HomeStreet Inc (HMST) 2015 Q4 法說會逐字稿

Good day and welcome to the HomeStreet fourth quarter 2015 earnings conference call.

(Operator Instructions)

After today's presentation there will be an opportunity to ask questions.

(Operator Instructions)

I would like to turn the conference over to Mark Mason, Chairman, President, and CEO. Please go ahead.

Thank you, Operator. Hello and thank you for joining us for our fourth quarter 2015 earnings call. Before we begin, I'd 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 made 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 risks 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 would affect the demand for our 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 10K for 2014 as well as our various other SEC reports.

Additionally, any information on 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. Please refer to our earnings release for a more detailed discussion of our financial condition and results of operations.

Joining me today is our Senior Executive Vice President and Chief Financial Officer, Melba Bartels. In just a moment, Melba will present our financial results but first I'd like to give a brief update of our recent events and review our progress in executing our business strategy.

During quarter and over the course of 2015, we made significant progress on our strategy to grow and diversify earnings. While the most recent quarter was challenged by mortgage banking market that saw volumes decline seasonally, and of course the impact of the recent update to [Telia Respa] disclosures, the integrated mortgage disclosures, or TRID for short, we are particularly proud of the achievements we've made in our commercial and consumer banking segment. The investment in growth that we have made there lays a foundation for strong consistent earnings growth going forward.

We expanded our commercial and consumer banking business by closing on the acquisition of Simplicity Bank and acquiring one bank branch in Eastern Washington this year, 2015. Additionally, we expect to close on our acquisition of Orange County Business Bank next week. We are excited about the potential this acquisition offers us for expanding our business to Orange County, California and beyond.

Our merger with Orange County Business Bank will provide HomeStreet access to Orange County and the greater Los Angeles area one of the premier commercial and consumer bank markets in the United States. Orange County business bank is a business focused bank that serves businesses throughout the region and HomeStreet will be able to bring substantially more products and services to better serve their customers, including higher loan limits and a broader menu of commercial and consumer loan deposit investment and insurance services

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

Additionally in December we acquired the American West bank branch in Dayton, Washington. At closing this branch had approximately $26 million in deposits and we received just under $5 million in related loans in the transaction. This acquisition increased our network of retail deposit branches in Eastern Washington to a total of five.

We successfully launched HomeStreet Commercial Capital, a California-based commercial real estate group whose primary focus is to originate, pool, and sell small balance commercial real estate loans last year. We also hired an Orange County based group specializing in small business SBA lending. These groups should significantly increase the non-interest income component of our commercial and consumer banking segment going forward as well as provide for additional opportunities to cross sell other loans and deposit products.

On our last quarterly earnings call, we announced our intention to apply to a conversion to a Washington State-chartered commercial bank. We expect to have that application process completed in the next several weeks.

Lastly, during the fourth quarter, as a part of our annual strategic plan development with our Board of Directors, we discussed and evaluated our capital needs and concluded that instituting a regular dividend was not appropriate at this time given our strategic growth objectives, and that we believe retaining this capital will create a superior return in the near term.

Before Melba reviews our financial results, I will share highlights from the year and quarter.

Total assets grew $1.4 billion in 2015 from $3.5 billion in 2014, finishing at $4.9 billion at year-end. The simplicity acquisition comprised $850 million of the year-over-year growth. Net income for the year excluding merger related items increased 82.9% from $24.2 million in 2014 to $44.3 million in 2015.

Return on average tangible equity excluding merger-related items increased from 8.8% in 2014 to 10.5% in 2015. Diluted earnings per share excluding merger-related items increased 30% from $1.62 per share in 2014 to $2.11 per share in 2015.

Tangible book value per share increased from $19.39 at the end of 2014 to $20.16 at the end of last year. Additionally we grew our retail branch network by 11 branches from 33 at the end of 2014 to 44 today.

Seven of these branches were acquired from Simplicity, one came from our recent acquisition from American West, and we grew our standalone lending centers by 12 offices last year from 58 to 70 today. We also closed and sold over $7 billion of mortgage loans during the year last year. Full time employees ended 2015 at 2,139, up from 1,611 at the end of 2014.

Our commercial and consumer banking segment is becoming a significant part of the companies earnings Total revenue for the quarter increased 8.2% from the third quarter and 50.4% from the fourth quarter of 2014 in the segment. In addition, net income, excluding merger-related items for this segment contributed 47.4% of our core net income for last year.

Our fourth quarter mortgage banking segment net income declined to $301,000 from $3.2 million in the third quarter reflecting seasonal low point in the mortgage business as well as higher costs in part associated with the new disclosure requirements. Closed loan volume on single family mortgage lending segment totaled $1.6 billion in the fourth quarter, compared with $1.9 billion in the third quarter. Interest rate lot commitments of $1.3 billion in the fourth quarter declined from $1.8 billion in the third quarter.

