HomeStreet Inc (HMST) 2015 Q3 法說會逐字稿

Good afternoon, and welcome to the HomeStreet Incorporated third-quarter 2015 earnings conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Mr. Mark Mason, Chairman, President and Chief Executive Officer. Please go ahead.

Hello, and thank you for joining us for our third quarter earnings call. Before we begin, I would like to remind you that our earnings release was furnished this morning to the SEC on Form 8-K, and is available on our website at IR.HomeStreet.com. In addition, a recording of this call will be available today at the same address.

On today's call, we will make some forward-looking statements. Any statement that isn't a description of historical fact is probably forward-looking, and is subject to many risk and uncertainties. Our actual performance may fall short of our expectations, or we may take actions different from those we currently anticipate. Those factors include conditions affecting the mortgage markets, such as changes in interest rates that affect the demand for mortgages, the actions of our regulators, our ability to meet our internal operating targets and forecasts, and economic conditions that affect our net interest margins.

Other factors that may cause actual results to differ from our expectations, or that may cause us to deviate from our current plans are detailed in our SEC filings, including our quarterly reports on Form 10-Q, and our annual report on Form 10-K for 2014, as well as our various other SEC reports.

Additionally, information on any non-GAAP financial measures referenced in today's call, including a reconciliation of those measures to GAAP measures may be found in our SEC filings, and in the earnings release available on our website.

First, I would like to introduce our new Chief Financial Officer, Melba Bartels. Melba came to HomeStreet from JPMorgan Chase, where she was the Chief Financial Officer of the $60 billion automobile finance and student lending division. Prior to that, she managed corporate financial planning and analysis for Washington Mutual in Seattle. So she knows our business and our markets, and we're thrilled that Melba has joined the Company. She will be joining me in presenting this update today.

Today I'll give a brief update on recent events, and review our progress on executing our business strategy, and Melba will present our financial results. Please refer to our earnings release for a more detailed discussion of our financial condition and results of operations.

In the third quarter, we made significant progress on our strategy to grow and diversify earnings. In the quarter, we expanded our commercial and consumer banking business organically, by opening two de novo bank branches in greater Seattle.

We are also acquiring a branch in central Washington, and we recently announced that we have entered into a definitive agreement to acquire Orange County Business Bank located in Irvine, California. This proposed transaction is expected to close in the first quarter of next year.

We have been expanding in Southern California over the last three years. First, through the opening of home loan centers in the region, and recently through our merger with Simplicity Bank earlier this year. The Simplicity merger added seven retail bank branches in the Los Angeles and San Bernardino counties to our retail branch network. These additions have provided us with a platform for building a full service commercial and consumer banking franchise in Southern California.

Our merger with Orange County Business Bank will provide HomeStreet access to one of the premier southern California commercial and consumer banking markets. Orange County Business Bank serves businesses throughout the region, and this merger will provide Orange County Business Bank with substantial additional products and services to better serve their customers, including higher loan limits, and broader menu of commercial and consumer loan, deposit, investment and insurance services.

Additionally in August, we agreed to acquire the AmericanWest Bank branch in Dayton, Washington. As of June of this year, the Dayton branch had approximately $27.1 million in deposits, and we will be receiving approximately $4.4 million in related loans in the transaction. These deposits represent approximately 24% of the deposits in the market area in Dayton.

We have received all necessary regulatory approvals, and we expect to close the acquisition in December. This acquisition will increase our network of retail deposit branches in eastern Washington to a total of five.

In the third quarter, we also built mortgage banking market share by continuing to opportunistically hire teams with strong originators in new and existing markets in the western United States, adding production offices in Glendora, San Diego, San Luis Obispo, Chico, and Riverside, California.

Reflecting the success of growing and diversifying our banking business, we are in the process of applying for a conversion to a Washington state-chartered commercial bank. We expect to complete this charter conversion by the end of this year.

Before Melba reviews our financial results, I will share some highlights from the quarter. Reflecting our overall progress, year to date return on average shareholders equity excluding merger-related items was 11% through the third quarter, compared to 8.5% last year. Return on average assets excluding merger-related items was 1.07% through the third quarter, compared with 0.77% last year at this time.

