Mechanics Bancorp (MCHB) 2014 Q4 法說會逐字稿

Good day, and welcome to the HomeStreet fourth-quarter and year-end conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference call over to Mr. Mark Mason, President and CEO. Mr. Mason, the floor is yours, sir.

Thank you. Hello, and thank you for joining us on our fourth-quarter and year-end 2014 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 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, information on any non-GAAP financial measures referenced in today's call, including a reconciliation of those measures to GAAP measures, may be found in our SEC filings and in the earnings release available on our website. 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.

During the last year, we made substantial progress on our strategy to grow and diversify earnings. We expanded our commercial and consumer banking business and built mortgage banking market share in new and in existing markets. We opened three de novo retail deposit branches. And, grew our transaction and savings deposits by 12% for the 12-month period.

Loan portfolio growth was strong. With total loans held for investment increasing 12% over the prior year, despite our sale of $267 million in single family loans out of the portfolio in the first and second quarters of 2014. Net interest income increased 43% this year, as a result of a 34-basis-point improvement in our net interest margin, and almost 20% growth in average interest earning assets.

This year, we also negotiated our planned acquisition of Simplicity Bancorp. We have now received all regulatory approvals. And, on January 6, we filed the definitive joint proxy statement relating to the proposed merger of our two companies. The joint proxy seeks approval of the proposed -- this merger from Simplicity stockholders and approval by some HomeStreet stockholders for the issuance of the shares of HomeStreet stock to be exchanged in the merger.

HomeStreet's special shareholder meeting is scheduled for this Thursday, January 29, and Simplicity's meeting is scheduled for February 11. Proxy votes to date, by both shareholder groups, are favorable to these transactions. To efficiently register the shares to be exchanged in this merger, we have requested a fairness hearing from the California Department of Business Oversight. Assuming that the fairness panel determines that the proposed merger is fair, just, and equitable to Simplicity stockholders, we will receive a registration permit that will allow the shares to be issued to be exempt from registration with the Securities and Exchange Corporation.

We anticipate that the hearing will be held on or about February 10. And, a notice of the upcoming hearing will be sent to Simplicity's stockholders prior to the hearing date. Assuming both HomeStreet and Simplicity receive approval or proposals from our respective shareholders, and assuming the California Department of Business Oversight timely grants the registration permit, we expect to complete the proposed merger at the end of February. We are excited about the potential this acquisition offers us for building a strong consumer and commercial banking franchise in Southern California to complement our growing mortgage banking and other business in the region.

I'd now like to share some key metrics from the quarter and full year. Fourth-quarter net income was $5.6 million, or $0.38 per diluted share, compared to $5 million, or $0.33 per diluted share for the third quarter. The increase in net income for the quarter was primarily due to $3.7 million in higher mortgage servicing income and $2.2 million in higher net interest income, which was primarily due to a 6.4% organic growth in average interest earning assets over the quarter.

Full-year net income was $22.3 million, or $1.49 per share, compared to $23.8 million, or $1.61 per diluted share for 2013. Excluding pre-tax acquisition-related expenses of $889,000 in the fourth quarter, and $3.1 million for the full year, net income was $6.2 million for the quarter, or $0.41 per diluted share, and $24.2 million for the year, or $1.62 per share.

Tangible book value per share increased to $19.39 per share at year end, compared to $18.86 per share at September 30, and $17 per share at the end of 2013. This represents a 14.1% increase in tangible book value per share for the year. Our net interest margin was 3.53% for the quarter, compared to 3.5% in the third quarter. And, 3.51% for the full year compared to 3.17% for 2013.

Noninterest income was $51.5 million, up $5.7 million, or 12% from the third quarter. And, an increase of nearly 43% over the fourth quarter of the prior year. Noninterest expense was $68.8 million for the quarter, compared to $64.2 million in the third quarter. The increase was related to higher technology costs, increased salaries tied to growth in headcount, and higher commissions as a result of higher single family mortgage closed loan volume in the quarter. At December 31, the bank's tier 1 leverage ratio was 9.36%, and total risk-based capital ratio was 14%.

