10-K 1 fbc-20161231xform10k.htm 10-K Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-16577
flagstara13a07.jpg
(Exact name of registrant as specified in its charter)
Michigan
 
38-3150651
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
5151 Corporate Drive, Troy, Michigan
 
48098-2639
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (248) 312-2000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.01 per share
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes        No  ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes        No  ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer 
o
 
Accelerated Filer  
x 
 
Non-Accelerated Filer  
o
 
Smaller Reporting Company  
o 
 
(Do not check if a smaller reporting company)   
 
  
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes        No  ý
The estimated aggregate market value of the voting common stock held by non-affiliates of the registrant, computed by reference to the closing sale price ($24.41 per share) as reported on the New York Stock Exchange on June 30, 2016, was approximately $512 million. The registrant does not have any non-voting common equity shares.
As of March 9, 2017, 57,043,565 shares of the registrant’s common stock, $0.01 par value, were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement relating to the 2017 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report on Form 10-K.




 
 
 
 
 
ITEM 1.
ITEM 1A.
ITEM 1B.
ITEM 2.
ITEM 3.
ITEM 4.
 
 
 
 
 
ITEM 5.
ITEM 6.
ITEM 7.
ITEM 7A.
ITEM 8.
ITEM 9.
ITEM 9A.
ITEM 9B.
 
 
 
 
 
ITEM 10.
ITEM 11.
ITEM 12.
ITEM 13.
ITEM 14.
 
 
 
 
 
ITEM 15.
ITEM 16.
FORM 10-K SUMMARY

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GLOSSARY OF ABBREVIATIONS AND ACRONYMS

The following list of abbreviations and acronyms are provided as a tool for the reader and may be used throughout this Report, including the Consolidated Financial Statements and Notes:
Term
 
Definition
 
Term
 
Definition
AFS
 
Available for Sale
 
Ginnie Mae
 
Government National Mortgage Association
Agencies
 
Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and Government National Mortgage Association, Collectively
 
GLBA
 
Gramm-Leach Bliley Act
ALCO
 
Asset Liability Committee
 
HELOC
 
Home Equity Lines of Credit
ALLL
 
Allowance for Loan & Lease Losses
 
HFI
 
Held-for-Investment
AOCI
 
Accumulated Other Comprehensive Income (Loss)
 
HOLA
 
Home Owners Loan Act
ARM
 
Adjustable Rate Mortgage
 
HPI
 
Housing Price Index
ASU
 
Accounting Standards Update
 
HTM
 
Held-to-Maturity
Basel I
 
Basel Committee’s 1988 Capital Accord
 
LIBOR
 
London Interbank Offered Rate
Basel III
 
Basel Committee on Banking Supervision Third Basel Accord
 
LHFI
 
Loans Held-for-Investment
BSA
 
Bank Secrecy Act
 
LHFS
 
Loans Held-for-Sale
C&I
 
Commercial and Industrial
 
LTV
 
Loan-to-Value
CAMELS
 
Capital, Asset Quality, Management, Earnings, Liquidity and Sensitivity
 
Management
 
Flagstar Bancorp’s Management
CD
 
Certificate of Deposit
 
MBIA
 
MBIA Insurance Corporation
CDARS
 
Certificates of Deposit Account Registry Service
 
MBS
 
Mortgage-Backed Securities
CET1
 
Common Equity Tier 1
 
MD&A
 
Management's Discussion and Analysis
CFPB
 
Consumer Financial Protection Bureau
 
MP Thrift
 
MP Thrift Investments, L.P.
CLTV
 
Combined Loan to Value
 
MSR
 
Mortgage Servicing Rights
Common Stock
 
Common Shares
 
N/A
 
Not Applicable
CPR
 
Common Prepayment Rate
 
NASDAQ
 
National Association of Securities Dealers Automated Quotations
CRE
 
Commercial Real Estate
 
NYSE
 
New York Stock Exchange
DFAST
 
Dodd-Frank Stress Test
 
OCC
 
Office of the Comptroller of the Currency
DIF
 
Depositors Insurance Fund
 
OCI
 
Other Comprehensive Income (Loss)
DOJ
 
United States Department of Justice
 
OFHEO
 
Office of Federal Housing Enterprise Oversight
DTA
 
Deferred Tax Asset
 
OTS
 
Office of Thrift Supervision
EVE
 
Economic Value of Equity
 
OTTI
 
Other-Than-Temporary-Impairment
ExLTIP
 
Executive Long-Term Incentive Program
 
QTL
 
Qualified Thrift Lending
Fannie Mae/FNMA
 
Federal National Mortgage Association
 
Regulatory Agencies
 
Board of Governors of the Federal Reserve, Office of the Comptroller of the Currency, U.S. Department of the Treasury, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, Securities and Exchange Commission
FASB
 
Financial Accounting Standards Board
 
RESPA
 
Real Estate Settlement Procedures Act
FBC
 
Flagstar Bancorp
 
RWA
 
Risk Weighted Assets
FDIC
 
Federal Deposit Insurance Corporation
 
SEC
 
Securities and Exchange Commission
FHA
 
Federal Housing Administration
 
TARP
 
Troubled Asset Relief Program
FHLB
 
Federal Home Loan Bank
 
TDR
 
Trouble Debt Restructuring
FICO
 
Fair Isaac Corporation
 
UPB
 
Unpaid Principal Balance
FRB
 
Federal Reserve Bank
 
U.S. Treasury
 
United States Department of Treasury
Freddie Mac
 
Federal Home Loan Mortgage Corporation
 
VIE
 
Variable Interest Entities
FTE
 
Full Time Employees
 
XBRL
 
eXtensible Business Reporting Language
GAAP
 
United States Generally Accepted Accounting Principles
 
 
 
 

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FORWARD-LOOKING STATEMENTS

    
Certain statements in this Form 10-K, including but not limited to statements included within the Management’s Discussion and Analysis of Financial Condition and Results of Operations, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. In addition, Flagstar Bancorp, Inc. may make forward-looking statements in our other documents filed with or furnished to the SEC, and our management may make forward-looking statements orally to analysts, investors, representatives of the media, and others.

Generally, forward-looking statements are not based on historical facts but instead represent management’s beliefs regarding future events. Such statements may be identified by words such as believe, expect, anticipate, intend, plan, estimate, may increase, may fluctuate, and similar expressions or future or conditional verbs such as will, should, would, and could. Such statements are based on management’s current expectations and are subject to risks, uncertainties, and changes in circumstances. Actual results and capital and other financial conditions may differ materially from those included in these statements due to a variety of factors, including and without limitation the precautionary statements included within each individual business’ discussion and analysis of its results of operations and the factors listed and described under "Risk Factors" below.

Any forward-looking statements made by or on behalf of Flagstar Bancorp, Inc. speak only as to the date they are made and do not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made.

    


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PART I

ITEM 1.
BUSINESS

Where we say "we," "us," "our," the "Company" or "Flagstar," we usually mean Flagstar Bancorp, Inc. However, in some cases, a reference to "we," "us," "our," the "Company" or "Flagstar" will include our wholly-owned subsidiary Flagstar Bank, FSB (the "Bank").

General

We are a Michigan-based savings and loan holding company founded in 1993. Our business is primarily conducted through our principal subsidiary, the Bank, a federally chartered stock savings bank founded in 1987. Based on our assets at December 31, 2016, we are one of the largest banks headquartered in Michigan, providing commercial, small business, and consumer banking services. At December 31, 2016, we had 2,886 full-time equivalent employees inclusive of account executives and loan officers. Our common stock is listed on the NYSE under the symbol "FBC." We are considered a controlled company for NYSE purposes, because MP Thrift Investments, L.P. held approximately 62.6 percent of our common stock as of December 31, 2016.

Our banking network emphasizes the delivery of a complete set of banking and mortgage products and services and we distinguish ourselves by crafting specialized solutions for our customers, local delivery, customer service and product pricing. At December 31, 2016, we operated 99 full services banking branches throughout Michigan's major markets where we offer full set of banking products to consumer, commercial, and government customers within those markets.

We have a unique, relationship-based business model of a leading Michigan-based bank leveraging a national mortgage business which, itself, leverages the bank. We believe our strong position and focus on service creates a significant competitive advantage in the markets in which we compete. The disciplined management team we have assembled is focused on developing substantial and attractive growth opportunities that generate profitable operations with significant operating leverage. We believe our lower risk profile and strong capital level positions us to better exploit the opportunities that our business model yields and deliver attractive shareholder returns over the long term.

We are a national mortgage originator and utilize multiple origination channels including correspondent, broker, distributed retail, and direct to consumer. We also service and subservice mortgage loans for others on a fee for service basis and may also collect ancillary fees, such as late fees and earn income through the use of noninterest bearing escrow deposits. These escrow deposit accounts and amounts received from servicing loans generate company controlled deposits which offer a stable, low cost, long-term source of funding.

Operating Segments

Our operations are conducted through four operating segments: Community Banking, Mortgage Originations, Mortgage Servicing, and Other. For financial information and additional details regarding each of these operating segments, please see MD&A – Operating Segments and Note 23 - Segment Information, which are incorporated herein by reference.

Community Banking
Our Community Banking segment, services consumer, governmental and commercial customers in the major Michigan markets we serve. We also serve home builders, correspondents, and commercial customers on a national level. We are focused on using capital and liquidity generated from the mortgage business to expand our community banking relationships and build enduring net interest margin revenue and fee income.
Our commercial customers are from a broad range of industries including financial, insurance, service, manufacturing, and distribution. We offer financial products to these customers for use in their normal business operations and financing of working capital needs, equipment purchases and other capital investments. Additionally, our commercial real estate division supports income producing real estate properties. These loans are made to finance properties such as owner-occupied, retail, office, multi-family apartment buildings, industrial buildings, and residential developments which are repaid through cash flows related to the operation, sale, or refinance of the property.

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In 2016, we launched a national home builder finance program to grow our balance sheet, increase commercial deposits and develop incremental revenue through our retail purchase mortgage channel and we expanded our product offerings by entering the equipment finance and leasing market.
Mortgage Origination
We utilize multiple production channels to originate or acquire mortgage loans on a national scale to generate high returns on equity capital. This helps grow the servicing business and provides stable, low cost funding for the community bank. We continue to leverage technology to streamline the mortgage origination process, thereby bringing service and convenience to borrowers and correspondents. We also continue to make available to our customers various web-based tools that facilitate the mortgage loan process through each of our production channels. We will continue to seek new ways to expand our relationships with borrowers and correspondents to provide the necessary capital and liquidity to grow mortgage servicing and the community bank.

Correspondent. In the correspondent channels, an unaffiliated bank or mortgage company completes the loan paperwork and also funds the loan at closing. After the bank or mortgage company has funded the transaction, we purchase the loan at an agreed upon price. We perform a full review of each loan, whether purchased in bulk or not, purchasing only those loans that were originated in accordance with our underwriting guidelines. Correspondents apply to the Bank and may be approved for delegated underwriting authority. Delegate correspondents assume the risks associated with the underwriting of the loan and earn more on loans sold compared to non-delegated correspondents. Non-delegated correspondents earn commissions and administrative fees for closing and funding loans which are then underwritten by the Bank. We have active correspondent relationships with 739 companies located in all 50 states.

Broker. In a broker transaction, an unaffiliated mortgage broker completes several steps of the loan origination process including the loan paperwork, but the loans are underwritten by us on a loan-level basis to our underwriting standards and we fund and close the loan in the Bank's name, thereby becoming the lender of record. Currently, we have active broker relationships with 615 mortgage brokers located in all 50 states.

Retail. In our retail channel, loans are originated through our nationwide network of stand-alone home loan centers. At December 31, 2016, we maintained 41 retail locations in 21 states. In a direct-to-consumer lending transaction, loans are originated through our Community Banking segment banking centers and from a national direct-to-consumer call center, both of which, may leverage our existing customer relationships. When loans are originated on a retail basis, most aspects of the lending process are completed internally, including the origination documentation (inclusive of customer disclosures), as well as the funding of the transactions. Our centralized loan processing provides efficiencies and allows lending sales staff to focus on business development.

The majority of our total loan originations during the year ended December 31, 2016 represented mortgage loans that were collateralized by residential first mortgages on single-family residences and were eligible for sale to the Agencies. In addition, we originate or purchase residential first mortgage loans, other consumer loans, and commercial loans for our HFI loan portfolios. Our revenues include noninterest income from sales of residential first mortgages to the Agencies, net interest income, and revenue from servicing of loans for others.

Our mortgage origination segment provides us with a large number of customer relationships through our servicing of loans sold to the Agencies and those loans we retain. These relationships, along with our banking customer relationships, provide us an opportunity to cross-sell a full line of consumer financial products which include mortgage refinancing, HELOC, and other consumer loans.

We primarily utilize borrowings from the FHLB to fund our mortgage loans held for sale and our warehouse lending portfolio. The FHLB provides funding on a fully collateralized basis to us. Our borrowing capacity with the FHLB is a function of the amount of eligible collateral pledged, which includes residential first mortgage loans, home equity lines of credit, commercial real estate loans.

Competition

We face substantial competition in attracting deposits and making loans. Our most direct competition for deposits has historically come from other savings banks, commercial banks and credit unions in our local market areas. Money market funds and full-service securities brokerage firms also compete with us for these funds and, in recent years, many financial institutions have competed for deposits through the Internet. We compete for deposits by offering a broad range of high quality customized

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banking services at a large number of convenient locations where our customers are served at a desk rather than in a teller line. We also compete by offering competitive interest rates on our deposit products.

From a lending perspective, there are a large number of institutions offering mortgage loans, consumer loans and commercial loans, including many mortgage lenders that operate on a national scale, as well as local savings banks, commercial banks, and other lenders. With respect to those products that we offer, we compete by offering competitive interest rates, fees, and other loan terms, banking products and services and by offering efficient and rapid service.

Subsidiaries

At December 31, 2016, our corporate legal structure consisted of the Bank and its wholly-owned subsidiaries along with our wholly-owned non-bank subsidiaries and captive insurance company through which we conduct other non-material business or which are inactive. The Bank and its wholly owned subsidiaries comprised 99.5 percent of our total assets at December 31, 2016. Currently, we also own nine statutory trusts that are not consolidated with our operations. For additional information, see Notes 1, 7 and 24 to the Consolidated Financial Statements.

