Mechanics Bancorp (MCHB) 2018 Q1 法說會逐字稿

Good morning, and welcome to the HomeStreet, Inc. First Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mark Mason, CEO. Please go ahead.

Hello, and thank you for joining us for our first quarter 2018 earnings call.

Before we begin, I'd like to remind you that our detailed earnings release was furnished yesterday to the SEC on Form 8-K and is available on our website at ir.homestreet.com under the News and Market Data link.

In addition, a recording and a transcript will be available at the same address following the call.

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 than those we currently anticipate. Those factors include conditions affecting the mortgage markets such as changes in interest rates and housing supply that affect the demand for our mortgages and the impact on net interest margin and other aspects of our financial performance; the actions, findings or requirements of our regulators; and general economic conditions that affect our net interest margins, borrower credit performance, loan origination volumes and the value of mortgage servicing rights.

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 detailed earnings release and in our SEC filings, including our most recent annual report on Form 10-K as well as our various other SEC filings.

Additionally, information on any non-GAAP financial measures referenced in today's call, including the reconciliation of those measures to GAAP measures, may be found in our SEC filings and in the detailed earnings release available on our website.

Please refer to our detailed earnings release for more discussion of our financial condition and results of operations.

I would like to inform you that the company, its directors and certain of its executive officers are participants in the solicitation of proxies from the company's shareholders in connection with the company's 2018 Annual Meeting of Shareholders.

The company filed and mailed a definitive proxy statement and proxy card with the SEC in connection with its solicitation of proxies for the 2018 annual meeting. Shareholders of the company are strongly encouraged to read the proxy statement, the accompanying proxy card and all other documents filed with the SEC carefully and in their entirety as they contain important information.

Information regarding the identity of the company's participants and their direct or indirect interest by security holdings or otherwise is set forth in the proxy statement and other materials filed by the company with the SEC, which can be found for free in the company's website, www.homestreet.com in the section Investor Relations or through the SEC's website at www.sec.gov.

We will not take questions regarding or comment on the proxy contest with Blue Lion Capital on this call.

Joining me today is our Chief Financial Officer, Mark Ruh. In just a moment, Mark will present our financial results. But first, I'd like to give an update on our results of operations and review our progress in executing our business strategy.

In the first quarter of 2018, we met many challenges. The limited supply of new and resale housing has become acute. It is now become a nationwide phenomenon with many markets experiencing the lowest historical levels of new and resale housing ever observed. The yield curve is flat and considerably to near historic lows. We have experienced higher levels of negative convexity in our servicing portfolio. And the debt capital markets experienced periods of extreme volatility during the quarter.

Additionally, lower industry loan volumes substantially increased price competition in the quarter. These challenges meaningfully reduced our profit margins, mortgage loan volume and mortgage servicing income in the first quarter, making the quarter that already reflects seasonally low volume more difficult and driving an operating loss from our Mortgage Banking segment in the quarter despite significant restructuring and cost reductions last year.

Nevertheless, we made substantial progress toward our growth and diversification goals. In the first quarter, loans held for investment increased 6%. This growth was broad based with meaningful increases in all of our lines of business.

Additionally, credit quality continued to improve in the first quarter with the ratio of nonperforming assets to total assets falling to just 16 basis points, down from the fourth quarter's level of 23 basis points, representing our lowest absolute and relative levels of problem assets since 2006.

Our early warning credit indicators continue to reflect strong fundamentals in all of our markets, which is not surprising given we do business with some of the strongest markets in the United States today. Job creation, unemployment, commercial and residential development activity and absorption, vacancies, cap rates and all other leading indicators of economic activity reflect strong growing economies in our primary markets.

Recently, we have observed slowing multi-family rental rate increases and slower new project absorption in the Seattle area. We believe these observations generally relate to the significant levels of new construction and that these projects will be absorbed in the normal course.

