FLG - NYSE

Ladies and gentlemen, thank you for standing by. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the Flagstar Financial Second Quarter 2025 Earnings Conference Call. [Operator Instructions] And I would now like to turn the conference over to Sal DiMartino, Director of Investor Relations. Sal, you may begin.

Thank you, Krista, and good morning, everyone. Welcome to Flagstar Financial's Second Quarter 2025 Earnings Call. This morning, our Chairman, President and CEO, Joseph Otting, along with the company's Senior Executive Vice President and Chief Financial Officer, Lee Smith, will discuss our second quarter results and outlook. Also joining us on this call this morning is Bao Nguyen, company's General Counsel and Chief of Staff to the CEO. Before we begin, I would like to remind everyone that during this call, we will be referring to a presentation, which provides additional detail on our quarterly results and operating performance. Both the earnings presentation and the press release can be found on the Investor Relations section of our company website, [email protected]. In addition, please note that certain comments made today by the management team of Flagstar may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements we may make are subject to the safe harbor rules. Please review the forward-looking disclaimer and safe harbor language in today's press release and presentation for more information about risks and uncertainties, which may affect us. Also, when discussing our results, we will reference certain non-GAAP measures, which exclude items from reported results. Please refer to today's earnings release for reconciliations of these non-GAAP measures. And with that, I would now like to turn the call over to Mr. Otting. Joseph, please go ahead.

Thank you, Sal, and good morning, everybody, and welcome to our second quarter earnings call. We are very pleased with our operating results achieved during the second quarter. We continue to accomplish everything we set out to do and make progress on several fronts. We had significant momentum on our C&I growth strategy as we generated almost $1.9 billion of commitments and $1.2 billion in new loans and added additional talent during the quarter as well. And I'll remind everybody, we really started this initiative in the third quarter of last year. We further reduced operating expenses on our plan to exceed prior estimates. Our credit quality improved as both criticized and classified assets declined 9% and nonaccrual loans declined by 4%. We meaningfully reduced our CRE exposure via record par payoffs, almost $1.5 billion, which was substantially over what our initial forecast was. We grew the net interest margin, and we reduced high-cost deposits and borrowings and this all resulted in our CET1 capital ratio increasing to 12.3%. Going forward, we will continue to focus on the following areas as we continue to execute on our winning strategy to transform Flagstar Bank into a top-performing regional bank. We anticipate that we'll continue to grow C&I. This will further diversify our loan portfolio and generate deposits and fee income. We'll continue to reduce operating expenses and will reduce the level of nonaccrual loans and criticized and classified loans. Lee will also provide an overview of our New York rent-regulated exposure and portfolio, which we think you'll see that we've substantially taken action against that portfolio and the overall risk is much less than I think that has been reported in the market. Before jumping into our financial results for the quarter more fully, I'd like to turn to Slide 3 to discuss the news we issued yesterday after the close of the market regarding our plan to merge our holding company into the bank. Flagstar Bank, thereby eliminating the holding company. This is a similar action that one of our regional bank peers undertook in 2018 when I was the comptroller of the currency. We were supportive of this then and feel this is the right move for our company. This action is designed to primarily enhance our corporate, legal and regulatory structure. Also, as you can see, there are additional benefits, including a further reduction in our operating expenses, streamlining certain functions across the bank, eliminating redundant corporate activities such as dual board meetings, reducing redundant supervision and regulation. I will add that other than the elimination of the holding company, really nothing else changes for our company. Our Board remains the same. Our management team remains the same, and our common stock will continue to trade on the New York Stock Exchange under the ticker of FLG. On the next slide, we highlight the 4 primary management focus areas for 2025, each of which gained momentum during the second quarter. We want to improve our earnings profile through margin expansion, fee income and reducing operating expenses, continue to execute on our C&I and private bank growth initiatives, proactively manage the CRE portfolio, including reducing our concentrations, and Lee will cover that later on a slide, but we've made really spectacular strides in not only reducing the CRE portfolio, but taking corrective actions and the credit quality improvement through lower provisions and credit losses. The next few slides show the significant progress made during the second quarter in our C&I business. Beginning on Slide 5, we show some of the key highlights during the quarter. In the second quarter, we hired an additional 46 new bankers and related support staff, including credit underwriters and portfolio managers. We have added more than 100 commercial bankers since June 2024, and we intend to add an additional 50 during the second half of the year. During the quarter, we showed tremendous growth in our 2 focus areas, specialized industries lending and corporate/regional commercial banking. Overall, new commitments increased 80% compared to the prior quarter to the $1.9 billion, while originations increased almost 60% to the $1.2 billion. But I think just more importantly is our pipeline currently stands at $1.2 billion, up 40% compared to the first quarter pipeline. And I really think this is just reflective of the focuses, the industries and bringing on really talented people into the organization, most who have 25 to 35 years of operating in their specific specialties. Our expansion strategy is really twofold. Our corporate regional commercial banking business is focused on building out a relationship-based national corporate banking effort and a middle market commercial banking franchise within Flagstar's main -- 4 main geographic areas. Our specialized industries and corporate banking business is a national model and focuses on several industry verticals, including sponsor finance, subscription, finance, lender finance, health care, oil and gas, power and renewable franchise, sports, entertainment and media and communications. And each of these have been staffed and are led by significant industry specialists in their respective area. We recently announced the expansion of this business, as you will see in the next few slides, it is already driving strong origination volume. Slide 6 depicts the momentum in these areas over the past several quarters. In our 2 focus areas, originations increased 81% to $810 million, while commitments slightly more than doubled to $1.7 billion. On Slide 7, while overall C&I loans declined modestly during the quarter due to our managed approach to derisking certain outsized credits in the legacy C&I portfolio, and this is really the result of us implementing a new hold limit policy within the company where we are driving down those commitments to be within our hold limits. The corporate, regional commercial banking and specialized industries portfolios increased $422 million or about 12% compared to the prior -- to the previous quarter. Runoff has decelerated as we have lowered our commitments in the C&I portfolio and along with growing momentum and new hires, we believe that the overall C&I portfolio will grow in the third quarter. On Slide 8, you can see the significant improvement the company has made over the past quarters in strengthening our balance sheet and is in line with what we said we would do and what we have done. Our CET1 capital ratio has increased by over 300 points to 12.3%, ranking us among the highest relative to our peer groups. We have significantly improved our reserve coverage through a rigorous credit review process. We've enhanced overall liquidity, and we've reduced our reliance on wholesale borrowings, which helps our margin going forward. So now I'd like to turn it over to Lee to cover some of the financial data.

