HomeStreet Inc (HMST) 2016 Q1 法說會逐字稿

Good day and welcome to the HomeStreet first-quarter 2016 earnings conference call. All participants will be in listen-only mode.

(Operator Instructions)

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

Hello, and thank you for joining us for our first-quarter 2016 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 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 affect the demand for our mortgages. The actions of our regulators, our ability to meet our internal operated 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 on our SEC filings including our Quarterly Reports on Form 10-Q and our Annual Report on Form 10-K for 2015, 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 on 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 on recent events and review our progress in executing our business strategy.

During the quarter, we completed the acquisition of Orange County Business Bank, located in Irvine California. The acquisition closed on February 1, 2016. With it, we added $188.3 million in total assets. $125.8 million in loans held from investment, $126.5 million in deposits, and one additional branch located in Irvine, California. Given the merger date of February 1, only two months' of combined results are reflected in results of operations for the quarter. We welcome Orange County Business Bank's employees, customers and shareholders, and we look forward to growing their business throughout Southern California.

In addition to the Orange County Business Bank location, we also opened two Denovo retail branches in the San Diego area, one in Kearney Mesa and one in Mission Gorge. These branches are located in close proximity to an existing Kaiser Permanente Hospital and a new one under construction. These branches extend our service to Kaiser Permanente employees and allow us to more quickly grow deposits in a new market like San Diego, as a consequence of our affinity relationship with Kaiser Permanente, that came with our acquisition of Simplicity Bank last year. These openings bring our retail branch count in Southern California to 10 locations. We also opened a Denova retail branch in Kaimuki, Hawaii, a suburb of Honolulu near Diamond Head. Additionally, we opened a single-family home loan center in Mesa, Arizona, and a commercial lending center in Spokane, Washington.

Last, but certainly not least, we are proud to announce that we have entered our ninth state, with opening of a commercial real estate lending center in Dallas, Texas. Earlier this month, we combined the leadership of our Seattle-based commercial real estate lending group and HomeStreet commercial capital, our small balance commercial real estate financial group located in Southern California, following the resignation of Randy Daniels, who has led our group here in Seattle since 2012. Bill Anderson has been named Executive Vice President of Commercial Real Estate and will lead the combined groups under the name HomeStreet Commercial Real Estate. Bill has 41 years of experience in commercial real estate lending throughout the Western United States and has a proven record of building strong teams of lending professionals focused on providing exemplary customer service.

On March 31, 2016, the Kroll Bond Rating Agency published a report, assigning the Company a BBB-minus rating at our holding Company and BBB at the bank level for senior unsecured debt. These ratings confirm the progress we have made in repositioning and diversifying our business and add to our flexibility in managing the capital needs of the Company. With that accomplished, we anticipate issuing senior debt at the holding Company sometime this quarter.

On April 14, 2016, we executed a $20 million unsecured line of credit for our holding Company. It is an annual revolver to assist us in managing our working capital and liquidity needs at the holding Company, however, we may also utilize the line to provide capital to the bank as needed, for the maintenance of target regulatory capital ratios. On February 28, 2016, we converted the charter for HomeStreet Bank from a Washington state-chartered savings bank to a Washington state-chartered commercial bank. The charter change reflects the progress we've made in our evolution from a traditional thrift, focused primarily on residential mortgage and construction lending, to a full-service commercial and consumer bank.

Concurrent with the change in the bank's charter, we converted HomeStreet, Inc. to a bank-holding Company and elected to become a financial holding Company. Additionally, I would like to announce that, in conjunction with the financial planning, related to my upcoming divorce, I plan to exercise all of my vested stock options and sell the related shares. I plan to exercise the options and sell the shares in the next 30 days. My share is subject to vested stock options, totaled 242,168 shares.

After the sale, I will still own over 242,000 shares, representing approximately 1% of the Company's outstanding common stock, in addition to which I have over 21,000 unvested shares of restricted stock units and a target of some 27,000 shares, to a maximum of 40,000-plus shares of performance-share units, based upon the achievement of certain performance goals for the Company. This option exercise and planned sale in no way reflects any negative change in my views on the business or prospects of the Company.

Before Melba reviews our financial results, I will share some highlights from the quarter. In the quarter, total assets grew $522.8 million to $5.4 billion. The Orange County Business Bank acquisition comprised $188.3 million of this growth and the remaining growth was 62% organic. Net income for the quarter excluding merger-related items, increased 11. 4% to $9.8 million, from $8.8 million in the prior quarter. Return on average tangible equity, excluding merger-related items, increased from 7.8% in the fourth quarter, to 8.1% in the first quarter. Diluted earnings per share, excluding merger-related items, increased 5%, from 39% per share in the fourth quarter, to $0.41 per share in the first quarter.

