Mechanics Bancorp (MCHB) 2014 Q3 法說會逐字稿

Good day, and welcome to the HomeStreet third-quarter 2014 earnings conference call.

(Operator Instructions)

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

Thank you. Hello, and thank you for joining us for our third-quarter earnings call. Before we begin, I'd like to remind you that our earnings release was furnished this morning with the SEC on form 8-K and is available on our website at www.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 these statements are 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. Factors that may cause actual results to differ from expectations or that may cause us to deviate from our current plans are detailed in our SEC filings, including our quarterly reports on form 10-Q and our annual report on form 10-K for 2013, as well as our various other SEC reports.

Additionally, any non-GAAP financial measures referenced in today's call, including a reconciliation of those measures to GAAP measures, may be found in our SEC filings and in the earnings release available on our website. Today, I'd like to update you on recent events, talk about our progress in executing our business strategy, and highlight key financial results.

I will also share a few thoughts about current market conditions. Please refer to our earnings release for a more detailed discussion of our financial condition and results of operations.

In the third quarter, we took important steps to execute our strategy to grow our business and diversify earnings. We had our best quarter yet for new loan commitments in our loans held for investment portfolio, an increase of 19% for the second quarter.

We are very pleased with the strong growth of our average earning assets, over 8% in the quarter. Our single-family mortgage close loan volume was up almost 18% in the second quarter despite ongoing lower industry loan volume. And on September 29, we announced our plans to acquire Simplicity Bancorp, a seven branch, $879 million asset retail franchise in Southern California.

This acquisition will provide us with a retail deposit branch network in the largest market in the Western United States. We already have a growing mortgage-origination presence.

This merger supports our recent additions of residential construction, including real estate lending in the Southern California market. And it provides an end market platform to which we will add full commercial banking services, including SBA lending.

We expect to complete this acquisition in the first quarter of 2015 after obtaining the approval of the shareholders of each company and the necessary regulatory approvals. The Mortgage Bankers Association recently revised its 2015 forecast upward and expects total originations to be 7% higher than 2014 previously.

The increase is based on stronger economic growth overall, job gains, and declining unemployment. Purchase mortgages are expected to increase 15% in 2015, while refinances are expected to drop approximately 3% next year.

That being said, lenders are currently seeing an increase in refinance applications with mortgage interest rates for fixed 30-year loans dipping under 4% for the first time in 16 months. We're expecting to see our October rate lock commitments come in about 25% over September and October, with a jump in refinancing, which has been ticking up all quarter to approximately 40% of total interest rate lock commitments.

If 30-year fixed interest rates on mortgages stay below 4%, this could serve as a welcome catalyst for move-up buyers and for people sitting on the fence, waiting to enter the mortgage market. The MBA has estimated the third quarter 2014 mortgage originations increased 1% over the second quarter.

By contrast, our originations continue to be significantly higher than the nation overall, increasing almost 18% in the quarter. We are still on track to meet last years origination volume.

Nationally, purchase share increased 3% to 62% of total originations in the third quarter. In the Pacific Northwest, the percentage of purchased mortgages decreased by 4% and is slightly below the national average at 60% of total originations. HomeStreet's purchase share, however, amounted to 78% of our closed loans in the quarter.

Home inventory continues to be a significant constraining issue on the housing recovery. US housing starts are continuing to recover, but are still well short of the long run average. The Pacific Northwest is expected to continue to grow more quickly than the rest of the country, consistent with the past six months.

The Puget Sound and Portland, Vancouver markets are forecast to be above the long-range average in 2015. Currently multifamily makes up just over half the housing starts in the largest Pacific Northwest markets, and 20% to 30% of starts elsewhere around the region.

Employment growth continues to be above the national average in Puget Sound, and many of the regions in which we have branches and lending centers. I would now like to share some key metrics from the quarter.

