Mechanics Bancorp (MCHB) 2016 Q3 法說會逐字稿

Good day and welcome to the HomeStreet third quarter 2016 earnings conference call.

(Operator Instructions)

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

Hello and thank you for joining us for our third quarter 2016 earnings call. Before we begin, I'd like to remind you that our earnings release was furnished yesterday 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 later 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 operating targets and forecasts, and economic conditions that affect our net interest margins. Other factors that may cause actual results to differ from our expectations or that may cause us to deviate from our current plans are detailed in our SEC filings, included in 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 in our SEC filings and in the earnings release available on our website. Please refer to our earnings release for a more detailed discussion of our financial condition and results of operations.

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

In July, we announced the hiring of Ed Schultz as our Executive Vice President of Commercial Banking for the state of California. California is a very important state for us from a growth perspective and Ed comes to us with a successful career in senior leadership in commercial banking in California and a track record of building successful commercial lending teams. We're happy to have Ed's help in this important initiative for HomeStreet.

On August 12, we completed the acquisition of loans and other assets, deposits and the two branches comprising the operations of the Bank of Oswego, located in Lake Oswego, Oregon, an affluent suburb in Portland, Oregon. In this transaction, we acquired approximately $40 million of loans, $50 million of deposits, and two retail deposit locations. These branches increased our retail deposit branch count in the Portland, Oregon metropolitan area to five. We are excited by the growth opportunities in Portland, as a result of the area's strong employment and population growth.

We also opened a new retail deposit branch in Riverside, California. This location is half a block away from a large Kaiser Permanente medical center and represents the most recent expansion of our relationship with the employees of Kaiser Permanente. The proximity to this Kaiser facility allowed us to open a branch in a new market where HomeStreet is relatively unknown, and the Kaiser employee base there provides us a built-in population of customers with whom we already have existing relationships.

Additionally, the previously announced pending acquisition of two retail deposit branches located in Granada Hills and Burbank, California from Boston Private Bank and Trust is scheduled to close next month. These branches have approximately $110 million in deposits today. These branches are also each located near Kaiser Permanente facilities and will increase the number of our retail deposit branches in Southern California to 13.

Additionally during the quarter, we opened three standalone home loan centers, two of which are in Arizona and one in Sherman Oaks, California. This expansion was offset by the closing of one standalone home loan center in San Rafael, California.

Finally, I'd like to take a moment and address our retail branch incentive compensation practices. In contrast to the retail incentive compensation practices at Wells Fargo, our culture is based on serving the customers' needs as expressed by the customer. While our branch management, not platform personnel, have incentives involving net new deposit accounts, we have no quotas or minimum expectations, and these incentives are a small minority of the incentives available to these personnel.

The preponderance of our retail branch incentives relate to net new deposit balances. Our branch personnel are incented primarily to attract and retain business deposit balances and those balances must be seasoned and these results are audited by our management personnel for authenticity and accuracy. Additionally, we do not today and never have had incentives based upon the number of accounts per customer. To our knowledge, we have never had an incident of an employee gaming our incentive system by boarding accounts not authorized by the customer.

We do have an effective system of incentives for cross selling referrals, but the referring employee has no ability to influence the outcome of the referral after it's made and the incentives are not paid unless the customer is served and a product is provided. In summary, the foundation of our corporate culture is to serve the customers' needs as expressed by the customer, not to push unwanted or unneeded products, and our incentive programs reflect this culture.

Before Melba reviews our financial results, I'd like to share some highlights from the quarter. Net income for the quarter, excluding acquisition-related items, increased 25%, to $28 million from $22 million in the prior quarter. This represents a new record for HomeStreet. Total assets grew $285 million, or 5% in the quarter, to $6.2 billion. Annualized return on average tangible equity, excluding acquisition-related items, was 20% in the quarter.

Diluted earnings per share, excluding acquisition-related items, increased 24%, from $0.90 per share in the second quarter to $1.12 per share in the third quarter. Tangible book value per share increased from $21.38 at June 30 to $22.45 at September 30.

Net income for the Commercial and Consumer Banking segment, excluding acquisition-related items, totaled $10.5 million, a record for this segment since we began reporting it separately in 2013. Also, operating efficiency, excluding acquisition-related items, was 64.5% for the quarter, reflecting the ongoing operating leverage we are generating with growth and the maturing of our Commercial and Consumer Banking activities.