Thank you, Joseph, and good morning, everyone. As Joseph said earlier, during the second quarter, we did exactly what we said we would do, and we're very pleased with the continued progress of our turnaround strategy. From a fundamental point of view, our CET1 capital ratio ended the quarter at 12.3%, ranking us as one of the best capitalized regional banks and our adjusted pre-provision pretax net revenue was a positive $9 million, an improvement of plus $32 million from last quarter as we look to return the bank to profitability in the fourth quarter of this year. We continue to deleverage the balance sheet by reducing high-cost flub advances and brokered deposits we made further progress on our expense reduction plans, reduced criticized assets by $1.3 billion, achieved significant growth in new C&I originations and saw record CRE par payoffs. In Q2, we paid down over $2 billion of brokered deposits at an average weighted cost of 4.60%. And we also let $2 billion of high-cost mortgage escrow-related deposits with a weighted average cost of 4.70% run off during the month of June. We also paid off $1 billion of flub advances right at quarter end with a weighted average cost of 4.50%. The reduction of these high- cost funds will provide us with an ongoing margin benefit during the second half of the year, and they also provide us with an FDIC insurance expense benefit. During the quarter, approximately $4.9 billion of retail CDs matured with a weighted average cost of 4.80%. We retained approximately 85% of these CDs, and they migrated into other CD products that were anywhere from 50 to 65 basis points lower than the maturing CDs. In the third quarter, we have another $5.2 billion of retail CDs maturing at a weighted average cost of 4.50%. These deleveraging actions, CD maturities and other deposit management strategies have allowed us to reduce our cost of deposits 11 basis points quarter-over-quarter and our overall cost of funds by 10 basis points compared to the prior quarter. We continue to actively manage our deposit costs and we will look for further opportunities to reduce our cost of funds during the remainder of 2025. We also accelerated $2 billion of investment securities purchases during the quarter to optimize our net interest margin. Collectively, these actions resulted in a 7 basis point quarter-over-quarter NIM improvement to 1.81%. Our NIM for the month of June was 1.88%. Joseph already commented on the strong results in the C&I business. We are thrilled with their performance and are firmly on pace to hit our target of $1.5 billion of funded C&I loans per quarter. I should note that during the quarter, we had legacy C&I payoffs as we took deliberate derisking actions to rightsize outsized credits by reducing hold limits and exiting lower risk rated and less profitable credits. In terms of asset quality, criticized assets declined $1.3 billion to $12.7 billion in the quarter, a result of payoffs and upgrades. Criticized assets have been reduced $2.2 billion or 15% since the beginning of the year. The one borrower we moved to nonaccrual status in the first quarter filed for bankruptcy during the second quarter. We believe this will lead to a more orderly process on about 82 of the 90 loans that are subject to bankruptcy proceedings. Of the remaining 8 loans, we've moved to appoint a receiver in the various jurisdictions and take direct control of these properties. With respect to the 30- to 89-day delinquencies, approximately $332 million were driven by one borrower who pays subsequent to month end and has done so again, meaning that about $329 million of their delinquent loans as of June 30 are now current as of July 23. On Slide 17 of the earnings presentation, we have provided significant information around our rent-regulated multifamily portfolio. When you look at all multifamily buildings that are more than 50% rent regulated, approximately $10 billion are within New York City with an average occupancy of 97% and a current loan-to-value ratio of 69%. Of this $10 billion, $5.6 billion or 57% are pass rated loans. The remaining $4.3 billion or 43% are criticized or classified loans, meaning they are either special mention, substandard or on nonaccrual. Of this $4.3 billion, the current LTV is 79%. Interestingly, $1.9 billion are nonaccrual and have already been charged off to 90% of appraisal value. Furthermore, of this criticized and classified population, we have recent appraisals within the last 18 months on 77% of these loans and updated financials on 93%. If you subtract the nonaccrual loans from this criticized population, you are left with $2.3 billion. Of this $2.3 billion amount between charge-offs and ACL reserves, we have approximately 6% or $137 million of charge-off and reserve coverage. I should point out that of the $2.3 billion of special mention and substandard loans, 50% have already reset to a higher rate and are paying and 40% will reprice by the end of 2026, meaning they are in the 18-month window of enhanced financial review. Suffice to say, given credit metrics, charge-offs and current ACL reserves, we feel that we are appropriately reserved against the portfolio. Also, we are currently reviewing the annual financial statements for all borrowers. And to date, we've completed the review on approximately 28%. I'm pleased to report that there have been more upgrades than downgrades, while the vast majority have stayed consistent compared to last year, implying that the overall trend is improving. Now turning to Slide 9. As we reported earlier today, our second quarter loss per share narrowed significantly compared to the previous quarter. And on an adjusted basis, it came in, in line with consensus. We reported a net loss of $0.19 per diluted share. And as adjusted, we reported a net loss available to common stockholders of $0.14 per diluted share compared to $0.23 net loss in the first quarter after adjusting for the following notable items: $14 million of merger-related expenses, $2 million of severance costs related to branch closures, $7 million in accelerated lease costs also related to branch closures