Regulation and Supervision

We, the Bank and the products and services we offer, are subject to regulation under state and federal laws. Regulatory reform and enhanced supervisory requirements have had and could continue to have an impact on how we conduct business. As a result, we continually assess the impact of regulatory changes and implement policies, processes and controls required to comply with new regulations.

Changes in applicable laws or regulations, and in their interpretation and application by regulatory agencies, cannot be predicted and may have a material effect on our business and results. For more information, refer to Item 1A. Risk Factors, herein.

Consent Orders and Supervisory Agreements

Consent Order with OCC.    On December 19, 2016, the OCC terminated its Consent Order with the Bank which had been in effect since October 23, 2012. Since entering into the Consent Order, the Bank implemented and adopted, what we believe are, industry best practices related to, among other things, regulatory compliance, enterprise risk management, capital and liquidity.

Supervisory Agreement. We are also subject to a Supervisory Agreement with the Board of Governors of the Federal Reserve (the "Supervisory Agreement"), dated January 27, 2010. A failure to comply with the Supervisory Agreement could result in the initiation of further enforcement action by the Federal Reserve, including the imposition of further operating restrictions, and could result in additional enforcement actions against the Company. The Company has taken actions which it believes are appropriate to comply with and intends to maintain compliance with all of the requirements of the Supervisory Agreement. For further information and a complete description of all of the terms of the Supervisory Agreement, please refer to the copy of the Supervisory Agreement filed with the SEC as an exhibit to the Company's Current Report on Form 8-K filed on January 28, 2010 and included as an exhibit to this filing.

Consent Order with CFPB. On September 29, 2014, the Bank entered into a Consent Order with the CFPB. The Consent Order relates to alleged violations of federal consumer financial laws arising from the Bank’s residential first mortgage loan loss mitigation practices and default servicing operations dating back to 2011. Under the terms of the Consent Order, the Bank has paid $28 million for borrower remediation and $10 million in civil money penalties. The settlement does not involve any admission of wrongdoing on the part of the Bank or its employees, directors, officers, or agents.

Holding Company Regulation

The Company is a savings and loan holding company regulated by the Board of Governors of the Federal Reserve (the "Federal Reserve") and the SEC.

Acquisition, Activities and Change in Control. We are a unitary savings and loan holding company, as defined by federal banking law, as is our controlling stockholder, MP Thrift. We may only conduct, or acquire control of companies engaged in, activities permissible for a savings and loan holding company pursuant to the relevant provisions of the Savings and Loan Holding Company Act and relevant regulations. Without prior written approval of the Federal Reserve, neither we, nor MP Thrift may: (i) acquire control of another savings association or holding company thereof, or acquire all or substantially

7



all of the assets thereof; or (ii) acquire or retain, with certain exceptions, more than 5 percent of the voting shares of a non-subsidiary savings association or a non-subsidiary savings and loan holding company. We are prohibited from acquiring control of a depository institution that is not federally insured or retaining control of a savings association subsidiary for more than one year after the date that such subsidiary becomes uninsured. Similarly, we may not be acquired by a bank holding company, or any company, unless the Federal Reserve approves such transaction. In addition, the GLBA generally restricts a company from acquiring us if that company is engaged directly or indirectly in activities that are not permissible for a savings and loan holding company or financial holding company.

Limitation on Capital Distributions. Under the Supervisory Agreement, we may not declare or pay any cash dividends or other capital distributions or purchase, repurchase, or redeem, or commit to purchase, repurchase, or redeem any equity stock without the prior written non-objection of the Federal Reserve. The Company does not currently pay dividends on capital stock.

Volcker Rule. The Dodd-Frank Act requires the federal financial regulatory agencies to adopt rules that prohibit banks and affiliates from engaging in proprietary trading and investing in and/or sponsoring certain "covered funds," including hedge funds and private equity funds. The statutory provision is commonly called the "Volcker Rule." Pursuant to the requirements of the Volcker Rule, we have established a standard compliance program based on the size and complexity of our operations.
 
Basel III Capital Requirements. The Bank and the holding company are currently subject to the regulatory capital framework and guidelines reached by Basel III as adopted by the OCC and Federal Reserve. The OCC and Federal Reserve have risk-based capital adequacy guidelines intended to measure capital adequacy with regard to a banking organization’s balance sheet, including off-balance sheet exposures such as unused portions of loan commitments, letters of credit, and recourse arrangements.

The Bank and Bank Holding Company have been subject to the capital requirements of the Basel III rules since January 1, 2015. Basel III replaces the framework established by the 1988 capital accord ("Basel I") of the Basel Committee on Banking Supervision. For additional information, see Note 20 - Regulatory Matters.

Stress Testing Requirements. The U.S. federal banking agencies, including the OCC and the Federal Reserve, issued final rules implementing provisions of the Dodd-Frank Act that require banking organizations, including savings associations and savings and loan holding companies, with total consolidated assets of more than $10 billion but less than $50 billion to conduct annual company-run stress tests, report the results to their primary federal regulator and the Federal Reserve and publish a summary of the results. Each Dodd-Frank Act Stress Test ("DFAST") must be conducted using certain scenarios (baseline, adverse and severely adverse), which the OCC and Federal Reserve will publish by February 15 of each year. Banking organizations are required to use the scenarios to calculate, for each quarter-end within a nine-quarter planning horizon, the impact of such scenarios on revenues, losses, loan loss reserves and regulatory capital levels and ratios, taking into account all relevant exposures and activities. The rules also require each banking organization to establish and maintain a system of controls, oversight and documentation, including policies and procedures, designed to ensure that the DFAST procedures used by the banking organization are effective in meeting the requirements of the rules.

Durbin Amendment. The Durbin Amendment to the Dodd-Frank Act alters the competitive structure of the debit card payment processing industry and caps debit card interchange fees for banks with over $10 billion in assets. The final rule establishes standards for assessing whether debit card interchange fees received by debit card issuers are reasonable and proportional to the costs incurred by issuers for electronic debit transactions. Under the final rule, the maximum permissible interchange fee that an issuer may receive for an electronic debit transaction will be the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. The impact of this amendment was approximately $2 million in for year ended December 31, 2016 and is estimated to be $4 million on an annual basis.

Source of Strength. The Dodd-Frank Act codified the Federal Reserve’s "source of strength" doctrine and extended it to savings and loan holding companies. Under the Dodd-Frank Act, the prudential regulatory agencies are required to promulgate joint rules requiring bank holding companies and savings and loan holding companies to serve as a source of financial strength for any depository institution subsidiary by maintaining the ability to provide financial assistance to such insured depository institution in the event that it suffers financial distress.

Banking Regulation

We must comply with a wide variety of banking, consumer protection and securities laws, regulations and supervisory expectations and are regulated by multiple regulators, including the Office of the Comptroller of the Currency of the U.S. Department of the Treasury, Consumer Financial Protection Bureau, and the Federal Deposit Insurance Corporation.


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FDIC Insurance and Assessment. The FDIC insures the deposits of the Bank and such insurance is backed by the full faith and credit of the U.S. government through the DIF. The FDIC maintains the DIF by assessing each financial institution an insurance premium. The FDIC defined deposit insurance assessment base for an insured depository institution is equal to the average consolidated total assets during the assessment period, minus average tangible equity.

Effective July 1, 2016, the FDIC implemented a new surcharge on large bank participants with more than $10 billion in assets and simultaneously reduced the base assessment rates. The new surcharge and lower assessment are not expected to have a material impact on our earnings.

All FDIC-insured financial institutions must pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation ("FICO bonds"), a federal corporation chartered under the authority of the Federal Housing Finance Board.

Affiliate Transaction Restrictions. The Bank is subject to the affiliate and insider transaction rules applicable to member banks of the Federal Reserve as well as additional limitations imposed by the OCC. These provisions prohibit or limit the Bank from extending credit to, or entering into certain transactions with principal stockholders, directors and executive officers of the banking institution and certain of its affiliates. The Dodd-Frank Act imposed further restrictions on transactions with certain affiliates and extension of credit to executive officers, directors and principal stockholders.

Limitation on Capital Distributions. The OCC regulates all capital distributions made by the Bank, directly or indirectly, to the holding company, including dividend payments. As a subsidiary of a savings and loan holding company, the Bank must file a notice and receive approval from the OCC at least 30 days prior to each proposed capital distribution before declaring any dividends. Additionally, the Bank may not pay dividends to the Bancorp if, after paying those dividends, the Bank would fail to meet the required minimum levels under risk-based capital guidelines and the minimum leverage and tangible capital ratio requirements. Payment of dividends by the Bank also may be restricted at any time at the discretion of the OCC if it deems the payment to constitute an unsafe and unsound banking practice.

Loans to One Borrower. Under the Home Owners Loan Act ("HOLA"), savings associations are generally subject to the national bank limits on loans to one borrower. Generally, savings associations may not make a loan or extend credit to a single or related group of borrowers in excess of 15 percent of the institution’s unimpaired capital and surplus (as defined by HOLA). Additional amounts may be loaned if such loans or extensions of credit are secured by readily-marketable collateral, but in no case may they be in excess of an additional 10 percent of unimpaired capital and surplus. The Bank has established an internal lending threshold that is more conservative than the limits required by HOLA and has a defined tracking and reporting process to monitor lending levels of concentration.

CFPB and Consumer Protection Laws and Regulations

The Bank is subject to a number of federal consumer protection laws and regulations. These include, among others, the Truth in Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Servicemembers Civil Relief Act, the Expedited Funds Availability Act, the Community Reinvestment Act, the Real Estate Settlement Procedures Act, electronic funds transfer laws, redlining laws, predatory lending laws, laws prohibiting unfair, deceptive or abusive acts or practices in connection with the offer, or sale of consumer financial products or    services, and the Gramm Leach Bliley Act regarding customer privacy and data security.
    
In addition to supervision by the OCC, the Bank is also subject to supervision by the CFPB, which has responsibility    for enforcing the principal federal consumer protection laws, such as the Truth in Lending Act, the Equal Credit Opportunity    Act, and Real Estate Settlement Procedures Act, and the Truth in Savings Act, among others, for institutions that have assets in    excess of $10 billion. Much of the CFPB’s regulatory efforts have addressed mortgage standards, mortgage servicing standards,    and appraisal and escrow standards. These laws include the Homeowners Protection Act, the Home Mortgage Disclosure Act,    the Home Ownership and Equity Protection Act, the Secure and Fair Enforcement for Mortgage Licensing Act, and the Real    Estate Settlement Procedures Act.

Incentive Compensation

The U.S. bank regulatory agencies issued comprehensive guidance on incentive compensation policies intended to ensure that the incentive compensation policies of U.S. banks do not undermine the safety and soundness of such banks by encouraging excessive risk-taking. The U.S. bank regulatory agencies review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of U.S. banks that are not "large, complex banking organizations." These

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reviews are tailored to each bank based on the scope and complexity of the bank’s activities and the prevalence of incentive compensation arrangements.

Bank Secrecy Act and Anti-Money Laundering

The Bank is subject to the BSA and other anti-money laundering laws and regulations, including the USA PATRIOT Act. The BSA requires all financial institutions to, among other things, establish a risk-based system of internal controls reasonably designed to prevent money laundering and the financing of terrorism. The BSA includes various record keeping and reporting requirements such as cash transaction and suspicious activity reporting as well as due diligence requirements. The Bank is also required to comply with U.S. Treasury’s Office of Foreign Assets Control imposed economic sanctions that affect transactions with designated foreign countries, nationals, individuals, entities and others.

Additional Information

Our executive offices are located at 5151 Corporate Drive, Troy, Michigan 48098, and our telephone number is (248) 312-2000. Our stock is traded on the NYSE under the symbol "FBC."

We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act available free of charge on our website at www.flagstar.com, under "Investor Relations," as soon as reasonably practicable after we electronically file such material with the SEC. These reports are also available without charge on the SEC website at www.sec.gov.

ITEM 1A. RISK FACTORS

Our financial condition and results of operations may be adversely affected by various factors, many of which are beyond our control. In addition to the factors identified elsewhere in this Report, the most significant risk factors affecting our business include those set forth below. The below description of risk factors is not exhaustive, and readers should not consider the description of such risk factors to be a complete set of all potential risks that could affect us.

Market, Interest Rate, Credit and Liquidity Risk

Economic and general market conditions may adversely affect our business.

Our business and results of operations are affected by the financial markets and general economic market, political uncertainty and social conditions, including factors such as the level and volatility of short-term and long-term interest rates, inflation, home prices, unemployment and under-employment levels, bankruptcies, household income, consumer spending, fluctuations in both debt and equity capital markets and currencies, liquidity of the financial markets, the availability and cost of capital and credit, investor sentiment and confidence in the financial markets, political risks and the sustainability of economic growth. Deterioration of any of these conditions could adversely affect our business segments, the level of credit risk we have assumed, our capital levels and liquidity, and our results of operations.

Our business and results of operations are also affected by domestic and international fiscal and monetary policy. Central bank actions can affect the value of financial instruments and other assets, such as investment securities and MSRs, and their policies can affect our borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in fiscal and monetary policies are beyond our control and difficult to predict but could have an adverse impact on our capital requirements and the costs of running our business.

Further, any deterioration in the mortgage market may also reduce the number of new mortgages that we originate, increase the costs of servicing mortgages without a corresponding increase in servicing fees or adversely affect our ability to sell mortgage loans originated by us. Any such event could adversely affect our business, financial condition and results of operations.

Our mortgage origination business is subject to the cyclical and seasonal trends of the real estate market. Cyclicality in our industry could lead to periods of strong growth in the mortgage and real estate markets followed by periods of sharp declines and losses in such markets. One of the primary influences on our mortgage business is the aggregate demand for mortgage loans in our market areas, which is affected by prevailing interest rates. If we are unable to respond to the cyclicality of our industry by appropriately adjusting our operations, headcount and overhead, our business, financial condition and results of operations could be adversely affected.


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In addition, seasonal trends have historically reflected the general patterns of residential and commercial real estate sales, which typically peak in the spring and summer seasons. Furthermore, Basel III provides for a countercyclical capital buffer to induce banking organizations to hold capital in excess of regulatory minimums.

