Oct 25, 2016
Executives
David Urban - Director, IR Sandro DiNello - President and Chief Executive Officer Jim Ciroli - Chief Financial Officer Lee Smith - Chief Operating Officer Steve Figliuolo - Chief Risk Officer
Analysts
Paul Miller - FBR & Company Bose George - KBW Kevin Barker - Piper Jaffray Henry Coffey - Wedbush
Operator
Good day, and welcome to the Flagstar Bank Third Quarter 2016 Earnings Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Mr. David Urban, Director of Investor Relations.
Please go ahead sir.
David Urban
Thank you, and good morning. Welcome to the Flagstar third quarter 2016 earnings call.
This is David Urban, Director of Investor Relations. Before we begin, I would like to mention that our third quarter earnings release and presentation are available on our Web site 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 2015 Form 10-K and subsequent reports on file with the SEC.
We are also discussing GAAP and non-GAAP financial measures which are described in our earnings release and in the presentation we made available for this earnings call. You should refer to these documents as part of this call.
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; and Steve Figliuolo, our Chief Risk Officer.
I'm going to start the call by providing a high level view of our performance for the quarter. 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, before opening up the lines for questions. As you know we posted a solid quarter this morning.
Net income totaled $57 million or $0.96 per share, our largest quarterly profit in nearly 3 years. With the completion of our TARP repayment at the beginning of the quarter, together with the 8th consecutive quarter of profitability, I think it's safe to say Flagstar has turned itself around.
The final i will be doted when we exit our consent order and I'm hopeful that will happen in the not-too-distant future. Our business model is clearly proving to be successful.
The underlying power of our core business is to provide consistent, diversified earnings regardless of the financial dynamics of the quarter, it is being demonstrated quarter-after-quarter. Deploying our capital is important to growing our earnings and we saw a strong growth in earning assets this quarter led by our community bank where commercial real estate was up 20% and warehouse loans were up 18%.
Expense discipline is also very important to our strategy and I'm pleased to report that top line growth drove positive operating leverage and improved efficiency ratio. The modest expense growth we experienced during the quarter was due entirely to performance driven items.
We also benefited from a lower cost of capital due to the repayment of our TARP preferred. As a result of the dividend the bank paid to the holding company in connection with the TARP repayment, our expectation as to the timing of payment to the DOJ has changed resulting in a reduction in the liabilities fair value.
Jim will provide a deeper dive on this matter when he discusses our financial results. In the mortgage side, low rates continue to fuel refinances which produce positive results in our mortgage business during the quarter.
Net gain on loan sales rose 11% to $94 million on adjusted results from the prior quarter with the increase largely attributable to our success at managing margin. We continue to take advantage of today's low rate environment and we are well-positioned to capitalize on the favorable economics of the purchase market when the time comes.
Solid credit quality was another hallmark of the quarter. Both our nonperforming loans and our net charge-off ratio were lower and we continue to have no commercial delinquencies or commercial nonperforming loans.
With TARP now behind us, we are in a position to reap the benefit of lower capital costs and that gives us the luxury of having more options, options to invest internally in our businesses, or to invest externally in businesses that will accelerate our growth and add value to our company. We believe we have a one-of-a-kind business model focused on growing our community banking business, expanding our mortgage business, and building our servicing business.
All this is aimed at delivering industry-leading returns for our shareholders within a strong risk compliance framework. With that my colleagues will take you through a more detailed discussion of our financials and operations.
First up is Jim.
Jim Ciroli
Thanks Sandro. Turning to Slide 6, our net income this quarter was $57 million, $0.96 per share as compared to net income of $47 million or $0.66 per share last quarter.
This quarter benefited from a drop in the fair value of the DOJ settlement liability totaling $24 million. Excluding this benefit, third quarter net income was $41 million or $0.69 per share and EPS increase was 5% from last quarter.
Our earnings this quarter were led by strong commercial loan growth, better gain on sale margins on higher volume and positive operating leverage. The quarter also benefited from two months of our post TARP redemption capital structure.
For the quarter we posted on an adjusted basis a return on assets of 1.2% and a return on common equity of 12.6% both enviable measures. It was a solid quarter with high-quality earnings.
Let's turn to Slide 7. Our third quarter net interest income rose 4% to $80 million.
This reflected a $679 million or 6% increase in earning assets led by increases in both loans held for sale and loans held for investment. As expected, our NIM also fell slightly in the quarter to 2.58% driven by a partial quarter of interest expense on the senior debt issued for TARP redemption.