Loans held for investment increased $66.5 million, or 1.8% during the quarter, to $3.8 billion. New portfolio loan commitments through the quarter remained strong and totaled $601 million in the quarter. However, net loan growth was adversely impacted by lower levels of loans funded during the quarter. Originations totaled $350 million for the quarter, as compared to $440 million in the second quarter. The ratio of non-performing assets to total assets ended the quarter at 0.52%, a slight increase from the second quarter's level of 0.45%, but still reflecting excellent loan quality. And our early warning credit indicators are continuing to show strong fundamentals in all of our markets.

Our third quarter mortgage banking segment net income increased to $17.6 million from $14.7 million in the second quarter, reflecting the continued low interest rate environment driving an increase in mortgage originations and another quarter of strong servicing revenue, risk management results, and the continued leveraging of our servicing platform as we grow our servicing portfolio. Closed loan volume in our single-family mortgage banking segment totaled $2.6 billion in the third quarter, compared with $2.3 billion in the second quarter. Interest rate lock-in forward sale commitments of $2.7 billion in the third quarter increased from $2.4 billion in the second quarter.

[Trade] remains a challenge for us and minor manual edits are required on most loans, resulting in increased time and cost to close loans as we continue to carry a higher percentage of support staff to sales staff than we believe is optimal. We prioritize purchase transactions in order to meet our customers closing schedules, and the increase in refinance volumes has strained our resources somewhat. The expected seasonal slowdown in the fourth quarter and our conversion to a new loan origination system early next year should improve our efficiencies and lower costs once fully implemented. And now I'll turn the call over to Melba, who will share additional details on our financial results for the quarter.

Thank you, Mark, and good morning, everyone. I'd like to first talk about our consolidated results and then I'll provide detail on each of our segments.

Third quarter net income was $27.7 million, or $1.11 per diluted share, compared to $21.7 million, or $0.87 per diluted share for the prior quarter. The increase in net income from the prior quarter was primarily due to a $7 million increase in the net gain on mortgage loan origination and sales and a $2.3 million increase in net interest income. Excluding after-tax acquisition-related items, core net income for the third quarter was $28 million, or $1.12 per diluted share, compared to $22.4 million, or $0.90 per diluted share in the second quarter. Acquisition-related expenses totaled $512,000 for the quarter, primarily due to the expenses related to the Bank of Oswego acquisition completed in the quarter.

Net income for the nine months of 2016 was $55.9 million, or $2.27 per diluted share, compared to $32.6 million, for $1.58 per diluted share for the same period in 2015. The increase period over period was primarily due to $23.4 million higher net interest income, $49.7 million higher net gain on mortgage loan origination and sale activities, and $24.9 million higher mortgage servicing income, partially offset by $41.4 million higher salaries and related expenses.

Average loans held for investment grew by 32.1% from the year-ago period, from $2.7 billion to $3.6 billion. Excluding after-tax acquisition-related items, core net income for the first nine months of 2016 was $60.2 million, or $0.0245 per diluted share, compared to $35.5 million, or [$1.72] per diluted share for the first nine months of 2015. Included in the non-core items for the first nine months of 2016 was $6.7 million of acquisition-related expenses, compared with $15.8 million of acquisition-related expenses and $7.3 million bargain purchase gain for the same period of 2015.

Net interest income was $46.8 million in the third quarter, compared to $44.5 million in the second quarter. The increase was primarily due to higher interest income from the growth in average interest earning assets, specifically a higher balance of loans held for sale stemming from the increased mortgage banking production this quarter and a higher balance of investment securities, as we temporarily invested the capital from our May debt raise until it is redeployed into future loan growth.

Our net interest margin was 3.34%, a decrease of 14 basis points from the second quarter, due to a shift in asset mix reflecting lower yield investment securities and loans held for sale and the higher cost of funds, primarily from a full quarter's impact of our long-term debt issuance. Average interest earning assets increased by a larger amount than average interest earning liabilities, increasing the impact of noninterest bearing sources to 17 basis points in the third quarter from 15 basis points in the second.

Noninterest income increased $9.3 million, or 9% from the prior quarter, due primarily to higher net gain on loan origination and sale activities, as well as an increase in mortgage servicing income. Net gain on mortgage loan origination and sale activities increased $7 million and mortgage servicing income increased $1.4 million from the prior quarter.

Noninterest expense was $114.4 million in the third quarter, compared to $111 million in the second quarter. Excluding acquisition-related expenses, noninterest expense was $113.9 million, compared to $110 million in the second quarter, an increase of $3.9 million. The increase in core expenses was primarily due to higher commissions paid as a result of the 17.1% increase in single-family closed loan volume.

