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Flagstar Bancorp Inc (FBC)
Q2Â 2019 Earnings Call
Jul 23, 2019, 11:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good day, and welcome to the Flagstar Bank Second Quarter 2019 Earnings Call. [Operator Instructions]
At this time, I would like to turn the conference over to Ken Schellenberg. Please go ahead, sir.
Kenneth Schellenberg -- Vice President of Investor Relations
Thank you, Paula, and good morning. Welcome to the Flagstar second quarter 2019 earnings call. Before we begin, I'd like to mention that our second quarter earnings release and presentation are available on our website at flagstar.com. I would also like to remind you that any forward-looking statements made during today's call are subject to risks and uncertainty. 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 2018 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.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Thank you, Ken. Good morning to everyone listening in. I appreciate you taking the time to join us today. In addition to Ken, I'm joined this morning by Jim Ciroli, our Chief Financial Officer; Lee Smith, our Chief Operating Officer; Kristy Fercho, our President of Mortgage; Drew Ottaway, our President of Banking; and Steve Figliuolo, our Chief Risk Officer. As usual, I'm going to start the call by providing a high-level view of our performance for the quarter, then I'll turn the call over to Jim for details on our financial results. Lee will follow with a review of our business segments and strategic initiatives, and I'll conclude with guidance for the second quarter before opening up the line for questions.
Overall, I was pleased with our results for the second quarter. The top line revenue growth and expected expense management combined to produce positive operating leverage. Our adjusted net income of $41 million, or $0.71 per diluted share exceeded the $37 million, or $0.64 per diluted share we achieved in the previous quarter, but was down 18% from the same quarter last year driven by the writedown of our commercial loans and Live Well Financial, our mortgage loan originator, which we disclosed as a concern in our first quarter 10-Q. I'll touch on this matter more later.
It's important to note that the increase in non-interest expenses is mostly attributable to a nice bump in mortgage originations during the quarter, especially in our growing retail channel where commission expenses are directly tied to originations. Results from the quarter demonstrated once again how our unique business model works. In this case an unexpected drop in interest rates that put pressure on interest margins presented us an opportunity to significantly increase mortgage revenues, which helped produce a solidly profitable quarter. It's an example of our flexible business model in action.
To expand on the commercial loans and Live Well, we experienced a $30 million partial charge-off after they unexpectedly cease operations and we came to learn about the collateral supporting the loan was not worth as much as had been consistently reported to us. Though there are some unusual circumstances around this credit as evidenced by the ongoing law enforcement and FCC [Phonetic] investigations, it would be an understatement to say that I'm extremely disappointed that this happened at all. We conducted a rigorous postmortem and have taken every step to reduce the likelihood of a reoccurrence of an event like this. Additionally, we are actively pursuing our legal remedies both within and outside bankruptcy proceedings. This of course means that we may not able to provide you with more details this time.
Turning to our banking business, we once again have a solid story. Net interest income grew 10% compared to the prior quarter driven by exceptional growth in earning assets. This growth was led by a 70% increase in warehouse lending as we benefited from the proactive management of utilization rates coupled with a seasonally higher mortgage market. We continue to see stable growth in our commercial and industrial, commercial real estate and consumer lending portfolios and the strength of relationships our teams have fostered over the years. While we have seen pressure on yields, we have not compromised any of our credit standards, and we have passed on a sizable number of opportunities due to thin spreads. Our servicing segment continues to grow nicely and its contributions to our bottom line keeps growing each quarter solidifying our position as a key player in this space.
Our mortgage team delivered an outstanding quarter as they maintained pricing discipline and focused on optimizing volume and expanding margin. Gain on sale margin improved 17 basis points compared to the first quarter. The spike in mortgage origination that we saw in March carried over into the second quarter and our team did an excellent job of identifying opportunities to grow volume and expand margins while carefully managing capacity. Fallout-adjusted locks rose to $8.3 billion, a 26% increase from last quarter. When you put this all together, the result is a quarter-over-quarter increase in mortgage revenue of $25 million and industry leading 45%.
Looking ahead, we've increased our projection for total originations for 2019 only slightly. For the most part, we see the year shaping up as we have projected in terms of the overall size of the origination market. The key will be that we can continue to grow average revenue as we did in Q2. We do believe capacity of adjusted debt and pricing has become more rational. This positions us well to leverage our strong customer relationships, our commitment to service and the consistency of that service. Quality is the backbone of our competitive advantage.
In closing, it was a quarter that highlighted a primary strength of our business model, our ability to consistently meet earnings expectations without adding significant risks. All of our business segments are critical to our success and we can leverage anyone depending on market conditions to help us continue to deliver consistent and durable earnings.
That concludes my comments. Now let me turn it over to Jim.
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Thanks, Andre. Turning to Slide 6, our adjusted net income this quarter was $41 million, or $0.71 per diluted share even with the $30 million charge-off. This performance compared to the $37 million, or $0.64 per diluted share of adjusted net income last quarter. This quarter was highlighted by revenue growth of 20% leading to strong operating leverage of 8%. Our results for the quarter were led by strong growth in net interest income and a higher level of mortgage revenue. We'll discuss earnings in more detail when we get to Slide 7.
