Best known as a mortgage lender, Flagstar Bancorp Inc. in Troy, Mich., is trying to make a bigger name for itself in retail banking.
The $15 billion-asset Flagstar is planning to open dozens of branches over the next four years in Michigan, Indiana, and its newest market, suburban Atlanta. Its chief executive said the additional branches would help lower its high cost of funds, generate more fee income, and, ultimately, bring more stability to its earnings.
"Mortgage banking by its very nature is cyclical," said Mark T. Hammond, Flagstar's president and CEO. "Retail banking provides slow and steady growth in earnings."
Seven of Flagstar's 144 branches opened this year, including one that opened Thursday in Dearborn Heights, Mich. It plans to open nine more by Dec. 31 and nearly 100 more by the end of 2010, Mr. Hammond said in an interview last week.
Earnings at Flagstar, a nationwide lender that originated $28 billion of mortgages in 2005, have fluctuated wildly in recent years. In 2003 it earned more than $257 million and had a staggering 38.96% return on equity. Last year it earned just under $85 million, with an ROE of less than 10%, and it is on a similar pace this year, according to Federal Deposit Insurance Corp. data.
Even in its most profitable years, Flagstar had significantly higher cost of funds than its peers. That's because it has historically had a heavy reliance on certificates of deposit and brokered deposits to fund its mortgages, most of which it sells on the secondary market. Its cost of funds over the past five years has averaged 3.83%, versus 2.64% for thrifts with more than $5 billion of assets, according to the FDIC.
It also has historically generated less fee income than its peers and had higher efficiency ratios.
Mr. Hammond said he expects Flagstar's performance to improve as it brings in more core deposits, though he cautioned that returns would not be immediate.
The company's strategy when it opens a branch is to pay up for deposits by as much as 75 basis points in hopes of attracting other banks' customers. Though that can get expensive, Mr. Hammond said it is cheaper than building market share through acquisitions. Flagstar was founded in 1987 and has made just one acquisition, in 1994.
"We'd rather pay 75 basis points more than competition on deposit yields than go out and pay 12% to 14% premium on deposits and book goodwill," Mr. Hammond said. Flagstar also stresses convenience. Drive-through lanes at its branches are open 7:30 a.m. to 7:30 p.m. weekdays.
Mr. Hammond said Flagstar's goal is to have 10% deposit share in each of its markets.
At midyear 2005 it was No. 6 in market share in Michigan, with 5.85% of its deposits, No. 2 in its home county of Oakland, with 14.75%.
Flagstar has more room for growth in areas such as Indianapolis, where its deposit share is just 1.15%, and Georgia, where it opened its first branch outside the Midwest in May 2005. It has opened six branches in the Atlanta area since and now has about $60 million of deposits there, Mr. Hammond said.
When the company decided last year to move into another state, it at first considered Ohio and Illinois but determined they were already heavily banked and were not growing fast enough to support another competitor, Mr. Hammond said.
It chose the Atlanta area for a variety reasons, he said, including "surprisingly good demographics" and the fact that banks there were generally paying 25 basis points less for deposits than competitors in Michigan were paying.
Flagstar had an Atlanta-area regional mortgage office that was performing well, and the company's research found that no banks in neighborhoods it planned to enter had expanded hours, Mr. Hammond said.
Finally, he said, "There were some recent mergers and acquisitions, and that provided some opportunities to pick up some good people and some real estate there."
Paul Miller, an analyst with Friedman, Billings, Ramsey Group Inc. in Arlington, Va., said he would prefer to see Flagstar concentrate on what it does best, making mortgages. He said he understands Flagstar's strategy of stabilizing earnings by building up its retail network, but that he is not sure now is the time to devote its resources to building branches.
"It was really easy for them to open up a branches a couple years ago, because they had a lot of excess earnings they could put to work," Mr. Miller said. "But now it is kind of hard, because they aren't making the same kind of money."
Mr. Hammond, however, said he manages Flagstar for the long term, not quarter to quarter, and that he can do so because his family owns more than 40% of the stock.
Besides, he said, the company is hardly turning its back on its bread-and-butter business.
"Over time more and more of our business is going to come from core banking, but it would be silly to throw away the mortgage business," he said.