This negative impact was partially offset by increased net interest income from a rotation into higher spread commercial loans. The quarterly provision for loan losses totaled 7 million for the quarter as compared to a provision benefit of 3 million in the prior quarter.
Asset quality continues to be strong and I'll provide additional detail in a couple of slides. Noninterest income increased $28 million to $156 million this quarter.
This included a benefit from the drop to the fair value of the DOJ settlement liability totaling 24 million. The fair value of the company’s DOJ settlement liability was 60 million at September 30 down from the 84 million fair value at June 30.
The lower value resulted from a change in the estimate as to the timing of payments to the DOJ. Payments to the DOJ will occur when the bank's Tier 1 leverage ratio is 11% or greater at the end of any quarter subject to OCC approval.
This quarter the bank paid a dividend to Bancorp of $200 million to support the redemption of our TARP preferred. This combined with an expectation for additional dividends in the future from the Bank to the Bancorp resulted in a projection of a longer time period before this remaining criterion that is Tier 1 leverage of 11% or greater is met.
So excluding the DOJ benefit, noninterest income rose 4 million or 3% primarily to higher net gain on loan sales and loan fees and charges. This positive impact was partially offset by a wider loss on the mortgage servicing asset.
So let's dive deeper into each of these items. Third quarter net gain on loan sales increased 4 million or 4%.
The increase from the prior quarter primarily reflected in improved gain on sale margin. Net gains on loan sales increased 9 million or 11% when excluding the 5 million of gains last quarter that were previously designated as HFI.
The net gain on loan sale margin was 113 basis points, an improvement of 9 basis points over last quarter when we saw our fallout-adjusted locks increased 2% led by an 18% increase in refinance activity. The net return on the mortgage servicing asset was a loss of 11 million this quarter resulting from higher prepayments and a charge of $7 million this quarter for MSR sales that will close next quarter.
Those MSRs had a carrying value of 50 million at quarter end. The R&W benefit rose 2 million this quarter as the R&W reserve fell to 32 million.
The result of continued improvement in risk trends and the repurchase demand pipeline that is now only 11 million, and other noninterest income excluding the DOJ benefit was 12 million in the third quarter as compared to 9 million in the prior quarter. This increase was led by a combination of several categories including securities gains, customer derivative revenue and improved fair value adjustments.
Moving now to expenses. Noninterest expense increased 2% to $142 million this quarter as compared to $139 million last quarter.
Overall, higher performance-based compensation and increased business activity drove this quarter's increase. Compensation and benefits increased $3 million and commissions rose $2 million.
The company's efficiency ratio excluding the DOJ benefit still improved to 67.0% this quarter as revenues grew without the addition of significant incremental expenses. Slide 8 highlights our average balance sheet.
Average earning assets increased $679 million or 6% led by solid growth in loans held for sale and loans held for investment. Loans held for investment grew 5% as average commercial loans grew 16%.
Lee will discuss commercial loan growth in a few minutes. Average deposits rose 495 million or 6% led by 19% rise in company controlled deposits.
At September 30, our common equity to assets ratio remains strong at 9.0% and our book value per share fell to $22.72 reflecting the impact of paying the deferred TARP dividends at redemption. Let's now turn to asset quality on Slide 9.
Nonperforming loans fell to $40 million at the end of the quarter down $4 million, while the nonperforming loan ratio of 63 basis points represented an improvement of 13 basis point over last quarter, there were no commercial nonperforming loans. Early stage delinquencies also remain low.
Only 8 million of consumer loans were over 30 days delinquent and still accruing and there were no commercial loans at September 30 that were more than 30 days delinquent. Net charge-offs were $7 million this quarter representing 51 basis point of loans compared to $9 million in the prior quarter or 62 basis points of loans.
Most of the charge-offs related to our loans with government guarantees where we recorded a charge of $5 million. At September 30, our allowance coverage was 2.3% of total HFI loans down slightly from the end of last quarter.
Coverage remains strong at 3.8% of consumer loans and 1.3 of commercial loans. Turning to Slide 10, capital remained strong.
As expected our [inaudible] fell to 8.9% largely due to the TARP redemption. Our Tier 1 leverage ratio was 30 basis points higher than at June 30 pro forma for this TARP redemption.
Our CET1 ratio was 12.0% and our Tier 1 and total risk-based capital ratios remained well above peer averages. These ratios are even stronger when reflecting upon the lower level of risk in the balance sheet and the strong risk management function we felt.
This strength is also reflected in a good deferred results we disclosed yesterday which show the benefits of de-risking efforts of the last few years and validates the strength of our capital position post TARP. We continue to grow our regulatory capital at a pretax rate as we utilize our net operating losses.
