Oct 27, 2015
Executives
David Urban - Director, IR Sandro DiNello - President & CEO Jim Ciroli - CFO Lee Smith - COO Steve Figliuolo - CRO Len Israel - President, Mortgage Banking
Analysts
Bose George - KBW Paul Miller - FBR and Company Scott Siefers - Sandler O'Neill and Partners Jesus Bueno - Compass Point
Operator
Good day everyone and welcome to the Flagstar Bank Third Quarter 2015 Earnings Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to David Urban, Director of Investor Relations. Please go ahead.
David Urban
Thank you, Nikki, and good morning everyone. Welcome to the Flagstar third quarter 2015 earnings call.
Before we begin, I would like to mention that our third quarter earnings release and presentation are available on our website at flagstar.com. I would also like to remind you that any forward-looking statements made during today's call are subject to risks and uncertainties.
Factors that could materially change our current forward-looking assumptions are described on Slide 2 of today's presentation in our Press Release and in our 2014 Form 10-K and subsequent reports on file with the SEC. With that, I'd like to now turn the call over to Sandro DiNello, our President and Chief Executive Officer.
Sandro DiNello
Thank you, Dave, and thank you everyone for joining us today. In addition to Dave, I am joined this morning by Jim Ciroli, our Chief Financial Officer; Lee Smith, our Chief Operating Officer; Steve Figliuolo, our Chief Risk Officer; and Len Israel, our President of Mortgage Banking.
I will start with the order of the call. First, I am going to provide a high level view of how the quarter fits into our overall strategy.
Then, I will turn the call over to Jim for a deep dive into our financial results. Lee will follow with a more detailed review of our business segments and strategic initiatives, and I'll conclude with guidance for the fourth quarter 2015, before opening up the lines for questions.
First, it's great to have another great, clean, profitable quarter under our belt. That's four solid quarters in a row, and with each one we put distance between the Flagstar of the past and the Flagstar of the future.
We've accomplished a lot. We put to rest key credit concerns, created a culture of risk management, and made expense control a way of life.
We have strengthened both our balance sheet and our capital and delivered on our promise to restore profitability and derisk our balance sheet which we have done by systematically replacing lower quality loans with higher quality assets. As reported in our earnings release, we executed on another large sale of interest-only loans during the quarter which now leaves us with a very small manageable portfolio.
Any future sales will be driven not by credit, but concentration issues, provide the opportunity to execute an attractive transaction. We're now in a post-crisis mode where the key words are growth and diversification and the watchwords are expense management and compliance.
We've seen a steady improvement in our efficiency ratio the past four quarters, and are pleased to have posted our third straight quarter of positive operating leverage. Boosting that leverage by improving efficiencies and getting top-line growth is front and center with this management team.
Earlier this year, we had good success retruing our third-party mortgage origination business to widen margins, reduced operating expenses, and better position Flagstar for future growth. We're continuing to look for ways to optimize fulfillment all while analyzing our footprint to see will it make sense for us to expand.
We are targeting growth in our retail distribution channel as a way to diversify originations and because the purchase business is less rate driven and refi we are making purchase as a priority. We see lots of upside opportunity in the direct to consumer business and recently hired an experienced executive, Gregg Christenson, to lead this origination channel.
He comes well credential to make Flagstar a frontrunner in this important space. And we have made other additions to staff to support our planned growth.
Matt Allen joined us last week as Chief Marketing Officer, and he too brings a strong background in his field. One of his first assignments is an important one refreshing Flagstar's brand to jump start consumer awareness.
We feel that Flagstar has a unique persona and a compelling story. We like to package that uniqueness and wrap it in a messaging that will help us grow our three lines of business.
The comments read here is that piece by piece we are putting together a team that is focused on growth and the future. As you would expect with any important personal additions though, we don't expect to see an immediate impact, as a result of their work because it will take time to integrate them into Flagstar.
We also continue to be encouraged with the progress we are making towards the lifting of our OCC consent order and we are holding to our target of resolving TARP no later than the second half of 2016. 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 now to Slide 7.
Our net income was $47 million, $0.69 per share in the third quarter as compared to net income of $46 million, $0.68 per share in the second quarter. Our earnings in the third quarter were again shaped by positive operating leverage.
