Mechanics Bancorp (MCHB) 2016 Q4 法說會逐字稿

Good morning and welcome to the HomeStreet, Inc. fourth quarter earnings update conference call.

(Operator Instructions)

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

Thank you. Hello. And thank you for joining us for our year-end and fourth-quarter 2016 earnings call. Before we begin, I would like to remind you that our earnings release was furnished yesterday to the SEC on form 8-K, and is available on our website in full form 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 is not 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 an interest rates that affect the demand for our mortgages, and that impact our net interest margins and other aspects of our financial performance.

The actions of our regulators, our ability to meet our internal operating targets and forecasts, and economic conditions that affect our net interest margins and businesses. Other factors that may cause actual results to differ from our expectations, or that may cause us to deviate from our current plans are identified in our earnings release and detailed in our SEC filings, including 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 an update on recent events and review our progress in executing our business strategy.

2016 was a year of significant progress toward our strategic goal of becoming a significant West Coast regional bank. While the most recent quarter was challenged for our mortgage banking business, both from the seasonal low point in origination volumes, and the impact of financial market disruptions stemming from the unexpected and sustained increase in interest rates, we are pleased with our full-year mortgage banking segment. And with our consolidated results.

We started the year with total assets of $4.9 billion and 114 branches and lending centers. We ended the year with total assets of $6.2 billion and 141 branches and lending centers. We continued our strategy of organic growth and investing our commercial and consumer banking segment, resulting in greater diversification of portfolio and geography, increasing density and our existing markets, expanding into new markets, and improving operating efficiency.

On February 1 of last year, we completed the acquisition of Orange County Business Bank. This acquisition increased our commercial banking business and gave us access to Orange County, a very important and still growing Southern California market. On August 12 we completed the acquisition of both branches including all loans, deposits, and certain other assets and liabilities of the Bank of Oswego. Located in Lake Oswego, Oregon and a fluid suburb of Portland Oregon.

On November the 10, we completed the acquisition of two retail deposit branches located in Granada Hills, in Burbank California from Boston Private Bank and Trust. These branches were also each located near Kaiser Permanente facilities, one of our affinity partners.

Additionally during the year, we opened a number of De Novo retail deposit branches and lending centers. We opened six retail deposit branches, 13 home loan centers, three commercial lending centers, and a standalone consumer insurance agency office. Four of those retail deposit branches were open in California, near Kaiser Permanente facilities.

Last year, we also began a significant investment in building out our California commercial banking business. We hired a California market president and subsequent to year end, we announced the hiring of market presidents for San Diego and Orange Counties and Silicon Valley. Additionally, we have opened our first Northern California commercial banking office in San Jose, California.

We plan to augment this office with our first retail deposit branch in Northern California during the third quarter of this year. And the future higher credit and lending personnel as we build out our team in this large and growing market. We also positioned ourselves for future growth by diversifying and strengthening our capital base.

In May, we issued senior notes for net proceeds of $63.2 million. And in December, we issued approximately 2 million shares of common stock in an aftermarket offering, netting proceeds of $58.6 million. We were fortunate to be able to issue this stock quickly into unusual market demand fueled by the post-election rotation into banks and financial stocks and the inclusion of HomeStreet into the S&P 600 Index.

Before Melba reviews our financial results I would like to share some highlights from the year. Net income for the year, excluding the acquisition-related items increased 41.6% to $62.8 million, or $44.3 million last year. Total assets grew $1.3 billion, or 27.6% during the year to $6.2 billion. Return on average tangible equity, excluding acquisition related items, was 11.7% for the year versus 9.8% last year. Diluted earnings per share, excluding acquisition related items, increased 2% from $2.11 per share to $2.53 per share. Tangible book value per share increased from $20.16 to $22.33 during the year.

Net income commercial and consumer banking segment, excluding acquisition related items, increased 69% to $35.4 million for the year, compared with $21 million in 2015. Also, the efficiency ratio, excluding acquisition related items, improved from 75% in 2015 to 69% in 2016, reflecting the ongoing operating leverage we are generating with growth and the maturing of our commercial and consumer banking activities.

Loans sold for investment increased $626.3 million, or 19.6% during the year to $3.8 billion. New portfolio loan originations, acquisitions, and advances during the year totaled $2.3 billion. However, net loan growth was somewhat impacted by payoffs and sales of $1.7 billion during the year. The ratio of nonperforming assets to total assets ended December at 0.41%, down from the third quarter's ratio of 0.52% in December 2015 ratio of 0.5%, reflecting continued excellent loan quality. Additionally, our early warning credit indicators are continuing to show strong fundamentals in all of our markets.

