growth in 2015 and now we are delivering.
The diversification of our revenue is critically important to our strategy and we will continue to focus on this objective through the growth of our structural balance sheet. On the credit side, we took another big step forward in the first quarter with the sale of $331 million of lower performing loans.
This was accomplished with no negative financial impact, another validation of the accuracy of the marks in our book. On the expense side as I mentioned earlier, non-interest expenses declined 2%.
Rest assured that our leadership team is focused on continuing to find efficiency opportunities. Lee will cover expenses more specifically in his remarks.
Now, a few other items of note, we remain ever vigilant with our interest only portfolio and continued to aggressively manage it with positive results. Lee will tell you more about that.
While I can't tell you when our OCC consent order will be lifted, I can tell you that we are making meaningful progress toward that end, that we are engaged in daily dialogue with the OCC and that we appreciate their efforts to help Flagstar be the best institution that it can be. With respect to our stock preferred, we continue to investigate all options that maybe available.
That said there are a number of considerations including the need for regulatory approval. That makes it difficult for us to pinpoint with exact certainty, when will we redeem these securities.
In any event, we expect that it will be no later than the second half of 2016. All-in-all, it was a solid performance for the quarter, characterized at the highest level by the positive operating leverage and further de-risking of our balance sheet.
We remain focused on compliance and risk management and those are evergreen. And right there with us is the overarching goal of improving our core profitability.
With that, my colleagues will take you through a more detailed discussion of our financials and operations. So let me now turn the call over to Jim.
Jim Ciroli
Thanks, Sandro. Turning to slide six.
Our net income was $31.5 million, a $0.43 per share in the first quarter as compared to net income of $11.1 million, or $0.07 per share in the fourth quarter. Our earnings this quarter were shaped by the structural improvements we’ve made over the past year, combined with the resurgence in refinance activity.
Revenue rose a solid 15% while expenses fell 2%. Our first quarter net interest income rose to $64.9 million as compared to $61.3 million in the fourth quarter 2014.
The increase in net interest income was led by earning asset growth, partially offset by net interest margin reduction. Our NIM dropped 5 basis points in the quarter to 2.75%, mainly due to increased borrowing costs as we lengthen federal home loan bank borrowings to provide a more stable funding for planned loan growth and improve our interest rate sensitivity.
Earning assets rose 8% last quarter due to growth in loans held-for-sale and the investment portfolio. Our success in opportunistically growing our loan book continued last quarter, with solid growth in warehouse, commercial real estate and C&I loans.
Average deposits increased $223 million from the prior quarter, driven by higher non-interest-bearing escrow deposits in growth and retail savings. We had continued success with our promotional campaign to increase retail savings accounts.
The quarterly provision for loan losses was a benefit of $3.5 million for the first quarter versus the provision of $5.0 million in the fourth quarter, as we reduced the overall size of the allowance in conjunction with the sale of $331 million of lower performing loans. Our net charge-offs of $40.5 million for the first quarter included $36.0 million of net charge-offs associated with the aforementioned sale.
Excluding this amount, net charge-offs were $4.5 million or 45 basis points of applicable loans. I will provide additional detail on asset quality in a couple of slides.
Non-interest income increased $19.9 million, or 20% to $118.3 million in the first quarter. The main improvement in non-interest income was a $37.8 million or 71% increase in gains on loan sales, which Lee will provide further details on it.
This positive development in non-interest income was partially offset by three items. First, a $4.6 million decline in R&W, reflecting Q4 recoveries and a reduction in the reserve recorded in the fourth quarter 2014.
We kept the R&W reserve unchanged this quarter. Our claims experience continues to perform better than we have modeled and we are encouraged by government efforts to assess risk-based penalties on documentation flaws instead of forcing repurchases.
Slide 37 in our appendix provides further information on this reserve. Second, our returns on the MSR asset were $2.4 million negative, $4 million worst than last quarter's return.