I'd like to speak now about our commercial and consumer banking business segment results. Our commercial and consumer banking business continues to expand, consistent with our strategic plan. 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 $3.3 million, compared to $3.5 million in the third quarter. This decrease was primarily due to a higher effective income tax rate in the quarter.

Pre-tax income increased $1.1 million from the prior quarter, as net interest income increased with higher interest-earning assets. Noninterest revenue and noninterest expenses both increased in the quarter and reflect growth in the business. Excluding acquisition-related expenses, this quarter income from commercial and consumer business represented 60% of total net income.

Our portfolio of loans held for investment grew 6.8% in the quarter and 12% year over year, to $2.1 billion. Excluding run-off, loans held for investment increased by $330 million, or almost 17% in the quarter. New commitments totaled $308 million, came all lending areas. The average yield of our portfolio increased by 16 basis points from last quarter.

Construction lending has historically been a core business of HomeStreet and is a growing part of our business today. As part of our strong focus on risk management, we are very deliberate about diversifying, both by product type and by geography. Residential construction has primarily been limited to shorter duration loans for detached, vertical construction and consumer custom home construction in the Pacific Northwest, Utah, and Southern California. Commercial real estate construction has primarily been in multifamily, with a focus on strong metropolitan markets in the Pacific Northwest and Southern California. Our relatively recent geographic expansion enables us to better manage concentration in this category.

Our risk-management focus is on lending to financially strong developers with successful track records. Credit quality continued to improve. With nonperforming assets decreasing to 0.72% of total assets at year end, down from 0.87% at September 30. Classified assets ended the year at 0.75% of total assets, down from 1.09% of total assets at September 30.

Nonaccrual loans were down to 0.75% of total loans at December 31, down from about 1% at the end of the third quarter. We recorded a provision of $500,000. Our first and only provision for loan losses this year. We have not needed to provision much this year, due to continuing improvement in credit quality. And, a very low level of charge-offs this year in relation to previously expected losses.

Total deposits grew approximately 1% in the quarter, with certificates of deposit increasing $127 million, or near 35% from September 30. We elected this quarter to raise some longer duration time deposits to provide additional funding for lending and improve our interest rate risk profile.

I'd like to talk now about our mortgage banking business segment results. Over the course of 2014, we expanded our home loan center network by 11 offices and mortgage production personnel grew by 18%. As a result of our continued hiring of strong loan producers, and despite a 39% decrease in industry loan volume, our single family closed loan volume designated for sale was approximately the same as in 2013. Additionally, closed loans per loan officer improved each quarter of the year. Totalling 3.8 loans per loan officer in the fourth quarter of this year, compared to 2.9 loans per loan officer in the fourth quarter of last year.

The most recent Mortgage Bankers Association monthly forecast anticipates total originations, including purchases and refinances, to increase 7.2% in 2015 over the prior year. And, housing starts are expected to increase by 12% next year. Mortgage interest rates have fallen in recent weeks and lenders are currently seeing a substantial increase in refinancing applications. The MBA expects 49% of originations in the first quarter to be refinances, up from an estimated 38% in the third quarter and 46% in the fourth quarter of last year.

In the fourth quarter, our refinances were lower than the national average, due to our stronger purchased mortgage market share. Closed loans were 32% refinances versus 38% of interest rate locks for the same period, as more homeowners began taking advantage of the lower mortgage interest rates.

In January, we've seen a dramatic increase in refinancing, which comprises 67% of our rate locks month to date. Through January 23, we have produced a fallout adjusted $546 million in rate locks. At this pace, we expect to set a new monthly record for the Company. Of course, it is unclear how long this refinancing activity will last.

The FHA recently announced a 50-basis-point reduction in mortgage insurance premiums for new originations. This reduction goes into effect at the end of this month and will enable more people, including first time home buyers, to qualify for loans and reduce their monthly payments. We anticipate this will spur some additional level of refinancing of FHA loans for borrowers who currently have higher interest rates and higher insurance premiums.

