With its plan to buy 52 Midwest branches from Wells Fargo & Co., Troy, Mich.-based Flagstar Bancorp Inc. will expand its physical footprint by more than 50%, double its customer base in the Midwest with 200,000 new customers and lower its funding costs at a time when interest rates are rising.
Assuming the deal closes in the fourth quarter as planned, Flagstar's bank will expand from Michigan into several neighboring states. Under this deal, it will acquire 33 branches in Indiana, 14 in Michigan, four in Wisconsin and one in Ohio. It will have 151 branches in the Midwest region and eight in California.
The deal furthers Flagstar's efforts to shift from a thrift to a commercial banking model. It stands to move more of its funding from wholesale borrowings to core deposits, reducing rate sensitivity. It estimated that total funding costs will decline 21 basis points after the deal closes. It said the deal will help it reduce wholesale funding to 13% from 23%.
Flagstar will acquire about $2.3 billion of deposits at an average cost of 0.04%, the company said in a presentation.
The buyer also gains access to a slew of new potential borrowers. Executives said that, among other possibilities, they see opportunity to expand small-business and middle-market commercial lending.
"This was an opportunity not to be missed — not only to change our balance sheet but to fundamentally change who we are," Alessandro DiNello, president and CEO of Flagstar, said during a call with analysts to discuss the deal.
The combination of more deposits at lower costs and new lending opportunities should substantially diversify Flagstar at a time when its core mortgage operation, while still a key business, is likely to come under pressure in a rising-rate environment, Wedbush Securities analyst Henry Coffey, who covers Flagstar, said in an interview.
"It's a no-brainer" for Flagstar, Coffey said. "It's such an important step forward in managing that balancing act" between real estate lending and its broader commercial banking ambitions.
Piper Jaffray analyst Kevin Barker, however, noted that Flagstar estimated it will pay a 7% deposit premium, valuing the Wells branch deal at roughly $160 million. That premium "is near the high end of deposit/branch acquisitions we have seen post-crisis" and could give some investors reason to sell shares.
Wells Fargo, for its part, takes a notable step toward a goal of reducing its branch count by roughly 900 over a few years; it is aiming to get down to around 5,000 branches. Wells is in the midst of a broad, $4 billion expense-reduction effort, including branch sales and closures, which it expects will bolster its overall efficiency.
The company is trying to reduce its efficiency ratio — expenses as a share of revenue — from above 60% into a range of 55% to 59%.
The San Francisco-based bank has struggled to grow revenue in the wake of a late 2016 sales scandal — authorities fined Wells for allowing its retail staffers to open millions of phony accounts over several years — and other customer-service challenges discovered since. Wells is under intense scrutiny. Regulators this year fined Wells $1 billion and the Federal Reserve ordered it to limit its total assets to the level at which it finished 2017.
Wells executives have said they are making steady progress toward resolving their customer woes and meeting regulatory expectations to get the size freeze lifted in 2019. But they have also emphasized that expense reductions, including branch sales, are vital as Wells pushes for greater efficiency.
"This is not related to the Fed consent order and asset cap, but rather is part of our ongoing branch network optimization strategy to decrease our branch network to 5,000 by the end of 2020," Steve Carlson, a vice president in Wells' corporate communications division, said in an email, referring to the branch sale to Flagstar.
Michael Kon, a Wells observer and director of research at big-bank investor Golub Group, said Wells is focused on expenses because that is an area clearly under its control. He also noted that the bank plans to reinvest about half of its $4 billion in expected savings into new products, services and technology. Reaching more customers with innovation, he said, is another effort that it can manage even while under elevated regulatory oversight.
"That's the way to go," Kon said in an interview. "What's under their control, they can plan for and execute."