The return was pushed negative by a $4.2 million increase in the amortization of the asset as prepayment speeds rose to 22% for the portfolio in the first quarter, up from 15% in the prior quarter. Additionally, we had $4 million of net hedge losses from interest rate volatility earlier in the quarter and $1.6 million in net transaction costs.
Please refer to slide 33 in the appendix for further details. And finally, the $6.3 million decrease in other non-interest income due to a $5.5 million reduction in the fair value of certain HELOCs.
To help you understand the change in fair value, I’d like to provide some background on our HELOC portfolio. Pursuant to the settlement we struck in 2013 with assured guaranty, we consolidate two securitization trusts they formally insured and carry the underlying assets of $112 million of HELOCs at fair value.
This fair value was 88% of UPB at March 31, 2015. The HELOCs are serviced by a third-party and the loans are structured to become due and payable at the end of their draw period.
As the HELOCs and the trusts are coming to the end of their draw period, we've noted that more HELOCs that we would like are not being repaid in full at the end of draw. Consequently, we reviewed the servicing strategy for the third-party servicer and we believe that Flagstar is better positioned to service these loans at the end of draw so we’re taking greater control of these assets.
Simply put, we have more options at our disposal and we don’t have to operate under a trust indenture as our servicer does. So we are electing to exercise our clean-up call where we can.
Slide 44 in the appendix provides more detail. Until we take control and demonstrate our ability to resolve these loans better, we have reflected a higher level of delinquencies on our fair value estimate resulting in the charge.
Moving to expense, noninterest expense fell 2% to $137.0 million in the first quarter as compared to $139.2 million in the fourth quarter. This included a $5.6 million decline in asset resolution costs, which fell sharply to $7.8 million, the result of process improvements and lower levels of problem assets and a $1.8 million decrease in legal and professional fees, driven by lower level of foreclosure actions and the completion of various consulting projects.
These were partially offset by approximately $3 million of higher compensation commissions and loan processing expenses related to the increased mortgage activity. Slide eight highlights our period end balance sheet.
Total assets increased 18% to $11.6 billion in the first quarter, led by growth in HFS loans, the investment portfolio and warehouse loans. Average deposits increased 3% resulting from higher levels of escrow deposits and a 5% increase in retail savings deposits.
When rates dropped early in the quarter as we consider funding for planned loan growth, we saw an opportunity to lengthen the duration of our funding by adding $625 million of longer-term FHLB advances with an average maturity of 5.5 years and an all-in cost of 1.68%. This action improved our liquidity position and increased our asset sensitivity.
We maintained a strong balance sheet with ample liquidity. Our common equity to asset ratio remained solid at 10%, while on-balance sheet liquidity improved to 21% of total assets.
Turning to slide nine. Our allowance coverage was 5.7% of total loans at the end of the first quarter as compared to 7.0% at the end of the fourth quarter.
Coverage dropped as a result of the sale of lower quality loans and the continued migration of our loan portfolio into higher quality assets, such as our warehouse loan book where credit losses are low. At quarter end, we had 9.5% allowance coverage and our consumer loan book down 146 basis points from the prior quarter end consistent with the sizable drop in consumer delinquencies and fewer lower quality assets.
The commercial loan allowance coverage remain fairly stable at 1.5% in Q1, reflecting the low levels of problem loans in this portfolio and growth of higher quality loans, such as warehouse loans during the quarter. Nonperforming loans were $84 million at the end of the first quarter as compared to $120 million at the end of the fourth quarter.
This $36 million decrease was driven by the sale of lower performing loans. Performing TDRs fell $251 million to $111 million in the first quarter reflecting the benefit of this recent loan sale.
Early stage delinquencies were down from Q4. Looking at consumer loans, 1.2% of consumer loans were over 30 days delinquent still accruing, an improvement of 47 basis points from the fourth quarter.
There were no commercial loans at March 31. They were more than 30 days delinquent.
Turning to slide 10. We continue to maintain robust regulatory capital ratios in the first quarter with the partial phase-in of Basel III.