HomeStreet's deposit growth was also strong during the quarter, increasing also by 6%. Business deposits increased by 4.3%. Deposits in our acquired branches increased by 4% and deposits in our de novo branches, those opened within the past 5 years, increased 9% in the quarter.

To support our growth, during the first quarter, we opened 3 de novo retail deposit branches in Puget Sound: in the Lake City area of Seattle; in Mill Creek, the northern suburb of Seattle; and in Gig Harbor, which is near Tacoma.

Commercial real estate loan sales decreased during the quarter, reflecting the seasonality of this business as well as a large number of commercial real estate loan originations closing late in the quarter. We expect commercial real estate loan sale to increase in the latter half of the year.

The Commercial and Consumer Banking segment finished the quarter with an efficiency ratio of 73%, consistent with prior years. We expect the efficiency ratio in this segment to improve as the year progresses, averaging under 70% of -- for the year with the second half of the year lower than 65%.

Our Mortgage Banking segment has been an important part of HomeStreet's success, and we expect Mortgage Banking will continue to be a contributor to our success going forward as we work through this challenging part of the mortgage cycle.

In response to these ongoing challenges in our Mortgage Banking segment and our reduced expectations for growth, we took additional steps in April to improve our cost structure and efficiency. These actions include reducing headcount and nonpersonnel-related expenses in the Commercial and Consumer and the Mortgage Banking business units as well as corporate support functions. These reductions were tailored to reduce costs meaningfully while maintaining safe and sound risk management and the ability to meet our goals. The reduction included 86 full-time equivalent employees, which together with the nonpersonnel-related costs cuts, will result in an annualized reduction of our planned pre-noninterest expense of $12.4 million.

We appreciate the service of those employees affected by these efforts and believe that the actions that we've taken will be sufficient to address our current challenges. We are, however, continuing to work on additional ways to improve our cost structure and efficiency.

And now, I'll turn it over to Mark who will show the details of our financial results.

Thank you, Mark. Good morning, everyone, and thank you again for joining us. I'll first talk about our consolidated results and then provide detail on our 2 operating segments.

Regarding our consolidated results. Net income for the first quarter was $5.9 million or $0.22 per diluted share compared to $34.9 million or $1.29 per diluted share for the fourth quarter of '17. Included in net income for the fourth quarter of '17 was a $23.3 million tax benefit resulting from the lowering of the corporate tax rate to 21% with the signing of the Tax Cuts and Jobs Act. Included in net income for the first quarter was $230,000 of recoveries related to our 2017 restructuring plan and $39,000 of acquisition-related recoveries, both net of tax.

Excluding the impact of tax reform, restructuring charges and acquisition-related expenses, core net income for the first quarter was $5.6 million or $0.21 per diluted share compared to core net income of $11.5 million or $0.42 per diluted share for the fourth quarter of '17. The decrease in core net income from the prior quarter was primarily due to lower noninterest income, largely from lower net gain on loan origination sale activities in both our Mortgage Banking segment and our Commercial and Consumer Banking segment and lower mortgage servicing income, but somewhat offset by lower noninterest expenses.

Net interest income decreased by $2.6 million to $48.5 million in the first quarter from $51.1 million in the fourth quarter of '17. This decrease in net interest income is primarily due to the lower balance of loans held for sale and a higher cost of funds.

Our first quarter net interest margin of 3.25% decreased 8 basis points from 3.33% in the fourth quarter of '17. The decrease in net interest margin is primarily due to an increase in the cost of interest-bearing liabilities, [specifically the cost of Federal Home Loan Bank advances, which increased as the fed funds rate increased by the Federal Reserve in March of this year.]

Noninterest expense, excluding the impact of restructuring and acquisition-related expenses, decreased to $101.1 million in the first quarter from $107 million in the fourth quarter of '17. This decrease in noninterest expense was primarily from lower commission costs on lower closed single-family mortgage loan volume and lower general and administrative expenses.

Our effective tax rate was 24.5% in the first quarter and differs from our expected 21% to 22% tax rate range, primarily due to the impact of a [discrete] item related to prior period state tax net operating losses.