Asset quality negatively impacted this quarter by the $30 million Live Well loan charge-off discussed earlier. As a result, our non-performing loan ratio increased 30 basis points. Additionally, we reduced our reserve by $17 million, mostly driven by the full pay-off of three substandard loans and also due to the continued low levels of charge-offs in the rest of our loan portfolio. Our allowance coverage of the loan portfolio decreased to 0.9%, reflecting the charge-off activity for the quarter, the reserve reductions and strong growth in period end warehouse loan balances. I'll provide more details when we get to asset quality. Expenses also scaled nicely this quarter showing only 12% growth and reacted with 20% increase in revenues. Mortgage origination volumes drove $20 million of the increase. On the basis of $1 billion attributed in loan warehouse loan growth, our capital ratios were lower this quarter, while our total risk-based capital was 11.6% on June 30th, this capital ratio would have been relatively flat to last quarter without that warehouse loan growth. And we believe those warehouse loans have little to no credit risk. Capital simplification will improve this ratio by 38 basis points, and I'll take it through a more extensive analysis of our capital later.
So let's turn to Slide 7 and dive deeper into the income statement. Net interest income grew $12 million to $138 million for the second quarter, which was 20% higher than last year's second quarter and excluding the fourth quarter's $29 million hedge gain surpassed $130 million in a quarter for the first time. The results primarily reflect a 9% increase in average earning asset led by 23% growth in average commercial loans. On the basis of this loan growth, the net interest margin was relatively flat. We'll discuss earning assets more in the next slide.
Non-interest income increased $59 million to $168 million. The quarter benefited from the $25 million reduction in the fair value of the DOJ settlement liability. The lower value of this liability reflects a reduced likelihood and longer timing for any payments that will be made related to the settlement agreements. Excluding the DOJ benefit, second quarter non-interest income increased $34 million, or 31% to $143 million. The increase was led by mortgage-related activity as mortgage revenues increased $25 million and loan fees and charges increased $7 million.
Our gain on sale revenue of $75 million, represented an increase of $26 million or 53% from the prior quarter. The improved gain on sale revenue was driven by a 17% -- 17 basis point increase in gain on sale margin as our mortgage team targeted higher margin sales channels at more attractive prices instead of chasing volume. Additionally, fallout-adjusted locks increased by 26% for the quarter. As you expect, the return on the mortgage servicing asset decreased by $1 million due to lower rates impacting prepaid fees. Our treasury team did an exemplary job in hedging our MSR position, despite the volatility in the quarter. In fact, due to the changes in rates during the quarter and other factors, we had a negative impact to our MSR position of $40 million, and we were able to hedge $39 million of that impact and still deliver a return of 6%.
Loan administration income decreased $5 million, or 45% driven by an increase in interest paid on custodial deposits which saw significant growth for the quarter. I'll cover the increase in average custodial balances later. Non-interest expense was $214 million, a $23 million in the prior quarter. The increase was primarily related to mortgage volume driven expenses such as commissions, loan processing and compensation due to higher levels of production and shift mix toward the retail channel. The remaining expense categories were relatively flat from the prior quarter demonstrating the scalability of our business. I'd also note that our effective tax rate increased to 19%, as a result of the DOJ benefit in the quarter. Nonetheless, we expect that our effective tax rate for full year will be at or slightly lower than our rate in the first quarter which is 18%. Credit costs reflected a little bit of charge-off this quarter as well as the higher level of charge-offs coming from the unsecured loans that we acquired with the Wells Fargo branch acquisition. These smaller balance loans have a higher rate of losses and therefore have higher interest rate. The charges this quarter represents some cleanup of that portfolio that came with the acquisition.
We'll dive to our credit quality in a couple of slides, so let's move to Slide 8, which highlights our average balance sheet this quarter. Average loans held-for-investment grew $1.4 billion, driven by an increase in average warehouse loans and well-balanced loan growth across our main loans held-for-investment portfolio. We saw more opportunities in the quarter with the high quality loans in the portfolio, especially in the warehouse, C&I, and non-auto indirect portfolios. And from those assets, the margin, the core deposits, while keeping the net interest margin flat to last quarter. In fact there were over $500 million of additional warehouse lending opportunities in the quarter that we didn't take as we thought the spreads would narrow.
Growth in average warehouse loans with productive actions we took to grow net interest income and leveraging the loans we acquired in the warehouse acquisition in early 2018, but also experiencing seasonally higher volume. The non-auto indirect loan growth reflects the continued growth of the business as average balances increased $154 million, or 84% compared to the first quarter. Also during the quarter, we managed the loans held-for-sale portfolio to a lower level than we expected considering the increase in origination volume and we decreased available for sale securities. Both actions were taken rotating the higher-yielding assets and to support this quarter's loan growth.
Average deposits increased $1.3 billion, or 10% in the quarter driven by a higher custodial and community banking deposits. Average custodial deposits rose $936 million, or 37% from a higher level of loan prepayments underlying our servicing portfolio. The growth of the number of accounts serviced and seasonally higher levels for T&I escrows. Total retail deposits grew $332 million, or 4% for the quarter. Finally our tangible book value per share increased to $1.51 to $26.16 per share.
So let's turn to asset quality on Slide 9. As noted earlier the quarter was significantly impacted by the Live Well loan that is partially charged off in place to non-accrual status during the quarter. At June 30th, this loan has been charged down to $37 million reflecting our estimates of the value of the underlying collateral. We expect to take possession of the collateral at some point during the third quarter and we are evaluating the most appropriate course of action once we take possession. Excluding the impact of Live Well, credit quality and loan portfolio remains strong. Early stage delinquencies continue to be negligible. Only $8 million of total loans were over 30 days delinquent and still accruing at June 30th, an improvement in the level of delinquencies last quarter.