and $3 million in trailing costs from the sale of the mortgage servicing and third-party origination business. Importantly, however, and as I previously mentioned, our adjusted pre-provision revenue was a positive $9 million this quarter, an improvement of $32 million compared to last quarter. The following slide provides our updated 3-year forecast through 2027. Given the earning assets are lower than previously forecast due to the higher loan payoffs, we are refining our net interest income and NIM guidance by $125 million and 10 basis points in 2025, but offsetting $75 million of that with a reduction in noninterest expense, resulting in adjusted EPS being approximately $0.10 lower than previously forecast. The lower balances then roll into 2026, so we have tempered net interest income by $100 million next year, but offset that entirely with $100 million of lower noninterest expense, meaning that our adjusted EPS guidance in '26 does not change, and there is no change to our '27 guidance. Slide 11 highlights our NIM trends. And as you can see, we had margin growth during the second quarter, and we expect to see margin growth over the remainder of the year. As I mentioned earlier, the NIM for the month of June was 1.88% compared to the 1.81% average for the second quarter. Drivers to our NIM expansion include a lower cost of funds as we continue to deleverage the balance sheet and manage our cost of deposits lower, low coupon multifamily loans resetting higher or paying off at par, net growth in higher-yielding C&I loans and a reduction in nonaccrual loan balances. Earlier, Joseph touched on the reduction in our noninterest expense. And on Slide 12, you can see the substantial progress we've made in reducing operating expenses. We've worked exceptionally hard to optimize the cost structure of the organization. Given actions to date, we've taken out over $700 million of costs on a year-over-year basis. Our cost reduction efforts are focused on the following 5 areas: compensation and benefits, real estate optimization, vendor costs, outsourcing, offshoring nonstrategic back-office functions and processes and FDIC expenses. Quarter-over-quarter, expenses decreased $24 million, and we are significantly ahead of our full year 2025 noninterest expense guidance. Our cost savings are net of growth in other areas such as the build-out of our C&I business, together with investments in our risk compliance and technology infrastructure. Turning now to Slide 13, which shows the growth and strength of our capital position. At 12.3%, our CET1 capital ratio is top quartile among our peer group. Our priority continues to be to redeploy this capital into growing our C&I business as we further diversify our balance sheet. The next slide is our deposit overview. As I mentioned earlier, the decrease in our deposits was due to the payoff of $2.2 billion of high-cost brokered deposits and approximately $2 billion of mortgage escrow-related deposits. The next slide shows our CRE par payoffs. We had a record quarter of par payoffs of approximately $1.5 billion, almost double the amount for the first quarter. Of this amount, 45% or $680 million were rated as substandard. Approximately $500 million of this quarter's par payoffs or 33% were New York City greater than 50% rent-regulated buildings. This quarter's record number of CRE par payoffs provides an indication of the robustness of the market for these loans. And while this acceleration of par payoffs impact short-term earnings, it also accelerates our strategy to diversify our balance sheet to 1/3 CRE, 1/3 C&I and 1/3 consumer. These par payoffs are also driving the significant reduction in CRE balances and in the CRE concentration ratio. Since year-end 2023, CRE balances have declined $8 billion or 16% to $39.7 billion while the CRE concentration ratio is down 80 percentage points to 421% compared to 501% at year-end 2023. Slide 16 provides an overview of the multifamily portfolio. This portfolio has declined nearly $4 billion or 12% year-over-year. We maintain a strong reserve coverage on this portfolio of 1.68%, the highest relative to other multifamily focused banks in the Northeast. Furthermore, the reserve coverage on multifamily loans where more than 50% of the units are rent regulated is 2.88%. Earlier, I stated that one driver to our margin expansion is the resetting of our multifamily loans. We have about $16 billion of multifamily loans either resetting or maturing between now and the end of 2027, with a weighted average coupon of less than 3.7%. If these loans pay off, we will reinvest the proceeds and capital into C&I growth or pay down wholesale borrowings. If they reset, the contractual reset is at least 7.5%, which gives us an immediate NIM benefit. Going back to January 1, 2024, approximately $4.9 billion of CRE loans have reset. Of that amount, $2.3 billion has paid off at par and $1.9 billion have reset and occurrence, meaning 85% of CRE loans that have reset have at either paid off at par or current. Skipping to Slide 18. This slide details our ACL by loan category. Our ACL reserve decreased $53 million quarter-over-quarter, a result of lower held for investment balances and lower criticized assets. These positives were offset by a weaker Moody's economic forecast, which added over $60 million to the reserve. Our coverage ratio, including unfunded commitments, was 1.81%, in line with last quarter of 1.82%. On Slide 19, we provide additional details around our credit quality trends. Criticized and classified loans declined $1.3 billion or 9% on a quarter-over-quarter basis to $12.7 billion, while they are down $2.2 billion or 15% since the beginning of the year. Net charge- offs of $117 million were relatively unchanged compared to the prior quarter at $115 million. We believe we further derisked and positioned the balance sheet for growth and profitability. Fundamentally, we have strong capital that we can invest into loan growth, strong liquidity and funding, strong credit reserves, and we've executed on optimizing the cost structure of the organization. I will now turn the call back to Joseph.