I'll now discuss some key points regarding our Commercial and Consumer Banking segment results. Commercial and Consumer Banking segment core net income was $10.2 million in the first quarter compared to core net income of $13.6 million in the fourth quarter of '17.

Net interest income decreased $429,000 in the fourth quarter of '17 to $45.4 million, primarily due to our cost of funds increasing at a greater rate than our asset yield.

The flatness of the yield curve is impacting our net interest income despite our strong loan growth.

The portfolio of loans held for investment increased 6% to $4.8 million in the first quarter.

Net loan growth was $250.9 million during the first quarter compared to $190.8 million in the fourth quarter of '17.

Segment noninterest income decreased quarter-to-quarter to $7.1 million from $12.7 million. This decrease was primarily due to lower net gain on loan sales, generally the result of seasonally lower commercial real estate [and longer origination sales activities].

Segment core noninterest expense was $38.3 million, a decrease of $323,000 from the fourth quarter of '17. This decrease is primarily due to a variety of general and administrative expense cost reductions, including marketing, employee firing and loan processing expenses.

Nonperforming assets declined to $11.2 million or 16 basis points of assets at March 31 compared to nonperforming assets of $15.7 million or 23 basis points of assets at December 31. This decrease was primarily a result of a $4.2 million reduction in nonaccrual loans related to the improved performance of loans to 1 single-family residential investor.

We recorded a $750,000 provision for credit losses in the first quarter compared to no provision in the fourth quarter. This increase in provision expense was primarily due to net portfolio growth, somewhat offset by $580,000 of net recoveries during the first quarter.

Deposit balances were $5 billion on March 31, an increase of $288 million from December 31 driven primarily by over 4% increase in both business and retail deposit accounts.

Deposits in our de novo branches or those opened within the past 5 years increased 9% during the quarter.

I'll now share some key points from our Mortgage Banking segment results. The Mortgage Banking segment's core net loss in the first quarter was $4.6 million compared to core net loss of $2.1 million in the fourth quarter.

This decrease in core earnings was due to lower gain on loan origination and sale activities and lower loan servicing income, partially offset by lower commissions and related origination costs.

Our decreased loan origination sale activity revenue was primarily due to the intense competitive pressures on composite margins.

Our gain on mortgage loan origination sale deposit margin decreased 25 basis points to 304 basis points in the first quarter from 329 basis points in the fourth quarter. The decline in deposits -- profit margin was primarily due to competitive pressures, but was also impacted by changes in the mix of purchased versus refinanced mortgages, government versus agency mortgages and the proportion of loan source to our affiliate, [WMN].

The volume of interest rate lock and forward sale commitments at $1.6 billion was higher than closed loans designated for sale by 8% this quarter. Note that single-family interest late lock being greater than closing in a given quarter positively affects Mortgage Banking segment earnings as the majority of mortgage revenue is recognized at interest rate lock while majority of origination costs, including commissions, are recognized upon closing.

Single-family mortgage servicing income was $6.7 million in the first quarter, a decrease from $8.4 million in the fourth quarter. This decrease was primarily due to lower risk management results, partially offset by higher servicing fees.

The flattening yield curve and increased negative convexity in our mortgage servicing portfolio have substantially reduced risk management results.

Mortgage Banking segment core noninterest expense of $62.8 million decreased $5.6 million from the fourth quarter of '17, primarily due to the reduction in closed loan volume.

The restructuring steps we took in the fall of 2017 and the implementation of our new loan origination system had resulted in lower direct origination expenses and more efficient processes, particularly for clients with requirements of TILA-RESPA Integrated Disclosure regulation.

Our portfolio of single-family loan serviced for others increased to $23.2 billion of unpaid principal balances at March 31 compared to $22.6 billion at December 31.

The value of our mortgage servicing rights relative to the balances of loan serviced for others was 127 basis points at quarter-end, an increase of 13 basis points compared to the prior quarter-end.