Our commercial and consumer banking segment had core net income of $6.3 million for the third quarter, compared to core net income of $5 million for the second quarter of this year. This improvement reflects our ongoing expectations of consistent growth and improved returns in this segment.

After closing a record volume of $2.02 billion in our single-family mortgage lending segment in the second quarter, we continued strong production with $1.93 billion in closed loan volume in the third quarter. Unfortunately, lower profit margins on mortgage origination, and higher costs in part associated with new disclosure requirements, reduced our third-quarter mortgage banking segment net income to $3.2 million, down from $9.5 million in the second quarter.

The cost of preparing for the October 3 implementation of the TILA-RESPA integrated mortgage disclosures has been more significant than we expected. To support the implementation of software upgrades, training and implementation, we added additional personnel in the third quarter, increasing our cost to manufacture loans. The recently implemented trade requirements has substantially incremented our documentation requirements and responsibilities, further complicating our already substantial workflow, and increasing our training costs in the interim.

The new rules have substantially lengthened our time to close loans, and added to our processing costs. We expect these added costs to continue in the near-term, and where possible, we are adjusting our prices to compensate for these costs. However, it is not certain that our competitors will increase market pricing sufficiently to cover these new industry costs.

Now I'll turn it over to Melba, who will share some additional details on our financial results for the quarter.

Thank you, Mark, and good morning, everyone.

Third quarter net income was $10 million or $0.45 per diluted share, compared with $12.4 million or $0.56 per diluted share for the second quarter of 2015, and $5 million or $0.33 per diluted share for the third quarter of 2014. The decrease in net income for the quarter was primarily due to lower net gain on mortgage origination and sale activities, as Mark had noted.

Excluding after-tax merger-related revenue and expenses, core net income for the third quarter was $9.4 million or $0.42 per diluted share, compared to $14.5 million or $0.65 per diluted share in the second quarter. Net interest income was $39.6 million in the third quarter, compared to $38.2 million in the second quarter of 2015.

Our net interest margin was 3.67%, an increase of 4 basis points over the second quarter, due primarily to ongoing changes in the composition of the loan portfolio through organic origination of commercial loans. Non interest income decreased $5.5 million or 8% from the second quarter, due primarily to lower net gain on loan origination and sale activities. Net gain on mortgage loan origination and sale activities decreased $12.1 million from the prior quarter, and increased $20.2 million from the third quarter of 2014.

Non interest expense was $92 million in the third quarter, compared with $92.3 million in the second quarter. Excluding merger-related expenses, non interest expense was $91.6 million, compared with $89.1 million for the second quarter. The increase was primarily due to higher salaries and related costs from increased headcount.

At September 30, the Bank's Tier 1 leverage ratio was 9.69%, and total risk-based capital was 14.15%. These ratios reflect the implementation of Basel III requirements on January 1.

I'd now like to share some key points from our commercial and consumer banking business segment results. The commercial and consumer banking segment net income was $6.8 million in the third quarter, compared to $2.9 million in the second quarter. Net income was higher, due to higher net interest income on higher average balances of loans during the third quarter, gain on sale of investment securities, and lower merger-related items.

Excluding after-tax net merger-related items, the segment recognized core net income of $6.3 million in the third quarter, compared to $5 million in the second quarter. We recorded $700,000 of provision for credit losses in the third quarter of 2015, compared to a provision of $500,000 recorded in the second quarter of 2014.

The portfolio of loans held for investment increased 3.9% to $3.01 billion, from $2.9 billion at June 30, an increase of $112.3 million. Net commitments totaled $417 million, compared with $313 million in the second quarter. We achieved this net growth in the loan portfolio, despite continuing high portfolio run-off of approximately 32.1% annualized in the quarter.

Credit quality remains strong, with nonperforming assets at 56 basis points of total assets at September 30, and nonaccrual loans of 64 basis points of total loans. Nonperforming assets were $27.7 million at quarter end, compared to non-performing assets of $32.7 million at June 30. We continue to enjoy positive charge-off experience, with net recoveries of $739,000 in the quarter.