The cost of preparing for the October 3 implementation of TRID has been more significant than we expected going into the quarter. The recently implemented TRID requirements substantially increased our documentation requirements, and more importantly our responsibilities as the lender, further complicating our already substantial work flow and increasing our training costs in the interim. The new rules have lengthened our time to close loans and added to our processing costs. In an abundance of caution, we made the determination to portfolio some jumbo non-conforming loans, subject to these new requirements, until we're confident that we're in complete compliance with the new rules and secondary market participants are satisfied with the quality of our production.

Prior to the end of the fourth quarter we had already begun selling these loans into the secondary market. In addition we have already seen some improvements in our work flow and processes and our vendors are providing updates to their software products supporting our origination process. However, we expect some of these added costs to continue in the near term until our software is fully compliant and our workflows are back to pre-TRID efficiencies.

Last but certainly not least, we're proud to have been a recipient of the 2015 American Banker's Association Community Commitment award. The award was given to HomeStreet in November for its activities in affordable housing.

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

Thank you, Mark, and good morning everyone.

Fourth quarter net income was $8.7 million or $0.39 per diluted share, compared with $10 million or $0.45 per diluted share for the prior quarter and $5.6 million or $0.38 per diluted share for the fourth quarter of 2014. The decrease in net income from the prior quarter was primarily due to lower net gain on mortgage origination and sale activities as Mark has noted.

2015 net income was $41.3 million or $1.96 per diluted share, compared with $22.3 million or $1.49 per diluted share for 2014. Excluding after-tax merger-related items, core net income for the fourth quarter was $8.8 million or $0.39 per diluted share, compared to $9.4 million or $0.42 per diluted share in the third quarter.

Core net income for the year of 2015 was $44.3 million compared to $24.2 million for 2014. Net interest income for the quarter was $39.7 million compared to $39.6 million in the third quarter. Our net interest margin of 3.61 was a decrease of 6 basis points from the third quarter, due primarily to a decline in the amount of non-interest bearing liabilities.

Non-interest income increased $2.1 million or 3.1% from the prior quarter due primarily to lower net gain on loan origination and sale activities, offset somewhat by increases in mortgage servicing income.

Net gain on mortgage loan origination and sale activities decreased $11.2 million from the prior quarter and mortgage servicing income increased $8.8 million, due to increases in both net servicing income and risk management activities stemming from slower long term prepayment speed expectations.

Non-interest expense was $92.7 million in the fourth quarter compared to $92 million in the third quarter.

Excluding merger-related expenses, non-interest expense was $92 million compared to $91.6 from the prior quarter. The increase was primarily due to higher general administrative costs related to the reversal of foreclosure advances that were deemed to be uncollectible in the quarter.

At December 31, the bank's Tier 1 leverage ratio was 9.45% and total risk-based capital was 13.91%. The consolidated company's Tier 1 leverage ratio was 9.94% and total risk-based capital ratio was 12.69%. These ratios reflect the implementation of Basel III requirements effective on January 1 of 2015.

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 $8.4 million in the quarter, compared to $6.8 million in the prior quarter. Net income was higher primarily due to higher net interest income from the growth on our loans held for investment, as well as higher gain on sale from the first sale of loans by HomeStreet Commercial Capital.

Excluding after-tax net merger-related items, the segment recognized core net income of $8.5 million in the fourth quarter compared to $6.3 million in the prior quarter. The portfolio of loans held for investment increased 6% to $3.19 billion from $3.01 billion at September 30. New commitments totaled $574.9 million compared to $416.6 million in the third quarter.

We achieved this net growth in the loan portfolio against $346.5 million of portfolio run-offs in the quarter. We recorded a $1.9 million provision for credit losses in the fourth quarter of 2015, compared to a provision of $700,000 recorded in the third quarter, reflecting growth in the balances of loans held for investment.

Credit quality remains strong, with non-performing assets at 0.5% of total assets at year-end and non-accrual loans at 0.53% of total loans. Non-performing assets were $24.7 million at quarter end compared to non-performing assets of $27.7 million at September 30.

We continued to enjoy positive charge off experience with net recoveries of $872,000 in the quarter. Deposit balances were $3.2 billion at year-end, down from $3.3 billion at quarter end September 30, primarily due to a 16.5% seasonal decline in non-interest bearing accounts related to our mortgage customer escrow accounts.

Property taxes for our borrowers are typically due during the fourth quarter. Segment non-interest expense was $29.5 million an increase of $1.4 million from the prior quarter. Included in non-interest expense for the fourth quarter and third quarter of 2015 were merger-related expenses of $754,000 and $437,000 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 branch banking network. Now I'd like to share some key points from our mortgage banking business segment.

Net income for the mortgage banking segment was $301,000 in the fourth quarter, compared to net income of $3.2 million in the prior quarter. The $2.19 million decrease in net income from the third quarter was primarily due to lower net gain on single family mortgage loan origination and sale activities, due to lower interest rate lot commitments during the quarter.