Thank you, Lee. On Slide 20, we highlight the significant embedded price appreciation potential in the stock price at current price levels. We closed yesterday at $12.05, reflecting 70% of second quarter tangible book value per share compared to 160% for our peers. As we continue to improve our credit quality profile, successfully execute on our strategic plan and return to profitability, we believe the valuation gap between Flagstar and our peers will narrow and ultimately go away. If we trade at only 1x our year-end 2027 tangible book value per share adjusted for warrants, our stock could trade at $17.64, representing potential upside of 46% from current levels. If we trade in line with the peer multiple, our stock price could trade at $28.23 representing potential upside of 134% from current levels. We have made significant strides during the first 6 months of the and collaboration. A turnaround is a team effort, and together, we will transform Flagstar into one of the best-performing regional banks in the country. Now operator, I would like to turn it over and open it up for questions. Thank you.

[Operator Instructions] Your first question comes from Jared Shaw with Barclays.

I guess on margin, can you give a little bit of detail on the securities purchase that happened? And then as we look out going forward with that 188, I guess, ending margin, does that take into account the FHLB payoff and sort of expectations around interest recapture in that? .

Yes, it does. So thanks for the question, Jared. We pulled forward $2 billion. If you go back last quarter, we -- that was what we forecast to buy between the end of Q1 and the end of the year. Given our excess cash position, we accelerated those securities purchases into Q2 because it maximizes NIM. We were basically buying agency CMOs with a weighted average coupon of about 5.25%. And so we just felt that, that was -- it was just another action we could take to optimize our NIM position. And the FHLB purchase or what we bought back, it was right at the end of June. So you don't see any benefit of that in the Q2 results, but it is included in the NIM forecast for the remainder of the year

Your next question comes from the line of Mark Fitzgibbon with Piper Sandler. .

Joseph, I think you had previously suggested that stock repurchases were possible in mid-'26. Is that still sort of the expected time frame for buybacks? Or do you -- has it been pulled forward at all given your strong capital position.