Total revenues increased 1% while expenses dropped 5%. For the quarter, we posted an annualized return on assets of 1.5% and returns on equity and common equity of 12.4% and 12.7% respectively.
On the basis of our revenue growth, our efficiency ratio improved to 65% which Lee will provide additional color on in a few minutes. Our third quarter net interest income was unchanged at $73 million.
The results were led by modest earning asset growth offset by a slight drop in the net interest margin. Our NIM fell 4 basis points in the third quarter to 2.75% due to a shift in the mix of the portfolio towards lower spread but higher quality residential mortgage loans as we portfolio these loans ahead of our early Q4 interest-only loan sales.
Average interest earning assets rose 3% in the third quarter led by a 10% increase in loans held for investments. We grew our loan books 16% in resi first mortgage loans and 16% in other consumer loans, predominantly home equity.
Average total deposits increased 7% from the prior quarter, driven by a $359 million or 32% increase in company controlled deposits, and a 13% gain in government deposits. The increase in company controlled deposits was driven by the return of mortgage escrow deposits, partially offset by seasonal factors.
The company experienced a provision benefit in the third quarter 2015 from the sale of lower performing loans. The quarterly provision for loan losses was a benefit of $1 million for the third quarter versus the benefit of $13 million in the second quarter, as we realized a $9 million net allowance release primarily related to the sale of $233 million of interest-only and lower performing loans.
Our net charge-offs of $24 million for the third quarter included $16 million of net charge-offs associated with the aforementioned loan sales. Excluding this amount, net charge-offs were $8 million, 61 basis points of loans.
The increase from the prior quarter was primarily due to $3 million of commercial charge-offs and $1 million of consumer loan charge-offs related to a one-time adjustment as we began recording charge-offs on certain loans before 180 days when we have evidence of an inability to repay. I will provide additional detail on asset quality in a couple of slides.
Non-interest income increased $2 million or 2% to $128 million in the third quarter led by a) an increase in the net return on mortgage servicing assets, b) higher net gains on sales of assets, and c) more other non-interest income. The $10 million improvement in other non-interest income resulted from $3 million of positive fair value adjustments this quarter compared to $6 million of negative fair value adjustments last quarter.
These adjustments were driven by three factors. First, the change in fair value of the company's commitments to purchase residential mortgage loans that are designated for HFI, improved $5 million due to a drop in interest rates at the end of the quarter, as compared to an increase in rates at the end of the prior quarter.
Second, the change in fair value of HFI residential mortgages carried under a fair value election was $3 million better due to the impact of the same change in rates. And finally, the fair value of HELOCs improved $2 million due to a $2 million charge in the prior quarter when certain of these loans were serviced externally.
At the end of the second quarter, we exercised our clean-up call on part of this portfolio and its performance in the third quarter has been consistent with our expectations. These positive developments in non-interest income were partially offset by $15 million decline in net gain on loan sales, reflecting a drop in the gain on sale margin and lower fall-out adjusted locks.
The net gain on loan sale margin decreased 16 basis points led by a return to more normalized government margins, increased price competitiveness on confirming conventional, and lower spreads on refinance business. Fallout-adjusted locks fell 5%.
The company increased government in jumbo production to partially offset a drop in conventional volumes. Moving now to expenses.
Non-interest expense decreased 5% to $131 million in the third quarter as compared to $138 million in the second quarter. During the third quarter, asset resolution expense declined $5 million, largely reflecting the positive impacts of building a stronger balance sheet.
Lee will provide additional details on asset resolution expense later. We also experienced a $2 million drop in other non-interest expense due to lower advertising costs and regulatory-related expenses.
These decreases were partially offset by $2 million increase in legal and professional fees, due to higher legal expense related to the execution of various non-agency loan sales and consulting fees on various projects aimed to further improve operational efficiency and further strengthen risk management. On the tax front, the company's effective tax rate in the third quarter fell to 34% resulting from the recognition of R&D tax credit and higher tax exempt income.
We anticipate that the tax rate in Q4 will be unusually low as result of state tax benefits that we anticipate recognizing. Our full year tax rate is expected to be 34%, a rate that we would consider normal, given our business and geography mix.
Turning now to Slide 8. We wanted to cut through the more significant noise this quarter to discuss core performance improvement.