I will now turn back over to Mark Mason to provide some additional insight about HomeStreet's outlook for the future.

Thank you, Mark.

Looking forward to the next 2 quarters. In our Mortgage Banking segment, we currently anticipate single-family mortgage lock and forward sale commitment volume of $1.8 billion and $1.9 billion in the second and third quarters of this year, respectively.

We anticipate mortgage held for sale closing volumes of $1.9 billion for both the second and third quarters.

For the full year of 2018, we now anticipate single-family mortgage loan lock and forward sale commitments to total $6.7 billion and loan closing volume to total $6.9 billion.

Additionally, we expect our mortgage composite profit margin to decline to a range of between 305 and 315 basis points during 2018. The decrease in our composite profit margin guidance reflects lower government and purchase mortgage originations as well as the current competitive environment. All of these issues have a potential to change positively in the near term. For example, as recently as January of this year, our composite profit margin was substantially higher than the average for the quarter.

These mortgage loan volume and composite margin guidance estimates assume the continuance of current challenges of low new and resale home inventory and competitive pressure on profit margins. We do expect the seasonal increase in volume during the midyear home buying season, but at lower levels than previously anticipated.

In our Commercial and Consumer Banking segment, we anticipate higher levels of commercial real estate loan sales during the remainder of the year, which will impact our average quarterly net loan growth. We continue to expect our 2018 quarterly loan portfolio growth to average between 2% and 4% for the remainder of the year.

Reflecting the continued flattening of the yield curve and absent changes in the market rates and loan prepayment speeds, we expect our consolidated net interest margin to increase in the second quarter to a range of 3.25% to 3.35% and continue up to range of 3.35% to 3.45% by the fourth quarter.

During the second quarter, we expect our total noninterest expense to increase given the seasonally higher closed mortgage loan expectations. However, noninterest expenses in our Commercial and Consumer Banking segment are expected to increase between 2% and 3% over the remainder of this year.

Notwithstanding the increase in noninterest expense in the Commercial and Consumer Banking segment, we expect segment revenues to grow at more than twice the rate of this expense growth.

For the remainder of 2018, we expect total noninterest expenses to grow between 1% and 2%. The growth rate of our total noninterest expenses will vary somewhat quarter-over-quarter, driven by seasonality and cyclicality in our closed mortgage loan volume.

This concludes our prepared comments. Thank you for your attention today. Mark and I would be happy to answer any questions you have at this time.

(Operator Instructions) The first question today comes from Jeff Rulis with D.A. Davidson.

Just a couple of questions on the headcount reduction. Are those 86 employees, have they been let go as of today -- I mean, is that a Q2 event?

All of those reductions are in April, yes.

Okay. With -- and so the mortgage quarter-end employee count of 1,307 does not reflect -- those additional 37 have been subsequent to quarter-end, is that correct?

That's correct.

Okay. And I guess within the expense save, is there any, I guess, severance offset to that? And I guess, if there were, any portion of layoffs that were sort of self-selecting in that process?

We have had attrition in both of our business segments that reduced the need for a reduction in force and that's more true in the Mortgage segment. Unfortunately, that also includes some significant loan originators due to competitive recruiting pressure. Though the numbers that we cite in the expense reduction details are all affirmative reductions at headcount.

Okay. And maybe I was a little unclear. The -- is there any severance offset? Is there an increase in expense? Or is that $12.4 million a net number?

The $12.4 million is...

Is an annual run rate. There is going to be a severance expense in the second quarter. It's going to be quite small, it's only almost $400,000.

What was that number?

About $400,000. It'll be a small number.

Okay, got it. And would anticipate the annualized number, I guess, to hit the run rate in -- granted we got your guidance on the seasonal increase in expenses, but that would take effect in 2Q.

That's right, with respect to Mortgage origination commissions primarily.