Net gain on single family loan origination sale activities in the fourth quarter was $43.5 million compared to $56 million in the prior quarter. Single family mortgage interest rate lock commitments totaled $1.3 billion in the fourth quarter, a decrease of $466.6 million or 25.8% from $1.8 billion in the third quarter. The gain on sale composite margin increased to 319 basis points in the quarter, from 311 basis points in the third quarter, partially due to product mix.

Single family mortgage closed loans totaled $1.6 billion in the quarter, a decrease of $285.4 million, or close to 15% from $1.9 billion in the third quarter of 2015. The volume of interest rate lock commitments was lower than closed loans designated for sale by 18.7% this quarter which negatively affected accounting earnings, as a majority of mortgage revenue is recognized at interest rate lock, while a majority of origination cost including commissions are recognized upon closing.

If rate lock commitments during the fourth quarter would have equaled closed loan volume, it would have resulted in approximately $8.7 million higher gain on loan origination and sale revenue.

Conversely, if closed loan volume had been the same as interest rate lock commitments, pretax income would have been approximately $3.8 million higher as a result of lower variable costs. Because of lower mortgage close loan volume in the quarter, mortgage banking segment non-interest expense of $63.2 million decreased $733,000 or 1.2% from the prior quarter. This decrease was despite overall segment personnel growth reflecting aforementioned expense of implementing TRID and expansion into new markets. We grew mortgage banking personnel by 1.4% in the quarter. Closed loans per loan officer declined in the quarter from 4.3 loans per officer, compared to 5 loans per officer in the third quarter.

Single family mortgage servicing income was $12.8 million in the quarter, an $8.7 million increase from the prior quarter. This increase was the result of $1.9 million in net servicing income for the fourth quarter, combined with $6.8 million increase in risk management results. Single family mortgage servicing fees collected in the quarter increased primarily due to higher average balances in our loan service for other portfolio. The portfolio of single family loan service for others was $15.3 billion at year-end, compared to $14.3 billion at September 30.

The $6.8 million increase in risk management results from the third quarter was the result of improved net risk management results, primarily from slower long term prepayment speed expectations.

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

I'd like to now discuss the national and regional economies as they influence our business today. First I'd like to remind everyone we're fortunate to operate in some of the most attractive market areas in the United States today. Strategically we're focused on the major markets of 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 Banker's Association monthly forecast projects total loan originations to decrease 7% this year from the past year, an upward revision from prior forecast of a 9% decrease. However, our focus has always been on the purchase market. The Mortgage Banker's Association forecasts that purchase mortgage originations are projecting to increase 13% this year over last year, while refinancing mortgages are projected to decline by 32%.

Despite the increase in short-term interest rates by the Federal Reserve in December, mortgage rates continue near historic lows and nationally, purchases are expected to comprise 67% of the mortgage volume this year. Housing starts for this year are expected to be up 11% over last year's levels.

To give some perspective, we are quoting a 30-year mortgage in the Puget Sound area at about 4% on September 30 last year, 4 1/8% at December 1 of last year and 4% last week. Substantially the same.

During the fourth quarter, purchases comprised 53% of originations nationally, and 53% of originations in the Pacific Northwest. HomeStreet continues to perform at levels above the national and regional averages, with purchases accounting for 70% of our closed loans and 67% 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. Home price increases in Washington, Oregon, and California based on FHFA data, accelerated across-the-board in the latest quarter, with the year-over-year increases ranging from 7.7% in California to 10.5% in Oregon.

According to the most recent Case-Shiller 10-city composite home price index report, which measures the change in value of residential real estate in 10 metropolitan areas, the index gained 5.3% from a year earlier. Seattle gained 9.7% over the last 12 months, Portland gained 11.2%, San Francisco gained 11.1% and Los Angeles gained 6.2%. These are the strongest numbers in the nation today.

Housing permits in Washington, Oregon and California, while cyclical are running between 75% and 95% of their long run average, with only Washington having slightly surpassed the 30-year average level.

The West Coast state economies continue to sustain much stronger relative job growth in the US economy as a whole. Year-over-year growth rates for non-payroll employment over the last five quarters have averaged better than 3% in Washington, Oregon, Idaho, and California, compared to approximately 2% for the nation.

The faster job growth has not produced lower unemployment rates compared to the US. This is mainly due to stronger state population growth or people following jobs.

Looking forward over the next three quarters in our mortgage banking segment, we currently anticipate mortgage lock volumes held for sale of approximately $1.7 billion and $2.3 billion in the first and second quarters of this year respectively. We anticipate mortgage held for sale closing volumes of $1.6 billion and $2.3 billion in the first and second quarters of this 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 $1.7 billion and $1.6 billion respectively for lock versus closed loan volume. Additionally, we expect our composite margin to range between 315 and 325 basis points over that period.