Our third-quarter net income was $5 million or $0.33 per diluted share, compared to $9.4 million or $0.63 per diluted share for the second quarter. Excluding acquisition related expenses of $722,000 in the third quarter, net income was $5.4 million or $0.36 per diluted share. Tangible book value per share increased to $18.86 as of September 30, compared to $18.42 per share at June 30.

Our year-to-date return on average tangible equity is 8.22%. Net interest income increased $2.2 million or 9% to $25.3 million, compared to $23.1 million in the prior quarter. The increase was primarily due to growth in average interest earning assets, which grew organically by 8.4% in the quarter.

The growth came from all lending units particularly commercial real estate, commercial construction, and residential construction. Our net interest margin was 3.50% on a tax equivalent basis, an increase of two basis points from the second quarter. Non-interest income was $45.8 million, down $7.8 million from the second quarter.

Included in the second quarter non-interest income was a pretax gain of $3.9 million from the sale of approximately $211 million of mortgage loans that were formally in our held-for-investment portfolio. And pretax servicing income was $4.7 million higher in the second quarter as a result of our sale of mortgage servicing rights last quarter.

Non-interest expense was a $64.2 million for the quarter, compared to $63 million in the second quarter. This increase was related to increased headcount and increased commissions on higher closed mortgage loan volume.

At September 30, the banks Tier 1 leverage ratio was 9.63%, and the total risk-based capital ratio was 13.95%. I'd like to speak now about our commercial and consumer banking business segment results.

Our commercial and consumer banking business continues to expand with strong segment core deposit growth, loan production, and the loan portfolio growth. We continue to target net growth in our loans held-for-investment portfolio of 5% or more per quarter, subject to liquidity and capital constraints.

Segment net income was $3.5 million in the quarter, compared to $3.8 million in the second quarter. The second quarter income included a $3.9 million pretax gain on the sale of portfolio mortgage loans in the quarter. Excluding acquisition related expenses incurred in both periods, net income decreased $144,000 in the quarter, compared to the prior quarter.

Excluding acquisition related expenses and the $3.9 million gain on sale of portfolio loans in the prior quarter, net income increased $2.4 million. Our loans held-for-investment portfolio grew 8.4% in the quarter, while new commitments totaled $324 million.

Nonperforming assets decreased to only 0.87% of total assets at September 30, compared to approximately 1% of total assets at the end of June. Classified assets also declined in the quarter to 1.09% of total assets, compared to 1.24% at June 30.

Due to continued improvement in credit quality and minimal charge-offs, we did not record a loan-loss provision in the third quarter. While total deposits grew less than 1% over the quarter, we continued to grow core deposits and reduce balances of higher costing time deposits.

Non-interest bearing transaction deposits grew to 11.2% of total posits from 9.8% at June 30. Total transaction and savings deposits rose approximately 2.8%, and now comprise 73% of total deposits.

We reduced certificates of deposit balances by 20% this quarter. These accounts now make up only 15% of total deposits. And during the quarter, we opened two retail deposit branches in strong neighborhoods in our core Seattle market.

Now let's talk about our mortgage banking business segment results. As I've discussed previously, our mortgage banking strategy is to build mortgage volume market share and market share to mitigate the impact of declining profit margins and lower industry loan volume.

Through the third quarter, national mortgage volume has declined 44% from the prior year. Our year-to-date, held-for-sale loan volume has decreased only 17% as a result of this growth strategy. Despite our volume decreasing less than the industry, these declines in volume and profit margins have been challenging for us.

Recently interest rates have declined and our refinancing loan originations have increased. This recent improvement will improve our October results, and if these rates continue through the fourth quarter, our fourth-quarter expectations for this segment will improve.

October interest rate lock activity, we now know, will be the highest for HomeStreet since 2013. Additionally, as a result of our continued hiring of high-quality loan producers, we are expecting our loan volume not to decline in the fourth quarter as we would normally expect, given historic seasonality and purchase mortgage volume.