When we normalize the allowance release and the changes in fair value, which cannot be counted on to recur, as well as swings in gain on loan sales, return on mortgage servicing rights, and asset resolution expense, we can see a core quarter-over-quarter improvement of $3 million. This core improvement while small was broad based.
We saw good performance improvement across many different lines, as we grew existing businesses at its new revenue streams in small ways and were able to peer back expenses slightly. Slide # 9 highlights our average balance sheet.
Average total assets increased 4% to $12 billion in the third quarter, led by growth in loans held-for-investment as we continued to deploy capital with residential mortgage loans. We maintained a strong balance sheet with a stable funding base.
Our common equity to assets ratio remained solid at 9.9% with deposits equaling 77% of average liabilities. Turning to asset quality on Slide 10.
Our allowance coverage was 3.7% of total loans at the end of the third quarter as compared to 4.3% at the end of the second quarter. Coverage dropped 65 basis points as a result of the sale of lower quality loans and the continued growth of higher quality assets.
At quarter-end, we had 5.2% allowance coverage of our consumer loan book, down 134 basis points from the prior quarter end, consistent with fewer lower quality assets. The commercial loan allowance coverage ratio remained at 1.4% in Q3, reflecting the high quality of this portfolio.
Nonperforming loans were relatively stable at $63 million at the end of the third quarter. While the ratio of nonperforming loans to loans held-for-investment fell 7 basis points to 1.15%.
Performing TDRs fell $11 million to $97 million in the third quarter reflecting the sale of lower performing loans. Early stage delinquencies remained at a low level in Q3.
Looking at consumer loans only 0.64% were over 30 days delinquent and still accruing, up modestly from the second quarter 2015, but down 131 basis points from the same quarter last year. The quarterly rise in consumer delinquencies was led by the HELOC loans on which we exercised our clean-up call in late Q2.
The company wrote-down the fair value of this portfolio earlier this year in anticipation of these non-renewals and this working resolved the issue. The loans are performing in line with expectations.
There continued to be no commercial loans at September 30 that were more than 30 days delinquent. Turning now to Slide 11.
We continue to maintain robust regulatory capital ratios in the third quarter with the partial phase in of Basel-III. On a partially phased in basis at September 30, 2015, our tier 1 leverage ratio was 11.7% as compared to 11.5% at June 30, 2015.
The increase in the ratio resulted from earnings retention and a lower deduction for NOL related deferred tax assets partially offset by earning asset growth. We continue to use our excess capital to support balance sheet growth.
Our tier 1 common ratio was 14.9% at September 30, 2015. Looking at the impact of a fully phased in implementation of Basel-III, our tier 1 leverage ratio would have been 9.9%, and our tier 1 common ratio would have been 9.6% at the end of the quarter, due to the detrimental treatment that mortgage servicing rights and the DTA receive under Basel-III.
Looking ahead, we should be able to grow regulatory capital at a strong pace as we utilize our NOL-related DTAs and scale back our concentration in MSRs. As we achieve a higher level of tier 1 capital from earnings and NOL use, there will be a positive multiplier effect that also reduces the deductions for excess DTAs and MSRs.
At September 30, 2015, we had $294 million of MSRs representing 21.1% of tier 1 capital. I will now turn to Lee for more insight into each of our businesses.
Lee Smith
Thanks, Jim, and good morning everyone. We're very pleased with our Q3 results but even more encouraged when you look back at the last 12 months where we generated $136 million of after-tax net income.
Furthermore and starting with Q4 2014, our performances continued to improve every quarter through Q3 2015. We worked diligently to derisk the balance sheet, optimize the cost structure, and strengthen the risk management practices of the bank in order to create a solid and efficient foundation from which to grow in our three major business lines and generate sustainable earnings.
I will now outline some of the key operating metrics from each segment during the quarter. Please turn to Slide 13.
Quarterly operating highlights for the community banking segment include average consumer loans increased $454 million or 16% in the quarter. We funded $651 million of jumbo and conventional products during the quarter that we added to our HFI portfolio, as we continued to execute on our strategy of swapping out lower performing and riskier assets for higher quality interest earning assets.
Average total commercial loans increased 1% to $2 billion versus the prior quarter primarily due to growth in our C&I and CRE businesses. During the last 12 months, we've grown total commercial loans by nearly $700 million, led by $416 million in warehouse lending, $140 million in CRE lending, and $142 million in C&I lending.