Tangible book value per share increased from $20.16, at December 31, to $20.37 at March 31. Full-time equivalent employees ended the first quarter at 2,264 employees, up from 2,139 at the end of the prior quarter. Net income for the commercial and consumer banking segment, excluding merger-related items, totaled $4.9 million and contributed 50.1% of our core net income for the quarter. Asset quality continued to improve and remains strong. Non-performing assets to total assets declined to 0.43% in the first quarter, from 0.50% in the fourth quarter.

Our first-quarter mortgage banking segment net income increased to $4.9 million, from $301,000 in the fourth quarter, reflecting in increase in interest-rate lock and forward-sale commitments, and a decrease in closed-loan volume during the quarter. Closed-loan volume in our single-family mortgage banking segment totaled $1.57 billion in the first quarter, compared with $1.64 billion in the fourth quarter. Interest-rate lock and forward-sale commitments of $1.8 billion in the first quarter increased from $1.3 billion in the fourth quarter.

The cost of the recently-implemented TRID requirements have still adversely affected our results during the quarter. While our processing times for loans have begun to normalize, we have been carrying additional support staff to reduce processing time and facilitate compliance with TRID. During the second and third quarters, these additional support staff will be gradually reassigned to process the seasonal increase in volume. Lastly, we believe that our strategy to portfolio a substantial a portion of our non-conforming loan production, worked well in that we have experienced minimal investor issues due to TRID, once we resume selling this production.

Now, I will 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. I will first talk about our consolidated results and then provide detail on each of our segments.

First-quarter consolidated net income was $6.4 million, or $0.27 per diluted share, compared with $8.7 million, or $0.39 per diluted share for the prior quarter. The decrease in net income from the prior quarter was primarily due to the merger-related costs from the Orange County Business Bank acquisition. Excluding after-tax merger-related items, core net income for the first quarter was $9.8 million, or $0.41 per diluted share, compared to $8.8 million, or $0.39 per diluted share in the fourth quarter. This increase in core net income was primarily due to higher net gain on mortgage origination and sale activities, partly offset by higher salaries and related costs. Net interest income was $40.7 million in the first quarter, compared with $39.7 million in the fourth quarter of 2015. The increase was primarily due to the growth in average interest-earning assets, specifically a $278.8 million, or 8.9% increase, in average loans held for investment.

Our net interest margin was 3.55%, a decrease of six basis points from the fourth quarter, half of which was due to the impact of purchased discounts and premiums from acquired loans and deposits, with the remainder due to an increase in the cost of interest-bearing liabilities, offset somewhat by an increase in non-interest-bearing liabilities.

While the Federal Reserve increased short-term rates in December, longer term rates have fallen since then, placing pressure on our non-interest margin. Non-interest income increased $6.3 million, or 9.6%, from the fourth quarter, due primarily to higher net gain on loan-origination sale activities, offset somewhat by a decrease in mortgage servicing income. Net gain on mortgage loan-origination and sale activities increased $14.6 million from the prior quarter, and mortgage-servicing income decreased $5.4 million, due to lower risk-management results, stemming from higher long-term prepayments speed expectations, offset somewhat by an increase in net servicing income.

Non-interest expense was $101.4 million in the first quarter, compared to $92.7 million in the fourth quarter. Excluding merger-related expenses, non-interest expense was $96.2 million, compared with $91.9 million in the fourth quarter, an increase of $4.2 million. The increasing core expenses was primarily due to higher salaries and related costs, due to the increase in employee headcount from the OCBB acquisition and organic-growth initiatives during the quarter, including a $1.5 million increase in FICA expenses, due to the annual reset of limits at the start of the year.

Upon the closing of the OCBB merger on February 1, we implemented the first of a series of planned merger-related operating cost reductions, impacting the combined Company. As non-integration-critical employees begin to depart, these reductions in personnel and other now duplicative operating expenses have resulted in achievement of approximately 30% of the planned 60% of pre-merger, run-rate operating expenses, in the first two months of combined operations. We expect to achieve substantially all planned cost savings by the end of the second quarter or this quarter.

At March 31 the Bank's tier-one leverage ratio was 10.2%, and total risk-based capital was 13.78%. The consolidated Company's tier-one leverage ratio was 10.5%, and total risk-based capital ratio was 12.5%.