As I mentioned earlier, our rules in future quarters could be further impacted by TRID requirements. We expect the increased costs we experience in the fourth quarter to continue at least in part through at least the next few quarters until our software vendors complete their updates and our manual adjustments, quality assurance, and other work-arounds normalize.

For the full year, we expect mortgage loan lock and closing volumes of $8.1 billion. In our commercial and consumer banking segment over the next several quarters, we expect to maintain net loan portfolio growth of between 4% and 5% quarterly. Going forward we generally expect our consolidated net interest margin will remain at roughly 3.55% to 3.6%, absent changes in market-rates, prepayment speeds, and other factors that would impact our margin.

Our non-interest expenses, we anticipate growing between 2% and 3% per quarter reflecting the continued investment in our growth in infrastructure. This growth rate will vary somewhat quarter-over-quarter, driven by seasonality in our single family close loan volume and in relation to the timing of further investments in growth of both of our segments.

This concludes our prepared comments. Thank you for your attention today. We will be happy to answer any questions you have at this time.

(Operator Instructions)

The first question comes from Paul Miller of FBR.

Mark, you talked a lot about your loan growth in the quarter.

Can you just, I mean have you seen -- a lot of people concerned about the credit quality out there across-the-board especially in the commercial side? Are you seeing anything out in the Pacific Northwest that could concern you down the road?

People's greatest concern here relates to potential bubbles that may be created in commercial real estate, particularly in the multi-family area. Because we have had so much multi-family construction, not just in Seattle and Puget Sound but in San Francisco the Bay Area, additionally in Southern California. But when we look at the numbers today, much of that has been catch-up and has been consistent with job growth.

We watch very closely, probably almost 100 early warning indicators in our various businesses and very discrete ones in the commercial real estate area and we still see growing strength. We do not yet see any indications of additional concessions, of any slowing of the velocity of rental increases and that's where we will eventually see softening. So I think that point is out there in these markets at which there will be a crossover between demand and supply.

Right now I think supply is not quite keeping pace with demand in most of these markets, but there will be a time when that changes and to date we've not seen it. We are being very careful about where we lend, particularly on construction in the commercial and residential areas.

We primarily lend in primary markets and strong secondary markets and particularly on larger commercial real estate construction projects we stay in primary Seattle, Portland and strong secondary markets of those areas with strong track record developers with substantial portfolio cash flow. And so we are being very careful about our investments, not just in construction but commercial real estate overall.

With respect to general commercial lend we're in the best markets economically in the country and we don't really see weaknesses in any of the areas we lend into. We are not an energy lender, as an example, so the recent changes in the oil prices and the energy sector have not had a direct impact on us.

Commodity prices have some impact. We do have some agriculture lending, but it's pretty diversified, and the folks that we lend to have very strong businesses. So overall we are fortunate in that we do not see pockets of weakness yet.

I think that our risk management, and our forward-looking approach to risk management, is going to give us an early look we hope. But right now we feel very good about credit quality in our markets and the strength of the economies.

And then, on the investment securities, this is the first time that you've seen a material selling of the securities. Was that just taking, redeploying some capital? Give us is some thoughts behind that?

That was largely adjusting the composition of the portfolio. We adjusted in particular our concentration in municipal bonds.

We are fortunate to have purchased many of them at attractive yields, and so as we rebalanced, we simply recognize some of that gain that existed in OCI and equity anyway. So all you're doing is realizing something that was already in tangible book value.

But going forward can we see this percentage in your balance sheet or will there be continued adjustments as you see opportunities?

I think there will always be management of the composition, right?

The absolute size of the portfolio, you should see grow, commensurate with the balance sheet. And we target a number of between say 12% and 14% of assets for that portfolio.

It's primarily a liquidity portfolio but we manage it really in two pieces. One piece, the amount of securities we need to hold for collateral purposes for trading and because of our hedging activities, that's a fairly substantial number. And then balance, which is purely liquidity securities, we manage to what we believe is a superior return for a very well-run diversified portfolio.

Okay. Mark, thank you very much.

Thanks, Paul.

The next question comes from Jeff Rulis of D.A. Davidson.

Thanks, good morning.

Hi, Jeff.

Mark, you walked us through some of the volume expectations for Q1 and Q2, appreciate that. I was, maybe if you could just take a broader view of looking at mortgage origination in 2015, you put up $236 million.

I guess, broadly speaking your expectations for the full year of 2016, a lot of variables, but maybe a high level view of your expectations this year?

Sure. And when we talk about mortgage origination in particular, the vast majority of that, we originate for resale. Primarily conventional conforming government mortgages, Fannie, Freddie, Ginnie Mae securitization.

We do put some single family mortgage volume into the balance sheet. Part of that is HELOC, part is closed in seconds, part of that are single closed custom home construction loans.