Average total deposits increased 7% during the third quarter and 17% over the last 12 months, primarily due to increases in retail savings and company controlled deposits. During the quarter, we also sold one of our branches, as we look to further optimize our branch footprints; we recognized the gain on this sale of approximately $2 million.
We intend to continue to grow our consumer loan balances, both from our own originations, as well as being opportunistic with asset purchases that fits our credit and risk profile. Of the $651 million, we grew our HFI book in Q3; $454 million was from jumbo originations, and $197 million was from conventional products.
This balance sheet growth contributed to the $1 million quarter-over-quarter interest income improvement. We continue to look for opportunities to grow our C&I and CRE businesses, as well as expanding our consumer and business banking offerings.
We are encouraged by the sustained growth we've seen in the warehouse business over the past 12 months, and will look to build on that further as we move forward, by growing business with existing customers, as well as adding new customers, including those that don't sell directly to Flagstar. On the technology front, we are about to launch a new and improved online banking platform that will enhance our overall service offering to our customers and we are in the process of replacing our entire fleet of ATMs with state-of-the-art terminals.
We have swapped out around 30% of our machines to-date and hope to swap out the remaining 70% by the end of this year. Please turn to Slide 14.
Third quarter operating highlights for the mortgage origination business include fallout-adjusted again on sale margin decreased 16 basis points to 1.05% in the third quarter, as compared to 1.21% in the second quarter. The decrease was primarily a result of increased capacity in the industry leading to lower margins on government products and refinance business in particular.
Fallout-adjusted lock volume decreased 5% to $6.5 billion, led by a decrease in conventional volume, partially offset by increased government and jumbo production. Purchase mortgages remained at 54% of locks during the third quarter.
We continue to remain focused on providing service excellence, while at the same time implementing strategies to refine and optimize our variable cost model on the fulfillment side of the business. We're continuing to invest in technology as a way to further improve the top-line performance and make us more efficient from an operating point of view.
We expect to launch phase 2 of our consumer portal before the end of the year. This portal will allow our customers to shop for mortgage and start the application process online, and it will also act as a document aggregator driving further operating efficiencies.
We are now processing loans under the new RESPA, TILA integrated disclosure requirements that went into effect on October 3, and has been extremely pleased with how smoothly this has gone. Finally, we are committed to growing our retail origination business on both the retail distribution and direct to consumer side as we transition to a purchase market.
As Sandro mentioned we hired Gregg Christenson during the quarter as head of our direct to consumer business and are excited about the knowledge and experience he brings to this role. Moving to servicing.
Quarterly operating highlights for the mortgage servicing segment on Slide 15 include we executed on the sale of $6.7 billion in aggregate UPB or 28,600 loans of residential MSRs during the quarter. We currently service approximately 369,000 loans, of which 221,000 are subserviced for others, making us the seventh largest sub-servicer in the nation.
The remaining 148,000 are loans where we only MSR or they are part of our HFI book. Approximately 97% of our servicing book is performing loans and 3% or approximately 10,000 loans are 60 plus days delinquent.
Over the last 12 months we have successfully reduced the number of seriously delinquent loans in our portfolio, given the significant cost associated with servicing such loans, and because servicing and working out delinquent loans is not part of our core growth strategy. As a part of our continued efforts to improve our serving platform, we went live with the second component default servicer on July 1.
This means we have two component default servicers where we can send seriously delinquent loans thus giving us more optionality. We have structured the second relationship similar to the first relationship meaning the component servicer plugs into our MSP system making it seamless for the borrower when any loan becomes 60 plus days delinquent.
Longer-term, we remain focused on growing our fee income generating subservicing portfolio, which has the capacity to service up to $1 million, and recently hired Rodney Moss as Head of Business Development to lead this effort. We 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 our mortgage customers wallet and the number of active accounts per household.
Moving to asset quality. We continued with our ongoing efforts to derisk the balance sheet.
We sold approximately $233 million unpaid principal balance of interest-only and lower performing loans during the quarter albeit the interest only trades for $214 million officially closed after the quarter ends in October. We've now sold over $1 billion in UPB of interest-only and lower performing loans in 2015 as part of a concerted effort to derisk our balance sheet and reduce the cost associated with non-performing and higher risk assets.
Please turn to Slide 16. As a result of this recent interest-only trade, we have materially eliminated the risk associated with interest-only loans.