On a partially phased-in basis, our Tier 1 leverage ratio was 12.0% and our Tier 1 common ratio was 15.4%. Diving deeper into each of these ratios, the partial phase-in reduced our Tier 1 leverage ratio by 57 basis points when compared to the same ratio under Basel I.
Interestingly, our common equity Tier 1 ratio increased 247 basis points under the phase-in rules as the absorption of the write-off of excess MSRs and NOL dependent deferred tax assets are born only 40% by common equity Tier 1 in the first year of the phase-in. The remaining NOL dependent DTAs and MSRs above the Basel III limits are written off against the non-common elements of Tier 1 capital, namely the TARP preferreds and the trust preferreds in this first year of phase-in.
Looking at the impact of a fully phased-in implementation of Basel III, our Tier 1 leverage ratio would have been 10.3% and our Tier 1 common ratio 9.4% at the end of the quarter. This 170 basis point adverse impact toward Tier 1 leverage ratio is mostly driven by the detrimental treatment that mortgage servicing rates received under Basel III.
Over the long-term we plan to continue to reduce our MSR to Tier 1 leverage ratio, taking into consideration market conditions to guide our pace of MSR reduction. Excluding our preferred stock and now $63 million of preferred deferred dividends from our Tier 1 capital, our consolidated Bancorp Tier 1 leverage and Tier 1 common ratios under Basel III fully phased-in would be 7.0% and 8.3%, respectively.
At March 31, 2015 we had $279 million of MSRs representing 22.2% Tier 1 capital relatively unchanged from the end of Q4. I'll now turn to Lee for more insight into each of our businesses.
Lee Smith
Thanks, Jim. And good morning, everyone.
On previous earnings calls we’ve talked about creating a solid foundation through de-risking the balance sheet and optimizing the cost structure from which to growing our three major business lines of mortgage originations, mortgage servicing, and community banking. As we pivoted to the growth stage of our strategy, we believe our efforts over the last two years to create that foundation demonstrated in the positive operating leverage and improved efficiency that you see in the first quarter results.
We’re encouraged by the progress we made and we will look to build on these results both in the second quarter and beyond. I will now outline some of the key operating metrics from each segment during the quarter.
Please turn to slide 12, quarterly operating highlights for the community banking segments include average commercial loans increased 10% to $1.7 billion versus the prior quarter primarily as a result of growth in our warehouse business. Commercial loan commitments grew 3% quarter-over-quarter to $3.2 billion.
Warehouse loan balances increased $79 million or 15% this quarter as a result of increased mortgage origination activity, an overall market share gains driven predominantly by an increase in the funding of loans purchased by other investors. During the last 12 months, we've grown warehouse loan balances by $674 million, C&I loan balances by $132 million and CRE loan balances by $122 million for net increase in new commercial loan balances of $928 million.
Average consumer loans increased $106 million or 4% during the quarter. This is a net increase even after accounting for the sale of $331 million UPB in residential TDRs, NPLs and scratch and dent loans.
We added $259 million of jumbo conventional product to our HFI portfolio during the quarter as we added higher color quality interest-earning assets to the balance sheet. Average deposits increased more than 3% during the first quarter and nearly 19% over the last 12 months, predominantly due to increases in savings deposits.
It is our intention to continue to grow our commercial businesses, including warehouse lending in a controlled safe and sound manner as we have been doing to date. We're encouraged by the growth we've seen in the warehouse business during the first quarter and we’ll look to build on that further as we move forward.
In the C&I and CRE segments, we continue to focus on the Michigan market. And we're also looking to expand that consumer loan offerings, given the experience of the team we now have in place.
We will also continue to de-risk the balance sheet of risk year assets when it makes economic sense to do so and replace them with higher quality loans in order to maximize interest income. Please turn to slide 13.
First quarter operating highlights for the mortgage origination business include fallout-adjusted lock volume increased 17% to $7.2 billion. Refinance mortgages accounted for slightly more than 63% of origination volume in the first quarter as compared to slightly more than 46% of origination volume in the fourth quarter.