At September 30, our Tier 1 leverage ratio was reduced by 127 basis points for the NOL-related DTAs and we anticipate the elimination of this deduction over the next two to three years given our profitability. MSRs in excess of the amount allowable under Basel 3 also reduced Tier 1 leverage by 105 basis points.
The sales of MSRs under contract at September 30 which are expected to close in Q4 will benefit Tier 1 leverage by 19 basis points. We anticipate that this accessed MSR deduction will be eliminated over the next six quarters through both flow and bulk sales.
The combination of these two reveals more than 230 basis points of capital deductions that we believe will be eliminated over the next 2 to 3 years providing an outsized level of internal regulatory capital growth during that period. I will now turn to Lee for more insight each of our businesses.
Lee Smith
Thanks Jim, and good morning everyone. We are very pleased with our performance in Q3, I believe it further validates the profitability and sustainability of our one-of-a-kind business model.
If you remember from our last earnings call, we spoke about how our three major business lines the community bank, mortgage originations, and mortgage servicing feed each other and enable us to generate high-quality interest-earning assets in multiple ways, and yet provide complementary hedges so we can operate successfully in any interest rate environments. During the quarter, we've seen almost 500 million of growth in our warehouse, CRE and C&I lending channels and this was supported by another strong quarter from mortgage operation.
This has enabled us to grow interest-earning assets by approximately 700 million during the quarter which resulted in an increase to total interest income of 7 million quarter-over-quarter. Adjusted noninterest income increased $4 million quarter-over-quarter despite a negative return on our MSR asset of $11 million.
We believe this quarter's performance demonstrates that the investment in our growth initiatives is paying off and that our scale across businesses gives us operating leverage which the improvement in efficiency supports. Q3 represents the 8th consecutive quarter of consistently strong profitability.
For the 12 months ended September 30, 2016 we generated $160 million of adjusted after-tax net income or $2.33 earnings per diluted share, excluding this quarter's DOJ benefit. Remember this earnings per share number includes 10 months of top dividends which is now gone, away so if you adjust for that pro forma EPS is $2.63 per diluted share over the last 12 months.
I will now outline some of the key operating metrics from each of our major business segments during the quarter. Please turn to Slide 12.
Quarterly operating highlights for the community banking segment include average commercial loans increased $445 million or 16% to $3.3 billion led by warehouse lending which increased $236 million or 18% and further bolstered by CRE lending which grew $193 million or 20%. Average commercial loans held for investment exceeded consumer loans held for investment as we continue to balance earning contributions between the mortgage and commercial businesses, smoothing out earnings volatility and allowing us to accelerate earnings in a favorable mortgage environment.
During the last 12 months, we've grown total average commercial loans by over $1.2 billion led by $616 million or 66% increase in warehouse lending. Of the $1.6 billion in average outstanding warehouse balances during the quarter, approximately 60% of the underlying loans was sold to investors other than Flagstar with the remaining 40% being sold to Flagstar.
Average CRE lending has grown $417 million or 63% over the last 12 months and C&I lending has grown $190 million or 43% over the same time period as we continue to execute on our relationship based approach with borrowers in many different industries. As you know we introduced several new commercial lending business lines at the beginning of this year including builder finance lending, MSR lending, and equipment finance lending.
We currently have 100 million in outstandings of builder finance loans, 27 million in equipment finance outstandings, and funded our first MSR facility during the quarter where we are also the subservicer of the underlying loans with further potential deals in the pipeline. We believe these new business lines will complement our existing C&I and CRE lending channels and we will continue to see solid consistent growth as we move forward.
Furthermore, we can leverage these lending relationships to generate of the synergies such as deposit growth and subservicing opportunities. We added 187 million of high-quality jumbo and conventional originations to our held to investment portfolio during the quarter as we look to balance earning asset growth between various asset classes to reduce risk.
Overall, average consumer loans decreased 166 million or 6% in the quarter led by a drop in mortgage loans due to prepayments and the impact of loan sales that closed towards the end of the second quarter and reduced average balances of the beginning of Q3. Our MPLs now stand at 40 million, the lowest level in over 15 years, and 30 to 89 day delinquencies totaled a modest 8 million at the end of the quarter which demonstrates both the quality of our overall book and attributes of our unique servicing platform.
It should be noted we have no delinquent or nonperforming commercial loans on our books at this time. Average total deposits grew $495 million or 6% in the quarter led by higher company controlled deposits.