Deposits increased $1.2 billion, or 37% during the year to $4.4 billion. And noninterest bearing commercial and consumer deposits grew $167.1 million, or 45% during the year. Our mortgage banking segment net income increased to $27.4 million in 2016, from $23.3 million in 2015. However, the segment reported a net loss of $9.8 million during the fourth quarter, compared with net income of $17.6 million during the third quarter.

The fourth quarter's results were significantly impacted by market changes that adversely impacted our rate lock volume, closed loan volume, and missed risk management results. During the fourth quarter, the financial markets were impacted by dramatic increases in long-term treasury rates, beginning after the presidential election, and an increase in short-term interest rates by the Federal Reserve in December. Higher interest rates drove lower than forecasted mortgage application volume and interest rate lock commitments and a lower level of pipeline fall out, which in turn resulted in a higher than expected volume of closed loans.

Both of these volume changes had a negative impact on earnings. As most of our mortgage origination revenue was earned at interest rate lock commitment, and most of our mortgage origination expense is recognized at closing. The unexpected and sustained increase in interest rates also resulted in asymmetrical changes in valuation between hedging derivatives and servicing valuations. This market dislocation reduced the value of our hedging derivatives to a greater extent than the value of our mortgage servicing rights increased in the quarter, resulting in lower risk management results.

Closed loan volume in our single-family mortgage banking segment totaled $2.5 billion in the fourth quarter, compared to $2.6 billion in the third quarter. Closed loan volume for the year increased 25% to $9.0 billion, compared with $7.2 billion in 2015. Interest rate lock and forward sale commitments of $1.8 billion in the fourth quarter decreased from $2.7 billion in the third quarter. Interest rate lock and forward sale commitments for the year totaled $8.6 billion, compared with $6.9 billion in 2015.

And now I will turn it over to Melba, who will share additional details on our financial results.

Thank you Mark. Good morning everyone.

I would like to first talk about our consolidated results and then provide detail on each of our segments. Net income for the fourth quarter was $2.3 million, or $0.09 per diluted share, compared to $27.7 million or $1.11 per diluted share for the third quarter. The decrease in net income from the prior quarter was primarily due to a $24.8 million decrease in gain a mortgage loan origination and sales. And a $14.5 million decrease in mortgage servicing income. Partially offset by a $1.3 million increase in net interest income. Excluding after-tax acquisition related items, core net income for the fourth quarter was $2.6 million, or $0.10 per diluted share. Compared to $28 million or $1.12 per diluted share in the prior quarter.

Acquisition-related expenses totaled $401,000 for the quarter, primarily due to expenses related to the two branches we acquired from Boston Private completed during the quarter. Net income for 2016 was $58.2 million, or $2.34 per diluted share, compared to $41.3 million, or $1.96 per diluted share for 2015.

The increase year-over-year was primarily due to $70.9 million higher gain on mortgage loan origination and sale activities. $31.7 million higher net interest income and $111.5 million higher mortgage servicing income, partially offset by $62.8 million in higher salaries and related expenses. Excluding after-tax acquisition-related items core net income for 2016 was $62.8 million, or $2.53 per diluted share, compared to $44.3 million, or $2.11 per diluted share for 2015.

Included in non-core items for 2016 was $7.1 million of acquisition-related expenses, compared to $16.6 million of acquisition-related expenses, and a $7.7 million bargain purchase gain for the same period of 2015. Average loans held for investment grew by 29.4% from the year ago period from $2.8 billion to $3.7 billion.

Net interest income was $48.1 million in the fourth quarter, compared to $46.8 million in the third. The increase was primarily due to higher interest income stemming from a change in the mix of our earning assets. Average balances for the quarter reflected a greater mix of higher-yielding commercial and multifamily real estate loans. And home equity loans, and a decrease in lower yielding securities and single-family loans held for sale.

Our net interest margin for the quarter was 3.42%, an increase of 8 basis points from the prior quarter due to asset mix shifts, due to higher-yielding loan types. Increasing our asset yield by 10 basis points, offset somewhat by a 2-basis point increase in deposit costs. The impact of non-interest-bearing sources remained unchanged quarter-over-quarter at 17 basis points.