Yes, this is Lee. I think as we've said, both Joseph and I, right now, the focus is on investing the excess capital in growing C&I and other asset classes, quite frankly. And so that's where we want to invest the capital in the franchise. And we feel -- you've seen the tremendous progress that we've made from a C&I point of view and we feel that, that trajectory and positive momentum will continue. I think in terms of stock buybacks, right now, we're not looking to do that. But as I've said previously, if we get to the middle of '26, we're back to profitability, we're firing on all cylinders. If we're still trading at a discount to book like we are today, that may well be something that we need to take a look at.

Yes. I think, Mark, what Lee said was kind of what we've communicated with clearly, we need to get through '25 well into '26. And if we start being accretive to capital, then I think the Board will have some dialogue on what to do with that excess capital.

Your next question comes from the line of Christopher McGratty with KBW.

Last quarter, you talked about the trajectory of the asset base over the next couple of years. I guess my question is, with this quarter's payoffs, albeit at par, I guess, what's the degree of confidence that the payoff acceleration will continue in the asset base will be smaller?

Yes. So it's a good point, Chris, and that's part of the reason why we've tweaked the interest income guidance. So right now, we believe that at the end of '25, the balance sheet will be about $93.3 billion. So that's about $2.7 billion less than what we thought it would be at the end of last quarter. And it's really just because of a couple of things, the CRE part payoffs coming in almost double what they were in Q1, and we actually think that Q3 will be another strong quarter of par payoffs. And then as we mentioned, we had a slide -- it was -- C&I was sort of on a net basis, down slightly as we look to derisk some of the legacy portfolios, where we felt we had outsourced positions, poorer credit or credits that weren't meeting our profitability thresholds. We do think that in Q3, we will be net positive from a C&I point of view. But you've got that smaller balance sheet. And as I mentioned in my prepared remarks, that rolls into '26 and then we start to recover some of that in '27. So the ending balance sheet at the end of '26 is about $98.5 billion. We were around $102 million -- and then in '27, the ending balance sheet is $109.6 billion versus $111.4 billion. And then the only other thing I'd add on '26 is just given the exceptional progress we've made with our expense optimization plan, we can offset dollar for dollar that reduction in guidance for net interest income with those cost reductions in '26.

Great. That's helpful. And my follow-up would be the collapsing of the holding company. I saw the $15 million of annual cost. That's great. I presume this will lead you to have to avoid to do CCAR. But any other comments on the collapsing would be great.

Yes. Clearly, as we've kind of gone line by line across the organization, looking at what is the value to the company and where we could take cost out, our estimate is this is roughly $15 million that will reduce our costs. And those are predominantly third- party costs. There will also be some internal costs that we feel that we can successfully take off. But I think also it focuses into one regulatory supervision process within the company. And you're right, there is -- obviously, the OCC does a capital review submission by the bank and -- but we will not be subject to the CCAR going forward. That's correct.

Your next question comes from the line of Ebrahim Poonawala with Bank of America.

I guess maybe just wanted to go through -- I think, Lee, you mentioned in terms of obviously nonaccrual loans are declining. You talked about repricing. If you don't mind just walking through the latest in terms of the health of the rent-stabilized multifamily landlords, both in terms of given where interest rates are, like would lower rates help if you don't get much relief on rates, is that incrementally negative or not if you look out the next 6 to 12 months? And then obviously, with all this chatter about the mayor elections in New York, how bad could that be for these clients.

Thanks, Ebrahim. So that's -- I'm glad you asked that question. That's why we sort of put Slide 17 into the earnings deck. And I know there's a lot of information here. But what we're really trying to point out is when you look at the New York rent regulated more than 50%, and I'm talking about New York City, we have about $10 billion. And of that $10 billion, 97% is occupied, and it adds a 69% current LTV. When you further break that sort of $10 billion down, $5.6 billion is pass rated. So as we've done our reviews, that is -- those are pass rated loans, 98% occupied, 62% current LTV. So then you're left with $4.3 billion, which is criticized and classified. So special mention, substandard and non-accrual. And of that $4.3 billion, $1.9 billion is nonaccrual. And as I said in my prepared remarks, we've already taken charge-offs, and you can see this in the table in the bottom left. $334 million or almost 15% of charge-offs against that population. And we have a further $82 million or 4% of reserves against it. So we've obviously done a lot of work on the nonaccrual portfolio and written that down to 90% of appraised value. So then you're left with $2.3 billion, which is special mention and substandard, and of that $2.3 billion, we've got $137 million or about 6% coverage between ACL and charge-offs. And I think what I would also point out about that $2.3 billion is 50% of that $2.3 billion has already reset and is continuing to pay. And 40% will reset within the next 18 months. What that means for us is it's in the enhanced review period. So we've done additional work on those because we know they're going to reset within the next 18 months. So we just feel that, first of all, when you look at it, a lot of big numbers were being thrown around by some sort of -- in some analysis that we were looking at that's not true, and we try to articulate it here. And given all the work that we've done, we feel that we are more than adequately reserved against the portfolio. And then to answer your other point, Ebrahim, if rates drop, that's obviously helpful. If we're in a declining rate environment, I would expect that you'll see it will speed up the payoffs of that multifamily portfolio. And I think it probably brings any of the multifamily loans that are nonaccrual, it moves them further into the money.