At June 30th, our allowance coverage grew 0.9% of total held-for-investment loans. I'd point out that this coverage reflects 23% of our loans held-for-investment in warehouse loans. Our warehouse loan portfolio has little to no credit loss on hand as these loans are fully secured and we control the collateral. Excluding warehouse loans denominator given their relatively clean credit loss history; our allowance for loans held-for-investment coverage ratio would stand at 1.2% at June 30th still relatively strong in the industry. We continue to work toward implementing CECL and intend to provide a more comprehensive update as we get closer to adoption. With that being said, we don't believe the events from this quarter including the reduction in our coverage ratio has impacted our overall view that we are set up as well as any mid-sized bank for whatever CECL's impact might be.
Turning to Slide 10. Capital remains solid. The total risk based capital ratio was 11.6% at June 30th. This represents a cushion of $226 million of total capital over the minimum level needed to be considered well capitalized. Final capital simplification regulations which take effect in Q2 of 2020 will increase this ratio by 38 basis points. As I mentioned earlier our risk-based capital ratio has declined as we had $1 billion of warehouse loan growth during the quarter. This factor alone reduced our total risk-based capital ratio by 85 basis points. Our target operating range, the size of the strategic flexibility buffer and the stress buffer above well-capitalized status are all informed by our stress tests. Due to the very low level of losses that we would expect to have from the warehouse loan portfolio and even in the adverse economic scenario combined with our expectation that our warehouse loan balances with trying CECL in the second half of the year, we remain comfortable with our capital levels at June 30th.
Our total leverage ratio was 8% at June 30th down 41 basis points from last quarter. Capital simplification will increase this ratio by 63 basis points, which will put us at the upper end of the target operating range of 8% to 9%.
I'll now turn to Lee for more insight in each of our businesses.
Lee Matthew Smith -- Executive Vice President and Chief Operating Officer
Thanks, Jim, and good morning, everyone. We're very pleased with how quickly we pivoted during the quarter to maximize revenue and earnings from our mortgage business given the lower 10-year treasury note rate as we saw healthy increases in both flat adjusted loss and gain on sale margin quarter-over-quarter. Average earning assets increased a commendable 9%, or almost $1.5 billion as we experienced positive growth in all consumer and commercial lending channels. The warehouse lending business we acquired a little over a year ago is paying dividends as we increase average warehouse balances an impressive 70%, or $822 million quarter-over-quarter. Average deposits increased $1.3 billion, or 10% and we're now servicing or sub-servicing almost 1 million loans and are the fifth largest sub-servicer in the country which provides us with another source of stable earnings.
We're obviously disappointed with the Live Well commercial loan partial charge-off of $30 million during the quarter after they abruptly and unexpectedly ceased operations. We are confident that this situation is not reflective of a deterioration in our remaining commercial portfolio and the underlying collateral for this loan was unique and not something we have elsewhere in that book. We ended the quarter with almost $20 billion in average assets and have once again demonstrated the flexibility of our business model where the different businesses act as a natural hedge meaning we can generate strong earnings in any interest rate environment.
I will now outline some of the key operating metrics from each of our major business segments during the second quarter. Please turn to Slide 12. Operating highlights for the Community Banking segment include average commercial and industrial and commercial real estate loans increased $294 million, or 8% in the quarter and the growth was evenly found between the two portfolios. Average consumer loans held-for-investment increased $333 million, or 8% in the quarter, as we added high quality non-auto indirect loans HELOCs and first-lien mortgages to our portfolio. Average warehouse lending loans increased a remarkable $822 million, or 70% in the quarter due to the increased activity in the mortgage industry, but also helped by our acquisition of the warehouse lending business which has helped bolster this growth.
Given our organic ability to originate loans both consumer and commercial together with our relationship based approach, we believe, we will continue to originate high quality consumer, commercial, and warehouse loan balances going forward. Average retail deposits increased $332 million, or 4% during the quarter, while custodial and escrow deposits increased $936 million, or 37% given the high number of loans sub-serviced and the low rate environment increasing refinance activity and therefore leading to higher principal and interest balances. We're very satisfied with the performance of our Community Bank as it continues to grow and further diversify the earnings power of the bank.
Please turn to Slide 13. Operating highlights for the mortgage origination business include fallout-adjusted lock volume increased 26% to $8.3 billion quarter-over-quarter, while the net gain on loan sale margin rose 17 basis points, or 24% to 89 basis points. As a result, gain on sale revenues increased $26 million to $75 million in Q2 versus $49 million in Q1. The increase in fallout-adjusted lock volume quarter-over-quarter was due to both seasonally higher volume and the lower 10-year treasury note rate and we were able to maneuver quickly in order to expand capacity and optimize earnings from our mortgage business. We also maintained that disciplined pricing approach to ensure we focused on generating business in the most profitable channels. It's this discipline that enabled us to increase our gain on sale margins 24% to 89 basis points quarter-over-quarter. We will continue to take advantage of this lower rate environment and remain disciplined in our pricing and capacity management, in order to maximize earnings from the mortgage business, while providing excellent service to our customers.