At September 30, the bank's tier 1 leverage ratio was 9.91% and total risk-based capital was 14.41%. The consolidated company's tier 1 leverage ratio was 9.52% and the total risk-based capital ratio was 12.25%.

I'd now like to share some key points from our Commercial and Consumer Banking business segment results. The Commercial and Consumer Banking segment net income was $10.1 million in the quarter, compared to $7.1 million in the prior quarter. Excluding after-tax net acquisition-related items, the segment recognized core net income of $10.5 million in the third quarter, compared to $7.7 million in the second quarter. Growth in core net income was driven by improved operating efficiencies, as revenues increased and expenses declined.

Core return on average tangible equity for the segment was 9.1% for the quarter, compared to 7.4% in the prior quarter. Net interest income increased to $39.3 million in the third quarter from $38.4 million in the second, primarily due to increases in loans held for investment and investment securities. Segment noninterest income increased from $8.2 million to $9.8 million, primarily due to higher prepayment fees collected during the quarter.

Segment noninterest expense was $32.2 million, a decrease of $1.9 million from the prior quarter. Included in noninterest expense for the second and third quarters of 2016 were acquisition-related expenses of $1 million and $512,000, respectively. Excluding acquisition-related expenses from both periods, the $1.4 million decrease in expense is primarily due to lower incentive compensation.

We recorded a $1.3 million provision for credit losses in the third quarter of 2016, compared to a provision of $1.1 million recorded in the second quarter, reflecting continued growth in the balance of loans held for investment and lower recoveries relative to the prior period.

The portfolio of loans held for investment [gross] increased 1.8%, or $65 million, to $3.8 million in the third quarter. New loan commitments totaled $601 million and originations totaled $349.9 million during the quarter. While payoffs and paydowns during the third quarter were consistent with prior quarters, origination and advances were somewhat lighter, resulting in lower net loan growth. We expect this to reverse itself going forward, as our pipeline of loan originations remains strong.

Credit quality remains strong, with non-performing assets at 0.52% of total assets as of September 30 and nonaccrual loans at 0.68% of total loans. Non-performing assets were $32.4 million at quarter end, compared to non-performing assets of $26.4 million at June 30. The increase was primarily due to an increase in single-family and commercial nonaccrual loans, offset somewhat by a decrease in other real estate owned.

We experienced net charge-offs of $18,000 during the quarter. Gross charge-offs during the quarter totaled $398,000, primarily from two home equity loans that were originated during 2006 and 2007. Recoveries for the quarter totaled $308,000.

Deposit balances were $4.5 billion at September 30, up from $4.2 billion on June 30. Transaction accounts increased 5% during the quarter. Total non-interest-bearing accounts, including deposits related to our Mortgage Servicing customers, increased 19% during the quarter. Notably, our de novo branches, those open since the beginning of 2012, grew deposits by 34.6% during the period. Deposits in our acquired retail branches increased 11.1% during the quarter, of which the deposits acquired from Bank of Oswego accounted for 4.2% of the quarterly growth.

I'd now like to share some key points from our Mortgage Banking business segment results. Net income for the Mortgage Banking segment was $17.6 million in the third quarter, compared to net income of $14.7 million in the second quarter. The $2.9 million increase in net income from the second quarter was primarily due to higher gain on single-family mortgage loan origination and sale activities, due to higher interest rate lock and forward sale commitments during the quarter.

Return on average equity for the segment was 68.4% for the third quarter, compared to 62.8% for the prior. Gain on single-family mortgage loan origination and sale activities in the third quarter was $88.9 million, compared to $81 million in the prior quarter. Single-family mortgage interest rate lock and forward sale commitments totaled $2.7 billion in the third quarter, an increase of $327.9 million, or 13.9%, from $2.4 billion in the second quarter.

The gain on sale composite margin declined to 330 basis points in the third quarter from 347 basis points in the second quarter. Single-family mortgage closed loans totaled $2.6 billion in the third quarter, an increase of $386.3 million, or 17.1%, from $2.3 billion in the second quarter. Mortgage Banking segment noninterest expense of $82.2 million increased by $5.3 million, or 6.9% from the second quarter. This increase was primarily due to higher commissions and incentives due to increased closed loan volume.