All in all, this time of year is usually quite challenging in the mortgage business. Particularly, in the Pacific Northwest, where seasonality is a more significant factor. But, with the low interest rates and this positive change from the FHA, we anticipate a better quarter than previously forecasted internally. How much better will depend on how long rates remain at or below these levels.

Now, a little bit about the segment results. Mortgage banking segment net income for the fourth quarter was $2.3 million, compared to $1.4 million in the third quarter. This increase in the quarter was primarily due to higher mortgage servicing income. Closed loan volume designated for sale was $1.33 billion. An increase of nearly 3% from the prior quarter and 72% above the fourth quarter of 2013. The combined pipeline of locks and closed loans held for sale was $891 million (sic - see press release, "$891.4 million") at year end, compared to $974 million at September 30.

Interest rate lock commitments totaled $1.17 billion for the quarter, 0.3% over the third quarter and 77% over the last quarter of 2013. The volume of closed loans designated for sale surpassed interest rate lock commitments by 14% this quarter. Which, negatively affects accounting earnings, as a majority of mortgage revenue is recognized at interest rate lock. While a majority of origination costs, including commissions, are recognized upon closing.

If interest rate lock commitments during the fourth quarter would have equaled closed loan volume, it would have resulted in approximately $4 million higher gain on loan origination sale revenue. Conversely, if closed loan volume had been the same as interest rate lock commitments, pre-tax income would have been approximately $1.7 million higher as a result of lower variable costs. Net gain on single family mortgage loan origination and sale activities was $36.5 million in the quarter, essentially flat from the prior quarter, and $13.2 million, or 56% above the fourth quarter of 2013.

The composite margin was 310 basis points in the quarter. A decrease of 6 basis points from the prior quarter. The decrease was due primarily to pricing competition and lower profit margins specifically on non-conforming jumbo mortgage loans. Which comprised over 13% of interest rate lock commitments adjusted for fallout during the quarter.

Single family mortgage servicing income was $9.3 million for the quarter. A $4 million increase over the prior quarter. Primarily due to increases in the fair value of single family mortgage servicing rights resulting from slower-than-expected long-term prepayments fees.

Single family mortgage servicing fees were down $524,000 from the third quarter. While the portfolio of single family loans serviced for others grew to $11.2 billion, from $10.6 billion at September 30. Segment noninterest expense was $47.6 million, an increase of $2.4 million from the third 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 cost to originate a loan decreased by an additional 12 basis points in the quarter. We are looking forward to a very exciting 2015.

This concludes my prepared remarks this morning. We appreciate your attention today. I'd be happy to answer any questions you have at this time.

(Operator Instructions)

The first question we have comes from Jeff Rulis of D.A. Davidson. Please go ahead.

Thanks, good morning.

Good morning, Jeff.

If you anticipate closing of the Simplicity deal at the end of February, when would you guess the back office conversion would be: the timing on that?

We are currently scheduled to integrate their back office systems during the month of April, generally.

Yes.

Some of the personnel will leave on legal day one. Obviously, personnel like their board of directors and certain members of management who won't be continuing. The rest of the back office staff who is running their base systems will be with us, of course, through integration and a little past: somewhere on the average of two to three months.

Okay, and could you remind me of the -- either the cost savings target on Simplicity alone, or the efficiency ratio goal for the combined company?

The cost savings were approximately 35%, I believe, an annual run rate of roughly $9 million, I think. Most of that cost savings is personnel-related. I believe almost $7 million of that is personnel.

Beyond that, systems and real estate expenses related to their corporate headquarters were the next two largest categories. The efficiency ratio targets for the Company are in the mid to low 60% range a few quarters out. I mean, in 2016, we hope to reach those numbers. With a fairly steady improvement over the period of time from then to now.

Sure, okay. And then separately, just interested in the pipelines on the commercial and consumer loan growth for perhaps the full year?