Increases in interest rates could lead to lower mortgage origination volume, which could adversely affect our business, financial condition and results of operations.

In 2016, approximately 55 percent of our revenue was derived from the origination of residential mortgages. The residential real estate mortgage lending business is sensitive to interest rates. Lower interest rates generally increase the volume of mortgage originations, while higher interest rates generally cause that volume to decrease. Therefore, our mortgage performance is typically correlated to fluctuations in interest rates. Historically, mortgage origination volumes and sales for the Bank and for other financial institutions have risen and fallen in response to these and other factors. An increase in interest rates would change these conditions and could have a material adverse effect on our operating results. From January through October 2016, average 10 year treasury rates, on which we base our pricing of our 30 year mortgages, remained low at 1.74 percent, 40 basis points lower than average rates experienced throughout 2015 which drove favorable mortgage loan originations, particularly refinancing activity. From November through December 2016, average 10 year treasury rates increased 58 basis points to 2.32 percent which had a negative impact on our fallout adjusted mortgage origination rate lock volume in the fourth quarter.

Changes in interest rates could adversely affect our financial condition and results of operations including our net interest margin, mortgage related assets, and investment portfolio.

Our results of operations and financial condition could be significantly affected by changes in interest rates. Our financial results depend substantially on net interest income, which is the difference between the interest income that we earn on interest-earning assets and the interest expense we pay on interest-bearing liabilities. While we have modeled rising interest rate scenarios and such scenarios result in an increase in our net interest income, our deposits and interest-bearing liabilities may reprice more quickly than modeled, thus resulting in a decrease in our net interest income.

Changes in interest rates may affect the average life of our mortgage loans and mortgage related securities. Decreases in interest rates can trigger an increase in unscheduled prepayments of our mortgage loans and mortgage-related securities, as borrowers refinance to reduce their own borrowing costs. As prepayment speeds on mortgage-related securities increase, any premium amortization would increase on a prospective basis. Any immediate adjustments required under the application of the interest method of income recognition may also result in lower net interest income. On the other hand, increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate mortgage loans.

Changes in interest rates also affect the fair value of our LHFS, LHFI and investment securities. Generally, the value of our investment securities, which are predominantly fixed-rate, fluctuates inversely with changes in interest rates. Decreases in the fair value of our investment securities, therefore, could have an adverse effect on our stockholders’ equity or our earnings if the decrease in fair value is deemed to be other than temporary.

The fair value of our MSRs is highly sensitive to changes in interest rates and changes in market implied interest rate volatility. Decreases in interest rates can trigger an increase in actual repayments and the probability of repayments which have a negative impact on MSR fair value. An increase in market implied interest rate volatility has a negative impact on our MSR assets and also lowers their fair value.

We manage MSRs using certain derivative strategies which may be ineffective.

We invest in MSRs to support mortgage strategies and to deploy capital at acceptable returns. Our MSRs are sensitive to market implied interest rate volatility and are highly susceptible to prepayment risk, basis risk, and changes in the shape of the yield curve, among other factors. We utilize derivatives and other fair value assets as part of our overall hedging strategy to manage the impact of changes in the fair value of the MSRs, but these risk management strategies do not completely eliminate risk. In addition, our hedging strategies rely on assumptions and projections regarding assets and general market factors, many of which are outside of our control. One or more of these assumptions or projections may prove to be incorrect or our hedging strategies may not adequately mitigate the impact of changes in interest rates or prepayment speeds, and as a result we may incur losses that would adversely impact earnings.


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At December 31, 2016, our MSR was $335 million of Common Equity Tier 1 Capital. We may be unable to effectively manage our MSR concentration risk which could impact our Common Equity Tier 1(CET1) under Basel III, which when fully phased-in will require any MSR balance exceeding 10 percent of our CET1 to be deducted from capital.

As of January 1, 2015, we are subject to new rules relating to capital standards requirements, including requirements contemplated by Section 171 of the Dodd-Frank Act as well as certain standards initially adopted by the Basel Committee on Banking Supervision, which standards are commonly referred to as Basel III. Basel III established a new qualifying criteria for regulatory capital, including new limitations on the amount of deferred tax assets and MSRs that may be held without significantly higher capital requirements. Basel III limits that amount of MSRs and deferred tax assets to 10 percent of CET1, individually, and 15 percent of CET1, in the aggregate. While we have established a plan to reduce these assets before the Basel III full implementation date of March 31, 2018 and are taking other actions to reduce our book balance by that date, no assurances can be given that we will be able to do so, or that we will be successful in selling these assets at their current fair value. If implemented today, we would experience another 201 basis points reduction in Tier 1 Capital (to risk weighted assets) and 105 basis points reduction in the leverage ratio (Tier 1 Capital to adjusted average assets) from those levels at December 31, 2016. For further information, see Note 20 - Regulatory Matters.

At December 31, 2016 our ALLL was $142 million, covering 2.4 percent of total loans held-for-investment. Our estimate of the inherent losses is imperfect, the portfolio is relatively new and we are using underwriting standards which have not been in place for a long period of time.

Our estimate of the allowance for loan and lease losses may not be adequate to cover actual credit losses inherent in the loan portfolio at December 31, 2016. If this level were insufficient, future provisions for credit losses could adversely affect our business, financial condition, results of operations, cash flows and prospects. Our ALLL is based on prior experience as well as an evaluation of the risks incurred in the current portfolio. The determination of an appropriate level of loan loss allowance is an inherently subjective process that requires significant management judgment, including estimates of loss and the loss emergence period. We make various assumptions, estimates and judgments about the collectability of our loan portfolio including but not limited to the creditworthiness of our borrowers and the value of real estate or other collateral backing the repayment of loans. New information regarding existing loans, identification of additional problem loans, failure of borrowers and guarantors to perform in accordance with the terms of their loans, and other factors, both within and outside of our control, may require an increase in the ALLL. Moreover, our regulators, as part of their supervisory function, periodically review our ALLL. Our regulators, who have access to broader industry data that we do not have, may recommend or require us to change our ALLL, based on their judgment, which may be different from that of our management or other regulators. Any increase in our loan losses would have an adverse effect on our earnings and financial condition.

Concentration of loans held-for-investment in certain geographic locations and portfolios may increase risk.

Our mortgage loan portfolio is geographically concentrated in certain states, including California, Michigan, Florida, Washington and Texas, which is approximately 65 percent of the portfolio. In addition, approximately 75 percent of our commercial real estate loans are in Michigan or are repayable by borrowers who have significant operations in Michigan. This concentration has made, and will continue to make, our loan portfolio particularly susceptible to downturns in the general economy and the real estate and mortgage markets. Adverse conditions beyond our control, including unemployment, inflation, recession, natural disasters, declining property values, municipal bankruptcies and other factors in these markets could increase default rates in our loan portfolio and could reduce our ability to generate new loans and otherwise negatively affect our financial results.

In 2016, we continued to grow our portfolio of commercial real estate and commercial and industrial loans, which generally expose us to a greater risk of nonpayment and loss than residential real estate loans due to the more complex nature of underwriting associated with commercial loans. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans and collateral may not offset the principal balance at default. Also, many of our borrowers have more than one commercial loan outstanding. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a residential real estate loan.

Liquidity is essential to our business and liquidity risk is inherent in our operations, which could adversely affect our financial results and condition.

We require substantial liquidity to repay our customers' deposits, fulfill loan demands, meet debt obligations as they come due, and fund our operations under both normal operating environments and unforeseen circumstances causing liquidity

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stress. Our access to liquidity could be impaired by our inability to access the capital markets or unforeseen outflows of deposits. Our access to external sources of financing, including deposits, as well as the cost of that financing, is dependent on various factors including regulatory restrictions. A number of factors could make funding more difficult, more expensive or unavailable on any terms, including, but not limited to, declining financial results and losses, material changes to operating margins, financial leverage on an absolute basis or relative to peers, changes within the organization, specific events that impact our financial condition or reputation, disruptions in the capital markets, specific events that adversely impact the financial services industry, counterparty availability, changes affecting assets, the corporate and regulatory structure, balance sheet and capital structure, geographic and business diversification, interest rate fluctuations, market share and competitive position, general economic conditions and the legal, regulatory, accounting and tax environments governing funding transactions. Many of these factors are beyond our control. The material deterioration in any one or a combination of these factors could result in a downgrade of our credit or servicer standing with counterparties or a decline in our reputation within the marketplace, and could result in higher cash outflows requiring additional access to liquidity, having a limited ability to borrow funds, maintain or increase deposits (including custodial deposits for our agency servicing portfolio) or to raise capital on commercially reasonable terms or at all.

Our ability to make mortgage loans and fund our investments and operations depends largely on our ability to secure funds on terms acceptable to us. Our primary sources of funds to meet our financing needs include loan sales, deposits, which include custodial accounts from our servicing portfolio, public funds, and capital-raising activities. Our company controlled deposits are considered stable sources of funding in our stress testing model. If we are unable to maintain any of these financing arrangements, are restricted from accessing certain funding sources by our regulators, are unable to arrange for new financing on terms acceptable to us or at all, or if we default on any of the covenants imposed upon us by our borrowing facilities, then we may have to reduce the number of mortgage loans we are able to originate for sale in the secondary market or for our own investment or take other actions that could have other negative effects on our operations. A prolonged significant reduction in loan originations that occurs as a result could adversely impact our earnings, financial condition, results of operations and future prospects. There is no guarantee that we will be able to renew or maintain our financing arrangements or deposits or that we will be able to adequately access capital markets when or if a need for additional capital arises.
    
We use assumptions and estimates in determining the fair value of certain of our financial assets and financial liabilities. Different assumptions and estimates could result in significant declines or increases in valuation.

A total of $5.2 billion of assets and $118 million of liabilities are carried on our Consolidated Statements of Financial Condition at fair value, including our LHFS, AFS investment securities, MSRs, derivatives, certain LHFI, and the DOJ settlement liability. Generally, for assets that are reported at fair value, we use quoted market prices when available. In certain cases, observable market prices and data may not be readily available or their availability may be diminished due to market conditions. In such cases, we use internally developed financial models that utilize observable market data inputs as well as asset specific collateral data included in market observable data to estimate the fair value of certain of these assets and liabilities. These valuation models rely to some degree on management's assumptions, estimates and judgment, which are inherently uncertain. We cannot be certain that the models or the underlying assumptions will prove to be predictive and remain so over time, and therefore, actual results may differ from our models and assumptions. Different assumptions could result in significant differences in valuation, which in turn could result in significant changes in the dollar amount of assets or liabilities we report on our Consolidated Statements of Financial Condition. In addition, sudden illiquidity in markets or declines in prices of certain loans or securities may make it more difficult to value certain balance sheet items, which may lead to the possibility that such valuations will be subject to further change or adjustment. If assumptions or estimates underlying our Consolidated Statements of Financial Condition are inaccurate, we may experience material losses.

We are a holding company and are, therefore, dependent on the Bank for funding of obligations.

As a holding company with no significant assets other than the capital stock of the Bank and a limited amount of cash, our ability to make payments for certain services we purchase from the Bank and to service our debt, including interest payments on our senior notes and junior subordinated debentures depends upon available cash on hand and the receipt of dividends from the Bank on such capital stock. The holding company had cash and cash equivalents of $70 million at December 31, 2016. The declaration and payment of dividends by the Bank on all classes of its capital stock is subject to the discretion of the Bank's board of directors and to applicable regulatory and legal limitations. If the Bank does not make dividend payments to us, we may not be able to service our debt which could have a material adverse effect on our financial condition and results of operations.


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Regulatory Risk

The Holding Company and the Bank remain subject to the restrictions and conditions of the Supervisory Agreement with the Federal Reserve and the Consent Order with the CFPB, respectively. Failure to comply with the Supervisory Agreement could result in further enforcement action against us.

There is no guarantee that the Bank will be able to fully comply with the Consent Order. In the event that we are in material non-compliance with the terms of the Consent Order, the CFPB has the authority to subject the Bank to additional    corrective actions. Moreover, they could initiate further enforcement actions against the Bank, seek an injunction requiring the    Bank and its officers and directors to comply with the Consent Order and seek civil money penalties against us and our officers    and directors. Any failure by the Bank to comply with the terms of the Consent Order or additional actions could adversely    affect our business, financial condition and results of operations. In addition, the Bank’s competitors may not be subject to    similar actions, which could limit our ability to compete effectively. These corrective actions could negatively impact the    Bank's operations and financial performance. For further information on Consent Order see Item 1. Business - Regulation and    Supervision.

The Supervisory Agreement, requires that we take certain actions to address issues identified by the OTS. The Supervisory Agreement is enforced by the Federal Reserve as the successor regulator to the OTS with respect to savings and loan holding companies. Under the terms of the agreement, we are required to submit a capital plan; receive written non-objection before declaring or paying any dividend or other capital distribution from the Holding Company, incurring or renewing any debt at the Holding Company and engaging in affiliate transactions (with limited exceptions); comply with applicable regulatory requirements before making certain severance and indemnification payments; and provide notice prior to changes in directors and certain executive officers or entering into, renewing, extending or revising compensation or benefits agreements of such directors or executive officers, with such changes being subject to Federal Reserve approval. While we believe that we have taken all action necessary to comply with the requirements of the Supervisory Agreement, failure to comply with the Supervisory Agreement in the time frames provided, or at all, could result in additional enforcement orders or penalties, which could include further restrictions on us, assessment of civil money penalties on us, as well as our directors, officers and other affiliated parties and removal of one or more officers and/or directors. Any failure by us to comply with the terms of the Supervisory Agreement or additional actions by the Federal Reserve could adversely affect our business, financial condition and results of operations. Moreover, our competitors may not be subject to similar actions, which could limit our ability to compete effectively. For further information on Supervisory Agreement see Item 1. Business - Regulation and Supervision.

Expanded regulatory oversight over our business could significantly increase our risks and costs associated with complying with current and future regulations, which could adversely affect our financial condition and results of operations.