Next year, over the next couple quarters in mortgage origination volume held for sale, on our prepared comments, I stated we expect mortgage loan locks for the first and second quarters of $1.7 billion and $2.3 billion, and for the full year $8.1 billion.

Closings, we're expecting $1.6 billion in the first quarter and $2.3 billion in the second quarter, and again, $8.1 billion in closings for the full year. So we aren't expecting any imbalance in the full year, just seasonal imbalances between locks and closings during the quarter.

The balance sheet originations of single family loans will total somewhere around $600 million we're sort of expecting this year. With equal parts of home equity lending and closed in, either single closed construction or closed in seconds. That's the smallest part of our balance sheet additions expected next year.

The vast majority of our 3% to 4% net growth per quarter in the held for investment portfolio is expected to come from commercial loans. And with strong contributions from commercial real estate, from residential construction lending and general C & I lending, as well. And in total, that amount of balance sheet lending will exceed $2 billion to hit that type of 4% to 5% quarterly growth, net of what we expect to be some still very strong run-off.

And part of the reason for the strong run-off has to do with construction lending. Particularly in the residential area our construction loans are lasting on average about 200 days. They aren't being fully drawn and they are being repaid very quickly because of the general inventory shortage in the markets in which we lend. And so the amount of lending that we have to do to create the type of growth that we plan strategically is very substantial from all of those groups.

I was trying to get to the correlation between the mortgage origination, just the fee income line item alone, versus some of the comments you made on the operating expense. Just ultimately what on an efficiency standpoint, you stated your expectations for non-interest expense growth. How does that play out for the full year, and more specifically, I'm talking about the fee side of the mortgage business as it relates to the expense growth?

Well, in the mortgage segment of course, seasonality plays a big part. Because of the impact of commissions and other sales incentives as it relates to changes in loan closing volume.

To a lesser extent, the pattern of growth in offices and personnel have some impact on that, so you'll see the absolute dollar value of expenses rise in the second and third quarters and fall in the fourth and first quarters, all else being equal.

Okay. Moving on, on the funding side, with a loan to deposit ratio now hitting, really 100%, any programs in place to cultivate more deposits, or is that a focus in the coming year?

It's always a focus. Our deposits have had some volatility the last few quarters, really related to large depositors. We have some large escrow companies and some other large customers with seasonal deposit patterns. We expect those deposits to grow again along with our mortgage-related deposits.

They are very seasonal, as well, if you think about the growth pattern of escrow deposits in relation to the timing of property taxes and insurance payments. But beyond that we have a portfolio of young branches now, each of which has an expected growth pattern until they hit maturity at about five years by our expectations. Well, if you look at the composition of branches in growth it comprises over a third of our branches today that will continue growing for several years, plus we expect to open several more branches this year. In addition to which we expect to raise some money in the time deposit market today if we have a need to mitigate differences between expected core deposit growth and total deposit growth.

For us, maintaining a level of non-core funding below 30% of our funding is a key target for us and we manage that through growing core deposits of course, but balancing at times with time deposits.

We have not had to do that much. If you look at the history of the company we have reduced reliance on time deposits very substantially. We'll have to see how the market reacts as interest rates rise and the cost of deposits rises as well.

Okay, thanks I'll step back.

Thanks, Jeff.

The next question comes from Jacque Chimera of KBW.

Hi good morning, everyone. I've been having some problems with my headset. Can you hear me okay?

We can, yes.

Okay, great. Just one last quick one on the deposits. What role has Simplicity played in that and has it accounted for any of the run-off or perhaps some of the growth you've been having?

Thanks, if you're looking at page 26 of the Earnings Release, you can see, I think, the three quarter trend from first quarter of 2015 declining, and that reflects run-off from the Simplicity acquisition particularly on the ending balances, which from March 31 to December 31 we're down about 7.4% related to Simplicity.

That has stabilized in the fourth quarter. The majority of that occurred in the second quarter of the subsequent four quarter to the acquisition that closed in the - in March of 2015. If we exclude the Simplicity impact you'd actually see our retail deposits up 5% over that same time frame, so it has had an impact, although that level of impact has stabilized in the last quarter.

So Q2-Q3 declines were impacted by Simplicity and then Q4 was impacted by the movement of large escrow accounts primarily?

That's right and those are in two places. Again on page 26, you'll see that in two places, one is in the NOW accounts, which is where our title companies hold their escrow balances and the other is in non-interest bearing accounts, which is where our customer escrow balances are held.

Mortgage escrow.

Mortgage escrow, yes.

Thank you, that's very helpful. A question on the taxes. If you could just provide some color on why that rate was lower in the quarter and what you expect the future rate to be?

Yes, absolutely. So, during the quarter, of course we reflected our estimate for the full year on an effective tax basis which is at 27.4%, and that differs from our expected marginal rate of 36.4% due to a couple of fairly large discrete items during the year.