Fallout-adjusted gain on sale margin which is what we use when reporting gain on loan sale increased 40 basis points or 46% to 127 basis points in the first quarter as compared to 87 basis points in the fourth quarter. The increase in margin was driven by stronger market pricing power as we priced the balance volumes in capacity as well as improve business performance.
The company made fundamental changes in its mortgage origination business towards the end of last year to enhance customer service and profitability. While we took advantage of the drop in interest rates at the beginning of the quarter as the 10-year bottomed out to 1.67% on February 2nd and the reduction in FHI mortgage insurance premiums, which went into effect at the end of January.
We certainly believe the operational enhancements we made, have created a degree of permanent improvements. We continue to remain focused on providing service excellence while at the same time implementing strategies to create a more variable cost structure on the fulfillment side of the business.
These efforts have allowed us to realize significant operating leverage during the quarter, an optimized overall returns in our mortgage business. As we look forward into Q2, we believe the low interest rate environment will continue to be beneficial to our origination business, together with the seasonal uptick created by the spring volume season.
We’re investing in technology as a way to further improve the topline performance and make us more efficient from an operating point of view. And we remain on target to be ready for the new RESPA-TILA disclosure requirements that go into effect in August of this year.
Finally, we are committed to growing our retail origination business on both the retail distribution and direct-to-consumer side. And we’ll keep you apprised of the progress on these fronts on future calls.
Moving to servicing. Quarterly operating highlights for the mortgage servicing segment on slide 14 include, we executed on the sale of $2.8 billion in aggregate UPB or 10,300 loans of residential MSRs during the quarter.
We currently service approximately 385,000 loans, of which 231,000 are sub-service for others. The remaining 154,000 are loans where we own the MSR or they are part of LHFI book.
Approximately 96% of our servicing book is performing loans, which means 4% or approximately 15,000 loans of 60 plus days delinquent. We're always looking at ways to reduce the number of default and delinquent loans in our portfolio, given the significant costs associated with servicing delinquent loans and servicing and working out delinquent loans, if not part of that core growth strategy.
We remain focused on growing our fee income generating subservicing platform and also want to better leverage the cross-selling we are able to do across our three business line verticals, in order to increase share of that mortgage customer’s wallet and the number of accounts per household. Moving to asset quality.
We continued with our sustained efforts to de-risk the balance sheet. We sold approximately $331 million unpaid principal balances of TDRs, NPLs and scratch and dent loans during the quarter.
We’ve now sold almost 1 billion in UPB of NPLs TDRs and scratch and dent loans over the last two years as part of the concerted efforts to de-risk our balance sheet and reduce the costs associated with nonperforming and lower quality assets. Other significant effects of these Q1 sale transactions include our NPL stand at $84 million or less than 1% of our overall balance sheet to the end of the quarter, the lowest level it’s been in almost 10 years, a decrease in NPLs is a percent of loans held for investments to 1.8% at the end of Q1 compared to 2.7% at the end of Q4, a reduction of $269 million in TDRs in our HFI portfolio.
These sales should lead to a continued reduction in asset resolution expenses in future periods as well as lower FDIC premiums in 2016. We continue to see strong performance from actively managing our IO portfolio.
If you turn to slide 15, you will see that we have $552 million of interest-only loans on our balance sheet that have yet to reset. Of these, $236 million or 43% are due to reset during the remainder of 2015.
The anticipated payment shock associated with these resets versus current payments is approximately 106%. The slide on page 16 of the earnings presentation contains a lot of key data points around this portfolio.
So you can see how we are handling and tracking the IO book. Rather than reciting the metrics from these slides verbatim, I want to focus on a few key highlights.
But before that, I would just say that we continue to be extremely pleased and encouraged with the performance of this portfolio. Key takeaways include of 1,696 IO loans that have reset through March 31, 2015, 24.9% unpaid principal balance or 367 loans have paid in full, 40.9% UPB or 759 loans, the cash flowing resets, of which 748 have been paying for three months or more and 477 or 63% of the specific population have been paying for six months or more.