As noted in Item 1 - Business - Regulation and Supervision, we are subject to a wide variety of banking, consumer protection and securities laws, regulations and supervisory expectations and numerous regulatory and enforcement authorities. As a result of and in addition to new legislation aimed at regulatory reform, such as the Dodd-Frank Act, and the increased capital requirements introduced by the Basel III final rules, the regulatory agencies generally are taking a more stringent approach to supervising and regulating financial institutions and financial products and services over which they exercise their respective supervisory authorities. We, the Bank, and our products and services all remain subject to greater supervisory scrutiny and enhanced supervisory requirements and expectations. We may face greater supervisory scrutiny and enhanced supervisory requirements in the foreseeable future.

The Collins Amendment to Dodd-Frank Act establishes minimum Tier 1 leverage and risk-based capital requirements for insured depository institutions, depository institution holding companies, and non-bank financial companies that are supervised by the Federal Reserve. The minimum Tier 1 leverage and risk-based capital requirements are determined by the minimum ratios established by the federal banking agencies that apply to insured depository institutions under the prompt corrective action regulations. The amendment states that certain hybrid securities, such as trust preferred securities, may be included in Tier 1 capital for bank holding companies with total assets below $15 billion as of December 31, 2009. As we were below $15 billion in assets as of December 31, 2009, the trust preferred securities will be included as Tier 1 capital while they are outstanding, subject to certain future limitations. If a depository institution holding company under $15 billion acquires a depository institution holding company and the resulting organization has total consolidated assets of $15 billion or more at the end of the quarter in which the transaction occurred, the resulting organization may no longer include such certain hybrid securities in Tier 1 capital.


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As a result of increasing scrutiny and regulation of the banking industry and consumer practices, we may face a greater number or wider scope of examinations, investigations, enforcement actions and litigation, thereby increasing our costs associated with responding to or defending such actions, as well as potentially resulting in costs associated with fines, penalties, settlements or judgments. In addition, increased regulatory inquiries and investigations, as well as any additional legislative or regulatory developments affecting our businesses, and any required changes resulting from these developments, could reduce our revenue, limit the products or services that we offer or increase the costs thereof, impose additional compliance costs, harm our reputation or otherwise adversely affect our businesses. Some of these laws may provide a private right of action that a consumer or class of consumers may seek to pursue to enforce these laws and regulations.

Both the OCC and the FDIC may take regulatory enforcement actions against any of their regulated institutions that do not operate in accordance with applicable regulations, policies and directives. Proceedings may be instituted against any banking institution, or any "institution-affiliated party," such as a director, officer, employee, agent or controlling person, who engages in unsafe and unsound practices, including violations of applicable laws and regulations. The OCC has authority under various circumstances to appoint a receiver or conservator for an insured institution that it regulates, to issue cease and desist orders, to obtain injunctions restraining or prohibiting unsafe or unsound practices, to revalue assets and to require the establishment of reserves. The FDIC has additional authority to terminate insurance of accounts, after notice and hearing, upon a finding that the insured institution is or has engaged in any unsafe or unsound practice that has not been corrected, is operating in an unsafe or unsound condition or has violated any applicable law, regulation, rule, or order of, or condition imposed by, the FDIC. In addition, the Federal Reserve may take regulatory enforcement actions against us, and the CFPB may also have the authority to take regulatory enforcement actions against us or the Bank.

Financial services reform legislation has resulted in, among other things, numerous restrictions and requirements which could negatively impact our business and increase our costs of operations.

The Dodd-Frank Act has significantly changed the bank regulatory structure and affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act and its' implemented regulations have increased and may continue to increase our operating and compliance costs and our interest expense.

The CFPB has broad and unique rulemaking authority to administer and carry out the provisions of the Dodd-Frank Act with respect to financial institutions that offer covered financial products and services to consumers, including prohibitions against unfair, deceptive or abusive practices in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service including regulations related to the origination and servicing of residential mortgages. The CFPB has finalized significant rules and guidance that impact nearly every aspect of the life cycle of a residential mortgage and continues to revise these rules and propose new rules. The Bank is subject to the CFPB’s supervisory, examination and enforcement authority with respect to consumer protection laws and regulations. As a result, we could incur increased costs, potential litigation or be materially limited or restricted in our business, product offerings or services in the future.

The Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending practices on financial institutions. The Department of Justice, CFPB, and other agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution's performance under fair lending laws in class action litigation. A successful challenge to the Bank's performance under the fair lending laws and regulations could adversely impact the Bank's rating under the Community Reinvestment Act and result in a wide variety of sanctions or penalties, which could negatively impact the Bank's reputation, financial condition and results of operations.

Bank regulators have increased their focus on consumer compliance and, as a result, those portions of our lending operations which most directly deal with consumers, in particular our mortgage operations and consumer lending, pose particular challenges. While we are not aware of any material issues with our compliance, mortgage and consumer lending practices raise compliance risks. Despite the supervision and oversight we exercise in these areas, failure to comply with these regulations could result in the Bank being liable for damages to individual borrowers or other imposed penalties.

Compliance obligations have exposed us and will continue to expose us to additional noncompliance risk and could divert management’s focus from our business operations. Furthermore, the combined effect of numerous rulemakings by multiple governmental agencies and regulators, and the potential conflicts or inconsistencies among such rules, present challenges and risks to our business and operations.    


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We are highly dependent on the Agencies to sell mortgage loans and any changes in these entities or their current roles could adversely affect our business, financial condition and results of operations.

We sell approximately 70 percent of our mortgage loans to Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac remain in conservatorship and a path forward to emerge from conservatorship is unclear. These roles could be reduced, modified or eliminated and the nature of their guarantees could be limited or eliminated relative to historical measurements.

The elimination or modification of the traditional roles of Fannie Mae or Freddie Mac could significantly and adversely affect our business, financial condition and results of operations. Furthermore, any discontinuation of, or significant reduction in, the operation of these agencies, any significant adverse change in the level of activity of these agencies in the primary or secondary mortgage markets or in the underwriting criteria of these agencies could materially and adversely affect our business, financial condition and results of operations.

Changes in the servicing or origination guidelines required by the Agencies could adversely affect our business, financial condition and results of operations.

We are required to follow specific guidelines that impact the way that we service and originate Agency loans, including guidelines with respect to credit standards for mortgage loans, our staffing levels and other servicing practices, the servicing and ancillary fees that we may charge, our modification standards and procedures and the amount of non-reimbursable advances.

We cannot negotiate these terms with the Agencies and they are subject to change at any time. A significant change in these guidelines that has the effect of decreasing the fees we charge or requires us to expend additional resources in providing mortgage services could decrease our revenues or increase our costs, which would adversely affect our business, financial condition and results of operations.

In addition, changes in the nature or extent of the guarantees provided by Fannie Mae and Freddie Mac or the insurance provided by the FHA could also have broad adverse market implications. The fees that we are required to pay to the Agencies for these guarantees have changed significantly over time and any future increases in these fees would adversely affect our business, financial condition and results of operations.

We depend upon having FDIC insurance to raise deposit funding at reasonable rates. Increases in deposit insurance premiums and special FDIC assessments will adversely affect our earnings.

The Dodd-Frank Act required the FDIC to substantially revise its regulations for determining the amount of an institution's deposit insurance premiums. The FDIC has defined the deposit insurance assessment base for an insured depository institution as average consolidated total assets during the assessment period, minus average tangible equity. Our assessment rate is determined by use of a scorecard that combines a financial institution's CAMELS ratings with certain other financial information. The FDIC may determine that we present a higher risk to the DIF than other banks due to certain factors. These factors include significant risks relating to interest rates, loan portfolio and geographic concentration, concentration of high credit risk loans, increased loan losses, regulatory compliance (including under existing Supervisory Agreement), existing and future litigation and other factors. As a result, we could be subject to higher deposit insurance premiums and special assessments in the future that could adversely affect our earnings. The Bank’s deposit insurance premiums and special assessments in the future also may be higher than competing banks may be required to pay. Our total exposure related to uninsured deposits over $250,000 was approximately $2 billion as of December 31, 2016. These balances could experience a higher propensity to reprice should rates rise or the Bank's financial condition deteriorate.

Operational Risk

A failure of our information technology systems, or those of our key third party vendors or service providers, could cause operational losses and damage our reputation.

Our businesses are increasingly dependent on our ability to process, record and monitor a large number of complex transactions and data. If our internal financial, accounting, or other information technology systems fail, we may be unable to conduct business for a period of time, which may impact our financial results if that interruption is sustained. In addition, our reputation with our customers or counterparties may suffer, which could have a further, long-term impact on our financial results.


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Also, because we conduct part of our business over the Internet and outsource a significant number of our critical functions to third parties, our operations depend on our third-party service providers to maintain and operate their own technology systems. To the extent these third parties’ systems fail, we may be unable to conduct business or provide certain services, and we may face financial and reputational losses as a result.

We collect, store and transfer our customers’ personally identifiable information, and any compromise to the security of that information may have meaningful consequences for us.

Data breaches are of a particular concern relative to the processing of consumer transactions, such as the servicing or subservicing of loans. Our businesses receive, transmit and store a large volume of personally identifiable information and other user data. There are myriad federal, state and international laws regarding privacy and the storing, sharing, use, disclosure and protection of personally identifiable information and user data.

We have policies and processes in place that are intended to meet the requirements of those laws, including security systems in place to prevent unauthorized access to that information. Nevertheless, those processes and systems may be inadequate. Also, to the extent we rely upon third parties to handle personally identifiable data on our behalf, we may be responsible if such data is compromised while in the custody and control of those third parties.

Privacy laws are still evolving and many state and local jurisdictions have laws that differ from federal law. At times, we may also be governed by privacy laws outside of the U.S., with which we are less familiar. If we fail to comply with applicable privacy policies or federal, state, local or international laws and regulations or any compromise of security that results in the unauthorized release of personally identifiable information or other user data, those events could damage the reputation of our business, and discourage potential users from utilizing our products and services. In addition, we may have to bear the cost of mitigating identity theft concerns, and may be subject to fines or legal proceedings by governmental agencies or consumers. Any of these events could adversely affect our business, financial condition and results of operations.

We may be terminated as a servicer or subservicer or incur costs, liabilities, fines and other sanctions if we fail to satisfy our servicing obligations, including our obligations with respect to mortgage loan foreclosure actions.

We act as servicer and subservicer for mortgage loans owned by third parties, which is approximately 10 percent of our revenue and results in approximately $1.6 billion of our average company controlled deposits. In such capacities for those loans, we have certain contractual obligations, including foreclosing on defaulted mortgage loans or, to the extent applicable, considering alternatives to foreclosure. If we commit a material breach of our obligations as servicer, we may be subject to termination if the breach is not cured within a specified period of time following notice, causing us to lose servicing income.

For certain investors and/or certain transactions, we may be contractually obligated to repurchase a mortgage loan or reimburse the investor for credit or other losses incurred on the loan as a remedy for servicing errors with respect to the loan. If we have increased repurchase obligations because of claims for which we did not satisfy our obligations, or increased loss severity on such repurchases, we may have a significant reduction to noninterest income or increase to noninterest expense. We may incur significant costs if we are required to, or if we elect to, re-execute or re-file documents or take other action in our capacity as a servicer in connection with pending or completed foreclosures. We may incur litigation costs if the validity of a foreclosure action is challenged by a borrower. If a court were to overturn a foreclosure because of errors or deficiencies in the foreclosure process, we may have liability to the borrower and/or to any title insurer of the property sold in foreclosure if the required process was not followed. These costs and liabilities may not be legally or otherwise reimbursable to us.

We may be required to repurchase mortgage loans, pay fees or indemnify buyers against losses in some circumstances, which could harm liquidity, results of operations and financial condition.

When mortgage loans are sold by us, we make customary representations and warranties to purchasers, guarantors and insurers, including the Agencies, about the mortgage loans, and the manner in which they were originated. We have made, and will continue to make, such representations and warranties in connection with the sale of loans. Whole loan sale agreements require us to repurchase or substitute mortgage loans, or indemnify buyers against losses, in the event we breach these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of early payment default of the borrower or we may be required to pay fees. We also are subject to litigation relating to these representations and warranties and the costs of such litigation may be significant. With respect to loans that are originated through our broker or correspondent channels, the remedies we have available against the originating broker or correspondent, if any, may not be as broad as the remedies available to purchasers, guarantors and insurers of mortgage loans against us. In addition, we also face further risk that the originating broker or correspondent, if any, may not have the financial capacity to perform remedies that

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otherwise may be available. Therefore, if a purchaser, guarantor or insurer enforces its remedies against us, we may not be able to recover losses from the originating broker or correspondent. If repurchase and indemnity demands increase and such demands are valid claims, the liquidity, results of operations and financial condition may also be adversely affected.

Our representation and warranty reserve for losses at December 31, 2016 is $27 million. This may not be adequate to cover losses for loans that we have sold or securitized into the secondary market which we may be subsequently required to repurchase, pay fines or fees, or indemnify purchasers and insurers because of violations of customary representations and warranties. The repurchase demand pipeline was $6 million at December 31, 2016. The original unpaid principal balance of 2009 and later vintage loans sold to the Agencies through December 31, 2016 was $183 million.

In addition, our regulators, as part of their supervisory function, periodically review our representation and warranty reserve for losses. Our regulators, based on their judgment, may recommend or require us to increase our reserve. Any increase in our loan losses could have an adverse effect on our earnings and financial condition.

We utilize third party mortgage originators which subjects us to strategic, reputation, compliance and operational risk.

Approximately 94 percent of our residential first mortgage volume depends upon the use of third party mortgage originators, i.e. mortgage brokers and correspondent lenders, who are not our employees. These third parties originate mortgages and provide services to many different banks and other entities. Accordingly, they may have relationships with or loyalties to such banks and other parties that are different from those they have with or to us. Failure to maintain good relations with such third party mortgage originators could have a negative impact on our market share which would negatively impact our net income.

We rely on third party mortgage originators to originate and document the mortgage loans we purchase. While we perform due diligence on the mortgage companies with whom we do business and review the loan files and loan documents we purchase to attempt to detect any irregularities or legal noncompliance, we have less control over these originators than employees of the Bank.

Due to increasing regulatory scrutiny, our third party mortgage originators could choose or be required to either reduce the scope of their business or exit the mortgage origination business altogether. The TILA-RESPA Integrated Disclosure Rule issued by the CFPB establishes comprehensive mortgage disclosure requirements for lenders and settlement agents in connection with most closed-end consumer credit transactions secured by real property. The rule requires certain disclosures are provided to consumers in connection with applying for and closing on a mortgage loan. The rule also mandates the use of specific disclosure forms, timing of communicating information to borrowers and certain record keeping requirements. The increased administrative burden and the system requirements associated with complying with these rules could lead to a decrease in our mortgage volume.

The Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending practices on financial institutions. This regulation applies to lending operations which deal directly with consumer lending. Mortgage and consumer lending practices raise compliance risks resulting from the detailed and complex nature of mortgage and consumer lending regulations imposed by federal regulatory agencies, and the relatively independent and diverse operating channels in which loans are originated. We, and our brokers, are required to apply fair lending and ensure lending practices do not result in a disparate impact to borrowers across various locations. Failure to comply with these regulations, by us or our brokers, could result in the Bank being liable for damages to individual borrowers or other imposed penalties.

Our ability to control the third party mortgage originators could have an adverse impact on our business. In addition, these arrangements with third party mortgage originators and the fees payable by us to such third parties could be subject to additional regulatory scrutiny and restrictions in the future.

We may be subject to corporate tax reform which could impact our net income and effective tax rate.

Congress is evaluating Tax Reform and certain proposals, such as a reduction in the corporate tax rate, which could have a material impact on the Company. If a reduction in rate is enacted we would expect to record a significant charge to expense through our tax provision for the revaluation of our net deferred tax asset. Going forward the reduction in rate may have a favorable impact on our effective tax rate.


18



General Risk Factors

MP Thrift, an entity managed and controlled by MatlinPatterson, owns 62.6 percent of our common stock and has significant influence over us, including control over decisions that require the approval of stockholders, whether or not such decisions are in the best interests of other stockholders.

MP Thrift owns a substantial majority of our outstanding common stock and as a result, has control over our decisions to enter into any corporate transaction and also the ability to prevent any transaction that requires the approval of our board of directors or the stockholders regardless of whether or not other members of our board of directors or stockholders believe that any such transactions are in their own best interests. So long as MP Thrift continues to hold a majority of our outstanding common stock, it will have the ability to control the vote in any election of directors and other matters being voted on, and continue to exert significant influence over us. Furthermore, MP Thrift may have interests that could diverge from the interests of other stockholders, and may use its control to make decisions that adversely affect the interest of other common stockholders and other holders of our debt or other equity instruments.

Additionally, our ability to use our deferred tax assets to offset future taxable income may be significantly limited if we experience an "ownership change" as defined for U.S. federal income tax purposes. An ownership change occurs if, immediately after any owner shift involving a 5 percent shareholder or any equity structure shift (1) the percentage of the stock of the loss corporation, owned by one or more 5 percent shareholders has increased by more than 50 percentage points, over (2) the lowest percentage of stock of the loss corporation owned by such shareholders. Section 382 of the Internal Revenue Code imposes restrictions on the use of a corporation’s net operating losses, certain recognized built-in losses, and other carryovers after an ownership change occurs. As we have a controlling stockholder, any stock offering in isolation or when combined with other ownership changes, could cause us to experience an ownership change and trigger these restrictions.

We are subject to various legal or regulatory investigations and proceedings.

At any given time, we are defending ourselves against a number of legal and regulatory investigations and proceedings. Proceedings or actions brought against us may result in judgments, settlements, fines, penalties, injunctions, business improvement orders, consent orders, supervisory agreements, restrictions on our business activities or other results adverse to us, which could materially and negatively affect our businesses. If such claims and other matters are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services, as well as impact customer demand for those products and services. Some of the laws and regulations to which we are subject may provide a private right of action that a consumer or class of consumers may pursue to enforce these laws and regulations. We have been, and may continue to be in the future, subject to stockholder derivative actions, which could seek significant damages or other relief. Any financial liability or reputational damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations. Claims asserted against us can be highly complicated and slow to develop, making the outcome of such proceedings difficult to predict or estimate early in the process. As a participant in the financial services industry, it is likely that we will be exposed to a high level of litigation and regulatory scrutiny and investigations relating to our business and operations.

Although we establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated, we do not have accruals for all legal proceedings where we face a risk of loss. Due to the inherent subjectivity of the assessments and unpredictability of the outcome of legal and regulatory proceedings, amounts accrued may not represent the ultimate loss to us from the legal and regulatory proceedings in question. As a result, our ultimate losses may be significantly higher than the amounts accrued for legal loss contingencies.

For further information regarding the unpredictability of legal proceedings and description regarding our pending legal proceedings see, Note 21 - Legal Proceedings, Contingencies and Commitments.

Other Risk Factors

The above description of risk factors is not exhaustive. Other risk factors are described elsewhere herein as well as in other reports and documents that we file with or furnish to the SEC. Other factors that could also cause results to differ from our expectations may not be described herein or in any such report or document. Each of these factors could by itself, or together with one or more other factors, adversely affect our business, results of operations and/or financial condition.


19



ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Flagstar's headquarters is located in Troy, Michigan at 5151 Corporate Drive. We operate a regional office in Jackson, Michigan. We own both the headquarters and regional office buildings. At December 31, 2016, we operated 99 branches in Michigan, of which 73 were owned and 26 were leased. Our Michigan branches consist of 76 free-standing office buildings, two in-store banking centers and 21 branches in buildings in which there are other tenants. In addition, we lease 31 retail offices located in 19 states. We also lease four wholesale lending offices and three commercial lending offices.

ITEM 3. LEGAL PROCEEDINGS

From time to time, the Company is party to legal proceedings incident to its business. For further information, see Note 21 - Legal Proceedings, Contingencies and Commitments.

ITEM 4. MINE SAFETY DISCLOSURES
    
Not applicable.

20



PART II 
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock trades on the NYSE under the trading symbol FBC. At December 31, 2016, there were 56,824,802 shares of our common stock outstanding held by approximately 14,761 stockholders of record. The following table shows the high and low sale prices for our common stock during each calendar quarter during 2016 and 2015:
Quarter Ending
Highest Sale
Price
 
Lowest Sale
Price
December 31, 2016
$
29.08

 
$
26.35

September 30, 2016
28.09

 
24.40

June 30, 2016
24.47

 
20.68

March 31, 2016
23.13

 
17.49

December 31, 2015
$
24.95

 
$
20.60

September 30, 2015
21.01

 
17.83

June 30, 2015
19.44

 
14.61

March 31, 2015
16.50

 
14.10


Dividends

We have not paid dividends on our common stock since the fourth quarter 2007. The amount and nature of any dividends declared on our common stock in the future will be determined by our board of directors. We are generally prohibited from making any dividend payments on stock except pursuant to the prior non-objection of the Federal Reserve as set forth in the Supervisory Agreement.

Beginning with the February 2012 payment of dividends on preferred stock, we exercised our right to defer regularly scheduled quarterly payments of dividends on preferred stock issued and outstanding. On July 14, 2016, we ended the deferral and made a payment to bring current all outstanding dividends as of that date and subsequently repurchased the outstanding preferred stock.

In addition, our principal sources of funds are cash dividends paid by the Bank to us and other subsidiaries, investment income and borrowings. Federal laws and regulations limit the amount of dividends or other capital distributions that the Bank may pay us. The Bank has an internal practice to remain "well-capitalized" under OCC capital adequacy regulations as discussed above. The Bank must seek prior approval from the OCC at least 30 days before it may make a dividend payment or other capital distribution to us.

Equity Compensation Plan Information

The following table sets forth certain information with respect to securities to be issued under our equity compensation plans as of December 31, 2016:
Plan Category
Number of
Securities to Be
Issued Upon
Exercise of
Outstanding
Options, Warrants
and Rights
 
Weighted Average
Exercise Price of
Outstanding
Options, Warrants
and Rights (1)
 
Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
Equity compensation plans approved by security holders (2)
1,507,701

 
$
17.68

 
2,634,462

Equity compensation plans not approved by security holders

 

 

Total
1,507,701

 
$
17.68

 
2,634,462

(1)
Weighted average exercise price is calculated including RSUs, which for this purpose are treated as having an exercise price of zero.
(2)
For further information regarding the 2006 Equity Incentive Plan (the "2006 Plan") and 2016 Equity Incentive Plan (the "2016 Plan"), see Note 18 - Stock-Based Compensation.


21



Sale of Unregistered Securities

We made no unregistered sales of our equity securities during the fiscal year ended December 31, 2016.

Issuer Purchases of Equity Securities

We made no purchases of equity securities during the fiscal year ended December 31, 2016.

Performance Graph

CUMULATIVE TOTAL STOCKHOLDER RETURN
COMPARED WITH PERFORMANCE OF SELECTED INDICES
DECEMBER 31, 2011 THROUGH DECEMBER 31, 2016
fbc-2016123_chartx41676.jpg
 
Nasdaq Financial
Nasdaq Bank
S&P Small Cap 600
Russell 2000
Flagstar Bancorp
December 31, 2011
100

100

100

100

100

December 31, 2012
114

116

115

115

384

December 31, 2013
157

161

160

157

389

December 31, 2014
161

165

167

163

311

December 31, 2015
166

176

162

153

458

December 31, 2016
205

238

202

183

533


22



ITEM 6. SELECTED FINANCIAL DATA
 
For the Years Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(In millions, except share data and percentages)
Summary of Consolidated
 
 
 
 
 
 
 
 
 
Statements of Operations
 
 
 
 
 
 
 
 
 
Interest income
$
417

 
$
355

 
$
286

 
$
330

 
$
481

Interest expense
94

 
68

 
39

 
144

 
184

Net interest income
323

 
287

 
247

 
186

 
297

Provision (benefit) for loan losses
(8
)
 
(19
)
 
132

 
70

 
276

Net interest income after provision for loan losses
331

 
306

 
115

 
116

 
21

Noninterest income
487

 
470

 
372

 
653

 
1,021

Noninterest expense
560

 
536

 
590

 
918

 
989

Income before income taxes
258

 
240

 
(103
)
 
(149
)
 
53

Provision (benefit) for income taxes
87

 
82

 
(34
)
 
(416
)
 
(16
)
Net income (loss)
171

 
158

 
(69
)
 
267

 
69

Preferred stock dividends/accretion

 

 
(1
)
 
(6
)
 
(6
)
Net income (loss) from continuing operations
$
171

 
$
158

 
$
(70
)
 
$
261

 
$
63

Income (loss) per share:
 
 
 
 
 
 
 
Basic
$
2.71

 
$
2.27

 
$
(1.72
)
 
$
4.40

 
$
0.88

Diluted
$
2.66

 
$
2.24

 
$
(1.72
)
 
$
4.37

 
$
0.87

Weighted average shares outstanding:
 
 
 
 
 
 
 
 
 
Basic
56,569,307

 
56,426,977

 
56,246,528

 
56,063,282

 
55,762,196

Diluted
57,597,667

 
57,164,523

 
56,246,528

 
56,518,181

 
56,193,515

 
December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(In millions, except per share data and percentages)
Summary of Consolidated
 
 
 
 
 
 
 
 
 
Statements of Financial Condition
 
 
 
 
 
 
 
 
 
Total assets
$
14,053

 
$
13,715

 
$
9,840

 
$
9,407

 
$
14,082

Loans receivable, net
9,465

 
9,226

 
6,523

 
6,637

 
10,914

Mortgage servicing rights
335

 
296

 
258

 
285

 
711

Total deposits
8,800

 
7,935

 
7,069

 
6,140

 
8,294

Short-term Federal Home Loan Bank advances
1,780

 
2,116

 
214

 

 

Long-term Federal Home Loan Bank advances
1,200

 
1,425

 
300

 
988

 
3,180

Long-term debt
493

 
247

 
331

 
353

 
247

Stockholders' equity (1)
1,336

 
1,529

 
1,373

 
1,426

 
1,159

Book value per common share
23.50

 
22.33

 
19.64

 
20.66

 
16.12

Number of common shares outstanding
56,824,802

 
56,483,258

 
56,332,307

 
56,138,074

 
55,863,053

(1)
Includes preferred stock totaling $0 million, $267 million, $267 million, $266 million, and $260 million for the years ended December 31, 2016, 2015, 2014, 2013 and 2012, respectively.



23



 
At or For the Years Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(In millions, except share data and percentages)
Average Balances:
 
 
 
 
 
 
 
 
 
Average interest earning assets
$
12,164

 
$
10,436

 
$
8,440

 
$
10,882

 
$
13,104

Average interest paying liabilities
$
9,757

 
$
8,305

 
$
6,780

 
$
9,338

 
$
10,786

Average stockholders’ equity
$
1,464

 
$
1,486

 
$
1,406

 
$
1,239

 
$
1,192

Selected Ratios:
 
 
 
 
 
 
 
 
 
Interest rate spread
2.45
%
 
2.58
%
 
2.80
 %
 
1.50
%
 
1.96
%
Net interest margin
2.64
%
 
2.74
%
 
2.91
 %
 
1.72
%
 
2.26
%
Return (loss) on average assets
1.23
%
 
1.32
%
 
(0.71
)%
 
2.08
%
 
0.43
%
Return (loss) on average equity
11.69
%
 
10.63
%
 
(4.97
)%
 
21.09
%
 
5.26
%
Return on average common equity
13.0
%
 
10.5
%
 
(6.1
)%
 
26.8
%
 
6.7
%
Equity-to-assets ratio
9.50
%
 
11.14
%
 
13.95
 %
 
15.16
%
 
8.53
%
Common equity-to-assets ratio
9.50
%
 
9.20
%
 
11.24
 %
 
12.33
%
 
6.38
%
Equity/assets ratio (average for the period)
10.52
%
 
12.43
%
 
14.22
 %
 
9.87
%
 
8.10
%
Efficiency ratio
69.2
%
 
70.9
%
 
95.4
 %
 
109.4
%
 
75.1
%
Bancorp Tier 1 leverage (to adjusted tangible assets) (1)(2)
8.88
%
 
11.51
%
 
N/A

 
N/A

 
N/A

Bank Tier 1 leverage (to adjusted tangible assets)
10.52
%
 
11.79
%
 
12.43
 %
 
13.97
%
 
10.41
%
Selected Statistics:
 
 
 
 
 
 
 
 
 
Mortgage rate lock commitments (fallout-adjusted) (3)
$
29,372

 
$
25,511

 
$
24,007

 
$
31,590

 
$
50,633

Mortgage loans sold and securitized
$
32,033

 
$
26,307

 
$
24,407

 
$
39,075

 
$
53,094

Number of banking centers
99

 
99

 
107

 
111

 
111

Number of FTE employees
2,886

 
2,713

 
2,739

 
3,253

 
3,662

(1)
Applicable to Bancorp for the years ended December 31, 2016 and 2015.
(2)
Basel III transitional
(3)
Fallout adjusted refers to mortgage rate lock commitments which are adjusted by a percentage of mortgage loans in the pipeline that are not expected to close based on previous historical experience and the level of interest rates.