Yes. Ebrahim, the other comment I'd make, if you look at the amortizing debt service coverage numbers, that kind of gets to your point. We all know that the next 12 months, the annual leases are going to go up 3% and multiyear, 2-year leases will go up 5.5%. Where you could see impact of the freezing of rent increases, which would not occur until July of '26, that the numbers on the debt service coverage, it would depend upon how fast expenses went up to impact those debt service coverage because we know those properties virtually stay 100% -- almost 100% occupied. But it really comes down to just if rents are frozen, then what's the arc of the operating expenses.

Your next question comes from the line of Manan Gosalia with Morgan Stanley.

Can you give us some more color on the change in the NII guide? I hear you that on the higher paydowns, but I was wondering if -- doesn't that come with paydowns of more lower-yielding loans and then that also gives you the ability to drive down those deposit costs, which have already been coming down nicely. So I'm wondering what I'm missing there. Is there less of a yield pickup as you move from some of the CRE paydowns into C&I or anything else happening there?

Yes. No, it's a great question. So when you look at the NIM change, there is sort of a rate and there's a volume impact. And I think we've obviously talked about the volume and what's -- what's driving that. But in terms of rate, I mean, the weighted average coupon of the loans that are paying off is -- it's sort of under 6% because what you've got is a situation where loans that are resetting at the higher rate for a short period of time are then paying off. And so yes, you've got a lot of the -- we're getting rid of a lot of the lower yielding loans, but you've also got loans that have reset at the higher rate and are then moving. And so you've got to factor that into the equation as well. And the other thing that impacts the rate, there's a lot of ins and outs at the moment, as you can see, as we are optimizing and tightening up the balance sheet. We've got new loans coming in. We've got runoff -- you've got things in there like the FHLB stock dividend. You've got nonaccruals. There's a lot of things that can just affect the overall NIM by a basis point here and there. And so you have a sort of cumulative effect. And it's not much it's sort of single-digit bps. But obviously, when you take those single digits on a $92 billion balance sheet, then you have the volume reduction. That's why we've just tweaked the guidance down by $125 million and 10 basis points.

Got it. Did you have what the new loans are coming on at?

Could you say that again, please?

Do you have what the new C&I loans are coming on at what...

Yes. Yes, they're coming on a spread to SOFR depending on the type, anywhere -- spread to SOFR anywhere from 175 to 300 just depending on the type of the C&I loan that's coming on.

Your next question comes from the line of Bernard Von Gizycki with Deutsche Bank.

Just questions. I know you're trying to reduce your multifamily concentration and utilize proceeds into growing C&I. So the $16 billion in the regulated portfolio, are you contemplating any sales here? Or will reductions here going forward be from any maturing or charge-offs?

Yes. So I think as you can see, we're doing a very nice job of receiving par payoffs and a substantial amount of those par payoffs are substandard. And as you correctly point out, between now and the end of '27, we've got another $16 billion resetting. So as it relates to the performing part of the portfolio, we feel very comfortable that what we're executing on right now is paying dividends. I think the sale option is -- it applies more to the nonaccrual loans. That's just one of the options along with DPOs, workouts. That's just one of the sort of strategies in terms of dealing with the nonaccrual loans. And so that's how I sort of think of the sales strategy.

Yes. And the other thing I would add there is, obviously, we're trying to work with borrowers where we can enhance the credit either through at maturities paydowns or then offering up additional collateral with cash flow to support the loan. So it is a multitude of buckets. And quite frankly, what you've heard from us for multiple quarters is our real desire to get the criticized loans paid down as a concerted effort, and we saw significant results this quarter from that effort.

Okay. And just one follow-up. Lee, I know you mentioned the one borrower that moved to nonaccrual status in 1Q and filed for bankruptcy in the second quarter. I know you took some adjustments in reserves and the NIM reversal in 1Q to reflect that. Just given the change in status, were there any updates in any NIM reversals or reserve increases for 2Q?

As it relates to that particular borrower, yes. So as we got some appraisals in towards the end of the second quarter, there was a net increase of $18 million and in just some additional charge-offs. So when you look at where we were in at the end of the first quarter from a provisioning and charge-off point of view and where we ended the second quarter as we got those appraisals in, there was a net increase of $18 million.

And no NIM reversal.

No. We took all of that in Q1. It was -- we moved it all to nonaccrual in the first quarter.