7.1% UPB or 141 loans have been charged-off or foreclosed on. And of this, 122 defaulted prior to the reset date and only 19 defaulted post reset dates.
The rolling 12-month average loss severity on the IO portfolio is 33 %. With respect to overall quality, slide 15 shows that 84% of all remaining IOs have FICO scores greater than 660 and 89% of those same loans have LTVs less than 100%.
We are currently at 97.5% right party contact rate for Q2, where we have 175 IOs or $47.3 million UPB resetting. In summary, it's been another productive quarter as we continue to reduce risk and strengthen the balance sheet.
Moving now to expenses on slide 17. Our noninterest expense during the first quarter was $137 million versus $139.3 million in the fourth quarter.
Variable cost including commissions and loan processing expenses increased a little over $2 million during the quarter as a result of increased mortgage origination volume while fixed cost declined $4.5 million due to lower asset resolution expense as a result of that process improvements and de-risking efforts over the last few months. We believe our current noninterest expense quarterly run rate is approximately $135 million to $140 million.
Managing that cost structure aggressively will continue to remain a focus. Our goal is to reduce excess capacity and create a more variable cost structure which is highlighted in the quarterly noninterest expense chart on slide 17.
We will continue to build on the work we have done today around vendor management and procurement expenses, asset resolution costs, legal and professional fees and optimizing our real estate portfolio. Our efficiency ratio improved to 74.8% in the first quarter from 87.2% in the fourth quarter.
The improvement was driven by an increase in revenues of $23.5 million quarter-over-quarter and a decrease in noninterest expense of $2.2 million despite the increase in topline revenue. We continue to work tirelessly to further optimize that cost structure and drive greater efficiencies.
As result of our expense management and discipline, what we expect you should see as we will look further forward is a cost base that increases at a lower rate than revenues as we continue to grow the three major business line verticals. Our first quarter results demonstrated positive operating leverage and expense discipline that has been instilled within the organization even as we invest some of these savings into our future growth strategies.
With that, I’ll hand it back to Sandro.
Sandro DiNello
Thank you, Lee, I am now going to close our prepared remarks with some guidance for the second quarter and then open the call for questions-and-answers. Please turn to slide 19 for those itemized guidance parameters.
We expect net interest income to increase approximately 10% as we continue to grow earning assets growth. Mortgage locks are expected to remain flat with originations up 10% to 15 %.
We expect the decline in gain on loan sale margin. Loan administration income is expected to remain at the Q1 level.
We expect the net return on the mortgage servicing asset to remain under pressure given alleviated prepayment rates. The ratio of our MSR to Tier 1 capital is expected to be consistent with March 31, 2015 levels.
We expect our provision expense to match net charge-offs consistent with the net charge-off ratio in Q1 adjusted for loan sales. As Lee noted, non-interest expenses should remain relatively flat and lastly, we expect the effective tax rate in Q1 to remain constant -- in Q2 to remain constant.
This concludes our prepared remarks and we will now open the call to questions from our listeners.
Operator
Thank you [Operator instructions] And we’ll go first to Scott Siefers from Sandler O'Neill.
Brendan Nosal
Hey. Good morning, guys.
This is actually Brendan Nosal on the line from Scott’s team. I was hoping you could start out with a little more color on gain on sale margin.
I mean, obviously, you had some really nice expansion here? And in the release you commented on some fundamental changes, the mortgage origination business that will help going forward?
But the other calls for a slight decline in the margin? Could you give us a sense for the magnitude of this decline in the 2Q and we’ll be hoping maybe to this quarter's results the 4Q figure?
Sandro DiNello
My best guess would be its going to be somewhere in between. I know that’s not as specific as you like to hear.
But it’s difficult for us to be able to pinpoint just how the gain on sale margin will react going forward. A lot of things took place in Q1.