Over the last 12 months, we've grown retail deposits by $305 million, government deposits by $78 million and company-controlled deposits by $483 million for total deposit growth of $866 million. This growth is been achieved through executing on several strategic initiatives including our rebranding strategy, the way into affect earlier this year, putting greater emphasis on bringing deposits from commercial customers and leveraging our subservicing business for custodial and escrow deposits.
Looking forward, we believe we can continue to grow - our commercial businesses as we leverage the new lending channels while building on that core CRE and C&I businesses. We're also looking to enhance this while introducing syndications on middle market teams in early 2017.
Furthermore and as we have mentioned, we can complement our commercial growth through portfolio growth of high-quality mortgage loans from our mortgage origination business. Overall, we are very encouraged by the sustained growth in the community bank, our positioning and potential for the future.
Please turn to Slide 13. Third quarter operating highlights for the mortgage origination business include fallout adjusted lock volume increased 2% to $8.3 billion led by higher refinance volumes particularly in our correspondent channel.
Mortgage closings increased 10% to $9.2 billion quarter-to-quarter as our underwriting and fulfillment teams were able to flex up and adjust to the higher lock volume while also maintaining consistent turn times. Our net gain on loan sale margin increased 9 basis points quarter-to-quarter to 113 basis points excluding the HFI loan sales in the second quarter.
The increase in margin was driven by stronger market pricing power as we priced the balance of volumes and capacity in order to maintain first class service levels. The steps we've taken during the first nine months of this year to expand that distributed and direct to consumer retail businesses are yielding positive results with retail fallout adjusted rate locks increasing nearly $250 million or 77% from the same period last year and $400 million or 36% on a year-to-date basis.
We're also leveraging our direct to consumer businesses to provide recapture and retention services to those clients with subservice loans for. This provides significant value to the owners of MSRs with the underlying loans and is another way our business lines complement one another.
Looking forward, we will continue to pursue the growth of our retail footprint via organic and inorganic strategies, as well as to expand our third-party originations business via new customer activations. As you know, we’re the six largest bank originator in the nation and are well-positioned to benefit from any market dislocation were interest rates rise and the refinance boom goes away.
We're also looking at launch narrowed securitized loan pools given where it originator of scale we already have a lot of the infrastructure in place to be able to offer securitized pools and it will provide us more optionality in terms of what we can do with loans we originate. Moving to servicing, quarterly operating highlights for the mortgage servicing segment on Slide 14 include, we executed on the sale of $5.3 billion in aggregate UPB of bulk and concurrent flow sales of residential MSRs during the quarter.
We also incurred disposition costs of approximately $7 million on a bulk Ginnie Mae MSR sales of approximately $4 billion in aggregate UPB that will close in Q4. This bulk sale is not reflected on Slide 14 and it represents nearly all of our remaining Ginnie Mae MSRs.
We currently service approximately 366,000 loans of which 198,000 are subservice for others making us the seventh largest subservicer in the nation. The remaining 168,000 are loans where we own the MSR or they are part of our HFI book.
Approximately 98% of our servicing book is performing loans and 2% or approximately 7,400 loans are 60 plus days delinquent. Average company controlled deposits which is directly correlated to our servicing loan count increased 292 million during the quarter to $1.9 billion as a result of growth in the number of loans serviced and higher prepayments during the quarter given the low interest rate environment.
We remain focused on growing our fee income generating subservicing business which has the capacity to service up to 1 million loans during the quarter we hired Don Klein, the head of all servicing and subservicing new business development. Don brings with him a strong track record and we're thrilled to have him on board.
And executing on our MSR reduction strategy, given the requirements of Basel 3, our goal is to reach the fully phased in MSR limit by the end of Q1 2018 through efficient bulk and flow sale transactions. Moving on to expenses on Slide 15, our non-interest income rose a modest $3 million to $142 million in the third quarter due entirely to performance-driven items.
Compensations and benefits increased on higher performance based compensation and commissions rose on increased business activity particularly within the mortgage business. Slide 15 illustrates how we’ve operated within a fairly tight range when it comes to expenses over the last five quarters.
This isn’t something that just happens, it requires tremendous amounts of discipline and my complements go to the team who are always looking at ways we can improve and become more efficient. Our adjusted efficiency ratio improved to 67% in the quarter compared to 68.2% in the prior quarter as adjusted revenues grew by $7 million or 3% and cost only increased $3 million or 2% further demonstrating the operating leverage we've built within our business model.