I would 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 $1.5 million in the quarter, compared to $8.4 million in the prior quarter. Excluding after-tax, net-merger-related items the segment recognized core net income of $4.9 million in the first quarter, compared to $8.5 million in the fourth quarter. Cornet income was lower, primarily due to lower non-interest income and an increase in non-interest expenses. Segment non-interest income declined from $8.8 million in the fourth quarter of 2015, to $4.6 million in the first quarter, due to lower gain on sale of loans primarily from our Fannie Mae DUS unit, as well as lower gains on the sale of investment securities. Typically, the first quarter is our seasonal low point for Fannie Mae DUS sales.

Segment non-interest expense was $36.6 million, an increase of $7.1 million from the fourth quarter, included in non-interest expense for the first quarter of this year and the fourth quarter of 2015, were merger-related expenses of $5.2 million and $754,000, respectively. Excluding merger-related expenses from both periods, the $2.6 million increase in expense is primarily due to higher headcount, related to our acquisition of OCBB, the growth of our branches, and lending centers opened during the quarter, as well as an increase in REO expenses. We incurred a $393,000 write-down of a commercial property in REO in the quarter. We recorded a $1.4 million provision for credit losses in the first quarter, compared to a provision of $1.9 million recorded in the fourth quarter of 2015, reflecting the continued growth and balances of loans held for investment, offset somewhat by continued recoveries during the quarter.

The portfolio of loans held for investment growth increased 10.3%, or $331.6 million, to $3.55 billion from $3.22 billion at December 31. The acquisition of Orange County Business Bank contributed approximately $125.8 million, or 37.9% of the quarterly growth. New loan commitments totaled $469.2 million, and originations totaled $317.9 million during the quarter. Credit quality remains strong, with non-performing assets at 0.43% of total assets at March 31, and non-accrual loans at 0.45% of total loans. Non-performing assets were $23.3 million at quarter end, compared to non-performing assets of $24.7 million at December 31. We continued to enjoy positive charge-off experience with net recoveries of $364,000 in the quarter.

Deposit balances were $3.8 million (sic - see press release "3.8 billion") at March 31, up from $3.2 billion on December 31. The acquisition of Orange County Business Bank comprised $126.5 million, or 21.4%, of the $591.1 million growth in deposits during the quarter. Growth was primarily in non-interest-bearing and other transaction in savings deposits, with some growth in certificates of deposits, to support the strong asset growth of the Company. A portion of the non-interest-bearing deposit growth is related to insurance and property escrow deposits for our mortgage-servicing customers and loan-payoff funds that we received that have not yen been remitted to investors, stemming from the elevated refinance activity during the quarter.

Excluding the impact of Orange County Business Bank, transaction accounts grew by 5.6% during the quarter. Notably, our Denova Branch strategy resulted in 17.9% deposit growth for just those branches during the quarter.

I would now like to share some key points from our mortgage banking business segment results. Net income for the mortgage banking segment was $4.9 million in the first quarter, compared to net income of $301,000 in the fourth quarter. The $4.5 million increase in net income from the fourth quarter was primarily due to a higher net gain on single-family mortgage loan origination and sale activities, due to higher interest rate lock and forward-sale commitments during the quarter.

Single-family mortgage interest-rate lock and forward-sale commitments totaled $1.8 billion in the quarter, an increase of $463.5 million, or a 34.6% from $1.3 billion in the fourth quarter. Net gain on single-family mortgage loan origination and sale activities in the first quarter was $59.5 million, compared to $43.5 million in the prior quarter. The gain-on-sale composite margin increased to 336 basis points in the first quarter from 319 basis points in the prior quarter, primarily due to higher composition of refinances in our interest-rate lock and forward-sale commitment volume.

Single-family mortgage closed loans totaled $1.57 billion in the first quarter, a decrease of $75.6 million or 4.5% from $1.65 billion in the fourth quarter of 2015. The volume of interest-rate lock and forward-sale commitments was higher than closed loans, designated for sale by 14.7% this quarter, which positively affects reported earnings, as a majority of the mortgage revenue is recognized at interest-rate lock, while a majority of origination costs, including commissions, are recognized upon closing. If rate-lock and forward-sale commitments during the fourth quarter would have equaled closed-loan volume, it would have resulted in approximately $6.9 million lower gain on loan origination and sale revenue. Conversely, if closed-loan volume had been the same as interest-rate lock and forward-sale commitments, pre-tax income would've been approximately $2.7 million lower, as a result of higher variable costs.

Despite lower mortgage closed-loan volume in the quarter, the mortgage banking segment, non-interest expense of $64.7 million increased $1.5 million, or 2.4% from the fourth quarter. This increase was due to overall segment growth of personnel and offices, from expansion into new markets, and the cost of the added support staff to comply with TRID requirements that Mark had previously mentioned.