Since the end of 2011, this portfolio has decreased more than 90% or $1.4 billion. As of September 30, 2015, we have approximately $124 million of I/O loans remaining on our balance sheet of which $97 million have yet to reset.
I'd like to complement the Flagstar team for their outstanding efforts in successfully dealing with this interest-only loan portfolio. These loan sales which have also reduced our NPLs to $63 million the lowest level they have been in nearly 10 years should lead to reduced asset resolution expenses in future periods, as well as lower FDIC premiums in 2016.
Moving now to expenses on Slide 17. Our non-interest expenses decreased $7 million or 5.1% to $131 million in the third quarter.
The reduction in expenses is in large part due to the continued decline in asset resolution costs quarter-over-quarter as a result of our balance sheet de-risking program. However we also benefitted from some one-time reimbursements in this line item during the quarter that amounted to approximately $2.5 million.
We have also experienced lower cost on the mortgage origination side of the business given the variable cost model we've implemented in this business line tracking the reduced mortgage origination revenues during the quarter. As always, we remain focused on optimizing our cost infrastructure and looking at ways to drive further efficiencies throughout the organization.
We estimate non-interest expense will be between $130 million and $135 million in the fourth quarter of 2015. Despite the modest increase in revenues in the quarter we saw continued improvement in the company's efficiency ratio to 65% from 69.6% in the previous quarter.
The improvement was primarily driven by decreases in non-interest expenses. We mentioned last quarter that our efficiency ratio target is around the mid-60s.
So we're pleased to have hit our target in Q3. The key for us is to maintain this efficiency ratio going forward, given that quarterly non-interest expense run rate it means revenues need to be approximately $200 million every quarter.
Looking forward, the efficiency ratio will remain more sensitive to changes in revenue given how consistent our expenses have been over the last 15 months. We continue to work tirelessly to develop and implement revenue generating initiatives further optimize our cost structure and drive greater efficiencies throughout the organization.
It is this focus and drive that will enable us to consistently achieve our efficiency ratio target. With that, I'll hand it back to Sandro.
Sandro DiNello
Thank you, Lee. I'm now going to close our prepared remarks with some guidance for the fourth quarter of 2015 and then open the call for questions-and-answers.
I've been very pleased with our results so far this year. We have exceeded the Street's expectations on profitability, while further strengthening the balance sheet.
Now as we look to the fourth quarter, I'm cautiously optimistic because I do believe we will experience some headwinds from seasonality and lower revenue from mortgage refinance activity. Please turn to Slide 19, where we have itemized our guidance parameters.
We expect a slight drop in net interest income and a slight contraction of the net interest margin primarily due to a modest decline in earning assets as our mortgage pipeline shrinked a bit due to seasonality. Mortgage locks will likely decline in line with mortgage industry activity as we don't expect any notable change in market share.
We expect to slightly lower gain on loan sale margins. We expect the number of loans serviced to decline a bit which will cause loan administration income to decline.
We expect to return to a normalized net return on the mortgage servicing assets of 4% to 6%. The ratio of our MSR to tier 1 capital will likely remain steady.
We expect our provision expense to match net charge-offs which we expect to be consistent with the net charge-off ratio in Q2 adjusted for loan sales. As Lee noted, non-interest expenses should remain stable between $130 million and $135 million.
And lastly, we expect an effective tax rate in the mid-20s in the fourth quarter. This concludes our prepared remarks and we’ll now open the calls to questions from my listeners.
Nikki?
Operator
Thank you. [Operator Instructions].
And our first question will come from Bose George, KBW.
Bose George
Just to clarify on the I/O sale that happened in October, is there going to be any impact on the fourth quarter or were they already put it in HFS last quarter that was we thought in 3Q earnings?
Sandro DiNello
Yes, no fourth quarter impact, it's all in Q3.
Bose George
Okay, great, thanks. And then, switching to the mortgage banking, in your commentary you noted lower margins in the government business this quarter.
Can you just discuss some of the dynamics driving that line?
Jim Ciroli
I'll let Len answer but it’s principally competitive factors, Bose that caused us to narrow the margin a bit in that business. Anything to add for that, Len?
Len Israel
Yes, this is Len. What we have seen is more a return to normalized margins, the first quarter going into the second quarter because of the FHA, MIP reduction.