Overall, we grew Mortgage Banking personnel by 5.3% in the quarter. Closed loans increased in the quarter to 5.7 loans per loan officer, compared to 5.3 loans per loan officer in the first quarter -- excuse me, in the second quarter. Single-family mortgage servicing income was $11.8 million in the third quarter, a decrease of $179,000 from the prior quarter. The portfolio of single-family loans serviced for others was $18.2 billion at September 30, compared to $17.1 billion at June 30, which accounted for the $1.1 million increase in single-family mortgage servicing fees collected during the quarter.

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

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

The major markets that we focus on are substantially larger than most of the other markets of the United States, which gives us ample opportunity to grow. The most recent Mortgage Bankers Association monthly forecast projects total loan originations to increase 12.8% this year over last year and to decline by 16.2% next year. The forecasted decline from 2016 to 2017 is driven by a 47% decline in expected refinancing volume; however the forecasted decline in refinance volume shouldn't impact our business to the degree it will nationally, as our focus has always been on the purchase market. The Mortgage Bankers Association forecasts that purchase mortgage originations are projected to increase 10.6% next year.

Despite the increase in short-term interest rates by the Federal Reserve last December, long-term interest rates have fallen this year, along with mortgage rates, and continue near historic lows. While the 10-year Treasury yield has increased somewhat since it fell to a record low 1.3% following the Brexit vote, it continues to remain low on an absolute basis at approximately 1.7%. These lows rate should continue to support housing affordability and keep demand for refinancing high.

Nationally, purchases are expected to comprise 54% of mortgage loan volume this year and 70% next year. Housing starts nationally for this year are expected to be up 8.5% from 2016 to 2017. It is worth noting that housing starts have not yet fully recovered from their lows during the recession and are expected to approach their long-run average level of 1.4 million units by the fourth quarter of 2018.

During the third quarter, purchases comprised 53% of originations nationally and 51% of originations in the Pacific Northwest. HomeStreet continues to perform at levels above the national and regional averages, with purchases accounting for 64% of our closed loans and 53% of our interest rate lock and forward sale commitments in the quarter.

Home price increases in Washington, Oregon and California, based on FHFA data, continued to remain strong in the latest quarter, with year-over-year rates ranging from 7.2% in California to 11.7% in Oregon. According to the most recent Case-Shiller 10-City Composite Home Price Index report, which measures the change in value of residential real estate in 10 metropolitan areas, the index gained 4.2% from a year earlier. Seattle gained 11.2% over the last 12 months; Portland, 12.4%; San Francisco, 6%; and Los Angeles gained 5.5%.

The rate of job growth in Washington, Oregon and California averaged more than 3% last quarter, 72% higher than the US growth rate of 1.8%. The average unemployment rate in the same three states averaged 5.2% last quarter, slightly more than the national average of 4.9%. This elevated level of unemployment in our markets is influenced by our growing labor mobility. In areas of strong job growth, migration of workers to areas where job opportunities are greater tends to hold up unemployment rates.

Looking forward to the next two quarters, in our Mortgage Banking segment we currently anticipate single-family mortgage loan lock and forward loan sale commitment volume of $2 billion in the fourth quarter and $2.1 billion in the first quarter of next year. We anticipate mortgage held for sale closing volumes of $2.4 billion and $1.8 billion during the same periods, respectively. We are entering our seasonally slower mortgage production period, as the fourth and first quarters are typically the slowest for mortgage originations and the second and third quarters, typically the strongest.

In addition, as we continue to close the elevated level of interest rate lock and forward commitments, our Mortgage Banking results will be negatively impacted due to closings exceeding locks. This earnings impact due to the difference between recognizing revenues and expenses due to the imbalance of timing of locks and closings should reverse again as we enter into seasonal mortgage production increases in the middle of next year.

Looking to 2017, we anticipate an increase in single-family mortgage loan lock and forward sales commitments to total $9.3 billion and loan closing volume to total $9.4 billion next year. These volumes will be subject to the typical seasonality we experience. Volumes will also be highly dependent on the housing markets in which we do business, local economic conditions affecting employment growth and wages, as well as prevailing interest rates.

Additionally, we expect our mortgage composite profit margin to come back down to a range of between 315 and 325 basis points over the next few quarters and stay within that range next year. We expect the increased trade-related costs we experienced in the third quarter to continue through the next several quarters until we complete the installation of our new loan origination system early next year.