Our growth continues to be targeted at, you know, this sort of net portfolio growth of a little more than 5% a quarter. Each quarter we put out a pretty substantial deck of additional investor information that has typically included pipeline information as of the end of that period. If you bear with me, I've got a draft of it.

Let me see if I can pull up the current pipelines as of year end. So the total -- I don't -- I'm sorry I don't have that number yet for December. Those are September numbers. I don't have the total pipeline yet. I mean, they've -- it's been running generally at about 130% of production for the quarter if you look across all of the groups. We expect pretty consistent contributions.

If you look at the full year production in commitments by each of our major lines of business, that's basically the contributions we're expecting to the portfolio next year. The only differences really lie in prepayment speeds. Our construction prepayment speeds have been very, very fast. Particularly, in residential construction. Which isn't a surprise, given the lack of housing inventory, at least in our markets.

So, turnover continues to be a problem. I think for the full year, our portfolio run-off rate is going to be somewhere between 10 and 15%. Probably closer to 15% for the year. Which is quite high. I mean, it makes our interest in growing the portfolio more challenging. But, we expect that to continue at this pace.

Okay. So from the production side, at least anecdotally, you enter 2015 on equal standing as you entered 2014? Or, you feel like you've put more boots on the ground and more optimistic in 2015 versus 2014.

I'd say we're in substantially better position in terms of pipeline and capacity. 2014, if you look at the improvement over the quarters, really showed a maturing of some of these lines of business that had to be restarted. And, the integration of the acquisitions we did last year.

If you remember, we did two smaller commercial bank acquisitions that closed in November of 2013. That integration all took place in the first and second quarters of 2014. And so, that all got smoothed out during the year and our commercial real estate business picked up a lot of momentum during the year. And so, I think that what you saw is a maturing of all of the lines of business and that allowed us to reduce the amount of single family mortgage volume we were putting into the portfolio. Allowed us to accelerate the change in composition of the portfolio.

I think at one point during the year, 60% of the portfolio was still single family mortgage. That's down to 40% currently and falling. And so, we go into 2013 not only with a better diversification and composition of the portfolio, but with substantially greater velocity.

Great, thanks, Mark. That's it for me.

The next question we have comes from Russell Gunther of MacQuarie.

Hello. Good morning.

Good morning, Russell.

I just want to follow up on the loan commentary. I appreciate the color you gave with regard to your outlook for commercial and consumer loans. And additionally, the color on the construction book in growth this quarter.

The other commercial buckets witnessed some run-off quarter on quarter. I wonder if you'd just give us some color as to the performance there?

Yes, make sure I understand your question. A little more color on the --

Sort of what -- the modest decline in commercial real estate, multifamily, CNI loans, link quarter.

Oh, the -- well, as I'm sure you know, the competition for permanent lending in the multifamily space is, at least in commercial real estate, the most competitive part of the market. And, we have been less successful competitively in the last couple of quarters in the permanent loan area as we have been in the commercial area.

Though, our success with respect to Fannie Mae lending has picked up during that period of time. So, we're working on our pricing going forward to see if we can become a little more competitive. And that's caused some run-off in the multifamily area. The -- and what was your question on construction? I didn't understand it.

No, no. I appreciate the color you offered on what was accounting for the growth in the quarter. I was just -- and, I look at the other commercial loan buckets. You know, there was just some modest run-off linked quarter.

And so, I mean, I think I hear you loud and clear that the target's still on track for the 5% quarter on quarter commercial growth. I was just looking for some color on the migration in the quarter.

Oh, sure. And I'm sorry, it's just price competition that we've been less successful in the multifamily area. You know, we feel -- still feel strongly that we're going to get the level of composition of contribution in that area going forward.

As an example, we're in the process of building a small balance commercial real estate group, which will run the small balance CRE portfolio that we're acquiring from Simplicity. A substantial amount of that production will be sold, but some of that will go into the portfolio, as well. So, we're coming into 2015 with, one, more mature existing lines and a little more capacity from some new business.