Okay. And then maybe last one on the expense front here. Is that all comp line then? I mean, can we back into the [pure] employee, I guess, comp line? Or is there other cost saves outside of the compensation line that is associated with that $12.4 million?

Yes, good question, Jeff. That is actually the $12.4 million annualized breakdown is $9.1 million of that is salaries-related employment costs and then other expenses are $3.3 million.

And the other would just be support or facilities of...

It's a potpourri of all sorts of different things, various operating expenses. It's going to be consultants, temps, other odds and ends that all add up to $3.3 million. We'd like to give you a breakdown further if you want to contact us later, but I don't have the specific detail right here.

That's high level enough, I appreciate it. Then maybe just one last one for Mark Ruh. The tax rate then -- so the 1 quarter -- was that a 1-quarter thing? Or is the new guidance on tax rate going forward at 24.5% or are we back down to that 21% to 22%?

We're looking like we're going to be in the range. That was a onetime event.

Of 21% to 22%.

21 to 22%, which is what we typically guided to, yes. So that was a onetime event that bumped us up to 24%.

The next question comes from Tim O'Brien with Sandler O'Neill.

Question for Mark Ruh. Mark, can you give a little bit of color on -- there was a mix change on the liability front. I know that the cost of interest-bearing liabilities was up 10 basis point, but there was some neutralization by noncosting liabilities, at least my take from the rate and yield table. Can you talk a little bit about that, what the outlook there specifically is on the funding side going forward for, I don't know, pricing pressure in the marketplace and what that might mean for your cost of funds?

Well, again, if I take a look here at the yields table, I think you're on Page 8 of our release here, again you can see the deposit-bearing liabilities increased 10 basis points. As you can see, we continued to have pretty significant pressure from Federal Home Loan Bank, big chunk from last quarter to this quarter, 138 basis points to 170 basis points. So we're working to deemphasize the use of the Federal Home Loan Bank. We accepted that basically using repos in this current quarter ended the quarter around $25 million balance in repos. I mean, outlook, again, I guess, my guess is as good as anybody's on how fast the yield curve is going to steepen and how fast rates are going to increase. But again, where I think we're positive is that, again, still we see a relatively low beta compared to peers in our deposit rates so -- but we have a pretty good handle on that, again you can see there what has been really kind of what's been getting us again and we called out this event, Federal Home Loan Bank advances.

And then the cost savings through year and the $12.4 million, that's very helpful information. Is that pretty much -- are we at a point here where strategic changes and adjustments that are -- have been determined to be made by the board and management -- is that what we're going to run with? Or is there something more that you guys have planning or in the works here that could continue to affect the mortgage unit here going forward? Are we -- are we in a state of a dynamic change here or are we -- have we reached a static point where the changes that have been made should get you through the end of the year the way that -- in the best way possible for shareholders.

I don't think that we believe we are finished with opportunities to improve the cost structure of the Mortgage unit. We've taken actions we believe we could take immediately and maintain the risk management and origination capacity necessary for the current environment. We continue to review opportunities to emphasize real estate of certain offices, potentially consolidate others and so I'd say that it's a dynamic environment.

That makes sense. It sounds like you'll be opportunistic. And then the last question is can you remind me, and I know I can get it out of a table, but the net production number for the quarter for held for investment loans was in the $200 million range. I know I've got it in my notes, I just don't spot it.

The additions for the quarter should be in the table, though we have a...

Yes, sorry about -- you guys gave that and it's here. I was going to use that as the basis for a question. I guess my question is this: of that, how much was originated by HomeStreet bankers in-house and were there any purchases to that? Because there is a line item in, I guess, the production table that suggested that some of that could have been purchased?

Yes. It's -- unfortunately, it's kind of buried, right? If you look at the earnings release on Page 13, there's a roll forward of the portfolio. There was a line item that includes both purchases and advances, right? So the advances on existing ...

Yes. Yes, that was it, that's what I spotted.