We did see a huge swell in volume industry-wide as well. As a result of that, we were able to enjoy abnormally high margins, and again we are seeing that normalized.
Bose George
Okay, great, thanks. And then, finally, any updates you can provide on TARP?
Sandro DiNello
Not anymore than what we said in the prepared comments, Bose.
Operator
And we’ll go to Paul Miller, FBR and Company.
Paul Miller
Can you talk a little bit about your thoughts or strategy behind the MSR sales? I know this is done -- you did this on a regular basis.
Do you market these on a consistent basis or do you want run your servicing portfolio at a certain level? Can you just talk about your theories behind that?
Lee Smith
Yes, hi, Paul, it's Lee. As you know, we have been in regular seller of MSRs over the last two years and we will continue to do so.
Given we're the tenth largest originator of mortgages in the country on the advent of Basel III, we've done a nice job of reducing that concentration in MSRs from the high point in September 2013, I believe. And we will be where we need to be by the end of Q1 2018, which is when Basel III will be fully phased in.
The way we intend to get there is through a combination of bulk and flow sales and the good news here is we can use the sale of MSRs to benefit our subservicing business whereby we retain the subservicing on the underlying loans being sold.
Paul Miller
Yes, that was my next question, you're going to be de-subservice some of these loans. So what percentage do you subservice; is it the bulk of them or just like half of them?
Lee Smith
Yes, we would like to subservice all of them. The transaction we executed on in Q3 the $6.7 billion that was the release deal.
And so I would say that so far this year it's probably been about -- we've retained about 60% of what we've sold, 40% we've sold on a release basis.
Paul Miller
And then you talked about the online origination platform because most of your stuff comes through brokers or correspondent, am I correct? And you do have some branches, can you talk a little bit about because this is a little bit of a change of strategy for you.
I mean what parentage originations are you as your goal on this online origination strategy?
Sandro DiNello
So Paul, I don't have a percentage to target for you, but what I will say is that given the fact that on the direct to consumer it's been a relative low amount of production for us. It's an opportunity we think that can incrementally improvement our retail business which is where our focus is, may be Len would like to expand on that.
Len Israel
Yes, we see a tremendous amount of opportunity, as Sandro and Lee both mentioned, we did hire Gregg Christenson who has a tremendous amount of experience in leading direct consumer channels and we are finding that with the opportunity to link to various service providers we have an opportunity to engage in more aggressive outbound solicitations and that is opportunity for us.
Paul Miller
Okay guys, thank you very much.
Sandro DiNello
Paul, I'll just add to that. I think with the way the market is going and the millennials who are doing more things on line, yes, this gives us an opportunity to reach out to that customer base.
And as I mentioned in the prepared remarks, so it is not only a sales tool it actually acts as a document aggregator as well. So, we can drive further efficiencies throughout the business because in theory it will mean our LOs are not chasing missing documents and when a package gets delivered to our fulfillment business it is a full package so they are not opening it and finding that there is a document missing either so.
It is going to help us both on the sale side but it is also going to help us from an efficiency point of view as well.
Operator
The next question comes from Scott Siefers with Sandler O'Neill and Partners.
Scott Siefers
Good morning. Let's see, a couple of questions here.
First though, I was hoping you could touch on the reserve, I mean you guys have done such an enormous amount of de-risking, particularly this year, and given just curious where you see the overall reserve level going it is still quite elevated relative to some of your peers and maybe over how and over what period of time you might hope to get it down to more normalized level?
Jim Ciroli
Yes, Scott, this is Jim. As we look at the reserve every quarter we set it to the level we think we feel appropriate.
And I would tell you that we take a very considering where we’ve been a very conservative view on the level of future losses because we just -- we don’t want to get over our skies there taking that down prematurely and have to take it back up. So we’re very cautious about the level we set it at but we look at that every quarter.
Scott Siefers
Okay. All right, and then maybe, Jim, next one is for you.
You gave a lot of good color on the nuance within other income this quarter and sort of all the deltas relative to the 2Q. I guess as you look at things and understanding with all that nuance it can be tough to pinpoint but what is your best guess as to where that other income number goes, and I guess maybe a more appropriate way to ask is would be what would have to happen to keep that level elevated up near to kind of $10 million number versus closer to zero it has been running just the last couple of quarters.