One related to acquisition of Simplicity and the other related to the recent Dayton branch acquisition, so the bargain purchase gains that we recognized over the course of the year actually contributed to the reduction off the marginal rate to the effective rate of close to 5% or 4.8%.

And then I think, as was mentioned earlier related to security sales during the fourth quarter, that released a valuation adjustment out of OCI also benefited our tax rate by about 1.9%. So those discrete items certainly impacted the full year and the true up in the fourth quarter.

In addition we typically see between 2% to 3% benefit from tax exempt interest income, as well, related to the marginal rate.

So going forward in 2016 we expect an effective rate of--

Between 33-34%.

Right.

Okay. So absent - the rate would have been around that absent securities, sales and or yes, securities, and sales?

And the bargain purchase gain, yes.

Okay, thank you that's also very helpful.

Mark, can you just provide a bit of an update for us on your expectations for FTE adds and LPO branch adds throughout the year you'd mentioned some de novo activity you might be looking into, and how that's varied, if it does vary from your conversations in past quarters?

Sure. We do expect to continue to grow personnel, mostly as a consequence of new deposit branches and new mortgage LPOs. We will be adding a few people still in infrastructure at corporate.

One of Melba's primary goals is to prepare us to go above $10 billion at some point. So we are focused on our infrastructure here, the quality of our controls and preparing for some future date to live up to some higher standards from our regulators.

Our expected adds this year will be in the range of 10% to 15% of personnel we believe, dependent upon the pace of branch openings. We expect to open at least five, and perhaps as many as nine new deposit branches this year. More concentrated in Southern California, some of that associated with our affiliation with Kaiser Permanente, that came from our acquisition of Simplicity Bank, and of course more infill here in Puget Sound.

And understanding that it's very early in the year. Do you have a sense of general timing of when you might open some of that, would it be more geared towards the first half or the second half?

It will be more geared toward the latter half of the year, though I would expect two to three branches in the first half of the year.

Okay, so some employment growth in the first half but ramping up towards the year-end?

Yes. Which is consistent with revenue growth, fortunately.

Always nice to balance those two. Okay, I'll step back now, thanks.

Thank you.

The next question comes from Russell Gunther of Macquarie.

Good morning.

Hi, Russell.

I appreciate the commentary on loan growth as it relates to magnitude and mix. Just want to talk about it in the context of your recently closed deal and the pending acquisition in the first quarter. As you look at integrating those two deals, how do you expect them to prove accretive to that overall growth rate particularly within the commercial buckets?

Absolutely. We do. I think that accretion or that contribution to growth is going to grow over the next couple of years, particularly with respect to Simplicity. That was exclusively a consumer bank, on the deposit side, and on the lending side, their only commercial products were small balance commercial mortgages.

And the businesses were very good, but that doesn't get anywhere near to our interest in being a full service commercial and consumer bank. So we are having to add personnel, change certain personnel, as we integrate into Simplicity, as an example, more commercial products, not simply on the deposit side but the lending side.

We are going to invest in commercial banking personnel in Southern California in a more significant way. In hiring teams of lenders and treasury and cash management personnel to build what is not in either of these groups yet, and that is a more substantial group of commercial lenders. And while Orange County Business Bank has a very fine business, it is small in relation to the market. And so we're going to take the opportunity to add to that business to integrate the markets around the Simplicity branches and build a much more substantial business. But that will take a little time.

Certainly. I appreciate the help with that. And then how are you thinking about translating this increased commercial growth expectation that we saw a bit in this quarter but as it relates to providing for growth? So, provision was up a little bit this quarter, charge-offs remain in recovery mode. How are you thinking about the provision going forward, particularly as you think about the robust loan growth expectation you just put out there? And do you have a forward look that you could share?

Provision is going to go up as we grow the portfolio. So last year's provisions were substantially mitigated by recoveries. That recovery benefit is substantially over.

Our provisioning for the coming year will grow with the portfolio, and given our anticipated portfolio growth, that means provisioning growth will be more substantial.

Last year our total provision was about $6.1 million. I would expect that number to almost double this year. Not having the benefit of recoveries and given the anticipated growth in the loan portfolio.

Okay, great, thanks Mark. And lastly on the expense side, the 2% to 3% per quarter, does that include the impact of TRID that you were laying out or, said another way, will that 2% to 3% decline throughout the year as the TRID cost becomes less?

We sort of look at it as, we aren't going to have to increase our expenses as loan volume grows this year in this segment.

Essentially, the reductions in TRID expenses, or another way to look at it, improvement in efficiency in processing, will serve to mitigate the need to add personnel as we grow the loan volume this year, so instead of outright reductions in absolute numbers I would expect to see the efficiency improve.

Yes, I would also just want to reinforce that the guidance of 2% to 3% per quarter is on average throughout the year, so not necessarily 2% to 3% on every quarter but on average over the course of the year recognizing we have seasonal highs and lows in the mortgage business and that our investment in growth is lumpy as well, so just something to keep in mind.