We’ve previously stated that our targeted long-term efficiency ratio is in the mid-60s which equates to approximately $0.75 earnings per share per quarter or $3 earnings per share annualized. Our immediate focus in achieving that goal is on growing revenues across all three major business lines while continuing to build on the cost discipline and risk management we've instilled throughout the organization.
We estimate non-interest expense will be between $140 million and $145 million during the fourth quarter of 2016 due to the seasonal slowdown in the mortgage business being offset by our investment in growth initiatives including our mortgage retail channels and various commercial lending businesses that I spoke about earlier. Furthermore, we believe our efficiency ratio will remain in the high 60s to low 70s given the investment period that is needed to ramp up new business opportunities.
However and as previously mentioned, we're very confident that these initiatives together with the growth we anticipate in existing channels combined with our cost and expense discipline will ultimately see us achieve our long-term goal of a mid-60 efficiency ratio. We're pleased with our progress and believe we have the right team, business model and strategies in place that will enable us to deliver continued strong returns for our shareholders.
With that I’ll hand it back to Sandro.
Sandro DiNello
Thanks Lee. I am now going to close our prepared remarks with some guidance for Q4 and then open the call for questions and answers.
Please turn to Slide 17. We expect to grow average earning assets slightly led by increases in C&I, CRE and jumbo mortgage loans partially offset by a seasonal decline in warehouse loans.
We anticipate a modest rise in the net interest margin as we rotate into higher spread loans. We expect mortgage locks will drop approximately 15% on a seasonal decline in the mortgage market.
We anticipate a moderately drop in the gain on loan sale margins also on lower mortgage demand. We expect the mortgage servicing asset will realize and annualize loss of approximately 5% on a net return basis.
We anticipate the balance of our MSRs will remain relatively flat through the end of the year. We expect our provision expense will be slightly lower on continued strong asset quality and as Lee noted, non-interest expense will remain fairly stable between $140 million and $145 million.
This concludes our prepared remarks and we'll now open the call to questions from our listeners.
Operator
[Operator Instructions] And we'll take our first question from Paul Miller with FBR & Company.
Paul Miller
Hi guys, good quarter. Can you add a little bit more color about the Ginnie Mae sales, I guess backing into - I guess you’re planning to sell between 20 billion and 25 billion of Ginnie Maes.
Are you expecting to take a gain on that or selling it at a price what you have remarked.
Sandro DiNello
I am not sure what you are referring to with respect to Ginnie Mae sales.
Lee Smith
We're selling Ginnie Mae MSRs, Paul that's what...
Paul Miller
Yes, Ginnie Mae MSRs that’s what I was talking about.
Lee Smith
Yes, so basically we’ve have a flow deal in place for the majority of our Ginnie MSRs that we just removed but we were left with a - call it a legacy amount that we just agreed to sell, there was fair value adjustment on that that’s why we took $7 million hit in the P&L and that’s shown in the return on the MSR line but once we close that sale which should be in the next two or three weeks we will have no more Ginnie MSRs left.
Paul Miller
So all your Ginnie Maes are gone?
Lee Smith
On the MSRs, yes.
Paul Miller
And then so, and then you have the flow agreement, [inaudible] any Ginnie Maes that - those Ginnie Mae MSRs just flow I mean flowed to whoever you have that arrangement with?
Sandro DiNello
Correct.
Lee Smith
Correct.
Paul Miller
Yes, okay. And then on the origination side, you’re growing your corresponded originations at a pretty good clip.
What do you guys see that as averaging out as a - on a – like you did $9 billion, 7 of it was corresponded, about - I guess 80% back of the envelope type stuff, is that that you want corresponded that you’re going to try to do more retail down the line?
Sandro DiNello
Okay, so let me start with the correspondent piece. I think that we are now in a position with our TPO channel where there is an opportunity to increase the number of TPOs that we have.
Now, that’s because I think we got a very good system in place to rate our TPOs and make sure that they meet the high quality standards that we have in place at Flagstar. So, this year we’ve seen a little bit of growth in the number of correspondence that are selling loans to us and I’m hopeful that we’ll see that continue to increase as we go forward.
With respect to the retail business we have seen nice growth this year in our retail business. We did slow that a bit if you will in the third quarter because there was so much refinance activity.
We wanted to make sure that the capacity that we had was taking care of that refinance activity, keeping our service levels high and the opportunity to expand and widen our margins presented itself. So overall I think when you look at both the correspondent, as well as the retail businesses, they are both good news stories.
Paul Miller
Okay. Hi guys, thank you very much.
Operator
And we'll now take our next question from Scott Siefers with Sandler O’Neill.