Overall, we grew mortgage banking personnel by 3.8% in the quarter and closed loans, per loan officer, declined in the quarter to 3.8 loans per officer, compared to 4.3 loans per officer in the fourth quarter. Single-family, mortgage-servicing income was $7.3 million in the first quarter, a $5.5 million decrease from the fourth quarter of 2015. This decrease was the result of a $5.9 million decrease in risk-management results in the first quarter, somewhat offset by $462,000 increase in collected servicing fee income.

Single-family, mortgage-servicing fee is collected in the first quarter of 2016 increased primarily due to higher average balances in our loan service-for-other portfolio. The portfolio of single-family loan service for others was $16 billion at March 31, compared to $15.3 billion at December 31. The $5.9 million decrease in risk-management results from the fourth quarter was the result of the decrease in fair value of mortgage-servicing rights, due primarily to changes in prepayment expectations, somewhat offset by net hedging gains.

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

I would like to now discuss the national and regional economies as they influence our business today. First, I would like to remind everyone that we're fortunate to operate in some of the most attractive market areas in the United States. Strategically, we're focused on the major markets in the Western United States, which today enjoy a 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 decrease 4.4% this year, over last year. A slight upward revision from its prior-quarter forecast of a 7.1% decrease.

However, our focus has always been on the purchase market. The Mortgage Bankers Association forecast of purchase-mortgage originations are projected to increase 10% this year over last year, while refinance mortgages are projected to decline by 22%. Despite the increase in short-term interest rates by the Federal Reserve in December, mortgage rates have fallen and continue near historic lows. And, nationally, purchases are expected to comprise 62% of loan volume this year. Housing starts for this year are expected to be up 10.9%, over 2015 levels.

During the first quarter purchases comprised 53% of originations nationally, and 49% of originations in the Pacific Northwest. HomeStreet continues to perform at levels above the national and regional averages, with purchases accounting for 62% of our closed loans and 59% of our interest-rate lock and forward-sale commitments in the quarter. Our applications for purchase mortgages have increased 55% during the first quarter, from $629 million in January, to $975 million in March.

The pace of housing permits has doubled nationally since 2009. While the pace in Washington is up 2.5 times, in California it is up 3 times since that time. Oregon matched the national average and Idaho was slightly weaker at 1.75 times.

Home price increases in Washington, Oregon and California, based on FHFA data, accelerated across the board in the latest quarter, with year-over-year rates ranging from 7.7% in California, to 10.5% in Oregon. According to the most recent case [showing a] 10-city composite home price index report, which measures the change in value of residential real estate in 10 Metropolitan areas, the index gained 4.6% from a year earlier. Seattle gained 11.0% over the last 12 months, and Portland gained 11.9%. San Francisco gained 9.3%, Los Angeles gained 6.8%, and Dallas, Texas, gained 9.0%.

The rate of job growth in Washington, Oregon, California and Idaho averaged more than 3% last year, a full percentage point above the US growth rate. The average unemployment rate in the same four states fell by one percentage point between 2014 and 2015, slightly more than the national decline, even as new job seekers migrated to the faster growing states. People are now following jobs again. Until recently, this staple of economic recovery was absent.

The outlook for the economy is in the four Pacific Northwest states, based upon the latest forecast from the respective state forecasting agencies, calls for continued but generally slower job growth, low unemployment rates, and further increases in housing activity. Looking forward, over the next three quarters in our mortgage banking segment, we currently anticipate mortgage-loan lock and forward-sale commitment volume, of approximately $2.3 billion in both the second and third quarters, and $1.8 billion in the fourth quarter of this year. We anticipate mortgage loan, held-for-sale closing volumes of $2.3 billion, $2.4 billion, and $2.1 billion, in the second, third and fourth quarters of this year, respectively.

The seasonality is expected to produce greater variation and reported 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. Additionally, we expect our composite margin to come back down to a range of between 315 and 325 basis points over that period, as the increased refinance activity we experienced in the first quarter wanes.

As I mentioned earlier, our results in future quarters could be further impacted by TRID requirements. We expect the increased costs we experienced in the first quarter to continue through the next several quarters, until our software vendors complete their updates and our manual adjustments and enhanced quality-assurance audit procedures normalize. In our commercial and consumer banking segment, over the next three quarters, we expect net-loan portfolio growth to approximate 4% to 6% quarterly.

Going forward, we generally expect that our consolidated net interest margin to trend down to the 3.45% to 3.40% level by the fourth quarter, reflecting now a flatter yield curve, absent changes in market rates and prepayment speeds. Our non-interest expenses are expected to grow, on average, approximately 3% 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, close-loan volume and in relation to further investments in growth of both of our segments.

This concludes our prepared comments. As always, we appreciate your patience and attention today. Melba and I will be happy to answer any questions you have at this time. Operator if you would poll for questions.