Deposit balances were $3.31 billion at September 30, down slightly from $3.32 billion at June 30, primarily due to a [4.5]% decline in certificates of deposit. Segment noninterest expense was $28.1 million, a decrease of $1.2 million from the second quarter. Included in noninterest expense for the third quarter and second quarter of 2015 were merger-related expenses of $437,000 and $3.2 million, respectively.

Excluding merger-related expenses from both periods, the increase in expense is due to the continued growth of our commercial real estate and commercial business lending units, and the expansion of our bank branching network.

I'd now like to share some key points from our mortgage banking business segment results. Net income for the mortgage banking segment was $3.2 million in the third quarter of 2015, compared to net income of $9.5 million in the second quarter of 2015. The $6.4 million decrease in net income from the second quarter of 2015, was primarily due to lower net gain on single-family mortgage loan origination and sale activities, due to lower servicing origination values, and lower secondary market gains.

Net gain on single-family mortgage loan originations and sale activities in the third quarter of 2015 was $56 million, compared to $67.5 million in the second quarter of 2015. Single-family mortgage interest rate lock commitments net of estimated fall out totaled $1.81 billion in the third quarter of 2015, a decrease of $76.2 million or 4% from $1.88 billion in the second quarter of 2015. Single-family mortgage closed loans totaled $1.93 billion in the third quarter, a decrease of $89 million or 4.4% from $2.02 billion in the second quarter of 2015.

The combined pipeline of interest rate lock commitments net of estimated fall out in mortgage loans held for sale was $1.5 billion at quarter end, compared to $1.65 billion at the end of the second quarter. The volume of interest rate lock commitments was lower than closed loans designated for sale by 7% this quarter, which negatively affects accounting earnings, because a majority of mortgage revenue is recognized at interest rate locks, while a majority of origination costs including commissions are recognized upon closing.

If rate lock commitments during the third quarter would have equaled closed loan volume, it would have resulted in approximately $3.5 million higher gain on loan origination sale revenue. Conversely, if closed loan volume had been the same as interest rate lock commitments, pre-tax income would have been approximately $1.6 million higher as a result of lower variable costs.

Despite lower mortgage closed loan volume in the quarter, mortgage banking segment non interest expense of $63.9 million increased $861,000 or 1.4% from the second quarter. This increase was the result of overall segment personnel growth, reflecting the aforementioned expense of implementing TRID and expansion into new markets. We grew mortgage banking personnel by 7% in the quarter. Closed loans per loan officer declined in the quarter to 5 loans per officer per compared to 5.3 loans in the second quarter.

Single-family mortgage servicing income was $4.1 million in the quarter, a $2.9 million increase from the second quarter of 2015. The increase was the result of a $1 million improvement in servicing fees collected in the third quarter, combined with improved risk management results.

Single-family mortgage servicing fees collected in the third quarter of 2015 increased primarily due to higher average balances in our loans serviced for others portfolio. Despite higher servicing income this quarter, we continue to suffer higher prepayment speeds, and related higher amortization of MSRs, mortgage servicing rights. The portfolio of single-family loans serviced for others was $14.3 billion at September 30, compared to $13 billion at June 30.

I'll now turn it back over to Mark, to provide some insights on the general operating environment and outlook.

I'd like to now discuss the national and regional economies as they influence our business. First, I would like to remind everyone that we are fortunate to operate in some of the most attractive market areas in the United States today. We are focused on the major markets in the western United States, which today enjoy lower unemployment and substantially higher rates of population growth, job creation, commercial and residential construction, and real estate value appreciation than the remainder of the country.

The most recent Mortgage Bankers Association monthly forecast projects total loan originations to increase 15% this year over the prior year, a downward revision from its prior quarter forecast of 20%. Mortgage rates continue near historic lows, and nationally, purchases are expected to comprise 57% of volume this year. Housing starts for 2015 are expected to be up 11% over 2014 levels. MBA currently forecasts an additional 12% growth in housing starts next year.