Got it. I appreciate that and just a question on the margin. You know, the expansion in the quarter is unique in bank land today. And, you did it with, you mentioned, locking in some longer duration CDs.

So, I was just wondering if you could comment. Do you think this earning asset remix can continue to drive expansion? Maybe even if we just looked to the first quarter of 2015, and if there's maybe additional room to lower the cost of funds, as well?

Well, we have shared that we believe our margin was going to expand 10 to 15 basis points next year. Which is counter intuitive to most of the industry today. That is going to largely be a consequence of improving asset yields as we continue to change the composition of the loan portfolio.

Our cost of funds, and that improvement is through the end of next year, potentially. Now that, of course, assumes no substantial change in interest rates from the current levels. Our cost of funds, we expect to increase slightly from here. But, given that expected increase in margin, we expect our asset yields to improve substantially more. And again, that's really from remixing.

Okay, and just so that I understand your margin guidance. You're saying 10 to 15 basis points of expansion? Is that from 4Q 2014's 353 through the end of 4Q 2015? Or, how should I think about that?

That's correct.

Okay, great. Thanks for that.

Thank you.

And then lastly, I have a couple ticky-tack questions on the income statement. You mentioned some non-core items, both benefits and expenses on the tax in the quarter. Can you just give us some color, sort of size up? Was there a net non-core impact, or did those wash out, and what we should look at for a tax rate going forward?

Thanks.

And, you know, it's one of the things that was disappointing to us in the quarter, that we had some true-ups and a little higher allocation to higher state tax jurisdictions than we had previously planned. Plus, we'd add a little lower levels of nontaxable interest income from lower levels of municipal bonds in the securities portfolio.

And so, all of that contributed to a much higher effective rate for the fourth quarter. Going forward, we will be having more taxable income in higher tax jurisdictions like California. So, we think an effective rate next year of about 34%.

34 to 35.

34 to 35 is probably appropriate. About as high as the fourth quarter, but higher than 2013 as a whole. Sorry, 2014 as a whole.

And we also had a balance in Q4 that was sizeable related to acquisitions.

Yes, I'm sorry. Cory reminded me of one other matter. One negative aspect to doing acquisitions is the non-deductibility of some of our merger-related expenses.

So, while we may recognize those as expenses in the income statement, they may not be deductible for tax purposes. They are capitalizable for income tax purposes. And, during the quarter and the year this year, obviously we had some level of that activity and we will next year, as well. So, that also contributed to the higher effective rate.

Sure. Okay. I appreciate that. Just a minor question.

Just on the other noninterest income line, it looked like there was a small loss in the quarter. Any color there? Something one time in nature, or?

Oh, right. Another unusual, and at this point clearly not a recurring item: you may remember earlier in the quarter we announced that we had identified an internal control weakness related to a hedging program on -- loan program that the Company had done between 2006 and 2008. In addressing the issues related to that situation, we elected to terminate all the related swaps.

Got it.

And, amortize the remaining marks on the loans and those losses were related to those swap terminations.

Okay, and just what was that in aggregate? Was that just the 9 million, or did that wash out some other income there?

No, those numbers are all pretty small. I mean, it's in the small hundreds of thousands of dollars.

Great. All right, good. Thank you so much. That's it for me.

Great. Thanks, Russell.

Next, we have Tim Coffey, FIG Partners.

Thanks. Good morning, Mark.

Good morning, Tim. How are you?

I'm good, thank you. Good. The slew of CDs that you locked in this quarter, what was the cost on those?

Let me ask Darrell Van Amen; our treasurer's with us this morning. Darrell, what would you say the average cost of the new CDs was?

We actually had some pricing differential between the three different markets we were in. But, primarily they were around 100 basis points, that we originated on mainland. So, we had different pricing, and --

That's the -- those are the retail CDs. The institutional CDs are in --

Were about -- and we didn't do much of those. They were very small and we cut those off in November. And, they were about 85 basis points.

And the brokered CDs?