The lion's share of that is advances on existing commitments. That also embodies purchases, as an example, from our affiliate Windermere Mortgage Services. The portfolio loans that they originate for us appears purchases. I don't have that number in front of us, but it's been running about $50 million a quarter roughly.

Great color, and maybe just to...

So that'll be only purchases.

So maybe just to -- maybe you can break those out going forward at some point, so we see the purchase versus advances, and I don't know, it might be useful to folks. Just a suggestion, Mark and Mark.

The next question comes from Tim Coffey with FIG Partners.

To help me kind of get an idea on expenses associated with the Mortgage business, can you give me an idea of what the typical expense base is on managing the MSR portfolio?

So first, the question on the definition of managing the portfolio, right? We have treasury activities and hedging activities. And then we have servicing, right, which is, as you would expect, processing payments, processing defaults, foreclosures and the like. Are you referring to the entirety of that activity or simply the treasury activity?

The entirety of the activity. I'm assuming it's one of the -- it's the less volatile of the expenses in the Mortgage Banking considering the origination activity.

That's true. We have not broken out those numbers separately in public filings and so we're not in a position to do that at this point. I would tell you that the servicing -- the cost for loan to service is among the most efficient in the United States and that's not because we have such a large portfolio. We have about $23 billion under servicing today by UPB, but it's because of the very high credit quality, right? We have very low delinquencies, very low defaults. It is -- on a cost-per-loan basis, I think it's running $11? I'm sorry, I'm asking our Treasurer sitting here.

It's a -- depending on which kind of product, but it's about $100 per year per loan.

Right, right, right. And we're servicing in terms of total loans...

106,000.

106,000 loans, something like that. Does that help?

It does. Did you say $100 per loan?

$100 per month roughly. Correction, per year. I apologize. Yes, per year.

No, that's the servicing portion of the cost, which gives an allocation of treasury and hedging and so on.

Okay, great. And then can you -- do you have the -- what the gain on sale margin was for the commercial real estate loans sold in the quarter? And kind of -- any kind of color on where those -- how those margins moved in the recent quarters?

We sure do, yes.

We didn't.

We didn't have a lot of sales in the quarter.

They were only DUS sales, correct?

SBA.

And SBA. So we didn't have non-DUS commercial real estate loan sales in the quarter. They were SBA sales and Fannie Mae DUS sales.

Okay. I thought I heard in the comments that -- the prepared comments that you might be looking to sell more of these CRE DUS loans in the coming quarters. So I'm now trying to get a handle on what the delta might be in terms of what lands in noninterest income.

Sure. If you look at the last half of last year, the run rate on non-Fannie Mae DUS commercial real estate loan sales was meaningfully higher, right? But that's seasonally true each year, right? It seems each year that at the beginning of the year, demand for the product is substantially lower. We believe that has generally to do with people working on their own origination activity in the early part of the year and beginning to supplement in the later part of the year and so loan volume, and accordingly, loan pricing improves. Our average gain on those sales, the non-DUS commercial real estate loan sales, was in the range of 2% to 2.5% roughly, if that helps.

Yes, it does. And then I didn't see it in the press release, but do you have a number for performing TDRs?

We used to have all that TDR information that no one cared about. I think they are substantially all performing and the number -- I think we just have a little information right here.

$72.7 million, yes.

Total TDRs. They're substantially all performing.

Next question comes from Jackie Bohlen with KBW.

Looking to focus in a little bit more on headcount just given the moving parts and understanding where we started at March 31 and then the 86 reduction that took place in April, how are you thinking about future headcount throughout 2018 in the 2 segments? Just understanding that it sounds like there's going to be some attrition, maybe more so in Mortgage Banking and then any potential de novo aspirations that you have and just other items that you see impacting headcount through the year.