 






24



ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
 

25



The following is an analysis of our financial condition and results of operations. See the Glossary of Abbreviations and Acronyms on page 3 for definitions of terms used throughout this report. You should read this item in conjunction with our Consolidated Financial Statements and related notes filed with this report in Part II, Item 8. Financial Statements and Supplementary Data.

Overview    

We are a Michigan-based savings and loan holding company founded in 1993. Our business is primarily conducted through our principal subsidiary, the Bank, a federally chartered stock savings bank founded in 1987. We provide a range of commercial, small business, and consumer banking services and a complete set of mortgage and banking products and services distinguished by local delivery, customer service and competitive product pricing. For additional details and information on each of our lines of business, refer to Part 1, Item 1, Business, of this report.

Critical Accounting Estimates

Our Consolidated Financial Statements are prepared in accordance with U.S. GAAP and reflect general practices within our industry. Our significant accounting policies are described in Note 1 to the Consolidated Financial Statements. Some of our significant accounting policies require complex judgments and estimates to determine values of assets and liabilities. The more judgmental, uncertain and complex estimates are further discussed below. These estimates are based on information available to management as of the date of the Consolidated Financial Statements. Accordingly, as this information changes, future financial statements could reflect different estimates or judgments.

Allowance for Loan Losses

The ALLL represents management’s estimate of probable credit losses inherent in our HFI loan portfolio. The ALLL is sensitive to a variety of internal factors, such as the mix and level of loan balances outstanding, TDR volume, net charge-off experience, as well as external factors, such as, property values, the general health of the economy, unemployment rates, bankruptcy filings, peer data, etc. Management considers these variables and all other available information when establishing the final level of the allowance. These variables and others have the ability to result in actual loan losses that differ from the originally estimated amounts.

The ALLL includes a component related to specifically identified TDR and NPL loans and a model based component. For further information on the methodologies used in determining our allowance, see Note 1 - Description of Business, Basis of Presentation, and Summary of Significant Accounting Standards.

Specifically identified component

The specifically identified component of the ALLL related to performing TDR loans is generally measured as the difference between the recorded investment in the specific loan and the present value of the cash flows expected to be collected, discounted at the loan’s original effective interest rate. Estimating the timing and amounts of future cash flow projections is highly judgmental and based upon assumptions including default rates, prepayment probability and loss severities. All of these estimates and assumptions require significant management judgment and certain assumptions are highly subjective.

Specifically identified collateral dependent NPL loans are generally measured as the difference between the recorded investment in the impaired loan and the underlying collateral value less estimated costs to sell. These estimates are dependent on third party property valuations which may be influenced by factors such as the current and future level of home prices, the duration of current overall economic conditions, and other macroeconomic and portfolio-specific factors.

Model based component

The model-based component of the ALLL is calculated on our consumer and commercial HFI loan portfolio by applying average historical loss rates experienced during an identified look back period to outstanding principal balances over an estimated loss emergence period. For portfolios that do not have adequate loss experience and purchased portfolios, we utilize peer loss data in determining the ALLL. The loss emergence period represents the time period between the date at which the loss is estimated to have been incurred and the ultimate realization of that loss (by a charge-off). Estimated loss emergence periods may vary by product and may change over time; management applies judgment in estimating loss emergence periods, using available credit information and trends.

26



The historical loss model calculation is then adjusted by taking factors into consideration, such as current economic events that have occurred but may not yet be reflected in the historical loss estimates and model imprecision. These adjustments are determined by analyzing the historical loss experience for each major product segment and its underlying credit characteristics. It is difficult to predict whether historical loss experience is indicative of current incurred loss levels, therefore, management applies judgment in making adjustments deemed necessary based on the following factors: changes in lending policies and procedures, changes in economic and business conditions, changes in the nature and volume of the portfolio, changes in lending management, changes in credit quality statistics, changes in the quality of the loan review system, changes in the value of underlying collateral for collateral-dependent loans, the potential impact of payment recasts, changes in concentrations of credit, and other internal or external factor changes. The application of different inputs into the model calculation and the assumptions used by management to adjust the model calculation, are subject to significant management judgment and may result in actual loan losses that differ from the originally estimated amounts.

Fair Value Measurements

Certain assets and liabilities are carried at fair value on the Consolidated Statements of Financial Condition.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is based on quoted market prices in an active market, or if market prices are not available, is estimated using models employing techniques such as matrix pricing or discounting expected cash flows.

The significant assumptions used in the models are independently verified against observable market data where possible. Where observable market data is not available, the estimate of fair value becomes more subjective and involves a high degree of judgment. In this circumstance, fair value is estimated based on management’s judgment regarding the value that market participants would assign to the asset or liability. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there are inherent limitations to any valuation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values.

A portion of our assets and liabilities are carried at fair value on the Consolidated Statements of Financial Condition. The majority of these assets and liabilities are measured at fair value on a recurring basis, however, certain assets are measured at fair value on a nonrecurring basis based on the fair value of the underlying collateral.

Level 3 Assets and Liabilities measured at fair value

Estimating fair value requires the application of judgment which is largely dependent on the amount of observable market information available to perform the valuation. Instruments classified within level 3 of the fair value hierarchy indicate that valuations are determined using internally developed methods and models that utilize significant unobservable inputs. Judgments used in these valuations are more significant than those required when estimating the fair value of instruments classified within levels 1 and 2.

Imprecision in estimating unobservable market inputs or other factors can affect the amount of gain or loss recorded. Furthermore, while we believe that our valuation methods are appropriate and consistent with those of other market participants, the methods and assumptions used reflect management judgment and may vary across businesses and portfolios.

27



The following table includes the fair value of our assets and liabilities classified within level 3 of the fair value hierarchy:
 
December 31, 2016
 
(Dollars in millions)
Level 3 Fair Value Assets
 
MSRs
$
335

Second mortgage loans
41

HELOC loans
24

Rate lock commitments, net
18

Total recurring
418

Total nonrecurring
39

    Total level 3 fair value assets
$
457

    Total fair value assets
5,155

    Total assets
$
14,053

Level 3 assets as a percentage of:
 
Total assets
3.3
%
Fair value assets
8.9
%
Level 3 Fair Value Liabilities
 
DOJ litigation settlement
$
60

        
Mortgage Servicing Rights. When we sell mortgage loans in the secondary market, we frequently retain the right to continue to service these loans and earn a servicing fee. At the time the loan is sold on a servicing retained basis, we record the MSR as an asset at its fair value. Determining the fair value of MSRs involves a calculation of the present value of a set of market driven and MSR specific cash flows. MSRs do not trade in an active market with readily observable market prices. However, the market price of MSRs is generally a function of demand and interest rates. When mortgage interest rates decline, mortgage loan prepayments are expected to increase due to increased refinances. If this happens, the income stream from a MSR portfolio is expected to decline and the fair value of the portfolio will decline. Similarly, when mortgage interest rates increase, mortgage loan prepayments tend to slow and therefore the value of the MSR tends to increase. The fair value of the MSR is also sensitive to market implied interest rate volatility for which an increase has a negative impact on the value of the MSR and a decline has a positive impact on the value of the MSR. Accordingly, we must make assumptions about future interest rates, market implied interest rate volatility and other market conditions in order to estimate the current fair value of our MSR portfolio. In certain circumstances, based on the probability of the completion of a sale of MSRs pursuant to a bona-fide purchase offer, we consider the bid price of that offer and identifiable transaction costs in comparison to the calculated fair value and may adjust the estimate of fair value to reflect the terms of the pending transaction. For further information and a sensitivity analysis of our MSR fair values, see Note 1 - Description of Business, Basis of Presentation, and Summary of Significant Accounting Standards, Note 10 - Mortgage Servicing Rights, and Note 22 - Fair Value Measurements. On an ongoing basis, we compare our fair value estimates based on both unobservable inputs and market inputs, where available, to report the various assumptions. On a quarterly basis, our MSR valuation is compared to two independent valuations performed by third parties. For further information regarding interest rate sensitivity analysis on the MSRs, see Note 22 - Fair Value Measurements.

DOJ litigation settlement. We elected the fair value option to account for the liability representing the remaining future payments. We use a discounted cash flow model to determine the current fair value. The model utilizes our forecast and considers multiple scenarios and possible outcomes that impact the timing of the additional payments, which are discounted using a risk free rate adjusted for non-performance risk that represents our credit risk. These scenarios are probability weighted and consider the view of an independent market participant to estimate the most likely fair value of the liability. For further information on the DOJ liability, see Note 21 - Legal Proceedings, Contingencies and Commitments.

For further information regarding the valuation of our financial instruments, including those that utilize unobservable inputs see, Note 1 - Description of Business, Basis of Presentation, and Summary of Significant Accounting Standards and Note 22 - Fair Value Measurements. For further information and sensitivities related to the valuation of our MSR asset see, Note 10 - Mortgage Servicing Rights and Note 22 - Fair Value Measurements. For further information regarding the valuation of our DOJ liability see, Note 21 - Legal Proceedings, Contingencies and Commitments and Note 22 - Fair Value Measurements.

28



Accounting and Reporting Developments

For further information of recently issued accounting pronouncements and their expected impact on our Consolidated Financial Statements, see Note 1 - Description of Business, Basis of Presentation, and Summary of Significant Accounting Standards.

Summary of Operations

 
For the Years Ended December 31,
 
2016
 
2015
 
2014
 
(Dollars in millions)
Net interest income
$
323

 
$
287

 
$
247

Provision (benefit) for loan losses
(8
)
 
(19
)
 
132

Total noninterest income
487

 
470

 
372

Total noninterest expense
560

 
536

 
590

Provision (benefit) for income taxes
87

 
82

 
(34
)
Preferred stock accretion

 

 
(1
)
Net income (loss)
$
171

 
$
158

 
$
(70
)
Income (loss) per share:
 
 
 
 
 
Basic
$
2.71

 
$
2.27

 
$
(1.72
)
Diluted
$
2.66

 
$
2.24

 
$
(1.72
)
    
Full year 2016 net income was $171 million, or $2.66 per diluted share, as compared to full year 2015 net income of $158 million, or $2.24 per diluted share. The 2016 full year results included a $24 million benefit related to a decrease in the fair value of the Department of Justice ("DOJ") settlement liability. Excluding this benefit, the Company had adjusted non-GAAP 2016 net income of $155 million, or $2.38 per diluted share. For a reconciliation and discussion of this non-GAAP financial measure, see MD&A - Use of Non-GAAP Financial Measures. The $13 million increase was primarily driven by a $36 million increase in net interest income and a $17 million increase in noninterest income partially offset by higher performance driven expenses and a lower benefit for loan losses. Net interest income increased as a result of growth in our interest earning assets as we execute on our strategic initiative to deploy capital and replace lower credit quality assets with higher quality residential and commercial loans. As a result of this initiative, we grew average interest earning assets by 17 percent from $10.4 billion during the year ended December 31, 2015 to $12.2 billion during the year ended December 31, 2016. Additional details of each key driver have been further explained in Management’s discussion below.

Net Interest Income

Net interest income is the amount we earn on the average balances of our interest-earning assets, less the amount the average balances of our interest-bearing liabilities cost us. Interest income recorded on loans is reduced by the amortization of net premiums and net deferred loan origination costs.

29



The following table presents on a consolidated basis interest income from average assets and liabilities, expressed in dollars and yields:
 
For the Years Ended December 31,
 
2016
 
2015
 
2014
 
Average
Balance
Interest
Average
Yield/
Rate
 
Average
Balance
Interest
Average
Yield/
Rate
 
Average
Balance
Interest
Average
Yield/
Rate
 
(Dollars in millions)
Interest-Earning Assets
 
 
 
 
 
 
 
 
 
 
 
Loans held-for-sale
$
3,134

$
113

3.62
%
 
$
2,188

$
85

3.90
%
 
$
1,534

$
65

4.24
%
Loans held-for-investment
 
 
 
 
 
 
 
 
 
 
 
Consumer loans (1)
2,832

99

3.52
%
 
3,083

114

3.68
%
 
2,681

103

3.85
%
Commercial loans (1)
2,981

120

3.97
%
 
1,993

78

3.88
%
 
1,294

49

3.70
%
Loans held-for-investment
5,813

219

3.75
%
 
5,076

192

3.76
%
 
3,975

152

3.80
%
Loans with government guarantees
435

16

3.59
%
 
633

18

2.86
%
 
1,216

29

2.39
%
Investment securities
2,653

68

2.56
%
 
2,305

59

2.55
%
 
1,496

39

2.61
%
Interest-bearing deposits
129

1

0.50
%
 
234

1

0.50
%
 
219

1

0.25
%
Total interest-earning assets
12,164

$
417

3.42
%
 
10,436

$
355

3.38
%
 
8,440

$
286

3.38
%
Other assets
1,743

 
 
 
1,520

 
 
 
1,446

 
 
Total assets
$
13,907

 
 
 
$
11,956

 
 
 
$
9,886

 
 
Interest-Bearing Liabilities
 
 
 
 
 
 
 
 
 
 
 
Retail deposits
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
$
489

$
1

0.18
%
 
$
429

$
1

0.14
%
 
$
422

$
1

0.14
%
Savings deposits
3,751

29

0.78
%
 
3,693

30

0.82
%
 
3,139

18

0.61
%
Money market deposits
278

1

0.44
%
 
258

1

0.31
%
 
266

1

0.20
%
Certificate of deposits
990

10

1.05
%
 
787

6

0.77
%
 
915

6

0.73
%
Total retail deposits
5,508

41

0.76
%
 
5,167

38

0.73
%
 
4,742

26

0.57
%
Government deposits
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
228