In our Commercial and Consumer Banking segment, we expect quarterly net loan portfolio growth to approximate 4% to 6% a quarter next year. Reflecting the continued flatness of the yield curve and consistent with our guidance last quarter, we expect our consolidated net interest margin to trend between 3.30% and 3.35% during the next two quarters and continuing through next year, absent changes in market rates and loan prepayment speeds. Reflecting the seasonal peak origination and sale activities, we believe that noninterest expense growth in the third quarter represented a peak for the year. Therefore, we do not expect our noninterest expense to meaningfully increase in the fourth quarter; in fact, we expect noninterest expense to decline somewhat from the third quarter levels.

During 2017, our noninterest expenses are expected to grow an average of approximately 2% per quarter, reflecting the continued investment in our growth and infrastructure. This growth rate will vary somewhat quarter-over-quarter, driven by seasonality in our single-family closed loan volume and in relation to the timing of further investments in growth in both of our segments.

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

(Operator Instructions)

Jeff Rulis, D.A. Davidson.

Thanks. Good morning.

Good morning, Jeff.

Question on the credit quality. And I don't know if this is Melba or Mark, but Melba touched on the single-family credits that popped up. Is there any sort of common theme with those or region that you identified?

There really isn't. It's actually a bit of a hangover issue from the recession. Several of the builders that the Company banked pre-recession maintain fleets of rental properties. They would commonly retain a certain portion of their production and hold it for rental. These portfolios, some of which were quite troubled during the recession, and most of that has been worked out.

We have one of those that we put on nonaccrual this quarter, because of overall credit problems the borrower was having. We are fully secured, however, and the property's cash flow, but because of the uncertainties surrounding the insolvency action that the client's going through, we put it on nonaccrual. So no implications on the portfolio as a whole.

Additionally, the commercial area, we downgraded and put on nonaccrual a couple of agriculture credits that we don't think really represent a trend in that portfolio. They were specific issues related to those two borrowers, and so we think that the downgrades and the slight uptick in non-performers is really not indicative of an new trend.

Okay. So Mark, on the residential credits, there's no other that meet that category or that criteria, you kind of re-fenced that group?

We have a couple other portfolios of that type, but they're all pretty strongly cash flowing and we don't have concerns about them.

Okay. Great. And then just a question in your filings on the inquiry on the fair value hedge accounting. Is that inquiry largely complete, and maybe what accounting adjustments have you made?

This SEC inquiry relates to the disclosure we made back in the third and fourth quarter of 2014, where we discovered that we had some errors in valuation and accounting for a pretty small orphan commercial loan program. It's a pretty common program, whereby the Bank would originate a 10-year fixed-rate commercial real estate loan, swap it to floating, and the borrower would be responsible in the event of prepayment for any loss on the swap. Pretty common program. It was pretty small here at the Bank. And I think because of that, it didn't get the accounting and Treasury attention it deserved to really get the numbers right.

The accounting error part of it was immaterial, but the method or the error potential could have been material. And so we recognized it as a material internal control weakness at the time, fully disclosed all that, did all the analysis work with our auditors to make sure there wasn't some restatement or something recordable. It was immaterial, in all cases. But we made the disclosure of the circumstances.

And the SEC was interested in understanding the background to it and how it occurred. We have not completed that process with the SEC yet, but I'm confident there's not going to be any material impact on the Company from resolving that inquiry, however it's resolved. And I'm hoping to resolve it here in the next several months. But again, I have no reason to believe there's any material outcome or impact on the Company.

So this didn't have anything to do on the fair value accounting or hedge accounting in the single-family MSR, it was all commercial?

Yes, nothing to do with our servicing hedging or our pipeline hedging on the single-family side. Only with respect to this -- I mean, relatively small, it was about $30 million of loans outstanding at the time, very small commercial real estate hedge program.

Got it. Thanks, Mark.

Sure.

Paul Miller, FBR and Company.

Mark, how are you doing? You had a fantastic quarter, with almost, I think, back of the envelope, almost 70% mix between mortgage banking and commercial bank. But your commercial bank went from $10 million, up from a rough $7 million last quarter. How much of that would you consider normal and right now, if we got in today, normal refi cycle, what do you think your mix shift would be?

We believe we're running about 50/50 right now, normalized for refinancing volume and profit. In the quarter, we did have a higher level of prepayment penalty income in the commercial real estate area and that increased earnings to the segment after taxes a little more than $1 million, roughly. So normalized, maybe that's a $9.1 million or $9 million quarter, which still shows well relative to the prior quarter and still shows strong improvement in operating leverage, as well, which is obviously one of our primary goals in the business, not just growing it, but making it appropriately efficient.