Your next question comes from the line of Casey Haire with Autonomous Research.

So I guess, just following up on that last question. I was wondering if you could provide an outlook for the net charge-offs. I know you guys kept your provision guide intact, but I was wondering if we could see some leverage from net charge-offs, which held flat this quarter.

I'm sorry, [ Cay ], I think we've -- yes, we expect the charge-offs to come down as we move into Q3, Q4. And we're very comfortable with the guidance that we've provided as it relates to the provision for the remainder of the year. I think I would just emphasize again, you've seen a reduction in -- and you've seen a reduction in the HFI portfolio predominantly because of those multifamily par payoffs -- and you've seen that very significant reduction in criticized assets, 15% or $2.2 billion since the beginning of the year. And so right now, we expect those trends to continue.

Okay. Great. And apologies if I missed this on a busy morning. But just wondering what has -- what have you guys seen in terms of changes from building owners? What have you guys been doing differently? And then have you seen any change in terms of -- when you get these CRE payoffs, I don't know if it's a bank or some of the GSEs that are taking the other side of this. What kind of change in behavior have you seen from these 3 different constituencies since the primary last month?

Yes. I think there's a couple of buckets. First, to address the payoffs, probably roughly 50% comes from the agencies -- excuse me, 20% come roughly from the agencies. And in most of the instance, those credits meet a higher standard to be able to clear the agency hurdle. Roughly 20% are coming from JPMorgan. So about 40% of the payoffs are coming from those 2 channels. And then the rest is just kind of spread around is the way we would describe it. And we are -- by our rollover documentation, we're 75 to 100 basis points, what I would consider over market -- so we -- it is a motivating factor with the borrowers as we're having discussions that our intent is to reduce our exposure. Obviously, we've said that all along. And so borrowers are incented to do what they can on the substandard credits, which are roughly 50% of the payoffs that they are offering up credit enhancements to get those off our books. And as we referenced earlier in the call, that can be paydowns, that can be adding additional collateral, but borrowers are moving those to gain lower interest rates in the marketplace. We do have a number of borrowers who exercise their option to roll that over. A lot of those are going to SOFR-related indexes under the assumption that we are going to see lower interest rates later in the year, and they can then prepay those without a prepayment penalty as we move forward. The other comment I would make is we did have a homebuilder business in the CRE group, and we've ran down pretty significantly any land lending in that portfolio over the last couple of quarters. So we don't have really a lot of exposure to what you're starting to hear that some of the inventory levels are backing up at the homebuilder level. So our exposure there is quite small.

Your next question comes from the line of Matthew Breese with Stephens.

I wanted to follow up on the asset size question. And I heard you loud and clear on the new somewhat lower outlook for total assets. But I guess the question is, what's the cutoff for qualifying for the formal Category 4 bank stress test next year as it seems like you'll be under the threshold. .

We will be under the threshold. But with our transaction that we announced yesterday, we won't even be subject to the requirements.

Understood. And there are additional cost saves from that?

Yes. So no external vendor spend, no need for internal staffing, all of those things.

Understood. Okay. And then, Joseph, maybe one for you. Earlier this year at a conference you made reference to diversifying the capital stack and perhaps adding some preferred capital, I think you said in late 2026. Can you talk about that a bit, curious about size, timing or if that's still necessary?

Yes. Well, clearly, where we sit at 12.3% today, the bank has very effectively raised its capital levels in the company. But we are a bit of a one-trick pony on our capital stack compared to our peers. And so looking at that clearly will be on the docket for the Board. As we -- as the balance sheet either expands and we use that capital or we have excess capital, what is the capital structure within the company look like? We obviously expect next year -- we're still forecasting a return to profitability in the fourth quarter and that we will be significantly profitable next year in '26. So that's going to start to offer up a lot of options for the Board to consider.

Your next question comes from the line of David Smith with Truist Securities.

I was wondering if you could speak to any downsides that you see to merging the holdco into the bank. You outlined what sounds like some pretty nice positives. I'm just wondering if this is just such a great idea, why we don't see more banks following the same decision.

This is Bao Nguyen. We don't see any downsides. As we sort of noted in our press release yesterday, today, we have most of our operations, 99% of our operations is in the bank. And the costs associated with the duplicative regulations of the holding company sort of outweighs the 1% of sort of assets that we really have at the holding company. So for us, given our structure and given that our activities are all at the bank, there is really no downside for us here. There's no changes in our activities. We don't have any plans on engaging in nonbanking activities, which is really the key reason for having a holding company. So for us, it's all quite positive and no downsides from our perspective.

And then I just want to confirm, you still expect to be GAAP EPS profitable for the fourth quarter of this year?

We do, yes, that absolutely, and we're on track given the results of Q2, the progress we've made from Q1, and that's exactly the goal and objective, and we're on track.