1

0.39
%
 
257

1

0.39
%
 
182

1

0.38
%
Savings deposits
442

2

0.52
%
 
405

2

0.52
%
 
320

2

0.51
%
Certificate of deposits
382

2

0.40
%
 
358

1

0.39
%
 
349

1

0.33
%
Total government deposits
1,052

5

0.45
%
 
1,020

4

0.44
%
 
851

4

0.41
%
Total deposits
6,560

46

0.71
%
 
6,187

42

0.68
%
 
5,593

30

0.54
%
Short-term Federal Home Loan Bank advances and other
1,249

5

0.44
%
 
311

1

0.30
%
 
893

2

0.22
%
Long-term Federal Home Loan Bank advances
1,584

27

1.72
%
 
1,500

18

1.17
%
 
46


0.01
%
Other long-term debt
364

16

4.34
%
 
307

7

2.42
%
 
248

7

2.72
%
Total interest-bearing liabilities
9,757

94

0.97
%
 
8,305

68

0.82
%
 
6,780

39

0.58
%
Noninterest-bearing deposits (2)
2,202

 
 
 
1,690

 
 
 
1,141

 
 
Other liabilities
484

 
 
 
475

 
 
 
559

 
 
Stockholders’ equity
1,464

 
 
 
1,486

 
 
 
1,406

 
 
Total liabilities and stockholders' equity
$
13,907

 
 
 
$
11,956

 
 
 
$
9,886

 
 
Net interest-earning assets
$
2,407

 
 
 
$
2,131

 
 
 
$
1,660

 
 
Net interest income
 
$
323

 
 
 
$
287

 
 
 
$
247

 
Interest rate spread (3)
 
 
2.45
%
 
 
 
2.58
%
 
 
 
2.80
%
Net interest margin (4)
 
 
2.64
%
 
 
 
2.74
%
 
 
 
2.91
%
Ratio of average interest-earning assets to interest-bearing liabilities
 
 
124.7
%
 
 
 
125.7
%
 
 
 
124.5
%
(1)
Consumer loans include: residential first mortgage, second mortgage, HELOC and other consumer loans. Commercial loans include: commercial real estate, commercial and industrial, and warehouse lines. Includes nonaccrual loans, for further information relating to nonaccrual loans, see Note 1 - Description of Business, Basis of Presentation, and Summary of Significant Accounting Policies.
(2)
Includes noninterest-bearing company controlled deposits that arise due to the servicing of loans for others.
(3)
Interest rate spread is the difference between rates of interest earned on interest-earning assets and rates of interest paid on interest-bearing liabilities.
(4)
Net interest margin is net interest income divided by average interest-earning assets.


30



Rate/Volume Analysis

The following tables present the dollar amount of changes in interest income and interest expense for the components of interest-earning assets and interest-bearing liabilities that are presented in the preceding table. The table below distinguishes between the changes related to average outstanding balances (changes in volume while holding the initial rate constant) and the changes related to average interest rates (changes in average rates while holding the initial balance constant). The rate/volume variances are allocated to variances due to rate.
 
For the Years Ended December 31,
 
2016 Versus 2015 Increase
(Decrease) Due to:
 
2015 Versus 2014 Increase
(Decrease) Due to:
 
Rate
 
Volume
 
Total
 
Rate
 
Volume
 
Total
 
(Dollars in millions)
Interest-Earning Assets
 
 
 
 
 
 
 
 
 
 
 
Loans held-for-sale
$
(9
)
 
$
37

 
$
28

 
$
(8
)
 
$
28

 
$
20

Loans held-for-investment
 
 
 
 
 
 
 
 
 
 
 
Consumer loans (1)
(5
)
 
(10
)
 
(15
)
 
(5
)
 
16

 
11

Commercial loans (2)
3

 
39

 
42

 
3

 
26

 
29

Total loans held-for-investment
(2
)
 
29

 
27

 
(2
)
 
42

 
40

Loans with government guarantees
3

 
(5
)
 
(2
)
 
3

 
(14
)
 
(11
)
Investment securities
2

 
7

 
9

 
(1
)
 
21

 
20

Total interest-earning assets
$
(6
)
 
$
68

 
$
62

 
$
(8
)
 
$
77

 
$
69

Interest-Bearing Liabilities
 
 
 
 
 
 
 
 
 
 
 
Retail deposits
 
 
 
 
 
 
 
 
 
 
 
Savings deposits
(1
)
 

 
(1
)
 
8

 
4

 
12

Certificate of deposits

 
4

 
4

 

 

 

Total retail deposits
(1
)
 
4

 
3

 
8

 
4

 
12

Government deposits
 
 
 
 
 
 
 
 
 
 
 
Certificate of deposits

 
1

 
1

 

 

 

Total government deposits

 
1

 
1

 

 

 

Total deposits
(1
)
 
5

 
4

 
8

 
4

 
12

Short-term debt
2

 
2

 
4

 

 

 

Long-term debt
8

 
1

 
9

 
15

 
2

 
17

Other
7

 
2

 
9

 

 

 

Total interest-bearing liabilities
$
16

 
$
10

 
$
26

 
$
23

 
$
6

 
$
29

Change in net interest income
$
(22
)
 
$
58

 
$
36

 
$
(31
)
 
$
71

 
$
40

(1)
Consumer loans include: residential first mortgage, second mortgage, HELOC and other consumer loans.
(2)
Commercial loans include: commercial real estate, commercial and industrial, and warehouse lending.

2016 Compared to 2015

Net interest income increased $36 million for the year ended December 31, 2016, compared to the same period in 2015. The increase for the year was primarily driven by growth in average interest earning assets of 16.3 percent, partially offset by a decrease in the net interest margin driven by a competitive interest rate environment and issuance of 6.125 percent senior debt used to fund the TARP redemption. Net interest margin for the year ended December 31, 2016 was 2.64 percent, as compared to 2.74 percent for the year ended December 31, 2015. The decrease in net interest margin from 2015 was driven by higher interest rates from longer term fixed rate debt taken to match-fund our longer duration asset growth, interest expense on senior debt issued to fund the TARP redemption and lower average interest rates on LHFS due to a more competitive interest rate environment. This decrease was partially offset by higher average yield on interest earning assets as we shifted from lower spread residential mortgage loans into higher spread commercial loans.

Average LHFS increased $946 million for the year ended December 31, 2016, compared to the same period in 2015, due to an increase in mortgage production resulting from a low interest rate market which drove increased refinance activity.

31



Average LHFI increased $737 million for the year ended December 31, 2016, compared to the same period in 2015, primarily due to growth in warehouse and commercial loans where we have increased our market share and begun to grow our new product portfolios.

2015 Compared to 2014

Net interest income increased $40 million for the year ended December 31, 2015, compared to the same period in 2015, primarily due to strong growth in interest-earning assets, partially offset by a decrease in the net interest margin.

Our net interest margin for the year ended December 31, 2015 was 2.74 percent, as compared to 2.91 percent for the year ended December 31, 2014. The decrease from 2014 was primarily driven by a significant portion of the interest earning asset growth being in relatively lower spread mortgage loans which were funded with higher cost, longer tenured liabilities.

Interest income increased $69 million for the year ended December 31, 2015, compared to the same period in 2014, primarily driven by higher average LHFS, LHFI and investment securities, partially offset by a decrease in loans with government guarantees. Average warehouse loans increased $431 million for the year ended December 31, 2015 to $877 million, compared to $446 million for the year ended December 31, 2014, primarily due to higher line utilization and new accounts. Average HELOC loans increased $225 million for the year ended December 31, 2015 to $347 million, compared to $122 million for the year ended December 31, 2014, resulting from the acquisitions of loan portfolios in 2015. Average residential first mortgage loans increased $195 million for the year ended December 31, 2015 to $2.6 billion, compared to $2.4 billion for the year ended December 31, 2014, primarily due to retained loan production from our mortgage origination business. Average CRE loans increased $153 million for the year ended December 31, 2015 to $679 million, compared to $526 million for the year ended December 31, 2014. Average C&I loans increased $116 million for the year ended December 31, 2015 to $438 million, compared to $322 million for the year ended December 31, 2014, in line with our strategy to grow interest-earning assets.

Interest expense increased $29 million for the year ended December 31, 2015, compared to the same period in 2014, primarily due to increased FHLB advances and interest-bearing deposits. Average interest-bearing deposits were $6.2 billion during the year ended December 31, 2015, increasing $0.6 billion or 10.6 percent, compared to the year ended December 31, 2014. Retail deposits increased $0.4 billion, led by growth in savings deposits. Average FHLB advances were $1.8 billion for the year ended December 31, 2015, an increase of $0.9 billion compared to the year ended December 31, 2014. Throughout 2015, we replaced certain short-term advances with longer term advances primarily to match- fund our longer duration asset growth which resulted in slightly higher cost debt.

Provision for Loan Losses

2016 Compared to 2015

The provision (benefit) for loan losses decreased $11 million for the year ended December 31, 2016, as compared to the year ended December 31, 2015. In 2016, the benefit resulted primarily from the sale of $1.2 billion unpaid principal balance of performing residential first mortgage loans and $110 million of unpaid principal balance of nonperforming, TDR and non-agency loans, partially offset by commercial loan growth. In 2015, the provision (benefit) for loan losses included a net reduction in the allowance for loan losses relating to several loan sales, including a net reduction in the allowance relating to interest-only residential first mortgage loans, partially offset by an increase related to the growth in our HFI loan portfolio
    
In 2016, we continued to experience strong credit quality. Our net charge-offs for the year ended December 31, 2016 totaled $30 million, compared to $91 million for the year ended December 31, 2015. The decrease was primarily due to charge-offs taken in 2015 related to our interest only and lower performing loans sold or transferred to HFS. As a percentage of the average LHFI, annualized net charge-offs for the year ended December 31, 2016 decreased to 0.52 percent from 1.85 percent for the year ended December 31, 2015. During the year ended December 31, 2016 and 2015, the annualized net charge-offs as a percentage of the average LHFI, on a non-GAAP adjusted basis, were 0.15 percent and 0.40 percent, respectively, excluding the charge-offs related to the loan sales or transfers of $8 million and $69 million, respectively.

2015 Compared to 2014

The provision for loan losses decreased $151 million for the year ended December 31, 2015, as compared to the year ended December 31, 2014. In 2014, we recorded a $132 million provision that was primarily driven by two changes in estimates: the evaluation of current data related to the loss emergence period on our residential mortgage loan portfolio and the

32



evaluation of the enhanced risk associated with payment resets relating to interest-only loans. In 2015, we sold 90 percent of our interest-only loans at prices that were favorable as compared to the continuing reset risk associated with us continuing to hold these loans in our portfolio when they were recorded consistent with our incurred loss methodology. This action along with the sale of $444 million TDR, nonperforming and jumbo loans resulted in a $69 million reduction to the ALLL which, along with an overall improvement in portfolio quality was the primary driver of the $19 million net benefit reported in 2015 being partially offset by a $1.9 billion increase in volume of average LHFI due to the origination of residential first mortgages and increased commercial lending.
    
Net charge-offs for the year ended December 31, 2015 totaled $91 million, compared to $42 million for the year ended December 31, 2014. The increase was primarily due to charge-offs relating to loans sold or transferred to HFS during the year ended December 31, 2015. We sought to de-risk the balance sheet by selling lower performing and interest-only loans. As a percentage of the average LHFI, annualized net charge-offs for the year ended December 31, 2015 increased to 1.85 percent from 1.07 percent for the year ended December 31, 2014. During the year ended December 31, 2015 and 2014, the annualized net charge-offs as a percentage of the average LHFI, on a non-GAAP adjusted basis, were 0.40 percent and 0.69 percent, respectively, excluding the charge-offs related to the loan sales or transfers of $69 million and $15 million, respectively.

For further information on the provision for loan losses see MD&A - Allowance for Loan Losses.

Noninterest Income

The following tables provide information on our noninterest income along with additional details related to our net gain on loan sales and activity that occurred within the period:
 
For the Years Ended December 31,
 
2016
 
2015
 
2014
 
(Dollars in millions)
Net gain on loan sales
$
316

 
$
288

 
$
206

Loan fees and charges
76

 
67

 
73

Deposit fees and charges
22

 
25

 
22

Loan administration income
18

 
26

 
24

Net (loss) return on mortgage servicing rights
(26
)
 
28

 
24

Net (loss) gain on sale of assets
(2
)
 
(1
)
 
12

Representation and warranty (provision) benefit
19

 
19

 
(10
)
Other noninterest income
64

 
18

 
21

Total noninterest income
$
487

 
$
470

 
$
372


 
For the Years Ended December 31,
 
2016
 
2015
 
2014
 
 
 
Mortgage rate lock commitments (fallout-adjusted) (1)
 
$
29,372

 
$
25,511

 
$
24,007

Net margin on mortgage rate lock commitments (fallout-adjusted) (1) (2)
 
1.02
%
 
1.13
%
 
0.86
%
Net gain on loan sales on HFS
 
$
301

 
$
288

 
$
206

Net (loss) return on the mortgage servicing rights
 
$
(26
)
 
$
28

 
$
24

Gain on loan sales HFS + net (loss) return on the MSR
 
$
275

 
$
316

 
$
230

Residential loans serviced (number of accounts - 000's) (3)
 
383

 
$
361

 
$
383

Capitalized value of MSRs
 
1.07
%
 
1.13
%
 
1.01
%
Mortgage loans sold and securitized
 
$
32,033

 
26,307

 
24,407

Net margin on loan sales
 
0.94
%
 
1.09
%
 
0.84
%
(1)
Fallout adjusted refers to mortgage rate lock commitments which are adjusted by a percentage of mortgage loans in the pipeline that are not expected to close based on previous historical experience and the level of interest rates.
(2)
Gain on sale margin is based on net gain on loan sales related to HFS loans to fallout-adjusted mortgage rate lock commitments.
(3)
Includes serviced for own loan portfolio, serviced for others and subserviced for others loans.


33



2016 Compared to 2015

Total noninterest income was $487 million during the year ended December 31, 2016, which was a $17 million increase from $470 million during the year ended December 31, 2015.