Those are -- but, those aren't the duration stretching CDs. Those are about 35 basis points, but they were short-term, those --

Okay, but they're all in the CD bucket?

They are.

So, what would you say the weighted average was?

The weighted average would have been something pretty close to about 65 basis points because of the nature of the brokerage.

He got it, then, yes.

All right, and how long were those?

Well, there's a number of different durations. The retail CDs are all roughly in the one year to 15 month.

15 month, yes.

Range. The brokered CDs are shorter.

Three to six months.

Three to six months.

All right. Do you feel like this is a -- I mean, do you feel like this is something you'll repeat again in forward quarters?

You know, it's unclear. It really depends on our success in growing transaction accounts. Obviously, that's our preference.

We took a look at the quarter and the year to date. Coming into the year, we had expected to raise substantially more CD money. But, we were more successful with transaction accounts and core accounts than we expected. So, it's going to depend on our success in raising core deposits. It's going to depend on our success in growing the loan portfolio.

And, a great deal of it has to do with monitoring our non-core funding dependency. We try to keep our non-core, or non-deposit funding, to less than 30% of total funding. And so, we're constantly balancing all of those things.

Okay, okay. That's clearly helpful. And then, a question about the hedging activity. Do you feel that you're adequately hedged going into this first quarter, given where the rates are and the size of the MSR portfolio?

We always do. I mean, despite what some folks may think, given the positive results that we fairly consistently show. We do not take a position on interest rates.

We hedge both sides of the potential change equally. In fact, we hedge potential rate movements that we know of no other party who does. We hedge black swan type spikes in rates that cost us money. We have just been quite good at dynamically managing that hedge. And so, our results have nearly always been positive.

Remember, part of the reason for that, though, is we are long in these instruments. And so, in a perfect world, we will still make money on the servicing hedge because we're long in the instruments and these instruments have a carry or an earning rate. And so, we kind of have a head start going into the quarter on the results.

Great. Those are all my questions. Thanks, Mark.

Thanks, Tim.

The next question we have comes from Paul Miller, FBR.

Hey, Mark. Hey, how are you doing, Mark?

Good.

Can you talk a little bit about, you know, when do you -- you know, we talked a little bit earlier this morning about this. But, when do you think the bank can stand on its own two feet and start to really take over the earnings of the Company? I mean, and what is your long-term goals with that also?

Well, upon the closing of the Simplicity acquisition, we believe that will change 2015 earnings to an expected more than 50% contribution from non-mortgage banking earnings based upon our internal numbers, and that also assumes a pretty significant mortgage banking earning year. So, we think, post Simplicity acquisition going forward, we should fairly consistently, except during, maybe, high refinancing periods, have the majority of our earnings coming from non-mortgage banking or commercial consumer banking sources.

I think the greater question is when will those stand-alone earnings provide a base, a full basis for valuation of the Company at levels at or above current valuation? When you think of typical bank earnings multiples. And, I think we are approaching that point here in the next quarter or so.

Where beyond that, if you're valuing the two segments separately, you should be able to get a reasonable commercial banking multiple out of the banking segment. And, some much lower multiple on the mortgage banking earnings. Understanding that, you know, those will always be valued at a lower multiple because of their cyclicality. So, I think that point is coming soon and the big change is going to be the Simplicity acquisition.

And then what about any -- what's the outlook for future M&A? Are we -- everybody knows that a lot of people want to sell two times bank. Were you able to find a decent deal at book?

Those deals don't fall off the trees every day. Are you going to continue to try to expand there, now you got a foot hold in California? Or, are you just going to be looking up and down the West Coast?

You know, theoretically we're looking at every major western market that we have a meaningful mortgage market share in. So, we look at deals in Southern California, Northern California, Oregon, Washington, Idaho, Hawaii. And soon, we'll start looking in places like Phoenix and Salt Lake City.