We will now begin the question and answer session.

(Operator Instructions)

Paul Miller, FBR Company.

Thank you very much. On the OCBB acquisition, that closed in the quarter -- what type of cost saves and headcount can we expect to come out over the next quarter or two from that acquisition?

We carried approximately $700,000 of additional cost in the first quarter. That is going to come out completely in the second quarter. Fully annualized, that is a little more than $700,000, because it was only two of three months. So, we are expecting something closer to about $1 million a quarter, going forward. In terms of headcount, I think that is in the eight to ten range, but there's also technology costs and other services that are duplicative, that are being eliminated during the quarter.

And on your -- you opened up six branches in the quarter. That definitely adds to headcount. What is your plan for this year -- what are your long-term plans in opening up branches over the next year or two?

I would expect a minimum of one branch a quarter, depending upon the pace of our permitting and being opportunistic. We have purchased some branches and deposits. That number is likely higher.

This year it will be slightly higher because of the pattern of when we leased and identified facilities and when those facilities get permitted and built out and so on. I would expect, this year, for our branch openings to be somewhere between six and seven on the retail side.

And what geographies are you putting them in? Are you putting them all in Seattle or are you opening up -- your down now in Orange County, San Bernardino. Where exactly are you opening up branches?

I would expect to see them both in Southern California and in the Greater Seattle area. We still have many submarkets in Greater Seattle, and Puget Sound, for that matter, that we would like to be in. We're -- that pacing has sort of been established.

In Southern California, we're taking the opportunity to work with Kaiser Permanente, to identify locations, both where we have existing customers that may not be served by a physical branch, and, in that regard, we have some 38, soon to be 40, ATMs in Kaiser Permanente locations, many of which are not served by a physical branch. And, so, like the two branch openings this quarter in Southern California, where they're taking the opportunity to enter new markets, where we would like to have a full-service banking presence, but have sort of a tailwind of a built-in customer base, from the consumer group at Kaiser Permanente. This strategy has really been working for us. If you look of the deposit growth trend over the last several quarters, it has been very positive on the retail side. In fact, our newer de novo retail branches that we opened since 2012 are growing at about three times the pace of the overall bank right now. So, we're pretty happy with the strategy at this point.

Thank you very much, Mark.

Thank you.

Jacque Chimera, KBW.

Good morning.

Hi, Jacque.

I wonder, Melba, if you might have where the individual line items for the M&A cost came from, just in terms of what was the compensation and occupancy and other items like that?

I can provide that to you, Jacque. In terms of the details, it's primarily in salary and related expenses, as well in legal and consulting expenses. We could provide the specifics.

And, Mark, what are your plans for Dallas?

Long-term. All we have done is open a commercial real estate lending office there. Dallas is in our strategy -- the state of Texas is in our strategy, long term. As a Washington state-chartered financial institution, we are subject to a Washington state revenue base tax, a business and occupancy tax, under which we get a first-mortgage deduction, which is pretty valuable to us; it's worth about $2 million of tax per year, for so long as we operate only in 10 states or less. It's an interesting law here. It protects the local and state banks.

So, we have identified 10 states that we expect to do business in. Long term and Texas is included in that 10-state total. We hope to be in the mortgage business and the banking business in Texas on a comprehensive basis at some point. To date, though, we just have a commercial real estate lending office.

So, at some point in the future, might you look to M&A, similar to what you did with Simplicity to help expand your presence there?

Yes.

What is your 10th state that you would like to be in?

Today, we do business, physically, in, obviously, the Hawaiian islands, Washington, Oregon, Idaho, Colorado, Utah, Arizona, California, and now Texas.

I meant -- you said that Texas is your ninth state, so I was wondered if you're willing to share with the 10th state is that you're looking to?

It could be Nevada, a could be Alaska.

Open for whatever presents itself to you.

Yes.

Then, can you provide an update on -- you gave great color last quarter on the heat map that you look at, in terms of what's going on in your economies and different -- within those micro-economies, what you are watching, and just what you're seeing, if there has been any change since last quarter?

Sure. We do watch very closely. When you do the amount of, particularly, real estate-related lending that we do, and the amount of construction lending, in particular, that we do, we have to pay very close attention to the balance of supply and demand in these markets. The direction of rental-rates absorption, velocity, CAP rate movement, all these things that have a bearing on our collateral and getting repaid timely.

As I mentioned earlier, we operate in the best markets in the United States. We focus on the primary markets and the strong secondary markets to lend in.

Those markets, today, continue to be characterized as having inventory shortages of, literally, all property types today, not simply single family housing. New and used inventories, those inventories range from a partial month to less than three months in all of our markets. Rental availability, while there has been tremendous new construction of multifamily housing in all of these markets, there continues to be shortages because of job growth and migration.