Jim Ciroli
Yes, Scott, as you look at our other non-interest income, we have about $3 million of fair value benefits this quarter. So I wouldn’t project, I can’t project to where the market is going to be in terms of fair value in the future but I would take as zero lines, I would take $3 million out of that line and that probably be your best play.
Lee Smith
I think just to add to that, Scott, I think I mentioned in my prepared remarks, it was $2 million gain on the sale of branch and that is also in that line item. So you can add that $2 million to the $3 million Jim just referenced.
Scott Siefers
Perfect. Okay, good, thank you.
And then maybe, Lee, I was hoping you could expand upon some of your comments on the subservicing business, you had given some good color a question or two ago which I appreciate, but just given that the capacity for what you could subservice is just so much in excess of what you’re actually going -- curious if you can talk a little bit about ongoing strategy there. And then if I heard correctly sounded like you might have some new management in that area so, I guess did I hear that correctly and what is your current thinking there?
Lee Smith
Yes. So the subservicing business is something we have talked about a lot over the last 12, 18 months.
As you correctly say, we are currently servicing 369,000 loans. We have the capacity to service a million loans, so we have plenty of capacity.
We, if you go back to the end of last year, we hired Mark Landschulz to run performing servicing; Mark brings a ton of experience in that role. And then this last quarter we brought in Rodney Moss as the Head of Business Development and so that is what you heard in the prepared remarks this time.
And so it is going to help in conjunction with Mark to grow that business. The way we can grow that business is sort of three-fold, one would be selling MSRs that we’ve originated and then we subservice the loans after the sale.
Onboarding loans that we haven’t originated, and given that we’re an active seller of MSRs we're very close to a lot of buyers who buy not just from us but from the organizations, and then we can work directly with the GSEs and Ginnie Mae to subservice their books of business as well. And then the other thing that I would point out, and again this is something that we’ve mentioned publicly before, for every 100,000 loans we add to our platform, we estimate it generates between $5 million and $7 million of incremental operating profit before tax.
Sandro DiNello
Scott, Sandro here. So just one additional comment relative to Mark coming to board a year or so ago and Rodney more recently, this is the right kind of sequencing, bring the operator in first let him get the operation in the right place, build the infrastructure, and then bring your sales people in to go find the business.
So that is what you've seen us do here, where you have seen us build the thing, get it ready to go, and now we'll opportunistically look for situations where we can bring other portfolios onto our platform.
Scott Siefers
Okay. That’s perfect.
Thank you, and I think maybe the final question, Sandro, either for you or for Jim, but I was hoping you could speak in a bit more detail on the anticipated pace of loan growth. I feel like the last couple of quarters have been a little colored in you had kind of balance sheet hole to fill with the IO sales, so looking ahead what you anticipate if you kind of ex out the noise would you anticipate this kind of pace of core loan growth to sustain itself or would you maybe take your foot off the pedal just a little bit now you longer have that pressure to just sort of refill the IO bucket so to speak or the bucket created by IOs leaving?
Sandro DiNello
Yes. So I think in terms of the next quarter, which is as far as we provided that guidance, we are not expecting any significant growth; in fact, I think we guided to a little bit lower number and earning assets.
More long-term, we will look for what the opportunities are to grow the balance sheet because we think that growing our net interest income in our community bank is where the opportunity is to continue to diversify the revenue and smooth out the seasonality of the mortgage business. So certainly that is what we want to do but we need to make sure that we do it the right way that we do with the right quality and everything in a safe and sound fashion.
Scott Siefers
All right, that is perfect. Thank you guys very much.
Operator
[Operator Instructions]. Our next question comes from Jesus Bueno with Compass Point.
Jesus Bueno
Good morning, thanks for taking my questions. My first question is just we heard lot of news about the trade implementation, so hoping you could offer some color about that, I guess how is it gone for you and if there has been any impact on closing timelines as a result?
Sandro DiNello
That's a great question. What appears to be the replacement of four disclosures brought about by federal law from 1974 is really it is a fundamental change in the workflows and timing involved in the production of the disclosures, and this really has shifted the roles and responsibilities of lenders or brokers, settlement agencies, all parties doing transaction and that includes the consumer.