As you say, you know, there are only so many deals that can be done today that would be feasible and not materially dilutive at our current stock price. So until that changes, we are not going to be in the market for the more expensive typical good quality commercial bank deals. Hopefully that changes in the future. Between now and then, though, we continue to look at deals that will trade closer to book value.

And, there are still some institutions out there for various individual reasons who would trade down near those levels. So, it's still possible we'll be able to do some other transactions in the interim.

Okay. Thanks a lot, Mark.

Thank you, Paul.

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

Good morning, Mark.

Good morning, Tim.

So, just couple of follow-ups. So, did you have -- did you book any in the noninterest expense line, any deal-related costs this quarter? I might not have seen that.

Well, we did. In fact, I think in the first paragraph of the earnings release --

Oh, yes.

-- we try to early on describe the magnitude.

Okay, yes, I was looking at the financials. So, a question regarding first quarter with the deal, you know, potentially closing this quarter. Will the lion's share of deal costs, you know, be recognized here at the end of this quarter and then a little cleanup in the second quarter? Is that the way to look at it? Or, is there going to be substantial related conversion in the second quarter, as well?

There will be material costs in the second quarter because of the systems integration. If you looked at them, more than half will be in the first quarter, assuming a February closing.

Probably two-thirds.

Maybe two-thirds, my guys are saying here.

Okay.

But still, a third of those costs are still pretty material. I mean, I believe it's $18 million, roughly, of total deal costs. So, $12 million of that likely is in the first quarter.

Now, will some of that be carried by Simplicity, of the $18 million? Or is it all -- that's your share?

You know, some of that is going to be taken by Simplicity pre-deal, so that reduces the net assets we buy. I don't think it's really a big number. Most of that is going to be recognized through our operating statement.

Okay. Great. That's great color. And then, that ratio that you mentioned that you monitor, which is non-core funding; ratio below 30%?

Yes.

Yes, where is that right now? It must be pretty low, I'd imagine.

Well, it's going to get lower when we complete the acquisition. At the end of 2014 -- bear with me and I'll tell you what it was. 28%? It's pretty high.

And, that's due in part to the level of mortgage loans held for sale. That number varies a lot, depending upon how active we are in the mortgage business. Because, most of that non-core number is borrowings from the Federal Home Loan Bank that are very short-term utilized to fund the warehouse of loans held for sale.

Got it, okay. And then, as far as the comment that -- or, the question that Paul had about stand-alone earnings out of the non-mortgage bank, you said above 50% contribution to earnings. Is that something you thought was going to be realized in 2015? And, is that a core number? Or, were you -- is that more of a 2016 idea?

That's 2015, based on our internal estimates and excluding acquisition-related expenses.

M&A, okay. Great. And then, another question for you on the -- just as -- I mean, your credits performance is excellent. As far as the reserve ratio is concerned at 106 at the end of the quarter. Reserve build going forward on that idea; what are you thinking there?

Clearly, we're going to be providing going forward. The reason -- the biggest reason the reserve today, as a -- in terms of a coverage level may look lower than some other institutions. How's it do at the level of single family mortgages in the portfolio?

Yes, sure.

So, as that composition declines, you may see a change in the coverage ratio. But, it's all going to relate to our experience; what we see other peer institutions doing, and our expected losses.

And you'll see --

But directionally, you expect we're getting towards the bottom as far as kind of a baseline there? And, it's more likely than not that, given the credit cycle, you're going to build from here that -- that reserves?

Well, at least we're going to be providing, right? And the -- whether the coverage ratio goes up materially from here or not is going to depend on credit performance and how the portfolio performs. You -- we have -- our internal expectations are that we will be providing each quarter going forward to the provision.

Yes.

Probably an ever-increasing number as the portfolio grows. To the extent we don't experience charge-offs, that could mitigate that. But, it's very hard to grow the portfolio and not increase your allowance.

I like to hear that. Thanks. Thanks for answering my questions.

All right, thank you.

(Operator Instructions)

Next we have a follow-up from Jeff Rulis, D.A. Davidson.