Mortgage banking segment net income for the quarter was $1.4 million, compared to $5.6 million in the second quarter. The decrease in quarter-over-quarter income was primarily due to the $4.7 million pretax gain on the sale of servicing that we recognized in the second quarter, as well as higher commission expense in the third quarter as a result of higher closed-loan volume.

Closed-loan volume designated for sale was $1.29 billion in the quarter, an increase of nearly 18% from the prior quarter. The combined pipeline of locks and closed loans held for sale was $974 million at September 30, compared to $953 million at June 30.

Interest rate lock commitments totaled $1.17 billion for the quarter, a decrease of $34 million from the second quarter. The volume of closed loans designated for sale surpassed interest rate lock activity commitments by 11% this quarter.

This differential negatively affects accounting earnings, as a majority of our mortgage revenue is recognized at the time of interest rate lock, while a majority of origination costs, including commissions, are recognized upon closing. If rate lock commitments during the third quarter would have been the same as closings, at $1.3 billion, it would have resulted in approximately $3.3 million higher gain on loan origination and sale revenue.

Conversely, if closed-loan volume had been the same as the $1.2 billion in interest rate lock commitments, pretax income would have been approximately $1.4 million higher as a result of lower variable costs, such as commissions and incentives. Net gain on single-family mortgage loan origination and sale activities was $37 million in the quarter, essentially flat from the second quarter.

We continued to experience some pressure on profit margins, due primarily to lower profit margins on nonconforming jumbo mortgage loans, which comprise 19% of interest rate lock commitments in the quarter.

The composite profit margin was 316 basis points, compared to 321 basis points in the prior quarter. Single-family mortgage servicing income was $5.3 million in the quarter, compared to $9.6 million in the second quarter. The decline in servicing income, again, was related to the second quarter gain on the sale of servicing of $4.7 million.

Additionally, fee income from servicing decreased $1 million from the second quarter, primarily from lower balances in the servicing portfolio as a result of this sale of servicing. Segment non-interest expense was $45.2 million, an increase of $2.7 million, or just over 6% from the second quarter.

This was primarily due to higher commissions related to higher closed-loan production. We continue to focus on improving production efficiency in the quarter, and as a result, our direct costs for originated loans decreased by about 3 basis points. We are expecting further improvement in this area in the coming quarters.

In the quarter we added a net of 23 production and operations personnel in mortgage banking. And as part of our efforts to gain mortgage market share in new and existing markets, we opened five new home loan centers in Washington, California, and Hawaii.

And in November, we will open our first home loan production office in Phoenix, Arizona. And we expect to open several more offices in Arizona before year-end. And now, I would like to make a few closing comments.

We continue to make solid progress on our plan to grow and diversify our business. Our recent results are showing the benefits of our strategy. Our commercial and consumer banking segment, loan portfolio deposit growth have been substantial, and far outpace industry and peer averages over those periods.

Growth in segment net interest income and in net income reflect this progress. And our pending acquisition of Simplicity Bank will accelerate our goal of increasing commercial and consumer banking segment income to consistently more than 50% of our total bottom line.

While the mortgage industry continues to produce substantially lower than historical loan volumes and confound forecasting, we have returned the segment to profitability, and we are on our way to re-levering our system and returning to expected levels of profitability.

Toward our goal, we continue to higher high-quality personnel and expand our franchise in strong western markets. We're looking forward to closing out 2014 in a very strong manner. And we're very excited about the prospects of 2015.

Thank you for your attention today. I'd be happy to answer any questions you have at this time. Operator?

(Operator Instructions)

Paul Miller, FBR Capital Markets.

Hey Mark. It's Jessica, in for Paul; how are you?

Good, Jessica.

We have one question. How can we think about capital management going forward, given your capital levels adjusted for the Simplicity merger? And, just maybe the possibility of a dividend or a buyback or even saving that capital for more acquisitions?

Thanks for the question. A important benefit of the Simplicity acquisition is the additional free capital. Today, Simplicity has extra capital that they have been utilizing to buy back stock over recent periods.