We did open 3 new de novo retail deposit branches in the first quarter. That is our complement for the year. We are not expecting to add any additional deposit branches perhaps until the latter half of the year, in the fourth quarter. And it's unclear whether those will open in the fourth quarter or the first quarter of next year. We -- so our additions to headcount over the remainder of the year, of course, headcount will decrease in the second quarter as a consequence of the headcount reductions we have disclosed today. And we have a few open positions across the company that are likely to be filled over the ensuing 2 quarters. And so you'll see, at least by plan, a smaller number of additions, somewhere in the range of 20 in the third quarter, maybe 10 in the fourth quarter on currently open positions.

And are most of those in the commercial bank?

Yes. Yes, absolutely, for core support functions.

Okay. And then do you anticipate attrition to be somewhat of an offset to that?

Yes, though attrition in critical positions will be refilled.

Okay, fair enough. And then the -- you mentioned this briefly already, but the areas that you're looking at for other potential areas to trim some expenses, it sounds like that could be primarily in occupancy expense and other related areas?

Yes, yes. That's sort of vague answer that's why I'm hesitating. I think all of our expense line items are subject to continuous consideration. We are thoughtful about risk management and safety and soundness and about our ability to support our diversification efforts. So we've been careful to not create risk, unwarranted risk, or disable our ability to be successful. But all those decisions, of course, are subject to review and so it's a work in process.

Okay, understood. And then just, lastly, if you could provide an update on how you're thinking about capital planning and management.

Well, we have reduced our expectations for growth last quarter, and despite more significant growth in the first quarter than we expected, we are still expecting lower quarterly growth moving forward. And this lower growth has reduced capital needs. Of course, lower earnings don't help that equation, but at this juncture, we are not anticipating the need for capital this year. And beyond that, it's a sort of dynamic question based upon our success or lack thereof.

(Operator Instructions) The next question comes from Steve Moss with B. Riley FBR.

Mark and Mark, this is Zach Weiss filling in for Steve today. Just a quick question on the portfolio. How has the duration changed since the fourth quarter? And then any update on the [variable versus fixed mix] would be helpful.

Sure. No material changes in the fixed versus variable [composition portfolio]. About 1/3 of our portfolio roughly continues to be truly fixed. The remainder has varying levels of term structure and duration that it fluctuates. In terms of duration, since the end of last year, asset duration has extended a little, right, from total asset duration, say, 2.2 years to around 2.3 years, right? So not really materially, though as rates rise that creates some asset extension.

The next question comes from Henry Coffey with Wedbush.

Two areas of focus. First, just in general, is it all defense or are there parts of the business that you would describe as more -- where there's more offense going on in terms of growth in loan production and the like? And then a second question.

Well, I think you can clearly define that by segment today. If you look at the results in the Commercial and Consumer Banking segment, 6% portfolio growth, 6% deposit growth, 4 -- almost 4.5% business deposit growth. Those are clearly offensive numbers that relate to the investments we've made over the years in growing our business. On the Mortgage side, this is clearly a tough market with the confluence of negative events, whether they be flattening yield curve, shrinking available home inventory, mortgage convexity in our servicing portfolio, all of those very negative events that forces you into a defensive posture regarding running that business and that should be easy to delineate.

I mean, if I had sat down with you 5 years ago and said here's the plan, building market share, a direct retail origination [ARM] in one of the best markets in the country would probably be a pretty good idea. Is there anything you can do to really preserve the value of that business and then find new paths for growth with, say, new products, such as non-QM and jumbo lending? Or is it really just you kind of have to live out the cycle?

Well, that's a -- that's the important question, is it? You can react to cyclical changes in a cyclical business by using those periods to improve the efficiency of your business, the effectiveness, the product desirability or you can simply go to ground or get out of the business. We are trying to navigate this very tough period of time by preserving our ability to do the best part of the business and trim whether it be offices, personnel or products that have the poorest future outlook. It is very challenging to have so many aspects of this business go against the industry at the same time. And we do not need to list all of them on this call, but, as an example, the aggregate level of government mortgage originations, and in particular FHA originations within the United States has fallen dramatically as a percent of the market. That's a consequence of a lot of things, but most significantly including FHA's inability to get their insurance cost down, including the initial insurance premium. It is not as competitive as similar LTV and credit-qualifying products in the general market, including with the agencies. The secondary market for products that is to say the spread between primary mortgage rates and secondary mortgage rates has shrunk dramatically.