Moving to servicing. Quarterly operating highlights for the Mortgage Servicing segment on Slide 14 include, we service or sub-service approximately 983,000 loans of which over 816,000, or 83% are sub-serviced for others, making us the fifth largest sub-servicer in the country as of March 31st for Inside Mortgage Finance. We've increased the number of loan serviced or sub-serviced by 440,000, or 81% in the last 12 months and have been one of the fastest growing sub-services in the industry during that period. To-date we have the capacity to service or sub-service 2 million loans as well as provide ancillary offerings such as recapture services and financing solutions to MSR owners. We recently announced that we would be acquiring the default servicing operation in Jacksonville, Florida, exclusively supporting our seriously delinquent mortgage loans, which is currently managed by third-party. The transaction is scheduled to close at the end of September.
With the rapid growth of our sub-servicing portfolio, it makes sense to strengthen our capabilities on the default side and bring the operation back in-house. This acquisition further leverages our industry-leading oversight and monitoring, while providing clients the risk and compliance infrastructure benefits Flagstar has to offer. The custodial deposits these loans generate also help us fund our loan growth. We held $3.5 billion of average custodial deposits throughout the quarter, an increase of $936 million, or 37% quarter-over-quarter. We're very pleased with how we've grown our sub-servicing business over the last 18 months. I believe you will continue to see flourish as we move forward.
Moving on to expenses on Slide 15, our non-interest expenses increased 12%, or $23 million to $214 million quarter-over-quarter, while revenues increased 20%, or $46 million during the same period excluding the DOJ benefit. This led to positive operating leverage of 8% in Q2 as our variable cost structure and dynamic business model allowed us to take advantage of market opportunities particularly in mortgage business. The majority of the increase in non-interest expense was due to the increase in mortgage activity with 87%, or $20 million of the $23 million increase quarter-over-quarter being because of high mortgage production.
Our adjusted efficiency ratio excluding the DOJ benefit was 76% for the second quarter, which was an improvement of 5% from the prior quarter. If you break it down further, gain on sale revenues and loan fees and charges increased $33 million in the quarter, while costs related to this business increased $20 million meaning revenues from other business lines increased $13 million and associated costs increased $3 million. The point being we have made thoughtful and deliberate cost investment decisions that have benefited the earnings of the bank and created shareholder value.
We estimate non-interest expense will be between $220 million and $225 million during the third quarter. A slight increase in expenses is all related to increased mortgage production volume. It's been a solid three months. We pivoted quickly and efficiently to take advantage of the lower rate environment particularly with our mortgage business. We saw excellent commercial and consumer loan growth together with strong deposit growth and our sub-servicing business continues to prosper bringing consistent non-interest fee income to our earnings. Given our diversified and flexible business model supported by our robust risk and compliance infrastructure, we believe we're well-positioned to continue to add value for our shareholders as we move forward.
With that, I'll hand it back to Sandro.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Thank you, Lee. I'm going to close our prepared remarks with some guidance for Q3 and then open the call for questions-and-answers. Please turn to Slide 17. We expect net interest income to improve approximately 5%, while net interest margin will be flat or decline slightly. The anticipated gain on loan sale income will increase 15% to 20%. We expect the return on the MSR to decline slightly. All other non-interest income is expected to decline 5% to 10%. As Lee noted, we anticipate non-interest expenses to be between $220 million and $225 million and we expect the effective tax rate to be 18%. This concludes our prepared remarks. We will now open the call for questions from our listeners.
So I will turn the call over to Paula.
Questions and Answers:
Operator
Thank you. [Operator Instructions] We'll take our first question from Scott Siefers with Sandler O'Neill.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Good morning, Scott.
Scott Siefers -- Sandler O'Neill -- Analyst
Hey, thanks for taking my question. I guess the first question is just on the gain on sales margins. I mean really, really strong improvement this quarter and appreciate the context you put it in about regarding the improved mix basically, but just curious if you could talk a little about how much is left. Could you continue to enriching the mix of originations and then just on sort of a steady state in other words if you had not improved the mix of originations, what kinds of trends are you seeing by channel on gain on sale margins?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
I'll give Kristy a second to think about that, but my reaction Scott is, I think we've seen improvement in our margin in all areas, some more than others. And I think that is because as we said in our prepared comments that we have really focused on optimizing the production as opposed to just optimizing volume. And I think that has proven to work very well for us. As I've said we increased our mortgage revenue by 45% quarter-over-quarter. I think that compares pretty favorably to other large mortgage originators.
Kristy W. Fercho -- Executive Vice President and President of Mortgage
Yes, Scott. What I would add is the big story in the mix really came in bulk. And so the way you saw the volume coming in bulk, we were seeing easily one pipe for billion a day and we just maintained the discipline there where the margins were in terms of that both channel choosing to do more in the retail originations as we said in our prepared remarks. So the volume certainly is there. It was the discipline around where we wanted to maximize that and take margin and not just take volume for volume sake.
James K. Ciroli -- Executive Vice President and Chief Financial Officer
And Scott, I'll just add. If you actually just look at Q1 over Q2, I mean just going back to Sandro's point, the volume growth we saw in multiple channels particularly correspondent, non-del, broker, and retail and that's where we saw the margin expansion. I mean because those are the higher margin channels and we focused on getting the business from those channels which is why the margin increased so much quarter-over-quarter.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
But the real important point really more than volume or margin is revenue that's what we were focused on and the revenue growth is what I was most pleased with.