And, now, office shortage. We have been waiting to see the office market solidify. The office vacancy in the City of Seattle is down to 8%. That was well over 20% at the height of the recession.

You see similar deficits of available office in the major markets in Portland, the Bay Area of California, and in the major markets in California, as well. We now see, for the first time, speculative construction in new high-rise offices, not just here in Seattle, but there are notable projects in San Francisco and California and Portland, as well. Our markets are characterized in the real estate areas by shortages and deficits of demand to supply.

Job growth continues to be strong. I think we quoted some of those numbers earlier. In our line of sight, all of the early warning indicators that we follow are stable to improving. So, we feel quite good about the risks that we underwrite every day in lending. I hope that helps.

Yes it does very much. Thank you for the color and I will step back down.

Thanks Jacque

Ryan Zacharia, Jacobs Assets Management.

Hey, Mark. Thanks for taking the question. Help me understand a little bit the profitability of mortgage origination, excluding servicing. It looks like the origination fee is kind of broke even this quarter, and that was with the favorable lock versus closed dynamics. Maybe provide a little bit of color on that?

We did better than break even for the quarter. I think that -- if you bear with me for a second, I can give you view of origination-only profitability.

So the servicing total was $7.3 million, between the core servicing income and the net gain on the servicing and hedges and the profitability of the segment on a pretax basis was $7.4 million for the entire segment.

Right. So origination for the segment, or in pretax, $3.4 million.

I'm not -- trying to understand that. So, the pretax income in the mortgage banking segment was $7.4 million. Doesn't that include the servicing income?

It does. So, servicing pretax for the quarter was about $3.9 million, roughly. And the balance was origination income.

So when you're looking at the mortgage servicing income, if you're looking at page 28 on the earnings release, that is just the income component.

That's just revenue, right.

Right. That's just the revenue. That isn't the net income or pretax income.

The offsets of that being your cost to service, which is -- over $3.5 million.

No. Direct costs are about $2.5 million, but we have corporate allocations, right? So, we fully allocated and absorbed each business unit.

Right. No, I typically see it with the amortization reflecting the cost to service, because your MSRs are held net of the servicing cost, but if that is the case, that answers the question.

Okay.

Thanks.

Thanks, Ryan.

Jeff Rulis, D.A. Davidson.

Thanks. Good morning. Mark, you touched on a little of this in your economic discussion, but more specifically on the multifamily segment. You've seen some operators in the region selling a lot of that production and a lot of it from a risk management standpoint. I guess if you could maybe outline what your thoughts on that segment, in terms of credit-quality outlook and if you're seeing strain within that, and, granted, that could be regional and I would be interested to hear that color, as well, but just your thoughts on the multifamily segment in general.

Sure. In our markets, and I have to qualify everything with that caveat, the performance of the collateral is just amazingly good. When we look at the actual build out and achievement of rents versus performers in multifamily construction, they are typically 10% to 15% above pro forma rents. The absorption, typically, 50% to 60% of pro-form absorption. Just as a generalization.

In terms of availability, I think I commented earlier, there still is a deficit of inventory to demand. From our own risk management -- so that is collateral performance. And that is primary and strong secondary markets, too, so when we're talking about performance, it's core Seattle, core Portland, strong markets next to these.

These markets are characterized by growing employment, falling unemployment, all the things you would expect to contribute to that performance. In terms of our balance-sheet risk management, we have target diversification by not only loan types, but collateral types, as well. Multifamily, we have always had a larger allocation to than other asset types because of its long-term performance.

So, we always carry a somewhat higher balance, either construction or permanent lending. Having said that, our origination volume and origination capability far outstrips our ability, ultimately, to hold 100% of our production. So, you'll see us this year sell a larger proportion of the production, mostly centered in the small-balance production that our operation previously called HomeStreet Commercial Capital generates. And we expect to sell about two-thirds, actually, of that small-balance production this year, either into the secondary market or, potentially, going forward through securitization.

Okay. Thanks, Mark for that color and maybe a less dynamic question on just the merger costs. I think you targeted 6.8% and you recognized 5.2% in the quarter. Are you guys ahead of plan, or would you recognized the balance next quarter, kind of where are you at there?

We expect that we recognized the majority of them in the first quarter. So, we actually outperformed our expectations.

So, what do we have left? $200,000, maybe, in the second quarter?

Yes. Very small.

Great. Thank you.

Tim O'Brien, Sandler O'Neill and Partners.

Good morning.

Hey, Tim.