Unidentified Analyst
Hi good morning guys. This is actually Brandon in line from Scott's team.
Just wanted to start with your recent balance sheet growth and the pace has been pretty extraordinarily strong in recent periods. I was wondering how much runway you guys - you think you have to keep up such a pace and if you get loans up 14% year-over-year, 8% linked quarter.
Any thoughts there would be helpful?
Sandro DiNello
Yes so I think this is one of the real positive things about our unique business model is that we have lot of alternatives that are available to us to grow our assets. So in the most recent quarter, you saw the opportunity was there in the commercial businesses and so we were able to grow particularly in our commercial real estate, in our warehouse businesses very nicely.
In the past, you've seen where we have taken advantage of the access we have to high quality adjustable rate jumbo loans and we've added those to the balance sheet, where the opportunity was there. And then when the opportunity was there to rotate out of those into higher yielding commercial assets, we took advantage of that.
So I think to answer your question very specifically, I think our confidence and being able to grow at the same pace we've been growing is pretty high and given the strong capital position that we're in, I think that the runway is there for us to be able to continue to do that.
Unidentified Analyst
That is great color. Thank you.
And then one other one, I wanted to switch over to the net return of the MSR, one, just to want sure I have the guidance for the fourth quarter correct and then two, I want to take a little bit of longer term outlook here. So I believe you guys said negative 5% return annualized for the fourth quarter which I believe comes to roughly $4 million negative for that line which should be roughly in line with this quarter outside of the $7 million negative impact, so one, is that correct and then two, how do you think about the return on the MSR as you look further out into 2017?
Sandro DiNello
So I'll look over to Jim to make sure that…
Jim Ciroli
Brandon, I think you're thinking about that in the right way.
Unidentified Analyst
Perfect.
Sandro DiNello
So with respect to returns going forward, it's largely a function of what is going on in the mortgage business, right, I mean when you have the high levels of prepayments that we have today, you're going to have challenge with respect to the MSR return, the good news at Flagstar is we've been able to overcome that with increased revenues in the mortgage business. So your guess is good as mine as to what might happen with interest rates going forward but if interest rates start to rise and if prepayments slow down as the MBA, Fannie Mae and Freddie Mac think are going to happen then I think you'll see the return on the MRS improved.
Jim Ciroli
The other thing you need to consider Brandon is that as we continue our sell down strategy over the next six quarters, we're going to continue to see transaction costs from those bulk sales and the flow sale shouldn't produce much in way of transaction costs. But from the flow sales we are going to have transaction costs flow through that net return line and that's going to depress the return.
Unidentified Analyst
Understood. Thanks for the color, guys.
Operator
Thank you. We'll now take our next question from Bose George with KBW.
Bose George
Hi, guys. Good morning.
Can you give us an update on the opportunities in the mortgage subservicing area?
Lee Smith
Yes, sure. This is Lee.
Bose, so I think what I would say is this sort of fixed into our MSR strategy in terms of us wanting to be fully aligned with Basel 3, when it's phased - fully phased in by Q1, 2018. And given that we are able to subservice loans, we can also offer recapture on retention services, the escrow and custodial deposits are helpful to us and we can offer financing solutions.
You are finding that there is a lot of people approaching us in terms of buying our MSRs because they know we can offer all of those services. So we see that as definitely a way we can grow the amount of loans that was subservicing just through the originations that we're doing day-in, day-out and then turning around and selling those MSRs.
What we are also finding now though is there is a lot of funds that are out there buying MSRs from others and because they like the quality of the subservicing that we're doing, they're talking to us about putting loans on our platform that we haven’t originated and I think we mentioned earlier this year that we won an award from Fannie Mae in the category of general servicing that shows some of the - just add strengths from a servicing and subservicing point of view and people are beginning to see that and recognize that. And then we can work directly with the agencies and Ginnie Mae to subservice their books of loans as well.
And so we've been in dialogue with those guys constantly over the last several months and that opportunity is there. And there is a fourth leg of the stool that we're actually thinking about launching in Q2 of 2017 and that's a private-label subservicing.
And so we're working on putting the technology in place that would enable us to do private-label subservicing. So, yes, we feel very good about the opportunity.
We feel very good about the quality and we feel very good that just given the rest of our business model, we can complement and help grow that subservicing opportunity, Bose.
Sandro DiNello
I'd just add Bose. I think we are the only full service financial institution in the nation that offers this comprehensive subservicing platform.
And I think that there are benefits that we have as being as highly regulated as we are that can provide comfort to third parties that need someone to service their loan. So I think I know the next year is important.