During the third quarter, purchases comprised 63% of originations nationally, and 60% of originations in the Pacific Northwest. HomeStreet continues to perform at levels above the national and regional averages, with purchases accounting for 75% of our closed loans, and 70% of our interest rate lock commitments in the quarter. While our purchase composition is strong, the overall home sales market remains well below historic levels, due to low inventories of new and resale homes.

Since the third quarter of last year, job creation in Washington, Oregon and California has averaged 3% on an annualized basis, 1 full percentage point faster growth than in the national economy. Since 2011, unemployment rates in the Northwest states and California have been cut by over 40%. Housing permits, though volatile due to multi-family swings, have largely trended higher in Washington in California in recent quarters, but more level in Oregon and Idaho. Since the recession low, however, the permitting rate has doubled in Oregon and Idaho matching the national performance, while climbing more than 2.5 times in Washington, and tripling in California.

Over the last four quarters, year-over-year home price appreciation based on FHFA data has ranged from 5.3% in Idaho, also the national rate, to between 6% and 8% in Washington, California and Oregon. In Washington, multi-family permits are expected to average 53% of total permits for the year. In California, multi-family permits are expected to total 55% of total permits.

Seattle was ranked in 2015 by the Urban Land Institute in the top 10 regions in overall real estate market prospects for investment, development, and home building. Seattle ranked 6th in technology and energy employment concentrations, and overall job creation in the last two years.

Looking forward over the next three quarters in our mortgage banking segment, we currently anticipate mortgage loan lock volumes held for sale of approximately $1.5 billion, $1.8 billion, and $2.3 billion in the fourth, first, and second quarters of next year, respectively. We anticipate mortgage held for sale closing volumes of $1.8 billion, $1.6 billion, and $2.3 billion in the fourth, first, and second quarters of next year, respectively.

This seasonality is expected to produce greater variation in accounting results, due to the timing of recognition of related revenues and expenses, and the expected imbalance between locks and closings. This imbalance is expected to negatively impact the quarters where closings exceed locks and vice versa, as we expect in the current quarter, with a forecast of $1.5 billion and $1.8 billion, respectively, for lock versus closed loan volume.

Based on these expectations, some analyst's current estimates for the fourth quarter appear high. Additionally, we expect our composite margin to continue to range between 315 basis points and 325 basis points over that period. As I mentioned earlier, our results in future quarters could be further impacted by TRID requirements. We expect the increase costs we experienced in the third quarter to continue at least through the current quarter.

For the full year next year, we expect mortgage loan lock and mortgage loan held for sale closings of $8.3 billion and $8.2 billion, respectively. In our commercial and consumer banking segment over the next three quarters, we continue to expect net loan portfolio growth to approximate 4% to 5% quarterly, and our net interest margin to remain at roughly the 3.6 % level, absent changes in market rates and prepayment speeds.

Going forward, we generally expect the consolidated non interest expense will grow approximately 2% per quarter, reflecting the continued investment in our growth and infrastructure. This growth rate will vary somewhat quarter over quarter, driven by seasonality in our single-family closed loan volume in relation to further investments in growth in both of our segments. Despite this extended guidance and caution regarding certain fourth quarter analyst estimates, we are generally comfortable with analyst's 2016 full year consensus estimates.

I am sharing this extended guidance with you this morning to assist investors, and to emphasize the seasonal changes in mortgage origination activity. Of course, this guidance is dependent upon many factors including, but not limited to those I mentioned earlier, and in particular changes in the mortgage and real estate markets, and general interest rates.

This concludes our prepared comments, and we thank you for your attention today. And Melba and I would be happy to any answer any questions you have at this time. Operator?

(Operator Instructions)

Paul Miller from FBR & Company.

Yes, thank you very much.

Hey, Mark, on the community, and on the consumer bank, you continue to show improvement in those earnings. I believe it was like you showed a net segment analysis profit of $6.2 million. Is that a good run rate going forward? Or should that continue to grow, because I know you've done a lot of hiring on that institution, especially in the lending side?