There was a lot of activity because of the decline and in the 10-year there was the impact of the FHA MIP reduction and that’s some of the things we did in terms of how we score our third-party originators, who are doing business with, how we deliver prices to our third-party originators. So there’s a lot of things that came into play in Q1 that produced the results we had.
So it’s just really difficult for me to be more specific going forward. I guess, what I would say is, I think, we executed pretty strongly on every aspect of that business in Q1 and we’re optimistic that that will be able to do so going forward.
Brendan Nosal
That’s great. Thank you for the color there.
And I was hoping we get shift over to the mortgage warehouse is definitely a very strong driver of this quarter’s loan growth. You guys seem very optimistic looking forward to the year?
Could you give a sense of how it’s going to look in the second quarter and then maybe kind of also update us just in the context of how you’re thinking about the warehouse 90 days ago?
Sandro DiNello
Well, I think, the change and the thinking and the warehouse started really quite sometime ago. In the prepared remarks, I referred to the March 31 levels of outstanding as well and more importantly, I noted how much of that outstanding was related to loan that were being purchased by other investors.
And that’s a real fundamental change in the way we think about that business today. So we're going up market if you will and we’re reaching out to large originators.
Many that are -- that don’t need Flagstar an aggregator. And so, I think, the opportunity is pretty significant.
We’re not providing any specific guidance in that area, but we’re going to continue to look for the right opportunities going forward.
Brendan Nosal
That’s awesome. Thank you very much for the color guys.
Sandro DiNello
You’re welcome.
Operator
Thank you. [Operator Instructions] And next we’ll go to Bose George from KBW.
Sandro DiNello
Hi, Bose.
Bose George
Thanks. Hi, guys.
Good morning. Congratulations on the quarter.
Okay, I just had a follow-up on the gain on sale question. In terms of the optimization of the Mortgage business in a commentary you had?
Can you just discuss that a little further is that sort of efficiencies on the cost side that is flowing through the gain on sale line item?
Sandro DiNello
Well, one of the other things that I didn’t mentioned in the prepared remarks or in my have to the earlier question is -- and Lee have talked a lot about this in the past in terms of building a variable capacity model, a model that could adjust to increasing volumes quickly and would minimize the fixed expenses in the business. And I think in Q1, with way the volume search that we were able to do there.
If you can see the expenses associated with that business didn’t increase particularly significantly in Q1. So I think there’s a lot of things like I mentioned both in the speech and in the question -- the answer to the earlier question.
But on top of that, I think, it’s the model and the way the model works and I think, it's pretty efficient and we got a real chance to see that work in real-time here over the last few months.
Bose George
Yeah. That definitely make sense and we saw that on the cost side.
But I am just curious just the piece that goes to through gain on sale margins itself? Is there -- so there is both a sort of strength in the market, but also the cost side of what flows through the gain on sale margins that's also improving?
Is that sort of two pieces of that that benefited this quarter?
Sandro DiNello
Yes. I’d say that each one of those things.
But as I said in my earlier response it’s just really hard for me to get specific with you as to where exactly I think it is and where it’s going to be. So right now we feel real good about it.
And one quarter doesn't tell the whole story for the future. So we need to see how things go here going forward.
But I can tell you we’re pretty optimistic about our ability to continue to execute pretty effectively.
Bose George
Okay. Great.
And then actually just switching over to the FHA volume, the FHA percentage looks like it went down a little both actually percent and then dollar count despite the premium cut. So just curious how FHA is playing into the mix, so is that just reflective of the market that you guys back away a little bit from FHA or anything else?
Sandro DiNello
Yes. So with the government business, the capacity model is a little bit different with the government business because we can’t outsource as much of the process as you can with the conventional business.
So we chose to slow down that business in order to be able to keep the service levels in place and then we just work with wider margins for the business that was coming in. So we balanced it pretty well and we’ve got real good results.
Bose George
Okay. Great.
And then just actually one last one on the growth in the balance sheet. The investment portfolio growth, can you just discuss what those assets are and just how we should think about the investment portfolio going forward?