Scott Siefers -- Sandler O'Neill -- Analyst
Yes, that's perfect. Thank you guys for the color. Let me switch gears to the Live Well situation maybe just a comment or two about what's left and I guess what gives you comfort that it's well secured, I know there was some question on the collateral valuation at the beginning. So just maybe a little more color on if what's left, if there's any question or additional risk to it or if you feel like this was a good very conservative whack at the apple, so to speak?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Yeah, we feel extremely comfortable with where we've valued the collateral. And so, you can't say anything for sure of course, but we're confident that the ultimate resolution will be similar to where we've marked the asset. And then as we go through the legal process perhaps there's other opportunities for recovery.
Scott Siefers -- Sandler O'Neill -- Analyst
Okay. Perfect. Thank you guys very much.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
You're welcome.
Operator
Well moving on, we'll go to Bose George with KBW.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Hi, Bose.
Bose George -- KBW -- Analyst
Hi, good morning. Just a follow-up on the gain on sale, is the guidance for next quarter for the increase driven by volumes or margins or both?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Probably a little bit of both. But I think more so margin than on volume. But you never know, Bose, right, it's hard to know what's going to happen tomorrow let alone over the next three months. I think what I'd like to emphasize is we'll adjust to where the opportunity is. And so if there's more opportunity for volume at a narrow margin, but we think that brings us more net revenue that's what we'll do. And I think we've been able to show quarter-over-quarter as we can make good and swift decisions on where the best opportunity is.
Bose George -- KBW -- Analyst
Okay, great. Thanks. And then switching to the guidance on the net interest margin, can you just talk about the drivers there and are you incorporating the rate -- two rate cuts or how does that work?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Well, let's look at yields and then cost, right? On the yield side as we noted in our prepared comments we're definitely seeing pressure on the yield side on the commercial book. And so we're concerned about how that's going to react not only from the press from competition but then of course if you get a 25 basis point decline in the Fed funds rate next week then you're going to see all of the adjustable loans adjust pretty quickly and you'd never know for sure just how quickly you can adjust the deposit cost to match up with that decline. So we're little cautious on that. And so I think that's how I would answer your question. Jim, you want to add?
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Yeah. The guidance we've given for the quarter reflects what you see in the curve right now, which is almost a certainty as Congress said at the rate cut next week, a small chance of 50 basis point cut, but we just go with what the market tells us. When you focus then on the short-term, the short end of the curve, we are slightly asset sensitive. And I think Sandro said it well that, that slight asset sensitivity defines what our goal is in terms of managing our deposit costs. So we'll get out and we'll manage those deposit costs in a very thoughtful and deliberate way and we know what we have to do to maintain that flat to down guide on NIM.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
I'd say add Bose that I was very pleased that we only saw 1 basis point narrowing of our margin this past quarter given all the pressures that were in the business and the way the interest rate -- interest rates reacted over the last three months. So I'm pretty confident that we can manage the margin reasonably well.
Bose George -- KBW -- Analyst
Okay. Thanks. And OK just one more just on the servicing fee, your average servicing fee has gone up quite a bit over the last year. Just curious are you getting better execution, just holding more excess servicing or mix shift, or is there anything else going on there?
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Yes, on the MSR we're definitely holding more G&A and that's having a positive impact on the carry and then we're holding a bigger asset, that's what we see, Bose.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Yeah, Bose, Jim did a good job in his comments talking about how well our team managed that investment. As you know we do a lot of warehouse lending. So we see a lot of other companies. And of course the non-bank mortgage companies don't hedge their MSR. And in this environment, we're out in the last month to see only a $1 million deterioration and the value of our MSR is pretty remarkable. And I think that shows how strong our team is managing that MSR on a day-to-day basis, but we've been able to keep it pretty much unchanged despite increasing or decreasing interest rates.
James K. Ciroli -- Executive Vice President and Chief Financial Officer
I'd add to that that track record goes back to the team goes back to 2016.
Bose George -- KBW -- Analyst
Okay, great. Thanks, guys.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
You're welcome.
Operator
Up next we have Steve Moss with B. Riley FBR.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Good morning, Steve.
Steve Moss -- B. Riley FBR -- Analyst
Good morning. I guess just following up on the Live Well asset here, just wondering what are your thoughts with regard to whether you retain the asset or liquidate it?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Well I can't, I don't know I can't speculate. It depends on what the market opportunity is. We don't have a desire to own the collateral long-term necessarily, but if that is the best that's the most efficient way to go that's what we'll do. But as I said to the earlier question, I'm not too concerned about where we have it marked. I think we're in a good place with it. And I think that we're going to be able to work through it reasonably well. Jim, anything you want to add to that?
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Yeah, what I'd add to that is we did bring some consultants in to help us evaluate the collateral; evaluate what our strategy and pricing was of collateral. So I'd say that that Sandro's comments were really informed by what that consultant was able to inform us about with respect to collateral and the pricing.
Steve Moss -- B. Riley FBR -- Analyst
Okay. And then I guess just perhaps digging a little further on funding costs and in particular deposit costs here, if we do see 50 basis points this quarter, what would we expect for your deposit pricing?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Well as you may know Steve, I've been managing or I did manage the deposit base here for many, many years. And my philosophy has always been that on the way down, you don't wait for others to move, you move in. So we will be aggressive in our adjustment of deposit rate that's in our history. Now we've got to balance that against our need for funding. So I can tell you that we lose deposit rates by 25 basis points, if the Fed drops 25, but we're not going to be overly cautious about it either. I think managing the deposit cost going to be important -- it's really important to managing the margin. And as Jim said, we're a touch asset sensitive and so the way to deal with that is by being more aggressive on the deposit side. So we're not going to be afraid to do that.