Net gain on loan sales increased $28 million for the year ended December 31, 2016, compared to the same period in 2015. The increase in gain on loan sales was primarily due to $3.9 million higher fallout-adjusted lock volume driven by an increase in refinance activity and a $14 million gain from the sale of performing LHFI. The increase was partially offset by lower loan sale margins driven by pricing competition.

Total loan fees and charges increased $9 million for the year ended December 31, 2016, compared to the same period in 2015, primarily due to higher mortgage loan closings.

Loan administration income decreased $8 million for the year December 31, 2016 to $18 million, compared to $26 million for the same period in 2015. The decrease was equally driven by lower fee revenue from loans subserviced for others and higher interest expense on average company controlled deposits which increased due primarily to higher refinance activity.

Our net loss on MSRs was $26 million for the year ended December 31, 2016, compared to a return of $28 million for the same period in 2015. The $54 million decrease was primarily due to a decline in fair value driven by higher prepayments, increased market implied interest rate volatility, and a $7 million charge related to MSR sales that closed during the year. These declines were partially offset by higher servicing fees and ancillary income received due to a higher average outstanding MSR balance carried throughout the year.
 
Other noninterest income increased $46 million, compared to the same period in 2015. The increase was primarily due to a $24 million benefit related to the reduction in the fair value of the DOJ settlement liability and an $11 million net improvement in fair value adjustments. Higher income earned on our bank owned life insurance and gains on the sale of AFS investment securities about equally drove the remaining improvement.

2015 Compared to 2014

Total noninterest income increased $109 million during the year ended December 31, 2015 from the year ended December 31, 2014. The increase was led by higher net gain on loan sales and lower representation and warranty provision, partially offset by a decrease in net gain on sale of assets and loan fees and charges.

Net gain on loan sales increased $82 million for the year ended December 31, 2015, compared to the year ended December 31, 2014. The increase in gain on loan sales was primarily due to higher fallout-adjusted lock volume and improved gain on loan sale margins. Loans sold and securitized increased to $26.3 billion during the year ended December 31, 2015, compared to $24.4 billion sold and securitized in the year ended December 31, 2014. For the year ended December 31, 2015, the mortgage rate lock commitments increased to $31.7 billion, compared to $29.5 billion in the year ended December 31, 2014.

Total loan fees and charges decreased $6 million for the year ended December 31, 2015, compared to the year ended December 31, 2014, primarily reflecting a decrease in deferred commercial and mortgage loan fees related to payoffs.

Net return on the MSR asset increased $4 million for the year ended December 31, 2015, compared to the year ended December 31, 2014. The increase was primarily due to elevated collections of contingent reserves, originally held back by the purchaser on prior MSR sales, partially offset by a decrease related to the net impact of market-driven changes. Also driving the increase was a benefit from slower prepayments and positive economic hedging results.

Net (loss) gain on sale of assets decreased $13 million to a loss of $1 million during the year ended December 31, 2015, compared to a gain of $12 million for the year ended December 31, 2014. The decrease was primarily due to a gain from loan sales during the year ended December 31, 2014 and a write down of land assets during the year ended December 31, 2015.
    
Our provision for representation and warranty reserve was $29 million lower for the year ended December 31, 2015, compared to the same period in 2014. An ongoing trend of lower charge-offs and volume of repurchase demands has been the primary driver of the decrease partially offset by an increase related to indemnification agreements on loans with government guarantees.


34



Other noninterest income decreased $3 million, compared to the same period in 2014. The decrease was primarily due to a $11 million benefit related to the reduction in the fair value of the DOJ settlement liability which was initially recorded in 2014, partially offset by an increase in the fair value adjustment on residential first mortgages for the year ended December 31, 2015.

Noninterest Expense

The following table sets forth the components of our noninterest expense:
 
For the Years Ended December 31,
 
2016
 
2015
 
2014
 
(Dollars in millions)
Compensation and benefits
$
269

 
$
237

 
$
233

Commissions
55

 
39

 
35

Occupancy and equipment
85

 
81

 
80

Loan processing expense
55

 
52

 
37

Federal insurance premiums
11

 
23

 
23

Asset resolution
7

 
15

 
57

Legal and professional expense
29

 
36

 
51

Other noninterest expense
49

 
53

 
74

Total noninterest expense
$
560

 
$
536

 
$
590

Efficiency ratio
69.2
%
 
70.9
%
 
95.4
%

2016 Compared to 2015

Total noninterest expense increased $24 million during the year ended December 31, 2016 from the year ended December 31, 2015.

The $32 million increase in compensation and benefits expense for the year ended December 31, 2016, compared to the same period in 2015, was primarily due to an increase in overall headcount in support of our new strategic initiatives along with an increase in performance-related compensation including the ExLTIP plan. For further information relating to ExLTIP plan, see Note 18 - Stock-Based Compensation. Our full-time equivalent employees increased overall by 173 from December 31, 2015 to a total of 2,886 full-time equivalent employees at December 31, 2016.

Commission expense increased $16 million for the year ended December 31, 2016, compared to the same period in 2015. Higher loan production and unfavorable product mix about equally drove a $9 million increase with the remaining increase being driven by our investment in new strategic initiatives.

Occupancy and equipment expense increased $4 million for the year ended December 31, 2016, compared to the same period in 2015, primarily due to an increase in maintenance costs related to software that was implemented in the fourth quarter 2015 along with a higher average depreciable asset base.

Federal insurance premium expense decreased $12 million for the year ended December 31, 2016, compared to the same period in 2015, primarily due to an improvement in our risk profile. During 2016, our FDIC rates declined due to improvements in our composition and level of capital, asset quality, and management of risk. The reduction in expense from this improved risk profile was partially offset by additional expense on our higher asset base.

Asset resolution expense decreased $8 million for the year ended December 31, 2016, compared to the same period in 2015, primarily due to a decrease in default servicing costs, foreclosure costs and an improvement in house prices.

Legal and professional expense decreased $7 million for the year ended December 31, 2016 compared to the same period in 2015, primarily due to implementation of company-wide cost savings initiatives resulting in decreased utilization of third party service providers.
    
Other noninterest expense decreased $4 million for the year ended December 31, 2016, compared to the same period in 2015 primarily due to higher litigation and regulatory related expenses that occurred in 2015.

35




2015 Compared to 2014    

Total noninterest expense decreased $43 million during the year ended December 31, 2015 from the year ended December 31, 2014. The decrease during the year ended December 31, 2015, was primarily due to decreases in asset resolution expense, legal and professional expenses and a CFPB penalty in 2014, which is included in other noninterest expense. These decreases were partially offset by increases in other noninterest expense, including higher general and administrative costs, an increase in fair value changes related to the DOJ settlement liability and an increase in the outstanding warrant.

The $4 million increase in compensation and benefits expense for the year ended December 31, 2015, compared to the same period in 2014, was primarily due to an increase in performance-related compensation, partially offset by lower overall headcount. Our full-time equivalent employees decreased overall by 26 from December 31, 2014 to a total of 2,713 full-time equivalent employees at December 31, 2015.

Commission expense increased $4 million for the year ended December 31, 2015, compared to the same period in 2014, primarily due to an increase in the volume of loan originations. Loan originations increased to $29.9 billion for the year ended December 31, 2015 from $25.1 billion in the year ended December 31, 2014.

Asset resolution expenses decreased $42 million for the year ended December 31, 2015, compared to the same period in 2014, primarily due to fewer repurchases related to servicer errors, lower compensatory fees resulting from our success rate on claim rebuttals and improved realization of claims and lower balances of FHA loans. In addition, there was a favorable variance in the repossessed asset portfolio driven by lower foreclosure expenses and higher gains on the sale of repossessed assets.

Loan processing expense increased $15 million for the year ended December 31, 2015, compared to the same period in 2014, primarily due to higher volume of loan closings.

Legal and professional expense decreased $15 million during the year ended December 31, 2015, compared to the year ended December 31, 2014, primarily due to a decrease in legal fees resulting from fewer litigation expenses and a reduction in consulting expenses resulting from cost saving initiatives.

Other noninterest expense decreased $21 million for the year ended December 31, 2015, compared to the same period in 2014, primarily due to a decrease of $38 million in expenses related to the CFPB settlement and penalties that occurred in 2014, partially offset by an $8 million increase in the value of the warrants as a result of an increase in the Bank's stock price.

Provision (benefit) for Income Taxes

Our provision for income taxes for the year ended December 31, 2016 was $87 million, compared to a provision of $82 million in 2015 and a benefit of $34 million in 2014.

Our effective tax rate was 33.7 percent for 2016 and 34.2 percent in 2015. The difference between the effective tax rate and the statutory tax rate of 35 percent is primarily due to the impact of the bank owned life insurance and state taxes in relation to pre-tax income.

Our effective tax rate for 2014 was (32.9 percent). The difference between the effective tax rate and the statutory tax rate of 35 percent is primarily due to the exclusion of the non-deductible penalty paid to the CFPB and the non-taxable impact of changes related to our warrants.

For further information, see Note 19 - Income Taxes.

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Fourth Quarter Results

The following table sets forth selected quarterly data:
 
Three Months Ended
 
December 31,
2016
 
September 30,
2016
 
December 31,
2015
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Dollars in millions)
Net interest income
$
87

 
$
80

 
$
76

Provision (benefit) for loan losses
1

 
7

 
(1
)
Net interest income after provision (benefit) for loan losses
86

 
73

 
77

Noninterest income
98

 
156

 
97

Noninterest expense
142

 
142

 
129

Income before income taxes
42

 
87

 
45

Provision for income taxes
14

 
30

 
12

Net income
$
28

 
$
57

 
$
33

Income per share
 
 
 
 
 
Basic
$
0.50

 
$
0.98

 
$
0.45

Diluted
$
0.49

 
$
0.96

 
$
0.44

Efficiency ratio
76.7
%
 
59.9
%
 
75.2
%

Fourth Quarter 2016 compared to Third Quarter 2016

Net income for the three months ended December 31, 2016 was $28 million, or $0.49 per diluted share, as compared to $57 million, or $0.96 per diluted share, for the three months ended September 30, 2016.

Net interest income increased to $87 million for the three months ended December 31, 2016, as compared to $80 million during the three months ended September 30, 2016. The increase was primarily due to average earning asset increase of 4 percent, led by growth in investment securities, commercial loans and mortgage loans, and net interest margin expansion of 9 basis points. The increase from the prior quarter was primarily driven by terminating certain fixed rate FHLB advances resulting in a $2 million benefit to interest expense, which accounted for 6 basis points of the increase.

Average LHFI totaled $6.2 billion for the fourth quarter 2016, increasing $315 million, or 5.4 percent, compared to the third quarter 2016. The increase was driven by higher CRE loans, consumer loans and C&I loans. Average CRE loans grew $127 million, or 11.7 percent, average consumer loans rose $111 million, or 4.3 percent and average C&I loans rose $88 million, or 13.9 percent.

Average total deposits were $9.2 billion in the fourth quarter 2016, increasing $107 million, or 1.2 percent, from the prior quarter. The increase was led by higher retail deposits, partially offset by lower government deposits. Average retail deposits increased $132 million, or 2.1 percent, primarily due to an $89 million increase in savings deposits and $28 million rise in demand deposits.

The provision for loan losses totaled $1 million for the fourth quarter 2016, as compared to $7 million for the third quarter 2016. The fourth quarter 2016 lower level of provision expense reflects strong asset quality and largely matched net charge-offs. Net charge-offs in the fourth quarter 2016 were $2 million, or 0.13 percent of applicable loans, compared to $7 million, or 0.51 percent of applicable loans in the prior quarter. The fourth quarter 2016 amount included $1 million of net charge-offs associated with loans with government guarantees compared to $5 million in the third quarter of 2016.

Fourth quarter 2016 noninterest income was $98 million, as compared to $156 million for the third quarter 2016. The decrease was primarily due to a $37 million decrease in net gain on loan sales and a $24 million benefit that was recognized in the third quarter 2016 from the reduction in fair value of the DOJ settlement liability.

Fourth quarter 2016 net gain on loan sales decreased to $57 million, as compared to $94 million for the third quarter 2016, primarily due to lower fallout-adjusted locks and a decrease in the gain on sale margin. Fallout-adjusted locks were $6.1 billion for the fourth quarter 2016, as compared to $8.3 billion for the third quarter 2016. The decrease was primarily due to

37



seasonality and lower refinance activity from significantly higher interest rates. The net gain on loan sale margin decreased to 0.93 percent for the fourth quarter 2016, as compared to 1.13 percent for the third quarter 2016 driven by price competition.
Net return on the MSRs increased to a net loss of $5 million for the fourth quarter 2016, as compared to a net loss of $11 million for the third quarter 2016. The increase was primarily due to lower prepayments and a $7 million charge recognized in the third quarter 2016 related to MSR sales that closed in the fourth quarter 2016, partially offset by unfavorable changes in fair value driven by an increase in market implied interest rate volatility experienced in the fourth quarter 2016.

Loan fees and charges decreased to $20 million for the fourth quarter 2016, as compared to $22 million in the third quarter 2016. The decrease primarily reflected lower mortgage loan closings.

Noninterest expense was unchanged at $142 million for the fourth quarter 2016, as compared to the third quarter 2016, primarily due to an increase in legal and professional fees, partially offset by a decrease in compensation and benefits.

Fourth Quarter 2016 compared to Fourth Quarter 2015

Our net income from continuing operations for the three months ended December 31, 2016 was $28 million, or $0.49 per diluted share, as compared to income of $33 million, or $0.44 per diluted share, for the three months ended December 31, 2015. The decrease was primarily driven by higher noninterest expense partially offset by higher net interest income.

Net interest income increased $11 million for the three months ended December 31, 2016, compared to the same period in 2015 primarily due to growth in interest earning assets.

Net interest margin for the three months ended December 31, 2016 was 2.67 percent, compared to 2.69 percent for the three months ended December 31, 2015. The decrease from fourth quarter 2015 was primarily driven by higher interest rates on fixed rate long-term debt used to match-fund our longer duration asset growth and increased interest expense on senior debt issued in conjunction with the TARP redemption, both of which were mostly offset by higher yield on our commercial loan portfolio.

Average LHFS for the three months ended December 31, 2016, increased $837 million or 33.7 percent compared to the same period in 2015, primarily due to slower deliveries of saleable mortgage loans to the Agencies. Average LHFI for the three months ended December 31, 2016, increased