Sandro DiNello
Yes. Let Jim take that one.
Jim Ciroli
Yes. Thanks, Bose.
We added some securities at the early parts of the quarter in that portfolio, but the securities we added are very consistent with the securities that we sold at the end of Q4. If you recall, we sold some securities at the end of Q4 in order to standard that $10 billion mark.
But the portfolio continues to yield around 2.5 with just under four-year duration.
Bose George
Okay. Great.
Thanks a lot.
Jim Ciroli
You are welcome.
Operator
Thank you. And we’ll go next to Kevin Barker from Compass Point.
Jim Ciroli
Hi, Kevin.
Kevin Barker
Hi. Good morning.
Your Tier 1 leverage ratio for the repayment at TARP increased from 6.9% to 7.1% fully phased-in for Basel III. What are you doing to get that number higher?
And at what level, do you feel most comfortable given how your business model setup today?
Sandro DiNello
Jim?
Jim Ciroli
So there's still quite a bit of change that we need to do and think about it as we approach any payoff we might have of TARP. Sandro made some comments in his prepared remarks about that.
So we continue to look at growing this by just optimizing the balance sheet and putting on better quality assets that’s the key element of all of this, both in terms of how you look at it from a regulatory ratio and how the regulators look at capital as well and just earnings retention.
Kevin Barker
So you expect purely it’s just a lot of blocking and tackling that you’re already doing as opposed to any reshuffling of the balance sheet?
Jim Ciroli
I think that’s the right way to think about it.
Kevin Barker
Okay. And then, do you think the regulators are focusing on the fully phased-in numbers or the current Basel III ratios when assessing your capital adequacy?
Sandro DiNello
We really haven’t had that conversation with the regulators. But I don’t know how you phased -- how you focused on the phase-in numbers, because we’re managing this bank for the long-term.
And I don't know why we look at something that’s going to be gone in just couple of years.
Kevin Barker
Great. And the other thing that's housekeeping, your tax rate was relatively high this quarter compared to past quarters and you guided to same tax rates going forward.
Was there anything in particular that's driving that?
Sandro DiNello
No, the reason why we’re at roughly 37% is just the state tax provision. And as you -- if you compared Q1 to Q4, we had a small state tax benefit in Q4.
And I think the benefit is -- the way I would explain the benefit is, at the end of the year we always through ourselves up to whatever return was and we had small benefit flow through Q4 along with the lower level than what we saw this quarter, pre-tax income level.
Kevin Barker
And you just said probably as they consist 37% absent some one-off for seasonal, why don't that may happen in the beginning or end of the year?
Sandro DiNello
Yes. That’s we said on that last slide.
Kevin Barker
Okay. And then one last one.
Considering how proactive you've been on distressed loan portfolio. Could you help quantify the decline in operating expenses that you expect going forward due to declines in FDIC insurance and asset resolution expense?
Sandro DiNello
So I will let Lee get into a little bit more detail there. But just on the FDIC expense, one thing I’ll say is remember we’re under the small bank, FDIC expenses in 2015 because we were under $10 billion at the last point time that's evaluated.
And in 2016, though, we would expect that we would go into the large bank. Our pricing, so therefore, we're trying to position the balance sheet with the right kind of assets, looking forward to what the FDIC expenses are going to be in 2016.
So that’s why in a couple of places there was reference made to reduction of FDIC in ‘16 as opposed to ‘15. Lee, little bit more on the expenses?
Lee Smith
Yeah. So on asset resolution, Kevin, you obviously saw a significant decline this quarter versus last quarter in asset resolution.
I think, as we look into Q2, the run rate for asset resolution is going to be pretty consistent with where it was in Q1. So we feel as though the de-risking efforts that we’ve undertaken not just in Q1, but prior to that as well are beginning to -- they are showing through basically in the asset resolution results.
And so, I would assume the current run rate for asset resolution is going to be consistent with Q1. And if you sort of go back and look at where asset resolution expenses were in 2014 full year and 2013, you’ll see the dramatic decline year-over-year.