I appreciate that and thank you for clarifying.

My last question: you may have mentioned it and I may have missed it. I was wondering if you had off hand the number of loan officers. You mentioned loans close per officer slowed but do you have the absolute amount at the end of the year?

464 exactly.

I appreciate that.

I had a little assistance here.

I can imagine. Thanks again.

Thank you.

The next question comes from Tim O'Brien of Sandler O'Neill & Partners.

Thanks, Mark. Hi, Melba.

Tim, how are you?

I'm great thanks. So here is a TRID question. Between lock and funding, is that where the TRID bottleneck hits, or does it hit pre-lock?

Well, it impacts both sets of disclosures. So remember the old disclosures, within a short period of time after making that application as defined, three days, it was required you'd receive a set of disclosures. Those initial disclosures, the Reg Z and RESPA-related disclosures have changed into what's called a loan estimate or an LE. That loan estimate format has changed pretty substantially and it is still due within three days from when an application is deemed to have been made.

The format of that disclosure is far superior to what previously existed. So as much as we complain about the challenges we've had in implementing these disclosures, I would say these are much better for the consumer, and once all of the kinks get worked out of this process we will have an improved process.

But early on, we've had changes in the format of that disclosure. Included in that disclosure are estimates of how the loan will close, not just estimates of the cost of the loan itself, which is what the old disclosures contained, but estimates of the cash flows and costs or other cash that's going to move around in the transaction, let's say in a purchase transaction.

Before closing, we must provide a closing disclosure, which reiterates everything in the original loan estimate, but corrects or amends anything that might have changed from the original estimates. And of course, in many transactions things change, particularly sales transactions and completes the disclosure of all of the cash flows associated with the loan and/or the real estate transaction, in this case. Things we had never been previously required to disclose as a lender.

If you think of a closing escrow statement on a home purchase, cash flows like, required home repairs, the commissions due each side of the real estate representatives, things just unassociated with the loan itself are now included in the reconciliation of total cash flows related to the loan.

Thinking through this, you can see there are sources of this information that are outside of our control, that we have to get from escrow or other parties associated with the loan and purchase transaction. And these new pieces of information are now being integrated into the disclosure. They have to be accurate.

If they are not accurate, we eat the difference, so we have risk not only in the cost of making loans, but if there are inaccuracies that are material and uncorrected, there's now the potential for private right of action by borrowers. And so we really don't know how all of this is going to play out long term. I think the industry is doing its best to implement a poorly designed rollout by the FPB and accordingly we're all playing catch up.

All of our software vendors have done, it sounds like, a uniformly poor job at integrating these disclosures accurately, and so all of us have a fair number of work-arounds and corrections to insure the disclosures we put out are consistent with the language of the new standard and all of that is moving along.

We clawed back some pretty poor inefficiencies early on. It was taking us about two and a half times normal to fund a loan. We're down to about 1.5 times. That's not total cost, that's just the funding process.

It's still not great, but a lot better than where we started and we expect to fully claw back these efficiencies at some point, but not until our software is in full compliance. I don't know if that helps, Tim.

It does. So suffice it to say what you're seeing is TRID impacts both - it lengthens the time it takes to lock plus the time it takes to fund.

Well, the customer's still locking on the same schedule. It takes more effort to reduce the disclosures associated with making an application and closing a loan.

Okay, and so the 2.5 times normal to fund a loan from lock to funding that you described that TRID has caused, and that's down to 1.5 times the time length that's from lock to fund that's what you measure, right?

Or is it receipt of application to fund?

It's service fee to application to fund but that's really just speaking to the funding process.

Of all of the processes we have you have a process of taking an application by the loan officer themself. You have a processing activity with someone called a processor who collects documentation, sets up the underwriting, and then once the loan is through underwriting there is a funding process where all of the requirements or conditions to closing are collected, verified, and then the loan is funded.

So it's that funding process where everything comes together at the end which has been lengthened so substantially.

Thanks for answering my question Mark. Good luck this year.

(Operator Instructions)

The next question comes from Jordan Hymowitz of Philadelphia Financial.

Thanks. Congratulations. Mark, did you say that if early in the release, that if the locks and fundings were equal this quarter it would have been $8 million more in net income?

If locks were equal to fundings yes, $8.7 million was it? Pretax.

Right. So if I annualize that number and it's obviously a weak quarter that's $35 million, 20% tax rate is $21 million, that's about a dollar per share.

Is it unreasonable to think that next year, if the market was around a trillion three you could make it a dollar per share [funding equal to happen] in just your mortgage business?

Sure, I mean we did this year, right? This year the mortgage segment made - it's in the release right? Hold on. Bear with me for a second. We have it shown in the quarterly trend but--

Full year is just over $23 million.

We have 22 million shares outstanding, that's a buck a share.