Our mix in succeeding years should continue to change. I think we should get to sort of a 60/40 mix within 12 months or so, and more beyond that. And that's without any additional acquisitions or substantial growth that we're expecting in California Commercial Banking. So we're hoping that mix continues to change positively.

And Paul, the only thing I would add to that comment is while the noninterest income in the quarter will see a benefit from higher prepaid fees, we do continue to expect noninterest income overall to remain fairly stable at the current-quarter levels, as we anticipate higher DUS sales in the current quarter.

Right.

Higher DUS sales? Is that considered mortgage bank or the commercial bank?

That's the commercial bank. So all the commercial real estate activities are in the Commercial Consumer segment, so that gain on sale activity from the origination and sale of Fannie Mae DUS loans is in the non-mortgage banking segment. And we' are expecting a solid quarter in the fourth quarter. Typically in that business, that is the highest quarter of the year. It's a good/bad, because it falls off pretty significantly in the first quarter. But we are expecting a strong next quarter.

Speaking about M&A, you've been a very active acquirer of banks. Are you taking a break here a little bit, or are you still looking to add in some footprints? And if you are, what footprints would you really like to move it?

We still are an active, I would say, evaluator of opportunities, both whole bank and branch opportunities, obviously deposit gathering is important to us at this growth rate. We worked on several this year, obviously that were not announced. We currently are looking at several. I can't put any probabilities on any of them, other than to say we remain actively involved in the properties that come to market that we can afford.

Even trading better recently, there are some of the best banks that will sell that for us to purchase would be just too dilutive to our shareholders. And so there are situations that we can't get involved in. We have been able to find solid properties that we can improve and add to our network, and I expect we're going to continue to.

Is there any footprints -- is it the Los Angeles market or is it just wherever you find an opportunity?

You know, obviously, we favor, as we've discussed, the larger population areas. So the coastal large metropolitan markets, we constantly look in, from Southern California from as far down as San Diego up through the Bay Area, the Portland Metropolitan area, the I-5 corridor, obviously up through Seattle, those are all favored. We would look at anything in Hawaii. But we have other markets that we are ultimately interested in that aren't quite as large, from Phoenix to Salt Lake City to Boise to Denver, and perhaps someday in Texas.

Okay. Thanks a lot, Mark.

Thanks, Paul.

Jackie Boland, KBW.

Hello. Good morning.

Good morning.

Just to clarify, the 60/40 is 60 commercial, 40 mortgage, right?

Correct. I'm sorry if that wasn't clear.

It may have been. I was writing quickly. Did any of the [specery] prepayments side impacted fee income, did any of that impact loan growth in the quarter?

Sure, because they were sizable loans. Prepayments fees in the quarter remain high and we're running in excess of 20% annualized rate each of the last several quarters. I don't think that we thought the prepayment speed was high enough to call it out in terms of what it's been running, but it remains fast. I think that's true for everyone today.

Okay. And just revisiting the comment during prepared remarks that prepaids had remained relatively constant on a quarterly basis, what was different in the loans that prepaid this quarter versus last quarter that drove the increase in fee income?

Most of it was of the unusual prepayments was related to one fairly sizable commercial real estate loan that was restructured during the recession, and it was a sizable prepayment penalty because of a pretty favorable structure that we negotiated to get the loan through the recession. And the property and the borrowers were covered to the extent that they could get a much better rate and they did it. It was a sizable prepayment penalty, you got the economic values of even doing it was larger.

And Jackie, I would just say that that was called out as a primary driver for the Commercial Consumer Bank in terms of servicing income, but overall, it really didn't stand out on a consolidated basis.

Okay. Thank you. That's very helpful. As I'm looking at the NIM and just thinking about it in light of the, I know we had the full quarter impact of the senior notes in there, are we nearing a bottom for that and could we see it go up from here, just as you deploy some of that liquidity into loans and out of held-for-sale and investments?

So we did give guidance in terms of our forward look on NIM between 330 to 335, which at the top end would be pretty stable to where we ended the quarter last quarter. And I would expect for the next quarter or two to remain around that level and then trend down over the course of the year. So there will be some offsetting factors in that.

But by trending down, it's within that range, 330 to 335.

Within that range, exactly.

And the 330 to 335 guidance that you provided, does that assume a remix of earning assets over the quarters?

It does. It assumes (technical difficulty) into loans held for investment.