I think the other thing, can I add on the holding company question. We will continue as a bank to be able to access the discount window, all those sorts of things that are available to banking organizations. So I think that just sort of emphasize for us, no change that are negative from our perspective.

Your next question comes from the line of Christopher Marinac with Janney Montgomery Scott.

I wanted to ask about deposit flows. And do you think that we will see a turn on the private bank and the Commercial and Premier? Are you incented or incenting growth in those channels?

Yes, absolutely. I think as we've said before, as we move forward here, we want to leverage the new relationships that we're bringing in on the C&I side to bring in deposits. Now it takes time. It doesn't happen overnight. But our strategy is to be a full relationship bank. And we're not sort of just going to give the balance sheet away. We want to have a deep relationship where we're creating deposit flows, fee income opportunities as well as the lending relationship. So that is absolutely a big part of the strategy as we move forward here.

Yes. I don't think you see -- we're not just buying participations. That's not our strategy. These are -- our new relationships are ones where the people are joining the company have been connected to these companies for significant periods of time. And we're already seeing it in our interest rate derivative products. We're seeing it in our 401(k) offerings to companies. And we've also, on 6 or 8 transactions, have either been named lead left or lead right on in our leading credit transaction. So that's kind of our sweet spot with our balance sheet gives us the ability to be quick and nimble on the credit process, but also be large enough to be able to be a significant player for either existing or prospective clients.

Great. And just a quick follow-up on sort of the payoffs in the multifamily bucket. Are you seeing agencies and other banks take loans from you? Is there any additional commentary on kind of how that mix has been?

Yes, absolutely. And as Joseph mentioned, that's exactly where they're going. So about 20% of the payoffs are going to Fannie, Freddie. The remainder are going to other financial institutions, the biggest of which is JPMorgan. So we're absolutely seeing other financial institutions and the agencies, although the agencies have always been there, leaning into this asset class.

Your next question comes from the line of Jon Arfstrom with RBC Capital Markets.

I'm just thinking about '26 and '27, you have big hiring plans. And curious when you miss on a new hire, what are the top couple of reasons? And then what are some of the reasons the new relationship manager can't get their clients to come to Flagstar? What are the things you need to work on or improve there?

I think one of our claim to fame is virtually all the people we've hired, except for one, they are people that we knew and did not use an executive recruiter. So we're describing hundreds of people who, through history, do Rich Raffetto or Joseph Otting as we have both spent 30 to 40 years in the banking business. And so a lot of people see that this is a team that they can join and be part of a winning strategy. So that's what I would say, number one. And number two is a lot of times, people are looking for growth. And if you're at an institution, a large regional bank or a national bank that may have their share of credits and commitments into a relationship, this is kind of a clean slate where they can come over here and be part of a clean slate. And so that excites people, I think, to be part of that strategy and the direction we're going. On the miss side, I would say the real misses ours where the bank comes back and just basically does whatever it takes to keep that person in the company. And that, to me, just reinforces the type of people we're trying to hire or the type of people that organizations want to keep from that perspective. And on the client side, I would say we're really good now in the syndications. I think we're really good in the interest rate derivatives, our products and relationships and credit -- how we deliver credit. The one area that we will probably need to invest a little bit more in is our treasury management. We're good enough but not great in treasury management. And so as we're doing some of the consolidation efforts this year in the technology and operations area, we'll be through most of those in late Q4 of this year, early Q1 of next year, that we'll be able to start to be able to focus on products within the company. We've also done a good job this year, we've introduced kind of a capital call facilities, equity investments for clients to be able to make equity investments in law firms and private equity. And then we did come out with a kind of a private banking-oriented jumbo mortgage program that is interest only on kind of 5.1 and 7.1 products that is also starting to gain some real traction with some of our private banking customers.

Okay. Good. And that's the comment around further strengthening commercial products and services.

Yes, exactly.

We have no further questions in our queue at this time. I will now turn the call back over to Joseph Otting for closing comments.

Okay. Thank you very much for joining us this morning and allowing us to give you kind of an update. The executive management team of the bank is very excited about our progress and the direction that we're heading. We laid out an ambitious plan when we first arrived shortly after March of 2024. For the most part, we've stuck with that plan and actually outperformed in certain areas of the plan, including expenses. I think at the time, people were questioning perhaps our sanity that we could take that much expense out, but not only are we going to take that out, we're going to exceed that. And also, the C&I business is coming along. We couldn't be more pleased with the talent and the growth in the C&I business. And that's a real driver for us to reshape what Flagstar Bank will look like in the future. So we do think we're well on track for all the parameters that we laid out and goals and objectives, and the team is really focused on building this into a really top-performing regional bank. So again, I'd like to thank you for taking the time to join us this morning and for your interest in Flagstar Bank.