James K. Ciroli -- Executive Vice President and Chief Financial Officer
I think when you look at our balance sheet, Steve, you'll see all of that. It's easy to see the assets that are going to reprice down the commercial loan portfolio. If you look at the FHLB, you look at the interest we pay where we're at the sub-servicer on custodial deposits. You look at the trust preferred, there's a whole host of liabilities were also priced down to that liability, the asset liability sensitivity and that short end of the curve is really something that we feel within our ability to manage to whatever degree we have to manage it, certainly what we see in terms of rate cutting back.
Steve Moss -- B. Riley FBR -- Analyst
Jim, on those custodial deposits is actually my next question. The interest there is paid is an offset to loan administration income. Just kind of thinking, how do we think about that line item? How indexed are those deposits if you will. And perhaps how can I translate into fee income for you guys?
James K. Ciroli -- Executive Vice President and Chief Financial Officer
We've given you a page, a new page to the deck, it's actually Slide 37 in the Appendix that will I think give you a lot more information, we've ever given before and I'll turn it over to Lee to elaborate.
Lee Matthew Smith -- Executive Vice President and Chief Operating Officer
Yeah, I think you're exactly right, Steve. The loan admin income includes servicing and sub-servicing fees less the amounts paid to MSR owners for the interest on those escrow deposit so remember with sub-servicing 84% of the overall portfolio, the benefit Flagstar receives from most parties is shown in interest income. So it isn't matched up on the GAAP rules which is why to Jim's point, if you look at Page 37 of the deck which is a new slide we've included this non-GAAP servicing profitability slide where we do match interest income and interest expense from escrow deposits. And as you can see from that, just from a servicing profitability point of view, we are achieving $4 million to $6 million of operating profit pre-tax for every 100,000 loans we have.
James K. Ciroli -- Executive Vice President and Chief Financial Officer
But Steve, I think if you look at that page, it's interesting to look how the interest expense has grown quarter-over-quarter related to the custodial deposits. And as was noted in the prepared comments, custodial deposits improved $1 billion from the last quarter. So there's a lot of and freshly in large part because of the prepayment of loans because a number of loans that we serviced really didn't change much quarter-over-quarter. So that billion of deposit, that's all tied to LIBOR. It ranges from LIBOR plus, little LIBOR minus, so there's something, but it's all tied to LIBOR. But the important point is, so as the LIBOR declines, the cost of those deposits going to decline immediately and that is completely viewing efficient for funding.
Steve Moss -- B. Riley FBR -- Analyst
All right. Well, thank you very much for that.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
You're welcome.
Operator
Moving on, we will go to Kevin Barker with Piper Jaffray.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Hi, Kevin.
Kevin Barker -- Piper Jaffray -- Analyst
Good morning. Just going back to some of the comments Jim made on capital and the share buybacks, it looks like you paused or bought back very little in the second quarter and then how the priorities look going forward given where your capital ratio stands today and the amount of growth that you put on the balance sheet especially in the second quarter?
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Well, let's just come back to the share buyback. If you recall buyback, we executed beginning of February and January was an accelerated share repurchase. And we have all said that we work with another -- we work with an investment bank and we execute immediate buyback. And then there is a settle-up transaction later which happens for us kind of mid-second quarter. So really the way we think about it from a share buyback, we've done in February with a small settle-up that we have that's what you're seeing come through Q2. So we used our total $50 million of authorization. But I go back to my prepared remarks, when we look at the capital ratios at the end of the quarter and you think about meeting capital, the risk of possible loss. I just don't -- when you look at the $1 billion worth of balance sheet inflation that we have which will also come down through the second half of the year from that warehouse loan increase, it is not something that, that bothers us, concerns us, and as the balance sheet deflates, you'll see the capital ratios come back up because of that and also because of the -- just the earnings accumulation will experience over the next couple of quarters.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
And not to mention, capital simplification next year. So -- but to your point Kevin we're managing the capital very closely and making sure that the assets we put on the books bring us the return that makes sense given the use of the capital. And that's why you heard a couple of us stating in our prepared remarks that we passed on quite a bit -- quite a few opportunities that we were comfortable that from a credit point of view but we couldn't get to the hurdle from earnings point of view.
Kevin Barker -- Piper Jaffray -- Analyst
Okay. And then obviously warehouse picked up quite a bit and your loans held-for-investment picked up quite a bit during the second quarter and you gave your guidance for the third quarter but as you look into the slower seasonal months in the fourth and first quarter, what do you expect as far as in average balance or do you feel like you could sustain your current loan balances as we move through those quarters given the seasonality of the balance sheet at this point?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Well only speaking to the third quarter, right. And we look at our guidance and we sit and we think that net interest income was going to grow about 5%. So that would suggest that there isn't going to be significant growth in the balance sheet projected over the next quarter. So while we might see some growth here, we might see some decline there and we got to pass that and we're not going to comment.
Kevin Barker -- Piper Jaffray -- Analyst
So would you expect to be able to sustain that NII going into the fourth and first quarter especially given the shape of the yield curve at this point?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Well again I don't want to speculate on anything further out. If you look historically at our net interest income performance, you can come to your own conclusions as to how we're able to perform in the fourth and first quarter. But I can't comment on that.
Kevin Barker -- Piper Jaffray -- Analyst
Okay. Alright. Thank you for taking my questions.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
You're welcome.