Mark, you mentioned the targeted outlook for net interest margin through the remainder of the year. Did you say 3.4% to 3.45%?

Yes.

Okay. Thanks. And do you have a targeted goal for deposit growth through the end of the year?

We do, internally. I think it's safe to assume that, given our guidance on loan growth, that that needs to be supported primarily with deposit growth. Right? We are right around 100% loan-to-deposits and we don't intend to go too far over that. It's important that we grow our deposits, consistent with our loan growth.

Makes sense to me. What you did this quarter, in terms of organic deposit growth, I saw CDs were up; it looks like $100 million, maybe on an average basis, though. And the cost there was a little bit higher and I think that kind of played into the overall cost of deposits. What is the strategy? Can you dig in a little bit as far as what you needed to do this quarter and what you might continue to do here, going forward, with regard to adding time deposits, perhaps, or where is the best opportunity to find the most attractive kind of funding that you want and need to support balance sheet growth?

Obviously, we have to be focused on funding, when you look at our strategy for growth. Part of that funding strategy will have to be made up with time deposits. We are seeking to keep that composition from rising much, though, that assumes that, as the total grows, the absolute total of time deposits, as well, will grow.

More importantly, though, our branch-opening activity and retail strategy, along with our commercial banking strategies, expected to grow the lion's share of the deposits, going forward. We may add to that with acquisitions; we have in the past, of branches and deposits, and it's an opportunistic activity. Obviously, M&A can help that funding equation, as well and, we continue to look at deals that exist in the marketplaces in which we are interested, and so, I would expect that the answer to that lies both in organic growth and in M&A.

So, looking at the end-of-quarter balances, on a linked-quarter basis it looks like CDs were at $732 million at the end of 2015 and $901 million at the end of first quarter. Were the CD additions this quarter - was that predominantly retail? Did you use any brokered CD's or --

It was -- there was a retail component. There was -- what would I call this one? It was an institutional component. There's an institution of peer-to-peer market for CDs that was a substantial part and then about $100 million of it was brokered.

Great. Did you guys purchase any commercial real estate loans this quarter? Or was it all in-house originated?

It's all in-house, directly originated. I'm sorry what?

Besides the Orange County Business Bank purchase, that is.

Right. I was excluding that. Our strategy does not include, nor need, secondary-market purchases of any loan type.

And no intent, then to use Snicks here, at some point, to get involved there. It's all going to be in-house generated?

It will be, but let me say about syndicated loans, at some point we will have some syndicated lending activity. To date, I think, now that I think about it, we did do one small syndicated participation. I think that will be opportunistic when really attractive deals come across the bow. Our business is primarily direct to the customer.

Out of curiosity, the kind of loan production that you would like to see take place out of the new Dallas office -- essentially, what is the niche you're going after there?

That is purely commercial real estate; permanent commercial real estate lending in, primarily, multifamily.

Did you hire somebody local and kind of build the office around that? Is that how --

It's a local originator. But -- local originator, but with a Western States book of business.

Great. Thanks for answering my question.

Thanks, Tim.

(Operator Instructions)

Tim Coffey, FIG Partners.

Good morning, Mark.

Good morning Tim.

I want to talk about the efficiency ratios and the different business units, kind of looking at the commercial and consumer banking segment against the backdrop of additional branch expansions already, and those you have planned. How should we think about the core-efficiency ratio?

Thank you for asking that. I have been beating up my internal people about how we report. If you look at our core-efficiency ratio I think we quoted it --

It's on page 17 on the earnings release.

So, this ratio excludes M&A-related expenses. It is more core. There are some others, sort of nonrecurring things, even things like intangibles amortization, that other people do not include in their calculation of operating efficiency, that we still do. But, we are expecting this ratio, the core ratio, to fall to the low 60% range by the fourth quarter of this year, mid to low 60%.

Yes. So, keep in mind, in this quarter, we had the overhang still from the remaining OCBB expenses that we will bring out. I should say this quarter, being the first quarter, relative to this quarter that will come out. We also had five new office openings in the quarter, so that impacted it.

And, additional FICA expenses, seasonally.

And additional FICA expenses. Now, you will see, in the second quarter, obviously, the full quarter impact of some of those additional offices from the first quarter, but as Mark mentioned, as we move throughout the course of the year we anticipate the efficiency ratio improving quite a bit.

Then, so, revenue side of that efficiency ratio is just going to be on balance sheet growth?

Correct. No, I take that back. The other significant item in the quarter was, really, the absence of any material loan sales or securities gains. If you look at the fourth quarter, as an example, we had eight-point-some million dollars of non-interest income, most of which $7 million or so, which was related to sales of Fannie Mae DUS loans, or SBA loans. We had very little of that activity in the first quarter, but we expect to have a substantial amount of that activity over the remainder of the year. So, you have two affects, both a change in operating expenses and a pretty substantial increase in revenue driving that change, that expected change in the operating-efficiency ratio.