Sandro DiNello
So just to reiterate, we are guiding to 135 to 140 expense level for Q2.
Lee Smith
Correct.
Kevin Barker
Thank you for taking my question.
Sandro DiNello
Thanks, Kevin.
Lee Smith
Thanks.
Operator
Thank you. We will go next to Paul Miller from FBR Capital Markets.
Sandro DiNello
Hi, Paul.
Paul Miller
Hey. How you guys doing?
A follow-up on the asset resolution question, can we assume that you'll continue to sell your TDRs and your NPLs as much as possible?
Sandro DiNello
So, a couple of things, Paul, if it makes economic sense to do so, then we will always evaluate asset sales. And furthermore as I mentioned in my prepared remarks, part of that core strategy as we move forward there is not to sort of work out lower performing assets, NPLs as such so.
Yeah, if the opportunity is there and it makes sense to do so, we’ll take that opportunity.
Paul Miller
Now I know one of the push backs target with you guys selling -- the TDRs that you sold are really good TDRs and probably the TDRs that couldn't get a good bid probably were kept on the balance sheet. I mean, how would you answer that question?
Sandro DiNello
Yes. We’ve got -- if you look at the overall TDR balance sheet that are left on the balance sheet now.
It’s a very small number. So, I don’t think it was any cherry picking as such.
I think the TDRs that were sold. The characteristics are reflective of the TDRs that remained.
Paul Miller
Okay. And then, you made -- feel like I got this correct, right.
The consent order -- on the commentary about consent order, you made two comments. You are working with the OCC to get rid of that consent order and secondly is on the TARPs, correct me if I'm wrong guys, that you don't -- that you shouldn’t have the TARPs gone no later than the second half of 2016.
Could that happen sooner and then what type of timing can you give us on the consent orders? Is this something that can be gone in 2015, or is that going to take a 2016 or ‘17 event?
Sandro DiNello
So first of all, with respect to the preferreds -- sure, it could be sooner. But we can’t be specific about that.
But we definitely expect that we’ll be able to complete it by the second half of 2016. And the other part of your question was…?
Paul Miller
Consent order.
Sandro DiNello
Yeah. I mean, we can’t talk specifically about the regulatory matters like that.
But our comments were meant to be positive and that we feel very good about the progress we're making. But to tell you, whether I think it’s 2016, I just can’t go there.
Jim Ciroli
Yes. Paul, this is Jim.
I just want to make sure that we’re talking TARP and not the TRIPs.
Paul Miller
Yes. I'm sorry, TARP.
Jim Ciroli
Okay.
Paul Miller
Yes. Meaning that mutually -- are they inclusive, exclusive one another?
In other words, do you had to do one to get the other gone or they are just two independent events.
Jim Ciroli
With the TRIPS in the TARP, or you talking in the consent order in TARP?
Paul Miller
The consent order in TARP, yeah. I think I've gotten confused now.
Jim Ciroli
They are not necessarily connected.
Paul Miller
Okay. Okay guys.
Thank you very much.
Jim Ciroli
You're welcome.
Sandro DiNello
Thanks Paul.
Operator
There are no further questions at this time. I’ll turn it back over to Sandro for any additional or closing remarks.
Sandro DiNello
Thank you, Jennifer. And thanks for your assistance today and to all of you for your interest in Flagstar.
Looking back at the quarter, we were encouraged to see the hard decisions we’ve made to improve our Mortgage Originations business are paying off, reduction in NPLs was also a big plus. And our overall business strategy continues to evolve positively.
I also want to thank all my Flagstar colleagues that are listening. Your commitment and great work is the backbone of the progress that we’ve reported this morning.
And I can assure everyone that the entire Flagstar team remains focused on operating in a safe and sound manner. And we all are committed to building a great company that builds value for our shareholders.
Thank you for your time this morning. I look forward to reporting on Q2 results in July.
Operator
That does conclude today’s conference. Thank you for your participation.