Noninterest income decreased $38.5 million from the prior quarter, due to primarily to lower gain on loan origination and sale activities. As well as a decrease in mortgage servicing income. Gain on mortgage loan origination and sale activity declined by $24.8 million and mortgage servicing income declined by $14.5 million from the prior quarter. Non-interest expense was $117.5 million in the fourth quarter, compared to $114.4 million in the third quarter.

Excluding acquisition-related expenses, noninterest expense was $117.1 million compared to $113.9 million for the third quarter. An increase of $3.3 million. This increase in core expenses was primarily due to salaries and related costs from incentives attributable to higher commercial real estate loan production volume, as well as higher headcount.

Also included in the fourth quarter, was an accrual four $500,000 non-tax deductible for a settlement announced last week with the FCC. At December 31, the banks' tier one leverage was 10.24% and the total risk-based capital ratio was 14.8%. The consolidated companies' tier one leverage ratio was 9.87% and total risk-based capital ratio was 12.56%.

I'd now like to share some key points from our commercial consumer banking business segment results. The commercial consumer banking segment net income was $12 million in the quarter, compared to $10.1 million in the prior quarter. Excluding after-tax net acquisition-related items, the segment recognized core net income of $12.3 million in the fourth quarter. Compared to $10.5 million in the third quarter.

Growth in core net income was driven by an increase in net interest income, a decline in provision for loan losses, and an increase in non-interest income somewhat offset by an increase in non-interest expenses. Net interest income increased to $40.6 million in the fourth quarter, from $39.3 million in the third, primarily due to the shift in asset mix from lower yielding single-family loans held for investment into higher-yielding multi-family and commercial real estate loans and home equity loans.

Segment non-interest income increased from $9.8 million to $13.1 million during the quarter. This $3.3 million increase was primarily due to a $2.4 million gain on the sale of $143 million of available for sale securities. Repositioning the securities portfolio to lower duration securities and a $2.7 million gain on the sale of approximately $67 million of adjustable-rate single-family loans to accelerate portfolio diversification, offset somewhat by a lower level prepayment fees collected in the fourth quarter versus the third quarter.

Segment non-interest expense was $35.5 million, an increase of $3.3 million from the third quarter. Included in noninterest expense for the third and fourth quarters of 2016 were acquisition-related expenses of $512,000 and $401,000 respectively. Excluding acquisition related expenses from both periods, the $3.4 million increase in expense was primarily due to higher incentive expense, attributable to higher commercial real estate loan production. We recorded a $350,000 net provision for credit losses in the fourth quarter. Compared to a provision of $1.3 million recorded in the third quarter, reflecting a net reduction in non-performing assets and lower specific reserves on impaired loans.

We experienced net charges offs of $319,000 during the quarter. Gross charge offs during the quarter totaled $902,000, primarily from one single-family permanent loan charged-off during the quarter. Recoveries totaled $583,000 during the same period.

The portfolio of loans held for investment gross, increased 1.4% remaining at $3.8 billion in the fourth quarter. Permanent commercial and multifamily real estate loan balances increased by 12.6%. Somewhat offset by reductions in the balance of the single-family mortgages, and mortgage and residential construction loans. New loan commitment total $704 million and originations total $425.5 million during the quarter. Payoff, pay downs and sales increased from $474.9 million in the third quarter to $530.2 million in the fourth quarter, which included the sale of single-family loans previously mentioned.

Credit quality remains strong, with nonperforming assets at 0.41% of total assets at December 31 and nonaccrual loans at 0.53% of total loans. Nonperforming assets were $25.8 million at quarter end, compared to nonperforming assets of $32.4 million at September 30. The decrease was largely due to a decline in single-family commercial real estate, and commercial nonaccrual loans, as well as a decrease in single-family OREO.

Deposit balance for the quarter were $4.4 billion at December 31, down somewhat from $4.5 billion on September 30. A decline in deposits was primarily due to a $162.2 million decline in our other non-interest-bearing balances, offset somewhat by increases in non-interest-bearing checking and savings balances. And net increases in total interest-bearing transaction balances.

Our non-interest-bearing accounts are primarily related to our mortgage servicing portfolio, and will fluctuate seasonally as insurance and property tax payments are due. Total transaction and savings deposits grew $93.1 million, or 3.3% in the quarter, primarily as a result of our acquisition of deposits from Boston Private.