As I mentioned in my earlier comments, we are expecting from here forward, for results in that segment to grow. Not just in bottom line, but in our efficiency in producing revenues. So we think that we've gotten past some of the scale challenges that we've had in the past, in terms of the relative size of the loan portfolios, and the operating expenses of the various lending units. The additions of Simplicity and soon Orange County Business Bank have already shown a substantial improvement, provided substantial improvement; and we expect more going forward. So we feel like this quarter is a good baseline to revenue and expenses, understanding that revenues will grow as the portfolio grows, and expenses will grow somewhat, as we continue to open branches, and grow personnel, building out the platform.

And then, can you talk a little bit about your M&A strategy right now? I mean, the Simplicity merger has been closed; that's probably the big one. But then, you did OCBB -- and is that the new -- are you just looking for little fill-ins at this point? Or is there any major areas that you would love to get a foothold in?

Well, theoretically, we shop in all of the markets we would ultimately like to be in. I think it's fair to say that we have tiers of interest. The top tier being, of course, in Puget Sound, where we had the most opportunity for consolidation and efficient mergers. But obviously, in southern California we're focused on building out a full platform there, and our operations currently don't reflect that. So we're very interested in both of those markets.

The next tier would be other significant markets: the rest of California, the Bay area, and the middle of the state. We're still interested in the I-5 corridor through Oregon and Washington, and then some of the other centers of population in the rest of the Western states. But given where we're trading, particularly today, relative to tangible book value, it is hard for us to do some of the more expensive acquisitions in terms of premiums to tangible book value. That's not to say that we wouldn't entertain larger, somewhat more expensive acquisitions if well-placed and of a size that would accelerate substantially our diversification interest.

Recently we've been more focused on transactions that more easily fit our acquisition criteria. And so, I'd say for the time being, we're still probably in this zone of properties. But if the right opportunity came along in a larger transaction that would accomplish all of our diversification objectives, we would have to consider it.

Okay. Thanks a lot, Mark.

Jeff Rulis from D.A. Davidson.

Thanks, good morning.

Good morning.

Maybe a quick one for Melba on the margin. Was there -- could you break out any accretion benefit you saw in Q2 versus Q3?

Accretion relative to the merger, the recent merger (multiple speakers)?

I assume you mean, accretion of the marks on Simplicity and the prior mergers, Jeff?

Correct. So did it add to the margin, or was that sort of flat quarter to quarter?

Okay. Jeff, I do not have that at my fingertips, so I'll have to follow up with you on that.

But I would say, because the second quarter was a full quarter of operations (multiple speakers) -- the second and third quarters were full quarters after the Simplicity closing on March 1, I would expect the impact to be relatively flat. Now, what we are experiencing is some acceleration from prepayments, but I don't think it's a material change quarter over quarter.

Okay. And then, Mark, on your noninterest expense outlook, 2% growth a quarter, would that include the acquisition coming on board in Q1, and you kind of soak that in? Or would that just be legacy, and then we add for that platform in Q1?

I think that's an ongoing expectation. I don't know that the closing of Orange County Business Bank is going to materially change that number in the first quarter.

Now, of course, we would exclude any specific merger-related expenses related to OCBB in that run rate. But Mark is correct; it wouldn't materially change the 2% guidance

Okay. Got it.

And then, Mark, just as -- I'm just jotting down the lock and held for sale origination expectations for 2016. Was that $8.3 billion and $8.2 billion, respectively?

That's correct. Is it -- I think it's $8.2 billion locks and $8.3 billion close. Let me check my notes.

$8.3 billion locks and $8.2 billion closings.

Yes.

And how does that compare to 2015, if you annualize Q4, or your expectations to close the year?

We -- so we're going to add $1.5 billion and $1.6 billion locks and closings to our year-to-date numbers, which would give us about $7.1 billion in locks and $7.3 billion in closings for 2015.

Got it. And just kind of backing into that -- your comments on comfortability with consensus -- you're looking for an increase in originations. I guess, the MBA forecast for 2016 is down 10%. That, basically [balling] that all up, you intend to outperform the general demand on originations, just from better execution and/or boots on the ground?