That's a direct correlation to competition. [Where] originators willing to originate loans at with a shrinking volume of loans available to be made and overcapacity of originators and lenders, this is another thing that has to be worked out over time. There will be more market participants leaving this business over the next period of time. We've seen some notable ones recently in the media. What we don't read about is the number of independents that are shutting their doors or reducing headcount. And so this is not a static situation. Cyclically, historically, capacity will shrink to available volume. Margins will improve and the business will reenter a new more profitable phase. And strategically, it's our challenge to find a way that is right for us as it relates to our longer-term strategic plan to navigate this part of the cycle, to preserve capital, to improve profitability and to make this business the right format for HomeStreet. It is very challenging, but it is a business that we try not to forget has provided substantial capital and earnings even since our initial public offering. It has provided a substantial amount of capital that has allowed us to grow this bank at an average 26% rate over the last 6 years and allowed us to make great strides and convert a very troubled thrift to a very large full service commercial and consumer bank. And it's a very tough period of time. We're doing our best to navigate it, to minimize progress [for] banking commercial bank and hopefully we're going to find the right answer here as we move ahead. Thanks for the question.

No, it's understandable. The other question is sort of more technical. I was just looking at your last 5 quarters in terms of servicing income and in the other four you had some -- one part of the equation or the other resulted in a positive fair value mark. Either you had strong MSR write-ups with limited hedging losses or you had small MSR write-downs with positive hedging gains. And then in this quarter, you had a substantial MSR write-up, which is sort of what, just based on the numbers, we would have expected. But a greater than that hedging losses, is that a limited dynamic? Or was that a change in how you're positioned around hedging? Or -- because the other 4 quarters worked and then this quarter, you weren't able to bring any of that gain to the bottom line.

Right, which is one of the many challenges I referred to. Mortgage rate volatility produces a substantial amount more transactions and rebalancing of our hedge. That alone has a transaction cost, right, just think of the bid-ask spread every time you have to reposition something. Additionally, as the yield curve flattens, our outright earning on derivatives we used to hedge the servicing assets shrinks in an absolute sense, right? You think of the spread between our average duration in the servicing portfolio or key rate duration that we hedge against, which is in the sort of 7- to 15-year range, well look at how much the spread between monthly rates and those tenors has flattened. That's pure loss of servicing income to us. In addition to which, the convexity in our servicing portfolio has risen as we have built the servicing portfolio over the last year or two such that as rates go back and forth in this range of volatility, you're walking back and forth across your hedge -- your hedge-able amount. And every time it walks one way or the other, you're making transactions. And all of this has resulted in a less efficient or less effective hedge and a lower-earning hedge. And that condition is going to exist for a little while until one of several things changes: one, mortgage rates rise meaningfully and we refill the servicing portfolio at higher average mortgage rates; two, mortgage rates fall meaningfully, right? So we're at this cuts [being placed of rates] in the market versus rates in our portfolio that produces this type of hedging costs. What we originated and what rates we originated at had a big impact on of this equation and we find ourselves unfortunately at this place in time with hedging results that are not [really] as good for us. I will tell you, though, Henry, that we still have the best hedging results of any large public servicer whose results we can track. And we measure that on a relative basis. Risk management results as a percent of the UPB of loans serviced and we are all suffering right now as a consequence of these various metrics. Good question. It does mean, though, that this also is subject to cyclical change going forward and it's one of the very challenging aspects of the business at this point. Sorry about the extended answer.

No, no, no. I mean, that's very helpful. So just a simple question, you are servicing this in-house, right?

Yes.

Yes.

This concludes our question-and-answer session and also concludes the conference. Thank you for attending today's presentation. You may now disconnect.