Notably, our de novo branches, those opened since the beginning of 2012, grew deposits by 16.8% during the quarter. Deposits in our acquired retail branches increased 12.6% during the quarter, of which, $106 million of deposits acquired from Boston Private accounted for 83.3% of this quarterly growth.

I would now like to share some key points from our mortgage banking business segment results. The net loss for the mortgage banking segment was $9.8 million in the fourth quarter, compared to net income of $17.6 million in the third quarter. The $27.4 million decrease in net income from the third quarter was primarily due to lower gain on single-family mortgage loan origination and sale activities, due to lower rate lock and forward sale commitments during the quarter. And an elevated level of closed loan volume due to lower pipeline fallout, which resulted in creating a significant imbalance between revenues and expenses.

Additionally, negative risk management results offset somewhat by higher servicing income, contributed to the segments' net loss for the quarter. Gain on single-family mortgage loan origination and sale activities in the fourth quarter was $61.1 million, compared to $88.9 million in the prior quarter.

Single-family mortgage interest rate lock and forward sale commitments totaled $1.8 billion in the fourth quarter. A decrease of $923.7 million, or 34.3% from $2.7 billion in the third quarter. Single-family mortgage closed loans totaled $2.5 billion in the quarter, a decrease of $133.3 million, or 5% from $2.6 billion in the prior quarter.

The gain on sales deposit margin remained unchanged from the prior quarter at 334 basis points. The volume of interest rate lock and forward sale commitments was lower than closed loan designated for sale by 42.4% this quarter, which negatively effects recorded earnings as a majority of mortgage revenue is recognized at interest rate lock, while the majority of origination costs, including commissions are recognized upon closing. If rate lock and forward sale commitments during the quarter would have equaled closed loan volume, it would have resulted in approximately $14.7 million higher net income for the segment. Similarly, closed loan volumes had been the same as interest rate lock and forward sale commitments, net income would have been approximately $6.1 million higher as a result of lower variable costs.

As Mark previously mentioned, the sharp increase in interest rates during the fourth quarter resulted in lower than forecasted interest rate lock commitments, and a higher level of pull through in our pipeline. Which resulted in more closed loan volume than expected. These combined factors contributed to lower revenue and higher expenses than expected in the segment results.

Mortgage banking segment non-interest expense of $82.1 million decreased $172,000 from the third quarter. This decrease was primarily due to lower commissions and incentives due to the decline in closed loan volume. Offset somewhat by the cost of implementing our new loan origination system.

Overall, we grew mortgage banking personnel by 4.8% in the quarter. Closed loans decreased in the quarter to 5.3 loans per loan officer, compared to 5.7 loans per loan officer in the third quarter. Single-family mortgage servicing income was a loss of $984,000 in the fourth quarter, as compared with revenue of $11.8 million in the third quarter.

The quarterly results were comprised of $3.9 million of net servicing income, and $4.9 million of risk management loss. The unexpected and sustained increase in interest rates during the quarter, resulted in asymmetrical changes in valuation between hedging derivatives and servicing valuations.

This market dislocation reduced the value of our hedging derivatives to a greater extent than the value of our mortgage servicing rights increased in the quarter, resulting in lower risk management results. Our portfolio of single-family loan service for others was $19.5 billion at year-end, compared to $18.2 billion at September 30, and the value of our mortgage servicing rates increased to 116 basis points from 82 basis points in the prior quarter.

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

Thank you Melba.

I would like to now discuss the national and regional economies as they influence our business today. First, not withstanding the disappointing results for the fourth quarter, we are proud of our full-year results. And are excited about our prospects for achieving the growth and diversification goals of our strategic plan. We believe that our ability to achieve our goals are unaffected by the events of the fourth quarter and we are optimistic about 2017 and beyond.

We are fortunate to operate in some of those attractive market areas in the United States today. These markets 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 a substantially larger than most of the other markets in the United States, which gives us the opportunity to grow meaningfully, without the necessity of acquiring a significant market share. Together Washington, Oregon, Idaho, and California account for 15% of the United States economy measured by employment, yet these markets are contributing 23% of the increase in jobs through the third quarter of last year.

Over the last five quarters, the year-over-year claiming growth rates for the states have averaged 3.1%. Compared to the 1.9% for the nation as a whole. The most recent Mortgage Bankers Association monthly forecast projects total loan originations to decrease 17.3% this year over last year, but an increase by 1.6% in 2018. The forecasted decline from 2016 to 2017 is driven by a 47% decline in expected refinancing volumes. However, we do not expect the forecasted decline and refinance volume to impact our Business to this degree, as our organization forecast has always been on the purchase market.