Okay. And just lastly, if we look at where guidance was for lock volume last quarter versus where it ended the quarter, what changed? What drove the strength that you saw? Was it just pounding the pavement and having a lot better results than you were anticipating? Any change in the environment?

I would say one of the key factors is percent of refi volume in the quarter and the industry in total. So in the second quarter, and I think Mark touched on this, our interest rate lock volume was 35% refi. In the third quarter, that went up to 47%. So of course, that increased our overall production quite a bit.

And we did not anticipate it with giving guidance.

Okay, that makes sense. Thanks, guys. I'll step back now.

Thanks, Jackie.

Tim Coffey, FIG Partners.

Good morning, everybody.

Hello, Tim.

Good morning

Mark, the growth of the commercial portfolio and the deposits that you're bringing in on that side, is that going to have any positive effect on your deposit costs going forward, you think?

Well, that's part of our goals, right? Ultimately, yes. Business customers tend to have higher levels and a higher composition of non-interest-bearing deposits to interest-bearing deposits. It is a significant goal to grow the balance of our C&I business and related deposits. We are getting better at it, but of course, these are still small portfolios relative to the whole. And so we expect that will have a positive impact on our relative deposit cost.

It already is having some benefit and how quickly we can do that is subject to some uncertainty at this point. I think our track record, though, of growth both in the business accounts and notably consumer accounts, through our de novo branching, that track record's very strong. I don't know if you caught the statistic in our prepared remarks that our new branch, or de novo branch, deposits grew almost 40% in the quarter. To me, that's a spectacular number. And a material part of that growth is in non-interest-bearing accounts.

Okay. I did, and that was actually my follow-up. Do you see those de novo branches becoming profitable on a standalone basis fairly soon?

Many of them are. The oldest, if they can call it older, the first de novo branch that we opened post IPO has total deposits in excess of $35 million already. So once you get above, say, $15 million to $20 million, you're above breakeven.

Okay. Great. And then on the DUS sales going forward, obviously you had a very good second quarter, slower sales this last quarter. What are we looking at for, say, 4Q and 1Q?

More in 4Q and less in 1Q. I don't have a solid estimate for you right now, because we're actually negotiating with Fannie Mae as to what we can deliver in the quarter. They have to manage their origination cap pretty closely.

And for that reason, I'm not sure yet what that reasonable range (technical difficulty) of sales, which for our financial results both are important, because that gain on sale, we don't recognize until sale, and that category of loans, because we carry them at lower cost or market as opposed to our single-family mortgage loans held for sale, which we carry at fair value, so we recognize a lot of that revenue at origination. In this case, we recognize most of it on the Fannie Mae commercial real estate loans, ultimately on the loans, upon ultimate sale to the securitization of Fannie.

Thanks. Those are my questions.

Thank you, Tim.

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

Good morning, Mark and Melba.

Hello, Tim.

Good morning.

Mark, I think you probably gave guidance on this, but I was listening but I missed it. Did you give held-for-investment loan growth guidance for 4Q or 4Q,1Q in 2017?

We did, Tim. It hasn't changed. We still --

5% per quarter?

4% to 6%, somewhere in that range. Obviously this last quarter, we were a little lower, approximately 2%, but we still are modeling and believe that we're going to be able to deliver 4% to 6% a quarter loans held-for-investment growth, on average.

And can you give a little bit of either quantitative, qualitative color on your outlook for growth in the construction loan book for coming quarters or 2017, or just thoughts on that, Mark, where you guys stand with that and how much more building there is an opportunity to do there?

Our markets are so strong, as you know, Tim, you're in the Bay area. We just -- I think we hit a new record for cranes in the city of Seattle, at 53 cranes. And the city of Seattle is not that big, as you know. We can see most of those outside our windows. So commercial construction here continues to be very strong and not just in multi-family.

The office market is strong. Office vacancies are about 8% in the city of Seattle today. The multi-family market continues to be very, very strong, despite a lot of deliveries over the last several years. So we will be involved, continue to be involved mostly in multi-family construction on the commercial side in the greater Seattle and Puget Sound area, as well as the greater Portland area. We haven't done much commercial construction, in fact, I'm not sure we've done a project in California, but we're likely to next year.

And in single-family residential construction this year, we will originate, we believe, somewhere in excess of $600 million. It's a very strong year, up almost 100% from the prior year. And those loans are still turning over very, very quickly and not being fully drawn out, as well. So that business we expect to grow next year, as well. If we originate in excess of $600 million this year, that number is (technical difficulty) for next year.