Thanks. Sorry. I had one quick follow-up. And, could you update us on the asset liability sensitivity, pre- and post-Simplicity?

Sure. First, in summary and then I'll let Darrell speak to maybe some details. Our sensitivity has actually improved pretty substantially this year by a couple things that we've done.

So, today we're in a very balanced position. That will be a negative if rates rise quickly. In the event they don't, we're very well positioned.

Of course, no one expected rates to fall here recently and that's not great if you're asset sensitive. But, we're in a pretty balanced position. Darrell, would you add anything to that?

No, and I would -- we have actually looked at the Simplicity interest rate risk and compared it to ours and we've done some modeling in that context. They have a large proportion of non-determinant -- indeterminate deposits which have a longer duration, which matches their loans. So, they are actually not that unlike us in terms of being -- having a relatively matched book. They have a very small securities portfolio.

The one thing that they do have, that's a little bit different than ours, is their FHLB advance. Although small, are very long in duration. So, that helps our duration on our liability side.

So on balance, we don't expect it to materially change our position.

No, no. I think they're -- they actually -- in fact, we don't expect that at all.

Okay.

And in terms of management going forward, you'd like to stay that balanced position, or move to more asset sensitivity?

Well, we would love to improve the liability side of the balance sheet. Our constant goal is to grow our non-term deposits. Which, of course, is a great improvement in sensitivity.

On the asset side today, about a third of our book is fixed in the loan portfolio. But, we do have, you know, not a lot of it is monthly adjusting. Some of it is. Not a lot of it. So, you know, the improvement would probably come from more lines of credit, more monthly adjusting assets. And, we are growing that if you look. Construction assets are a good example of great asset-sensitive instruments.

I'm not sure how much we can change it quickly, though. I mean, we can improve the liability side somewhat, but that's a long -- a long-term challenge. In the asset side, we're looking for diversity and some of that comes with shorter-term sensitivity. Some doesn't. And so, I think we're going to be probably in a balanced position like we are now going forward.

Great. Thank you.

Next, we have a question from Joe Noll, investor.

Hello.

Good morning.

Congratulations on a good quarter. And, I hope we can translate that to a better stock price. (laughter)

Thank you. So do we. (laughter)

Yes, I believe you said your tangible book value now was $19.39. I was wondering what the book value is.

I'm sorry. What?

I believe you said that your tangible book value now was $19.39. I was wondering what your book value is now.

Oh, the gross book value. Bear with me for a sec.

Okay. I was wondering if -- it seems like you're trading, the stock was trading quite a bit below. Maybe you are ripe for a buyout. (laughter)

Well, I hope not at these levels. So, the gross book value per share is in the -- in the earnings release on the first page of statistics, on page 9. It is $20.34 per share.

Okay. All right. So, like you said earlier, you were looking for companies trading near book value for a good buyout. Is there any chance you might be a buy -- bought out yourself?

I think that would be a pretty poor price, given the forward outlook for this Company.

Yes.

There are other companies who have been less successful recently, who don't have asset growth or margin growth, or businesses like the mortgage business that provide us additional noninterest income. We don't think, at least at these levels, with any reasonable premium that this would be a very good value for our shareholders.

Okay. Thank you. Is there any chance that you're reconsidering reinstatement of dividend any time soon?

Boy, we sure hope to. So, I think I made this comment when we talked about the acquisition of Simplicity. After stabilizing that acquisition, we are planning to revisit the issue of a regularly quarterly dividend with our board. So, that would be sometime later this year.

Okay. Sounds good. Thank you.

All right.

(Operator Instructions)

Well, at this time, we have no further questions. We'll go ahead and conclude the question and answer session. I would now like to turn the conference back over to management for any closing remarks. Gentlemen?

Thank you. We -- again, we appreciate your patience and attention today. Appreciate all the great questions. Look forward to talking to you next quarter.

And, we thank you, sir, and to the rest of the management team for your time today. The conference call iss now concluded. At this time, you may disconnect your lines. Thank you, and have a great day, everyone.