The Mortgage Bankers Association forecast that purchase mortgage originations are projected to increase 10.3% this year and 7.8% next year. During the third quarter purchases comprised 49% of originations nationally, and 44% of originations in the Pacific Northwest. HomeStreet continues to perform at levels above the national and regional averages, with purchases accounting for 57% of our closed loans. And 63% of our interest rate lock and forward sale commitments in the quarter.

Despite the increase in long-term interest rates in the fourth quarter, interest rates remain low on an absolute basis. While the 10-year treasury yield is increased since it fell to a record low 1.3% following the Brexit vote, it continues to remain low on an absolute basis at about 2.4%. These low rates should continue to support housing affordability.

Nationally, purchases are expected to comprise 70% of loan volume this 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 not expected to approach the long-term average level of 1.4 million units until the fourth quarter of 2018.

On the commercial side, Seattle's office market absorbed 1.4 million square feet of office space in the third quarter, one of only three markets in the United States to absorb more than 1 million square feet, and office vacancy ended the third quarter at 9.4%, the first time it was below 10% since the recession. There was a 4.7 million square feet of single-family and multifamily or multitenant space under construction in the Seattle area, placing it fifth in the nation today.

Portland absorbed over 115,000 square feet of office space in the fourth quarter and asking rents averaged $25.88 per square foot, up from $24.41 in the prior quarter and $23.49 in the year ago period. Vacancy ended the quarter at 10.3% compared to 10.2% in the year ago period.

Stable vacancy and increasing rents are supporting robust construction, with 1.1 million square feet of office space currently under construction there. In Los Angeles, almost 512,000 square feet of positive net absorption in the fourth quarter marked the 14th straight quarter of net occupancy gains.

Vacancy fell to 13.6%, compared to 14.4% in the year ago period. The construction pipeline is at 2.3 million square feet, up from 2.2 million in the prior quarter. Average asking rents in the fourth quarter were $37.20 per square foot, unchanged from the prior quarter, but higher than the $36.02 per square foot ask for the year ago period.

Looking forward to the next two quarters in our mortgage banking segment, we currently anticipate single-family mortgage lock and full sale commitment volume of $1.8 billion in the first quarter, and $2.8 billion in the second quarter of this year. We anticipate mortgage held for sale closing volumes of $1.9 billion and $2.7 billion during the same periods respectively. We are in 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.

For the full year 2017, we anticipate single-family mortgage loan lock and forward sale commitments to total $9.3 billion and loan closing volume to total $9.4 billion. These volumes will be subject to the typical seasonality we experience. Generally lower volumes in the first and fourth quarters of the year and higher volumes in the second and third quarters. Volumes will also be highly dependent on inventory levels in the housing markets in which we do business. Local economic conditions affecting unemployment growth and wages, as well as prevailing interest rates.

Additionally, we expect our margin composite profit margin to come back down to a range between 315 and 325 basis points over the next two quarters and stay within that range without the year. We expect the increased trig-related cost we have been experiencing last year to continue through the next several quarters until we complete the installation of the new loan origination system later this year.

In our commercial and consumer banking segment, we expect average quarterly net loan portfolio growth to approximate 4% to 6% during this year. Reflecting the increase in interest rates and the steepening of the yield curve, and absent changes in market rates and loan prepayment speeds, we expect our consolidated net interest margin to trend between 3.20% and 3.25% during the next two quarters, as we temporarily invest the proceeds of our common stock offering and lower yielding securities. We expect that our net interest margin will increase to between 3.35% and 3.40% in the second half of 2017 as higher-yielding loans are originated.

During 2017, our noninterest expenses are expected to grow on average 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. Thank you for your attention today. Melba and I would be happy to answer any questions you have at this time.

(Operator Instructions)

Jeff Rulis, D.A. Davidson & Co.

Question on the single-family mortgages that are held in portfolio. It looks like those balances were down 10% in 2016. Any expectation for a similar drop in 2017?

Part of the reason for the drop in this year was the sale of single-family mortgages of approximately $70 million in the fourth quarter. That had an impact on balances. I would expect by composition to continue to see that portion of the held for investment portfolio comprised of single-family mortgages to drop as a percentage of the portfolio but continue to grow generally.

Got it. Did you have sales in Q2 and Q3 as you had a declining balance there as well?