We built this infrastructure. Lee talked about hiring Don to lead the marketing efforts.
And so we look to increase the number of loans that we serviced on a steady basis going forward.
Bose George
Great. And then actually on a related note the MSR financing in opportunity, can you talk about how meaningfully that is that just landscape there how competitive et cetera?
Lee Smith
It's another arrow in the quiver both individually it isn’t the needle mover, but when you take a lot of these kind niche businesses you put them all together if they do move the needle. And this is a lending area where not a lot of banks are involved in and so from the competitive point of view I don't think that's the issue.
It's finding the right counter party that you're comfortable with lending to that meet all of our high standards relative to operations and capital and so forth. So it's been a nice addition for us and one that I think has some growth opportunities going forward.
Sandro DiNello
I think I'll just add post why we look at MSR lending, it's a product that we want to leverage into a much deeper relationship with the counterparty. So we don't look at it just as one transaction and you are done.
I mean we want to sort of use that to then bringing subservice loans that we subservice or deposits. All those other things that we can sale MSRs to the person that we’re providing the financing to.
So we look at it more as helping us establish a much deeper relationship with a particular counterparty.
Jim Ciroli
And that term relationship is important, that’s where all of our business is kind of tied together. So clearly we don’t want to be making just an MSR loan to someone.
We want that to be one of the services that they use Flagstar for.
Bose George
Okay, thanks. And actually just one last one.
On the rep and warranty side yesterday Fannie Mae announced that the one day certainty as I guess should be able to step towards more clarity on the rep and warranty side. Can you just talk about how you feel on what’s happened to the - but also with the FHA, is the FHA doing more or do you see any signs there to help lenders about issue.
Lee Smith
Well I think the news on the R&W is certainly good, I haven’t had much of a chance to dig into to it read anybody’s opinions but certainly it sounds like it’s another step in the right direction. I think we’ve already seen some benefit from some of the changes Fannie Mae and Freddie Mac have made and as a result at Flagstar we’ve enjoyed a reduced liability in connection with rep and warranty.
On the government side that’s still an open question Bose. I think lenders are still looking for more and more clarity from the FHA in particular or relative to those issues that could cause them indemnifications or other false claims back issues but I am happy to tell you at Flagstar compare ratios are very strong, they are in the low below 100 and so we are maintaining high quality and I think that if you as an originator if you maintain high quality, if you keep your compare ratios at a low level that you’re less likely to have a problem in that business.
Bose George
Okay, great. Thank you.
Operator
Thank you. We’ll now take our final question from Kevin Barker with Piper Jaffray.
Kevin Barker
Hi, good morning. I just want to follow-up on the FHA DOJ settlement fair value mark.
Your Tier 1 comment obviously came and that affected your projection but you’re going to be selling much MSRs going forward what should benefit your regulatory capital ratios. So would you expect that liability to mark back up in the future?
Lee Smith
No, I think we’ve projected what we think the capital ratios are going to be at the bank level contemplating exactly the things that you’ve talked about dark glide path to selling the MSR down and the capital benefit that is going to provide. So that’s already incorporated in the numbers we’ve disclosed today.
Kevin Barker
Okay. So you have a little flexibility to kick the can down the read on paying that liabilities right?
Lee Smith
I wouldn't put it that way, not at all, no. I mean this is a function of our business model.
So as we run our projections for what we think will happen relative to the earnings of the company and the growth of our assets, we determine where we think capital is going to be and the big difference here between a quarter ago as Jim said in his prepared remarks is that we paid a $200 million dividend from the bank to the holding company. And that alone just changes the projections for when your payments are going to take place.
You add to that the consideration of future dividends to the holding company to support the debt service. That further impacts what you think the projection for payments will be.
So this is just math and coming back to what the current fair value is and that’s just simple as that.
Kevin Barker
Okay, that makes sense. And then when I think about - you made some comments around consent order and hoping that will be lifted…
Lee Smith
I didn’t say much about that Kevin.
Kevin Barker
I know, hopefully it will be lifted sometime in the future. But when I think about that consent order and your capability to - could you just remind us your capacity to either make bank or non-bank acquisitions and your capacity to either buyback stock or not buyback stock while operating under a consent order and what flexibility you have around utilizing your capital base.
Sandro DiNello
So certainly you know that when you’re under a consent order you cannot file a licensing application. So anything, any business transaction that would require a licensing application is not available when you are under a consent order.
So when the consent order is lifted, that opens the door to us thinking about those things. Otherwise everything else is still available to us.