We will utilize that additional capital to mitigate any potential need to raise additional capital in the near term. That opportunity is limited not simply to any calculable excess capital on their balance sheet today, but we may restructure components of their loan portfolio to provide additional lending room that would not require additional capital.

And so we're pretty happy with the opportunity to take off the table any considerations of capital raising in the near term. The other aspect of the Simplicity acquisition for us that's important is being able to build a significant amount of our earnings in basic spread earnings, basic net interest income.

That should allow us some time, we hope, next year after we have completed the acquisition and stabilized the consolidated group post-acquisition, to contemplate the adoption of a regular quarterly dividend, because we will have a very significant base of durable spread income. And so we would hope to have that conversation internally sometime in the second half of next year with the hope for expectation of initiating a regular quarterly dividend.

Great, thanks so much.

Thank you, Jessica.

(Operator Instructions)

Tim Coffey, FIG Partners.

Thanks. Morning, Mark.

Good morning, Tim.

Can you give us an idea of what the pipeline is looking like on the commercial banking side going into 4Q?

That's a good question. I don't have the pipeline numbers in front of me, though, I would say on balance, we expect to close more in terms of dollars in the fourth quarter than this quarter, both in the loan portfolio and with respect to our Fannie Mae DUS business.

We have, as you've seen from the commitment detail over the last several quarters, a building portfolio of unfunded construction loans, which are funding up, plus permanent loan closings that are anticipated for the fourth quarter. So, as a directional statement, I think we expect it to be higher than the third quarter as a consequence of not just prior activity and existing commitments, but other loans scheduled to close in the quarter.

Okay. And what does that tell us or what -- how should we read into that in regards to the provision expense because for the first three quarters of the year it's been almost nothing? What do you see for the fourth quarter and into 2015?

Well, we've been fortunate that notwithstanding our loan growth, our improvement in credit quality and much lower than expected charge-offs has prevented the need for a provision so far this year. We expect that to change in the fourth quarter, for us to settle at coverage ratios similar to those at the end of the third quarter.

And so to the extent that our loan portfolio grows and/or we experience charge-offs, that would create a need for provisioning. And we think that fourth quarter is going to be the time that we -- the first-time we experience that in the recent past.

So, if you are thinking about the coverage levels today, with some level of anticipated charge-offs in the quarter, you can probably calculate that expected provision for the quarter. And, similarly, next year, if you think about a level of charge-offs that is probably still smaller than current year, despite current your charge-offs having come down quite a bit.

Okay. That's great. And did I hear you in your comments say that the loan fee margin on the mortgage side of the Business, you see those going up?

No. I think one, I commented that the margins had deteriorated a little bit on our composite margin a few basis points this quarter. I don't think I commented on our forward look, but I can. We are deemed conservative in our internal forecasting about the forward margin.

We're expecting growth in our loan volume to mitigate that next year. But we expect to still see some softening in margins. We said that last year about this year, and, frankly, margins have been much higher this year than we had forecast them coming into this year.

I think the probability of a significant decline in our composite margin is probably not great when you consider the number of companies that are breaking even or losing money on mortgage origination today. What that reflects is the cost of production for everyone has grown dramatically over the last several years, with increasing credit and underwriting requirements and very substantial increases in data and file quality requirements by the agencies and even in securitization.

And so the cost of production must be near the revenue today if people are breaking even or losing money. So we think the probability of people being interested in even greater price competition from here is probably less likely than it was a year ago.

Okay. Great, thanks. That's good color. And then turning to Simplicity, do you have any updates on their quarter?

They have not yet released earnings. I think their scheduled to release early in November, in the first week in November. So I can't comment on that yet. I would ask that question of the Simplicity Management.

Okay. And then as it relates to deal costs on the Simplicity deal, do you still anticipate splitting those between 1Q and 2Q, provided it closes within the timeline? Or do you think you can perhaps lump those into one quarter?