No, I think that is the height of the prepayment. Double that we had during the year.

Okay. A couple of housekeeping items. Maybe from Melba. One, the tax rate expectation for 2017 and two, the SEC fine, that $500,000, was that in the general and administrative line item?

Yes it was. The second question I will take first, the $500,000 was in G&A. And in terms of our tax rate expectation for 2017, I don't want to be too precise, but I would say around 34.5%. Somewhere between 34% and 35%.

Okay. And maybe one last one on overall credit quality. A good trend in the NPA number a little lighter net growth on the loan side. First on credit, some overall comments about trends you think you will see in 2017 and how you expect the provision for that?

Obviously, like many of us, we have been enjoying an excellent credit environment. And we remain pretty cautious underwriters. Trying to stay in the middle of the market. And generally competing on price and not credit. So, we are expecting going forward, to continue to enjoy solid credit.

Having said that, because of our expected growth in our loans held for investment portfolio, I would expect provisioning to follow that growth at approximately the same coverage levels that we run at today. I am talking about our coverage on non-purchased loans. Which I believe is around 108 basis points roughly. We can get that number to you later, Jeff. If you look at portfolio growth or organic growth expectations, and consider we are going to have to provide up front 100 basis points or so, that should generally reflect our provisioning going forward.

The only thing I would add to that is as you can see from our results for the full year, we did enjoy a net recovery over the course of the year. I wouldn't anticipate that we would have that same level going into this year.

Okay thank you.

Jackie Boland, Keefe, Bruyette & Woods

Good morning.

Hello.

Melba just to clarify I mentioned that the settlement was in G&A. But was that captured in the commercial banking segment?

Yes it would have been.

Okay, thank you. And then also to clarify Mark, with the no change to the outlook in terms of close and [loss] volumes versus what you had discussed on the third quarter's call, just so I understand it correctly. That is because as you look out and look forward, you are not forecasting a high level of refis, you are just looking to the purchase market?

That is correct. When we were forecasting last year, even before the run-up in rates, we were expecting a rate rise and an end to the refinancing volume we were experiencing at the time. So our total number next year has not changed on either locks or closings. We changed somewhat the seasonality numbers. So I think we are a little lower in the first quarter than our prior guidance by maybe $100 million. But we think we will make that up in the middle of the year.

Okay, that is helpful. And then sorry it went out of my head. I'm going to get back in the queue. Sorry about that.

Thanks, Jackie.

Paul Miller, FBR Capital Markets

On the M&A front, I know you've done a great job on building out the California franchise. And I'm just wondering given that the new, with Trump winning and better valuations are you seeing more people talking to you? And what geographies are you really focusing on? Are you continuing to focus on the California markets? And are you looking at picking up mortgage companies are just retail banks?

Thanks Paul. It's hard to say what the impact of higher valuations of public banks is going to do for total M&A activity. I think that, you know, we've been at this for a while. And, as we get farther away from the recessions, those smaller institutions, which have not been able to generate sizable returns, cover the cost of capital, and or have aging management teams continue to consider transactions and partnership. I think that to the extent that we're another year in, and there is the prospect, and I will say the prospect of better valuations. I think that we already have and we are going to see more transactions this year. Until they are contracted for and closed though, they just remain possibilities.

In terms of locations, we continue to focus on California currently. We are always interested in the Pacific Northwest and the markets that we are in. Puget Sound, Portland and the larger greater markets. We also have considered transactions in Phoenix, Salt Lake City, and in Colorado. And if we find the right transaction in any of these areas we would.

With respect to commercial banking and mortgage. Because of our long-term goal of reducing the concentration of mortgage banking income in the company's income, not that we've backed away from organic growth, but that's much slower than making acquisitions. We do not expect to make any acquisitions in the mortgage banking area.

Okay. Employment. You guys have been averaging roughly adding about 100 people a quarter. I think some of that is factored in with some of the acquisitions that you made, and some of that is organic. I believe some of that is on the commercial bank and some on the retail mortgage bank. Can you give us your philosophy on hiring people? And should that start to flatten out at this point or should we continue to expect greater employment?

On the growth side we tend to be opportunistic. Right. So if you think about branch acquisitions. Like we acquired two branches in the fourth quarter from Boston Private, opportunistic opportunity. In terms of mortgage banking production growth, also opportunistic. When we find teams of high-quality originators in new markets we hire them en masse as a team. They come up when they come up.