I mean, look, $200 million from the bank to the holding company that required regulatory approval. When we get into new lines of business for the most part, that requires regulatory non-objection.
So we’ve navigated through all of that and it’s not hampered us in terms of improving shareholder value and earnings per share and so forth. So I don’t think in the short-term there is anything that really is going to be constraining for us because of the consent order.
And as I said in my comments, this isn't going to be around forever and before you know it will be lifted and then we’ll see how that changes our business strategies going forward.
Kevin Barker
Okay. That’s helpful, very helpful.
Thank you, Sandro.
Operator
Thank you. We'll now take our next question from Henry Coffey with Wedbush.
Henry Coffey
Good morning. Thanks for taking my question.
Kind of continuing down the same line, is it an overly simplistic view that if you paid off the DOJ on day X, because you accrued for the liability that the impact on capital would be zero or minimal?
Jim Ciroli
Yes, if you're paying something out of liabilities, I think that’s correct.
Henry Coffey
Right.
Jim Ciroli
What we have it - the gross liability there is $118 million and we have it on the balance sheet of $60 million at end of September.
Henry Coffey
So is that a gaining factor for when you can declare a dividend and buyback stock paying off that $118 million?
Jim Ciroli
No, we wouldn't think about it that way, Henry. So if would take any action like what you’ve mentioned and we have no plans to take any buyback or dividend action at this point in time, that would affect the holding company, the capital trigger or payments to the DOJ as at the bank level.
Henry Coffey
But there is nothing in the agreement with the DOJ that says you can up dividend capital to the holding company, is there?
Jim Ciroli
No, we just did it.
Henry Coffey
Right, right, that's why I'm asking. No you could - it's not a gating factor, you could move forward.
The consent order is obviously more of an issue regulatory non-objection is an issue, but this in of itself is not a - isn't what would prevent you is that the way to think about this?
Jim Ciroli
I think that's right. And you probably know this but just in case the DOJ settlement agreement is a public document so you know you can read that if you would like to.
Henry Coffey
And then in terms of business development - are there any one of these new initiatives whether it's home lending or MSR lending that could open up some larger volumes. I know we haven't really seen big numbers on MSR lending yet.
But maybe you could give us some sense to where those two business lines are going?
Sandro DiNello
So Henry with respect to all of our different lines of business, our strategy is to be very disciplined in the growth rates of any one type of business. So we have in place what probably in the industry would be relatively conservative concentration limits internally.
So we work very hard at keeping very, very strong diversification amongst all of our business lines. So it allows us to take advantage of whatever the market opportunity is and we do that within these conservative concentration limits that we've established.
So I think all of these different lines of business including the two you mentioned have nice opportunities for growth going forward, but you won't see anyone of them get huge because we don't want to be exposed to any one line of business that could have a negative impact on our operation in the short-term.
Jim Ciroli
I mean I’ll just add to what Sandro said, I mean we also look at these business lines and see where they're complementary to one another. So when we look at these new commercial businesses, it is waste to bringing deposits as a result that's interesting.
We brought on board the builder finance team at the beginning of this year and we've looked at synergies with that origination business because they’re dealing with predominantly Tier 1 and Tier 2 homebuilders. And then we talked about MSR lending and how that can help from a sub-servicing point of view.
So a lot of these niche businesses they bring a lot of synergies with other parts of the bank and again here is talk about our one of the current business model and that's what we mean when we say that.
Henry Coffey
Great. Thank you very much.
Sandro DiNello
Thanks Henry. Cody, any other questions.
Operator
There are no questions currently in the queue sir.
Sandro DiNello
All right, thanks Cody. And thanks everyone for your interest in Flagstar.
Looking at the quarter I'm very pleased with the quality of our earnings and even without the DOJ benefit they were very strong. They were led by continued growth in our banking business supplemented by strong mortgage revenues.
We also realize our lowest cost of capital from TARP redemption. These strong consistent results for the past few quarters demonstrate the underlying strength and reliability of our one-a-kind business model.
Post TARP we are now better positioned to pursue opportunities to grow our community bank, expand retail mortgage originations and build our subservicing business. We will continue to look for ways to increase profits and shareholder value and we believe we are uniquely positioned to deliver industry leading results.
We appreciate the support of our shareholders and their confidence in our business plan and we thank our employees for their hard work to do it every day and make Flagstar a success and these results belong to them. Finally, thank you for your time this morning.
I look forward to reporting Q4 results in January.
Operator
And that does conclude today's conference. Thank you for your participation.