And those loans are across a larger regional market, not just Puget Sound and greater Portland. We also have a very strong business in the greater Boise area, as well as Salt Lake City, which remains one of the busiest homebuilding areas in the United States, and then Southern California and we have a few projects in the Hawaiian Islands again. It's a solid business that has some regional diversity, as well.

And maybe Melba, you might have this, did you guys disclose or can you tell me what your new commitments per construction were in the third quarter?

We did not specifically talk to construction in terms of the commitments, but we could follow up with you on that.

That would be great. And just relative to second quarter. And are you pretty optimistic about fourth order pipeline there, as well?

We are. We are. The appetite for new homes, apartments, office, is so strong here in these areas. Fortunately, we're able to really choose the people we work with and the areas we work, in to the extent that we feel super comfortable with the credit, with the projected absorption of this construction, and it's been a great business for us.

Thanks for the color, guys.

(Operator Instructions)

Bill Dezellem, Tieton Capital Management.

Thank you. That's Tieton Capital. First of all, would you talk about the shift in mix to refis jumping from, I think, 35%-ish to roughly 47% here in the Q3? What do you feel drove that?

It's interest rate driven. If you look at the 10-year Treasury rate during the quarter, you'll see there was a couple of pretty significant rallies, where the rate fell pretty substantially, and it remains at a historically low rate. So despite it being up a little from the lows during the prior quarter, our refinancing volume continues to be above normal for us. And normal for us is about 25% to 30% of our production. There's always someone refinancing in every interest rate environment.

Our environment today is characterized by lower rates and a great deal more equity. If you think about our earlier comments regarding home price appreciation in our markets, many people have created a substantial amount of equity that they're now using for traditional purposes, like debt refinancing, home improvement, automobile purchases, investments. And so we're seeing a little more activity in cash-out refis and not just rate and term refis.

That was helpful, Mark, but what I was really driving at is in past periods where refis have been strong, if I remember right, it's been a smaller percentage of your mix and you've really been able to hold that back down. Now maybe that was capacity constraint and now you didn't have the same degree of constraint. I'm wondering if there are some variables in there that you can't specifically highlight.

Well, it's hard to predict, Bill. Earlier this year, we had a pretty substantial rate rally in January and February, if you remember. And in some of those months, our refinance percentage got as high as 60% to 70%. So the percentage could be much higher. It is seasonally dependent, though, right? The second and third quarters, much higher purchase volume. If we had this same type of refinance volume in the first or fourth quarter, that would make the composition of the refis as a percentage much higher. So it's somewhat dependent upon when it occurs.

It's also dependent upon what we call burnout. When you had low rates for a certain period of time and you've refinance a great deal of the people who would economically benefit with a refi, you'll start to see burnout at ever lower levels of refinancing, despite low rates. We're never quite sure when we're going to hit that. Because despite you being able to look at, let's say, our servicing portfolio and say there's a certain percentage of people who would have an economic benefit, they never all refinance, for a variety of reasons. It may have to do with qualification, them paying attention, a whole bunch of reasons. And so the absolute level of refinancing is awfully hard to predict at any time.

Great. The point's very well taken. And then two additional questions. First of all, will you discuss what appears to be somewhat consistent uptrend in the securities portfolio? And then your consulting fees, although small, do continue to go up, and hopefully you can explain what's going on behind the scenes there, please?

Sure. Specifically with respect to the securities portfolio, Melba discussed earlier our short-term utilization of the capital that we raised, or downstream to the bank from our second quarter bond offering. That utilization will be moved ultimately from the securities portfolio to the loan portfolio, as we utilize that capital for the intended purposes of growing our long-term balance sheet. So we have a slightly higher percentage of assets in securities today than on a normalized basis.

In terms of consulting expenses, we utilize consultants for a lot of different things here. Some of the largest costs today are in helping us implement our new loan origination system in the single-family area, but we have consultants working on a variety of projects here related to mostly infrastructure. They may be systems projects or operations-related projects that we're investing in to grow and improve the infrastructure and risk management as we grow the Company. And these expenses, you'd love to cut them back and avoid them, but given the requirements of growth, they're a necessity right now.

Thank you, Mark.

You bet. Thanks, Bill.

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Mason for any closing remarks.

Again, we appreciate your patience and your great questions today. Obviously, we are pleased with the results this quarter and looking forward to talking to you next quarter. Thank you.

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