Infill for expansion in existing markets in the mortgage business we are continuously in the market for personnel. But we also have attrition that offsets that. So, most of our growth comes from new teams on the mortgage banking side.

We also are having to grow our infrastructure. And as we grow toward the $10 billion asset level absent a change in the DFAST requirements, we are building infrastructure and it is a simple ratio exercise. In some of the support departments like human resources, IT, and some of the other service departments, we have to simply grow personnel as we grow total personnel to support the growth. So, you will see lumpiness in that growth of personnel. But it's somewhat dependent on our opportunities for growth in the business segments.

Looking at trying to model out the expense base. Especially the salaries and related costs, and I get it that you want to open up more retail branches in a purchase market and things like that. But should be looking at your expense base? I mean what kind of growth would you put on the expense base? Especially salaries and overall expenses as you open up new branches?

It depends on the branch. A retail deposit branch requires about 4.5 FTE each. Mortgage production branches can vary from one or two people in a satellite office to as many as 20 or 25 or more originators and operations personnel in a large mortgage branch. Infrastructure people, they sort of move up in ratio with our business. And I don't have a ratio for you there. But we can try to develop one as we think about it.

The important part about expense growth, is it should always be substantially less than revenue growth. And our business plan on earnings growth on the non-mortgage side in our commercial consumer business largely involves operating leverage. And continuing to improve our efficiency ratio through growth of revenues exceeding growth in expenses.

Your expenses came in right around $117 million. Should we be maintaining that throughout? Or what type of growth should we put on that number?

So for the quarter, I think expense growth in total was about 2.7%. And our forward guidance, and again while as Mark mentioned it will be lumpy, we look at it as averaging around 2% per quarter.

Okay, that helps, guys. Thank you very much.

Thanks, Paul.

Tim Coffey, FIG Partners

Thank you good morning Mark, and good morning Melba.

Morning.

Mark I want to circle back on your expectations for the mortgage business in 2017. Relative to the guidance from last quarter, what gives you more confidence that we will see a more robust mortgage market in the second half of the year?

Well, in part you have the annual home buying season, and that is year end year out consistent. That we have substantially higher levels of purchase volume in the second quarter and the third quarter, falling in the fourth and first quarters. We have no reason to believe that pattern is going to be different this year.

The biggest challenge, frankly, in our markets is not demand, it is inventory. Seattle, in December, was noted as the most impacted market in the United States in terms of demand versus supply. Fortunately, we do not normally operate in Seattle. There is so much economic activity, wage growth, home price appreciation in the West that home inventories are low. So, my only caveat to our forecast of volume is, it could be impacted by inventory levels.

Having said that, we believe home turnover is poised to begin improving again. Post recession we have been running about 5% a year. Some quarters 7%. Existing home resale versus the long-term average of 10% a year. Recovery in that number alone would support and improve our numbers. So, I think we are confident that the home buying season is going to come and go again this year. The outstanding question is going to be inventory levels.

Okay. And did you change your expectations for producers at all since last quarter?

No. Remember our focus when hiring producers is to hire producers with a track record of focusing on the purchase market. While we always have some attrition on producers that don't continue their track record and trend before we hire them, the lion's share of our producers are purchase focused and people we will be hiring this year will be similarly purchase focused. And so we are confident they will do as well as the market will allow.

Okay. Thank you those are my questions.

Thanks.

Tim O'Brien, Sandler, O'Neill & Partners

Good morning.

Good morning.

Mark you gave the updated MBA guidance down 17% for 2017, was that correct?

In total, yes.

So for the full country. Did you also give regional for Pac Northwest? Did they break that out or do you have any indication of overall production for the Pac Northwest for 2017?

Unfortunately we have begged the MBA for that for several years and they do not provide a regional forecast. They will provide monthly regional actual closings. Right. If you need to track that during the year. But they don't give a regional forecast. It is our expectation that regionally our markets will do better on the first and second. Tempered somewhat by my prior comments about inventory.

Do you happen to also track new houses brought to market and do you have a ballpark number of number of new houses that were brought to market in 2016? And can you give us an estimate of the number of houses that are under construction, being built that should come to market in 2017? So in other words is production volume picking up in the Pac Northwest? Are people getting their entitlements in place and is the pipeline getting built for new product to come onto the market that will support your purchase business.