So if you look at it a different way you made $0.39 right this quarter with nothing from mortgage, correct?

Substantially correct, yes.

That's about $1.56 annualized on a run rate basis with nothing for mortgage. If you add a dollar with no growth whatsoever you had basically a $2.56 run rate.

Obviously there's some seasonality, but is that a crazy number to think that you could make next year?

No, and I think that it's consistent with analyst estimates if you look at the range of --

But arguably there might be some growth you're in the best markets in the country and the acquisitions you've made haven't been fully integrated and hypothetically there could be another acquisition.

It just seems like you are in a pretty good space at this point.

Look, we feel very comfortable with our growth expectations this year. We think that everything we've done in the last couple years, foundationally in the non-mortgage businesses have produced what should be consistent growth and consistent quality in the non-mortgage businesses.

And the mortgage business, while I know it can be exasperating because of its seasonality, the reality is in the middle of the year we make a lot of money. And this is a segment that made return on equity well in excess of 20%, closer to 23% to 24% this year. And if you can handle the seasonality, it's a great contribution.

Got it, and final question, any comments on what happened to your Seahawks?

Slow start going East. A slow start to the game unfortunately.

Be back next year.

Thank you.

We have a question from Tim Coffey of FIG Partners.

Thanks, good morning everybody.

Hi, Tim.

What kind of M & A costs are you expecting in this quarter with the closing of Orange County?

We will have some pretty substantial costs. I think they are in the $5 million to $6 million range, and we can follow-up on that, but if you look at our deck, and I should have brought it with me out of my office from when we did the deal - we have an estimate of one-time costs and I think it's in that range.

I'll follow-up with you, but the deck we filed, we 8-K'd,at the time we announced, that has an estimate in it.

Okay and when we think that drag that TRID caused in Q4 was it more pronounced, did you say, on the revenue side or on the expense side?

Well a little of both, right? Because we elected to portfolio some loans we previously would have sold at a gain in the quarter and we had the drag of expenses.

You know, I don't know which was larger, I'd have to think about that. The impact on loan sales - I'd have to think about that instead of giving you a hip shot.

Well, how about if we think from a net effect on the revenue or the income from the mortgage operation, how much do you think TRID cost net income out of that unit?

It would be a guess, which I hate making.

Let me simply say that it is in the hundreds of thousands of dollars, and it's not in the millions of dollars on the cost side. And on the revenue side I'd say the same thing. So together you might get a million plus dollar impact. But we haven't tried to dimension it in that manner.

Okay, no problem. You said that lag time is starting to decline.

It was very bad in October and November. December was substantially better. January better yet.

We're expecting some to roll some updates to our software at the beginning of February, which should further improve our work flow, and more coming. So really, the improvement is dependent upon software at this point.

Okay, understood, and then the process for evaluating prepayment speeds in the MSR portfolio, is that done on an annual basis a quarterly basis or as needed basis?

Well it's almost daily, frankly. Because we have to manage the hedge.

Formally it's done monthly, right? That's when we know for the month, what the total prepayments have been by tranche and we tranched our servicing into, is it 20?

43.

Oh, I'm sorry 43 separate pools, each one having a different enough prepayment curve that we needed to analyze them separately.

We are starting to get some real benefit. This quarter our decay was down substantially from the third quarter and I think the first quarter will be down even more.

That's meaningful dollars in terms of servicing revenue because it's a straight offset to what we collect. And so, I think next year or this year you'll see continued increases in servicing revenue as the servicing portfolio grows, but you'll see a continued decrease in the first couple quarters we're expecting absent of rally and rates.

So I think you're generally going to see a better servicing result in 2016.

So even if mortgage rates continue to stay kind of lowish, if not decline more, you'll think the decay is going to slow?

Yes, that's what we're seeing right now. And in answer to your earlier question, first quarter merger costs for Orange County Business Bank: $6.8 million.

Great, thanks. And the expansion in FTE had as a mortgage banking unit, is that a result of the environment for adding those FTEs being accommodated, or is it a year-end slowdown for originations in 2016?

So for us our strategy has been to be opportunistic. And when we are presented with an opportunity to bring on full offices of high performing people in current markets or new markets we admire, we'll take that opportunity.

We planned for a certain number of them. We don't know where they will come from.

They could be in market. They could be additions to existing offices, or they might be new offices. And so as it is our plan to take these opportunities when they arise, we put it into our strategic plan for growth. Even though we don't know exactly where they will be.

Okay, so that's been done to maintain loan volumes then.

Well it's done to grow loan volume.

Right, yes.

We're here to grow the business and to generate operating leverage in that business, as well.

Okay, well those are my questions, thank you very much.

Thanks, Tim.

This concludes our question and answer session. I would like to turn the conference back over to Mark Mason for any closing remarks.

Thank you all for your patience in listening to our prepared remarks today and for your very good questions. We'll look forward to talking to you next quarter. Thank you, Operator.

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