Two things: one, as I mentioned earlier, we have a substantially higher purchase concentration than the nation as a whole. So the MBA numbers reflect the national numbers. Next year, the MBA is forecasting growth in purchase originations of -- I think it's around 12% roughly? So we should outperform the country, without any growth in capacity, simply on higher purchase composition. But in addition to that, we expect ongoing growth in our origination capacity by hiring more teams and individual loan officers next year, as has been our strategy. So the combination of those two, we think should result in growth from $7.1 billion to $8.2 billion in locks next year, and similar in closings.

And I guess, just last one, not to beat it up here, but with that composite margin of 3.15% to 3.25% -- I'm not -- it wasn't clear if that was for the full year, or for just for the next three quarters. But I guess the idea is that originations, from your perspective, are set to increase in 2016, but maybe a lighter composite margin? Is that directionally correct?

That 3.15% to 3.25% is, we think good for the whole year. We think it's somewhat seasonal. Typically as volume drops, margins drop, as originators stretch to do more volume. So we would see the year, having slightly higher margins in the second and third quarter, slightly lower in the first and fourth quarters, but averaging around that 3.15% to 3.25% range.

Thanks for the color, Mark.

Sure.

Jacque Chimera from KBW.

Good morning, everyone.

Hello, Jacque.

So information services costs that were up in the quarter, is that related to the higher regulation and disclosure that you discussed? Or is that something different?

In part, though as we continue to improve our infrastructure here, sometimes those expenses are a little lumpy. So we have an ongoing series of implementation of new software systems in the various lending groups. And I think this reflects somewhat lumpiness there, and the work on TRID.

Okay. So some of it will be ongoing, at least over the next couple of quarters, but others of it will just be quarterly fluctuations based on timing? Is that the way to think about it?

Yes.

And then a question on the yield on securities in the quarter. That line item has been a little bit lumpy over the past couple of quarters. Has there been a change in premium amortization that might be impacting it? Or something else that I may not be thinking of?

Well, that is what's impacting it. We have a fairly sizable composition of mortgage-backed securities in our securities portfolio. With higher prepayment speeds, our prepayment speeds have been pretty volatile. I mean, if you think of first quarter, very high; second quarter, not so high; third quarter, high again. And under the prescribed accounting here, which is a retrospective recalculation of live to date amortization, it provides, unfortunately, some pretty significant swings in yield on that portion of our portfolio. And that's what you see.

Do you happen to have the dollar amount of 2Q versus 3Q for your premium [am]?

I don't offhand, but we can provide that later.

Okay. Great. And then, just one last one.

So you had mentioned changing over to become a Washington State bank. Would you, at that point in time, become a bank Holding Company as well?

That's correct. I think they're called financial holding companies in the federal reserve vernacular.

Okay. All right. Great. Thank you very much.

Thanks, Jacque.

Russell Gunther from Macquarie.

Good morning, guys.

Hello, Russell.

I appreciate the guide on continued commercial growth expectations of 4% to 5%; how you guys exceeded, you outperformed the high end of that range in this quarter. Just want to get a sense for what you expect to be able to drive continued 4% to 5% range, and maybe why we shouldn't expect a continued outperformance, given all the investment in the Southern California franchise?

Well, in terms of lending, we have some pretty strong existing lending groups that we've been building for several years. But you may remember earlier in the year also, we brought on two new groups in Southern California, a new SBA lending group, and a small balance commercial mortgage group. Between the addition of those groups, Orange County Business Bank, and continued growth in the Pacific Northwest in our existing commercial lines, we feel pretty comfortable that we're going to be able to maintain that kind of pace, albeit on a larger base, right? I mean, the denominator is growing. And because of that, we feel it's going to continue to be well-diversified and predictably strong.

Great. Thanks for that, Mark.

I just wanted to circle up on the commercial loans this quarter. Saw that balance decline a little bit; others were strong. Is there any seasonality in that number, or is it just coincidence that trends down in the third quarter? Could you give a little color on the dynamics within the C&I line this quarter?

Yes, I don't think it's seasonality. I think we suffer, similar to everyone else in that business, in that there's not enough business to go around. And with lower rates, term lending has gotten refinanced at a much higher pace. Companies are not borrowing as much as they used to, so line utilization for all of us is down, and I think you're just seeing some volatility there. We are expecting growth in that line item.