Operator
And Henry Coffey with Wedbush has our next question.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Good morning.
Henry Coffey -- Wedbush Securities -- Analyst
Yes, good morning everyone. Good morning. Thank you for taking my question. It's interesting to see how quickly you can kind of turn on the mortgage machine to take advantage of the rate decline. When we look at the -- when we look at the collateral behind your mortgage warehouse loan that you're having issues with the press says --?
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Henry, let me correct you just one second.
Henry Coffey -- Wedbush Securities -- Analyst
Yeah.
James K. Ciroli -- Executive Vice President and Chief Financial Officer
That is not a warehouse loan, we did have a warehouse loan. Let me just explain. We have two loans at Live Well, one was a warehouse loan, the warehouse loan is completely paid off without any loss or charge-offs. The other loan which was secured by marketable securities is where the issue lies.
Henry Coffey -- Wedbush Securities -- Analyst
Okay, got. Now thanks for clarifying that. When you look at Live Well, the press says that the problem was that you had Ginnie Mae IO collateral that you and others that were exposed to that credit were counting on Ginnie Mae IO collateral, which obviously is a pretty volatile item. I'm going to assume that's correct. I would take from some -- I would take it from some of the remarks you made on the call that you don't have other loans so collateralized, is that accurate or --?
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Yes, it's accurate. But I also want to -- I want to say one other thing. Maybe just a clarification from what something you just said. We do not believe that the collateral issue is related to market conditions.I want to be very clear about that. There's a different problem that we're researching, so I've made reference to the law enforcement and the FCC investigation. We don't have all the answers to that. I can't really comment on it any further. But I just want to be clear that we do not believe that the collateral issue that we experience and the charge-off associated with that had anything, anything to do with market conditions.
Henry Coffey -- Wedbush Securities -- Analyst
So there's no -- you're not looking at your overall approach to the business is saying oh, oh, we need a better telescope here, you're happy with your telescope so to speak?
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Yeah, given the uniqueness of this particular credit, credit absolutely. Now that doesn't mean we don't inform ourselves and look deep into our operations to make sure that it couldn't be something similar, but we've done that and I'm comfortable answering your question today than I did.
Henry Coffey -- Wedbush Securities -- Analyst
Great. Thank you. The other thing kind of from a broader look a couple of banks have been talking about issues in their A, C and D acquisition and development portion of their portfolio which obviously includes both commercial and residential activity. You have a pretty broad scope on that -- view on that market. Are you seeing weakness in the A, C, D business, strengths in the A, C, D business because of where the mortgage market is. What are your thoughts on the overall tone of that sub-portion of the lending market?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
I will let Drew comment, I'll just say to begin that we haven't seen any weakness whatsoever from a credit perspective. So we don't have delinquencies at any level in the A, C and D but Drew I know you'd probably want to chime in that.
Andrew W. Ottaway -- Executive Vice President, President of Banking
I'm happy to add on. I mean we are really happy with the way we've grown that book of business. It's very well diversified. We banked seven of the top 10; we banked 51 of the top 100. We really take concentration policies around what we take as collateral, that mix of that collateral and how we monitor that collateral. So as Sandro said, we haven't any concerns today with that book of business. I think affordability is still an issue out there, but I think price appreciation is slowing. So we think there's ample room for us to continue to grow that book of business.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
The opportunities have come in, almost every week and our loan committee were seeing new opportunities in the space.
Henry Coffey -- Wedbush Securities -- Analyst
Are the builders at the very low end of the spectrum maybe that's not even the top 100, the five trucks and 20 homes a year; is that builder having access to credit or is that builder in your view credit starved?
Andrew W. Ottaway -- Executive Vice President, President of Banking
I do think the market overall is still constrained by available credit. We don't happen to bank builders like that. We only bank large regional builders that do significantly more than 20 houses and five trucks.
Henry Coffey -- Wedbush Securities -- Analyst
Great. Thank you very much.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
You're welcome, Henry.
Operator
Next we will go to Chris Gamaitoni with Compass Point.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Hi, Chris.
Chris Gamaitoni -- Compass Point -- Analyst
Hi everyone. I wanted to clarify one of the guidance points on the all other non-interest income down 5% to 10%. Is that inclusive or exclusive of the DOJ fair value change?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Yes, the DOJ completely excluded from many comments that we've made.
Chris Gamaitoni -- Compass Point -- Analyst
Okay, that's helpful. And then thinking about the HFI growth of 5% to 10% quarter-over-quarter. Is there any thoughts on kind of the composition of that, is that strength in core commercials, is it homebuilder loans, is it greater warehouse balances. Just wondering to kind of get a better understanding of what's going on in the business to drive that?
James K. Ciroli -- Executive Vice President and Chief Financial Officer
In the past quarter you're speaking Q2 --
Kristy W. Fercho -- Executive Vice President and President of Mortgage
Future guidance.
Chris Gamaitoni -- Compass Point -- Analyst
No, the future guidance.
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Yes, I think it's going to be very similar to what we saw in Q2 and honestly that's what you see just about every quarter for Flagstar is that doesn't typically come in any one area. Now Q2 was unique in that we had such a big increase in the warehouse business and there's a lot of reasons for that and we touched it finally on our prepared comments, number one Drew and his team did a really good job of maximizing utilization rates. So jumping on top of the opportunities that presented itself once the rates produced a little bit of boom in the refinance area reacting quickly to overlying requests and things of that nature that allowed us to grow that that business that is really good from the return perspective quickly. But otherwise it's very balanced against CRE and inside of CRE with finance, and then with C&I. And then also the continual growth of our consumer loan book and non-auto indirect performed really well here this year. So I wouldn't expect it to be much different. Drew, do you have any other?