Yes. In my comments, when you check the transcript, you'll see I cited that housing starts nationally are expected to be up 8.5% this year. And I think the Pacific Northwest will be higher. Housing starts in our various markets -- bear with me and I will give you a number. I have permits. Which have been running in Washington State in 2015 at about the 38,000 permits a quarter level. In 2016 that was probably up to around 40,000 per quarter. Peaking in the second quarter at 44,000. And in California permits are running about 100,000 a quarter. With a low of about 97,000 in second quarter of last year.

The forecast in Washington is that total housing permits will grow from 40,000 in total for the state in 2016. Stable this year on starts growing in 2018 to 41,000. And I'm sorry I don't have California numbers.

That is per quarter you said 40,000 per quarter.

Yes and I'm sorry I do have the California forecast on housing permits.

It's okay. I do not need the California. I am more curious about Pac Northwest.

Okay.

It is where the rubber meets the road. So I got Pac North. That is good color on that. But we will see flat to increased permits and it starts and such so that's a positive for you guys.

And then one other question I have for you. Is the two hires that you announced in California these market presidents, can you give a little bit of color or background on the kind of commercial banking business that they did? Who they led? How big the portfolios of the groups were that they had? And just give some color on why these guys came aboard and what you think they can do here? I guess the timing and impact on C&I.

Sure. These gentlemen came with backgrounds of institutions like Comerica, Union Bank, City National Bank. They have led teams at the local level 5 to 25 or more originators by office. Their focus has been the middle-market. And in Northern California in part agricultural and technology as well. So, they have experience not only in our middle-market business market but in some of the areas of concentration, as an example, in the Northern California market. And they have a long track records of successfully building teams and portfolios.

Thank you for answering my questions.

Thanks, Tim.

Jackie Boland, Keefe, Bruyette & Woods

Sorry about that earlier. I just wanted to get a little bit of clarity on the ARM sale that occurred in the quarter. Was that captured in the commercial banking activity line item? Under origination and sales.

Yes.

Do you have an estimate on where you can see that going in 2017?

That sale is the fourth quarter was certainly one off sale. We were working with Freddie Mac on some interest they had in a certain type of loan. It helped us a little accelerate the changing composition of the portfolio. And given the challenges of the quarter, it seemed like a good time to execute on [some people] accomplish more on those objectives. But that is not a day in and day out goal for us to sell out of the portfolio.

Maybe just some added color on your expectations for small balance CRE sales and the Fannie Mae DUS product?

We have had a fantastic Fannie Mae DUS year last year. And fortunately or unfortunately some of that carried over into the fourth quarter. I guess fortunate for the fourth quarter. I believe we closed about $375 million of Fannie Mae DUS originations. One of my people may correct me. I'm sorry, $325 million this year. Which is a high for the Company. We were hoping for $400 million but we carried over some of that to next year.

We are hoping to do as well or better this next year. As you know, Fannie Mae multi family program is a very good program. From time to time they are out of the market on pricing. That is more so on the larger loans. We are trying to concentrate on smaller loans in our markets. So we're hoping for a similar or better year next year.

In terms of sales of small balance commercial real estate loans, I believe we are hoping to originate and sell a little over $200 million of that product this year. That is going to be subject to a lot of uncertainty in the secondary market there. As we try to understand buyers' appetite for additional levels of commercial real estate in this environment.

How does that $200 million compare to what was sold this year?

This year we sold, do you have the number? 100 and?

I am not sure of the exact (Inaudible) the other sold this year was $157 million that is not all [HBC]. It's also SBA and.

It is over $100 million but we'll have you back to you on the exact number.

So basically normalized for the one off sale of the ARM portfolio. But then expect growth in the CRE sales depending on market conditions and then potentially as well or better in the Fannie Mae DUS is that a good way to characterize it?

Fair enough.

Yes Jackie, I would just add in terms of you are looking at the noninterest income trend line for the commercial consumer banking segment. Recall last quarter we had a high level of prepayment related to one loan in that quarter that was about $1.7 million. It benefited that quarter.

Prepayment fees.

Prepayment fee and this quarter both the single-family gain on sale that we discussed as well as the AFS sale would be represented in that number. So adjusting for those two and then in anticipation of increased sales over the course of each quarter this year, I think you can start to see a trend.

Okay, that's very helpful, thank you.

Thank you.

(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.

Thank you everyone who joined us on the call today. We appreciate your patience and taking the time to dial in and ask questions. Looking forward to talking to you next quarter.

This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.