Well we estimate the total deal costs at just over $19 million. Some of that we've already taken, right? In this quarter of the approximately $570,000 of merger-related expenses in the quarter, $700,000-some, a little over, or about $570,000-some related to the Simplicity merger.

So those have already been incurred. We're going to incur maybe another $400,000 in the fourth quarter. So that's going to leave us approximately $18 million of costs that we have estimated yet to incur. To the extent that the transaction closes in the first quarter and the systems conversions occur subsequent to that, say in the second quarter, we would expect to incur somewhere around $10 million in the first quarter and $8 million in the second quarter, for a total of $18 million.

To the extent that the systems conversions might occur concurrent with the legal closing, that would shift quite a bit of that $8 million into first quarter. And that would be great, right, because we want to get past those expenses as quickly as possible and start printing clean quarters. But it's going to rely on the timing of closing and the timing of those conversions.

Any updates on regulatory approvals or conversations or anything like that?

No early promises, other than to date we have not run in to any hurdles or any concerns from any of the agencies. So at this juncture, we don't have reason to believe that our estimated first quarter closing is in danger; though, we have yet to file the proxy, the joint proxy that we'll be filing for the two related shareholder votes.

And, of course, there has been a couple of lawsuits now filed, which is common, unfortunately, in the transaction. I don't know if it's two or one, actually. It's kind of confusing.

We have notices if you look in the Press Releases of all these law firms they look like two law suits. They may be actually the same suit. But, in any event, there's at least one lawsuit, which has become common, unfortunately, in transactions to date.

They appear to act at the end of the day as transaction tax because, at least to date, the history of these pieces of litigation has been a settlement that didn't impair the intended closing date of the transactions. Too early to give an opinion on the status of that litigation, though I am very comfortable in saying that we do not see anything that has transpired in the marketing of Simplicity nor the negotiation of the proposed merger that we think is actionable on any basis.

And we think all these parties have acted in the best interest of their respective companies. So, I expect this litigation to conclude in the same manner as others before it.

Okay, great. Thanks, those are all my questions.

Thank you, Tim.

(Operator Instructions)

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Mason for any closing remarks. Actually, sir, a question has just come in. Tim O'Brien, Sandler O'Neill.

Good morning, Mark.

Hi, Tim.

Hey, could you talk a little bit more about the Arizona expansion?

Sure. Our basic strategy is to expand our mortgage market share in existing markets wherever possible, and to expand to other major mortgage markets in the Western United States to subsequently grow a meaningful mortgage market share, and then follow that with the full-service banking probably through acquisitions.

We have done this opportunistically to date. That is to say that in hiring teams -- and we generally don't hire individuals in new markets, we hire teams of high-performing individuals. We first find teams that we think would be additive to our system, and then open offices in their markets.

We don't choose a market and then go look for a team, other than knowing there are major markets we generally like to be in. So, we recently got an opportunity to hire teams of significant successful track record in Arizona.

And so since this is a market that is on our list of markets that we'd ultimately like to operate in, we're opening offices for them. This is the same exercise that predated our entry into northern and southern California, similarly in Idaho and in other markets in Oregon and Washington.

And the fact that it's in Arizona this time is only significant in that we're not yet in the state of Arizona physically. Though, we have been originating loans in Arizona for some period of time related to borrowers who may have second homes or loan officers who may have existing relationships in the state of Arizona.

So, you said several more branches by the end of the year? Or did you say by end 2015?

We're hoping to add several more by the end of this year in the fourth quarter of 2014.

And that would -- what markets are we talking about besides Phoenix, if any? Tucson?

I really shouldn't say yet.

That's all right. No worries.

I think you know the major markets.

Sure. Thanks for the color.

Thank you, Tim. Operator, would you poll for questions one more time.

Certainly.

(Operator Instructions)

Seeing that there are no questions, I'll turn the call back over to you, Mark Mason, for any closing remarks, sir.

Again we appreciate your patience in listening to our prepared remarks and in the great questions from analysts following our Company. Thank you all, good day.

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