Okay. That's great. And then, just on the consumer loan, the single-family continued to trend down a little bit, home equity balances have been kind of steadily increasing. Could you give us a sense for your thoughts around what you're going to continue to portfolio there?

Sure. On the single-family front, we seek to portfolio certain classes of single-family assets. Home equity loans, as you mentioned, in that business, has been growing. For us, it is always been a very fine business. I mean, even during the recession, our HELOC portfolio never got above 4% delinquent. So the Company has a proven record of strong credit quality in that product, and if that product is great from an interest rate risk standpoint, in that it's a floating rate instrument.

Additionally, we portfolio custom home construction loans. These are loans that -- in a single close, start as loans for individuals to build customer homes. They roll into a permanent loan. Because we are not interested in hedging them for those long periods of time and then reselling them, we keep them in our portfolio. They do tend to have historically somewhat higher prepayment speeds, so that mitigates somewhat the rate risk in that category. And then beyond that, other fixed junior liens and some nonconforming jumbos that we don't sell in pools, and other non-jumbo loans that make sense -- that makes up the remainder of that line item.

We're expecting in the longer term to get our single-family loan concentration down below a third of the portfolio. So we're a little above that now still, but down substantially from when single-family loans made up almost 60% of the portfolio. So we're looking for a little lower concentration going forward, but it's another one of those great product lines to have. You can really meter your portfolio growth when you'd like, with single-family loans, which continue to have better yields than commercial loans (laughter).

Okay. Okay. I appreciate that.

And then, with regard to the forward guidance, particularly as it relates to expenses -- and it may be trying to tie everything all together -- is there an efficiency ratio target you're thinking about for 2016? And if we can think about it maybe on rising fed fund scenario?

Sure. We are expecting our efficiency ratio to trend below 80% next year, and in the best quarters, hopefully approximating something close to 75% overall. But very different from the segment standpoint, the mortgage business should run between 75% and 85% efficiency. The commercial and consumer business, we ultimately hope to get below 60%. That's not going to happen next year, but we're going to make tremendous progress towards those numbers next year.

Okay. Well, thanks very much for taking my questions. Very helpful guys.

Thanks, Russ.

(Operator Instructions)

Tim Coffey of FIG Partners.

Thanks. Good morning Mark, good morning, Melba.

Good morning, Tim.

Good morning.

Can you give us some color on the declines in the deposit portfolio the last two quarters?

Sure. In the current quarter, the primary reason for decline, was a decline in timed deposits. If you look at the quarter-over-quarter detail, which is -- let me see, I'll direct you to --

Page 26.

Page 26 of our earnings release.

Okay. Any specific reason that -- I mean, we just run (multiple speakers)

Mostly broker deposits, brokered CDs that ran off, that we didn't need to replace.

Okay. Would you expect more of that in the forward quarters?

It's going to depend on a lot of things, like lending volume, our success in gathering core deposits. To the extent that we can't fulfill our funding needs in that manner, or that we get to a level of FHLB borrowings that we don't want to exceed, we may have to go back into the timed deposit market. I would expect ultimately that line item to grow consistent with the overall growth, and maybe a little more depending upon funding needs.

Okay. And then, on the construction lending that you've seen, the strength in that -- is there any particular market where you're finding the most opportunities?

Gosh, in our markets, there's so much construction going on. I wouldn't cite any one as being stronger than the others. Of course, most of our construction business is in the Pacific Northwest.

On the commercial side, most of the construction is in primary or strong secondary markets surrounding Seattle and Portland. We do have a broader home-building business with strength in Utah, in the Salt Lake City area, which is a very strong home-building market today. And in Southern California, which, again, from Central to Southern California, where there is available land, is quite a strong market. So it's traditionally been the same for us. We have not really extended commercial construction yet outside of the Pacific Northwest, though we expect to next year sometime. And these are all very strong markets with lots of opportunity. So we're picking our spots.

Okay. As you extend commercial construction outside of the Pacific Northwest, would that entail hiring new lending teams, or do you already have the people in place for that?