Okay. Are there any planned branch consolidations on the consumer or commercial banking side?

Consolidations, no. We have not -- we don't expect to acquire any that would be consolidatable. And those that we open are in new markets.

So, kind of the run rate for expenses on the commercial consumer side is expected to go up then?

It will, but not as quickly as revenue. So, we expect that operating leverage to not only improve earnings, but the ratios related to them, like operating efficiency.

Okay. And, speaking of loan sales, do you have any expectations for loan sales this year out of that [SEE-ARI] division?

Yes. We are expecting somewhere in excess of $200 million.

What are the prevailing premiums on those, or gain on sales for those?

Obviously, it depends on the market and market timing. We have seen premiums run from, let's say, 2% to 3%-plus.

And then, my last question on the net interest margin, how much of that, say, decline from here is the result of higher cost of deposits?

So, when you look at our net-interest-income sensitivity, we do see that we have more liabilities refunding and repricing in zero to three months than we do assets. A number of that is our federal home loan bank advances repricing, and then, the remainder would be to higher cost of deposits.

Okay. Those are my questions. Thank you very much.

Thanks, Tim.

We have a follow up from Tim O'Brien of Sandler O'Neill.

On the Fannie Mae DUS loans, now that you mentioned the first quarter was a low-water point for that, what's the kind of range of quarterly revenue that you expect to see here and through the remainder of the year?

That's going to be -- it could be lumpy. The timing of not just the origination but the sale of loans may not be really even.

I would say -- so, Mark mentioned, as well, that last quarter was a high-water mark, with respect to that non-interest income coming through that segment and the first quarter is a low-water mark, so, I think it's fair and reasonable to take the average of the two quarters, in terms of expectations, going forward.

So this quarter that number was down in sort of the 1 point?

In total, in addition to the DUS sales, the other multifamily sales, as well.

Right. So, depending upon the level of activity, that number could range from $2 million-$5 million, depending on the quarter.

Including multi--

Including multi, right - sort of all in - and, including SBA, actually.

Thanks. I appreciate it.

Bill [Tazelum] of Titanium Capital Management.

Thank you. A couple of questions. First of all, relative to your DUS sales being down in the first quarter, versus the fourth-quarter, and having virtually none this quarter, can you tell us why that was, and if it's pricing or something else going on?

Sure. It's a little bit typical seasonality. The fourth quarter, typically, has a lot of activity, loans that investors or buyers of property, or people refinancing, want to get concluded by year end, so there is always a rush to close as much of the pipeline as possible for customer purposes, as well as our own. And, typically, in the first quarter, there are not as many sales transactions.

People are just starting the year and activity is seasonally slower. So, we expect the remainder of the year to be more typical, seasonally, with higher activity. But the fourth quarter is always busier, and the first quarter is typically slower.

And then, secondarily what is the timing for when you anticipate your additional commercial expenses that you have been incurring here this quarter, to turn into earning accretive?

So, for the Orange County Business Bank acquisition, we are still expecting that acquisition to be accretive this year. Some 3%. We will have some transition expenses in the second quarter, but by the end of the second quarter, all of the expense savings will have been realized. So, from third quarter forward, we should be at the run rate we expect out of that acquisition.

And then, additional expenses that you have just -- people you have been hiring. It looks like their cost was greater than the revenue that they generated here in the quarter. Wondering when you think that that will reverse?

With respect to de nova branch openings, that occurs over a more lengthy time frame, because it's related to the acquisition of deposits in the marketplace. Typically, we expect branches to be breaking even, depending on how you calculate the interest rate associated with the deposit, at about two years. Fully-funded, or fully grown, I guess, in about five years.

Our branch has been running ahead of that number, typically, I think all but two cases are well ahead of the deposit acquisition pace that we expect. So, with respect to new branches, that is the timeframe.

With respect to other positions that may relate to corporate infrastructure, they may not be revenue-producing positions, but they may have to be added as consequence of our growth, so those ads are related to current growth in other areas. It might be in compliance or legal or county finance, some of these areas -- Human Resources -- that ultimately become sort of size denominated. Our lending centers, however, are expected to be profitable within a couple of months of opening, so any of our expansion expenses invested in new lending centers, whether it be single-family, homebuilding or commercial real estate, are expected to be profitable in a relatively short period of time.

Thank you.

Thank you.

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

Again, we appreciate your patience your attention this morning. All of the great questions. We look forward to talking to you again next quarter. Thank you.

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