Andrew W. Ottaway -- Executive Vice President, President of Banking
No, I think that's exactly right. I mean I think we have a really good mix of commercial and consumer and warehouse and I think we've been able to take advantage or the advantages presented themselves. In this quarter, we had an out-sized advantage with warehouse that we jumped on and we have a great book even within warehouse over 300 customers. So it's not like a type or concentrated in any one name and frankly the acquisition that we had last year has helped bolster those results. But the C&I is very well diversified in terms of local core businesses and national platforms that we service, CRE very, very much the same thing. And then you can see the continued diversification in the consumer book of business including the non-auto indirect.
Chris Gamaitoni -- Compass Point -- Analyst
Perfect. Thank you so much.
Operator
Our next question will come from Daniel Tamayo with Raymond James.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Good morning.
Daniel Tamayo -- Raymond James -- Analyst
Hey, Good morning guys. So this is kind of a longer-term question on the asset growth. You've obviously had very strong asset growth and deposit growth in the last several years even excluding the Well's branches. I think you've talked in the past about kind of a $3 billion to $5 billion number over two to three years on an organic basis? Is that still something you think is achievable going forward here or how do you think -- how are you thinking about kind of long-term balance sheet growth now?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Well, growing the company is important than growing earnings per share. But I think that we're at today given capital levels and the growth that we have achieved, we've got to be careful that the growth that we have going forward is meeting higher return levels. And so we're very, very focused on that and the opportunities are going to be there because we have lots of good people that have come to work at Flagstar and have great relationships not only here in Southeast Michigan, but across the country. And so we know that we're going to get the opportunity. What we don't know is whether the opportunities will produce a return that will be satisfactory to support the use of our capital. So we're probably going to be a little bit more cautious about that going forward, but only because of capital levels. But as we've done in the past, we will take advantage of the opportunities that present themselves to us and we'll execute on them in a positive way.
Daniel Tamayo -- Raymond James -- Analyst
And then how does the kind of help for investment loan to deposit ratio which has crept over 80% here factor into that or is capital still the kind of defining threshold for how you're thinking about loan growth?
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Well, yeah, I think capital is defining threshold not to say that HFI or the ratio that you approved to is not considered, but clearly I think capital. Jim, would you agree.
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Yeah, and I think Sandro said it well, it's not that we ignore those modified loan in deposit ratio where we cognizant of what our runway is from a liquidity standpoint, but as we look at it right now, we've invested the capital that we have and improving the outlook and the stability of the company now have the ability to buy back stock. We initiated a dividend earlier this year. So we have the capital management tools that enable us, if we don't like the returns that we're seeing what's presented to us, we can always sit back on the capital and maybe even buy some of it back if we think that's the right thing to do. So we've got more tools available to us to manage that return on equity mix as we go-forward.
Daniel Tamayo -- Raymond James -- Analyst
That it. I appreciate it guys. Thank you.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
You're welcome.
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Thanks, Daniel.
Operator
And we do have a follow-up from Kevin Barker with Piper Jaffray.
Kevin Barker -- Piper Jaffray -- Analyst
My question has been answered, thank you.
Alessandro P. DiNello -- President, Chief Executive Officer and Director
Thanks, Kevin.
Operator
Thank you. And now I'll turn it back to Mr. Sandro DiNello for any additional or closing comments.
Sandro DiNello -- President and Chief Executive Officer
Thanks, Paula. All said, it was a good quarter with solid contributions across the board from retail banking, commercial, and mortgage including servicing, they all came through with strong results. And this quarter in particular, we completed payoff of our acquisitions, Wells Fargo and DCB and the deposits that efficiently funded our loan growth, focus on a strong performance of our retail mortgage channel, and Santander and the huge upswing in warehouse lending, plus the new businesses we started such as our indirect non-auto lending are emerging as important contributors. And you put it all together, you get the profile of a unique bank with many diverse pieces that work together and complement each other to deliver consistent earnings and long-term growth and shareholder value.
In closing, thanks again to the Flagstar family for your outstanding performance. Thanks to our shareholders for your support. And thank you again for taking the time to listen in today. I look forward to reporting third quarter results in October.
Operator
[Operator Closing Remarks]
Duration: 58 minutes
Call participants:
Kenneth Schellenberg -- Vice President of Investor Relations
Alessandro P. DiNello -- President, Chief Executive Officer and Director
James K. Ciroli -- Executive Vice President and Chief Financial Officer
Lee Matthew Smith -- Executive Vice President and Chief Operating Officer
Kristy W. Fercho -- Executive Vice President and President of Mortgage
Andrew W. Ottaway -- Executive Vice President, President of Banking
Sandro DiNello -- President and Chief Executive Officer
Scott Siefers -- Sandler O'Neill -- Analyst
Bose George -- KBW -- Analyst
Steve Moss -- B. Riley FBR -- Analyst
Kevin Barker -- Piper Jaffray -- Analyst
Henry Coffey -- Wedbush Securities -- Analyst
Chris Gamaitoni -- Compass Point -- Analyst
Daniel Tamayo -- Raymond James -- Analyst