We’ve seen choppy action and the industry has this well. First, there is a swelling volume coming up prior to October 3 date, then it kind of died down as everybody was trying to absorb and identify any issues in processes and then to fix on the technology side any systems related issues as well as the communications with the settlement agency making sure those were straight.
From our perspective, we spent over 50,000 hours just in IT related configuration, testing and retesting alone, and another 20,000 hours in training with both our correspondent customers, our broker customers and through our retail. So 70,000 hours in total.
So, the impact to us has been minimal.
Jim Ciroli
I think the only thing I would add, Len as well, if you actually look at locks around the October 3 date it was definitely a pull forward of locks into the week before October 3 and then there was a reduction in the week post October 3, but if you average the two weeks out, it was on track. So you call it that's the sort of phenomenon that you saw occur around the October 3 day.
And as Len mentioned, just a phenomenal effort from the team, I mean it was 47,000 IT man hours and another 20,000 non-IT man hours to put this into place.
Sandro DiNello
And bottom-line everything is working smoothly at Flagstar, we are not delaying any closings, I mean everything is working the way it did before tread, and these guys stayed the hell of a lifting to get to this point, but as usual our team did a great job and now it is business as usual.
Jesus Bueno
Great, it sounds like quite undertaking, I appreciate the color. I guess back on I guess the TARP repayment, just a double check I know we have discussed this before, but the OCC consent order is I guess do that two go hand in hand, I mean is it something you continue go and repay TARP without having the consent order with it, our regulators are they taking into account the OCC consent order if you could add any color on that, that would be great?
Sandro DiNello
I would say, Jesus, is that one does not necessarily connect to the other and timing of what we set forth is what we expect to happen, and there is really nothing more than I can add to that.
Q - Jesus Bueno
Great. And then if I can get it one more on the primary servicing, I guess as you sell off primary center for servicing and as you retain sub-servicing I was looking back and doing about 28 basis points on the primary and that makes about 8 basis points on the subservicing.
So I guess going forward, as you think about servicing income in the context of non-interest income, I guess are you looking out for ways to pull kind of the lost income from the switch to subservicing? Are you looking to do that primarily through expanding your subservicing operation or there other ways of that you are looking at growing the non-interest income [indiscernible]?
Jim Ciroli
Yes, I mean I think we have an MSR asset today is around $290 million and it’s a little over 20% concentration MSR for tier-1 and again with the advent of Basel III we need to get that down to 10%. So what you are going to see is reduce that over time.
And you’re right, I mean look it is an asset that is generating and so, as a result, we need to replace that. And the way we’re going to do that is three-fold, we got the subservicing business and so subservicing the loans that we sell that will allow us to build the income, fee income from the subservicing business.
As Sandro just alluded to, we want to grow the balance sheet and that will help generate interest income and then we’re looking at ways, I mean we talked about the consumer portal to further grow our origination business particularly on the retail side. So the reason just one area it's going to come from, it is a combination of the three business lines that we have always spoken about.
Sandro DiNello
And I would add with respect to the servicing business, as we’re able to grow the subservicing business and increase the number of loans that we serviced along with that comes great funding because of the custodial enterprises, and if we do end up seeing interest rates increase that will be a great advantage to us to have growth in that funding for us.
Operator
And there appears there are no further questions.
Sandro DiNello
Okay, thanks, Nikki, appreciate your assistance, and thanks to all you for your interest in Flagstar. It was a quarter for putting to rest post-crisis issues, executing on our business plans, drive operating leverage and laying the foundation for the future.
I'm pleased that we are able to achieve higher total revenue on a linked-quarter basis despite lower mortgage origination, proof that the diversification strategy we embarked on in 2013 is working. I'm also pleased with the rigor we applied to de-risking our balance sheet.
As Lee noted, nearly $1 billion in lower performing in the first three quarters of this year were replaced with higher quality assets; that's a significant accomplishment. Further, as you can clearly see, we have been unwavering in our commitment to control cost.
At this point, our quarters are starting to look a lot like each other, but that's okay. We would like to steady progress, the consistency and the solid performance.
Going forward, our focus is on growing and diversifying earnings, all within the framework of a robust and empowered risk management system. Finally, thanks to all my Flagstar colleagues for their hard work and commitment to build a truly great company.
Thank you for your time this morning. I look forward to reporting on Q4 results in January.
Operator
Thank you. And that does come close today's conference.
Thank you for your participation.