We mostly have the people in place for that. In Southern California, for example, we hired a strong team of originators that today are focused on small balance commercial permanent mortgage lending. But those folks also have construction, bridge, and other expertise. So our ability to extend that product down there substantially exists, with perhaps a few additions.

Okay. And with a potential for a higher-rate environment, how is that going to change your hedging strategy on the mortgage servicing portfolio?

It doesn't change our strategy. We don't trade that hedge to position it for rising or falling rates; that would be speculative. And we know that we're not great predictors of interest rate movements; the economists aren't either. So we keep that flat, to either direction of potential movement. So we'll use the same instruments we've generally used before, and we will keep that profile flat on either end of the potential movement. So far, it's been a good place to be.

Yes, [it worked] so far.

And then the estimates for your locks and closed loan production the next -- at least the next quarter -- how much of that is seasonal, and how much of that is TRID related?

All seasonal. Just because we, as the manufacturers of loans have a new disclosure standard, that doesn't change market demand for mortgages. So our lock volume and new application volume will be what the season allows. It's our job to get it closed timely, in light of the new standards (laughter).

Okay. Excellent. Those are my questions. Appreciate it.

Thanks, Tim.

Tim O'Brien from Sandler O'Neill & Partners.

Hello, guys.

Hello, Tim.

A couple questions around credit: it looked like TDR balances came down this quarter nicely, accruing TDR -- maybe that's not so nice. Can you give a little color there?

Sure. We have held a balance of TDRs since the recession; that has been, until recently, a little more than $100 million. Most of that number, $75 million or so, has been in single-family loans that were modified during the recession. They have performed very well. I mean, as you can see, there's only a small amount of nonaccruing single-family loans. The biggest part of the change quarter over quarter came not in the single-family loan segment, but in commercial loan TDR portfolio. And we had one large $15 million loan that had been performing, and had been a permanent TDR, as a consequence of modification during the recession that prepaid during the quarter. And so that accounts for the significant difference in commercial real estate accruing TDRs. If you look on page 24, there's a large detail of those amounts.

That's great color. Thanks.

And the credit performance is just -- it's been really solid. I noticed just a slight uptick in 30 to 89 day past-due loans, sequentially. Can you talk a little bit about that? Is that even a blip that registered on your radar screen?

It has, though we don't think it's meaningful or indicative of a new trend. Some of these delinquencies came from the portfolio that we acquired in the Simplicity acquisition. And so they are centered generally in Southern California. But given our review of those delinquencies, we think that they will substantially cure, and it represents a little volatility, I would say at this juncture. But we're going to watch it.

And then, last question.

It looked like another nice recovery of a previous charge-off. What's the outlook for additional recoveries going forward?

I think we're still going to experience some out of the single-family portfolio. I don't know that, that's a really material number, because we only have so much left to recover against. I mean, we do have some deficiency notes still outstanding from the cleanup of the construction portfolio. Again, I don't think that there's going to be really material recoveries there. We have some we are going to see in the fourth quarter, we think. I don't think it's a seven-figure number. But until we realize them, and put the money in the bank, we're not sure.

So I -- look, I think the real issue in charge-offs is, we don't see credit deteriorating in the near term, based upon everything we see. And while we'll have some minor recoveries, what we're really expecting is relatively low charge-off experience in the near term. In the longer term -- we've been discussing this internally ourselves as we do strategic planning -- it's really hard to predict a change in the credit environment, even looking out two to three years, because we don't have any precursors to really note. At some point, we will go through another credit cycle. As you know, this recovery has been elongated, and I think that's going to be true of the credit cycle as well.

Everything we know today. But we are fortunate, right? We are in some of the strongest economic markets in the United States, and that is going to be helpful with respect to credit as well.

It seems like every cycle has its own unique triggers.

Sure. And there will be a new one, I'm sure, when we see it.

Thanks for answering my questions.

Thanks, Tim.

Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Mason for any closing remarks.

Well, thank you, Operator, and thanks to everyone who joined us on the call today. Melba and I appreciate your patience during our prepared remarks, and your great questions. Have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.