Mechanics Bancorp (MCHB) 2025 Q4 法說會逐字稿

(audio in progress) which finally eliminated the credit discount double count rule and resulted in a [$20.2 million] one time negative loan loss provision just one quarter after we recorded the initial charge. So a bit messy, but we'd rather have the capital now than accreted in over the life of the acquired loans.

Our ACL was unaffected by this adjustment and is 1.08% of total loans. This is also a very robust 2.96 times our total non-performing assets as of [12-31]. We did have a $7 million net charge off during the quarter from a legacy Home Street syndicated credit, but this was not a surprise as we identified the issue during due diligence and fully reserved for it.

We incurred $3.5 million of one-time merger expenses in Q4, which was down substantially from the charges recorded in the third quarter. There is still more restructuring to come but moving forward, our earnings should get cleaner and more straightforward with each passing quarter.

When you back out the one-time items, including the bargain purchase gain, the double count provision reversal, and the merger expenses, it adds up to just under $60 million of core net income for the quarter, which represents a core ROAA of 1.06% and a core ROTC of 14.3%.

Our total assets are now $22.4 billion, with total net loans of $14 billion total deposits of $19 billion and tangible shareholders’ equity of $1.8 billion. We remain 100% core funded but our balance sheet will likely shrink modestly next quarter as we continue to run off high cost legacy home street CDs and legacy mechanics auto loans.

Importantly, this will free up additional excess capital. Speaking of which, our CET1 ratio is 14.1% and Tier 1 leverage ratio is 8.6% at the end of the year, and I'll discuss our capital return strategy a bit more in the coming pages.

Our cost of deposits was 1.43% for the fourth quarter and most importantly, our spot cost of deposits at 12/31 was just 1.3%. Our NIM was 3.47% for the quarter and our CRE concentration ratio continued to drop, checking in at 344%.

Turning to slide 5, I'd like to provide you with an update on some of the key strategic initiatives happening at the bank. Our integration of HomeStreet is proceeding smoothly and the core systems conversion will occur in March, which is a major milestone that will allow us to complete the restructuring of the combined companies and deliver on our cost savings estimate of $82 million by the fourth quarter.

This implies an expectation of annual run rate non-in expense for mechanics of approximately $430 million, excluding CDI amortization which I think is the better way to look at things given the non-cash nature of CDI. We're still running off high cost legacy HomeStreet CDs and believe that the total runoff of CDs will reach our expected $1 billion and perhaps a bit more sometime in the first quarter.

However, our team has done a great job staying in front of legacy HomeStreet clients, and I'm happy to report that core deposit attrition has been minimal. As I mentioned, we sold our dust business line to fifth, third in early December for $130 million.

This is a highly talented and specialized division within Mechanics Bank focused on multi-family lending and servicing under the Fannie Mae Dus program. Transaction remains subject to Fannie Mae's approval and is expected to close sometime in the first quarter.

Assuming that occurs, we'd expect to return the excess capital that's generated as part of a second quarter dividend subject to regulatory approval. As you've seen, we continue to manage our CRE levels down post-merger and are planning for our CRE concentration ratio to eventually drop below 300%.

We are still originating commercial real estate and multi-family loans but can be selective with the loans we choose to put on the books versus letting them go to a competitor. We are excited to build out our commercial banking, wealth management and treasury sales staff across our new West Coast footprint and are very focused on growing core deposits and assets under management.

There's also a significant opportunity to improve our client experience and peer leading efficiency metrics by further investing in technology, especially AI across the bank. Well, core conversion is the main priority right now. We have a number of initiatives that will kick off the back half of 2026. That should really help us as a company.

As I mentioned last quarter, we expect modest NIM expansion in 2026 and beyond as our deposit costs decline and our legacy mechanics earning assets continue to reprice up. We remain bullish on the future earnings power of mechanics and expect to hit our target of $300 million of run rate earnings by the fourth quarter of 2026 with healthy earnings growth continuing into 2027 and beyond.

These earnings levels imply a robust 18% ROTC and a 1.44 -- 1.4% ROAA. Importantly, we have approximately $92 million of excess capital above our 8.25% tier 1 leverage ratio target at the end of the year and expect to pay an estimated $0.39 dividend in the first quarter subject to Board and regulatory approval.

Let's flip to side 6, which shows an overview of Mechanics Bank Corp today. Again, we have $22.4 billion in assets with 166 branches and tremendous deposit market share. We are the third largest community bank in California and the fourth largest on the West coast.

On the right side of the page is our branch map, which is very unique and quite hard to replicate given all the consolidation that has occurred in these markets. While our earnings are already strong, our expectations are high and we believe mechanics should be one of the top performing banks in the nation, despite taking relatively little risk.

I'll draw your attention to a few statistics about halfway down the page on the left hand side. This is a comparison of mechanics versus all publicly traded banks, $10 billion to $100 billion in assets, which, including us, has 81 banks in the comparative group.

What you can see is our cost of deposits for the fourth quarter was 1.43% versus the median for the 81 banks of 1.94%, giving us a rank of number 12, and I expect this rank to improve over the next few quarters as we continue to run off high cost legacy HomeStreet CDs, especially given that our spot cost of deposits was 1.3% at the end of December.

Next, our non-interest-bearing deposit mix is 35%, which is the fourth best out of 81%, and underpins the strength of our deposit franchise. I've also added a new statistic this quarter that is interesting and very important, which is looking at our percentage of risk weighted assets to total assets with mechanics at 59% versus the group median at 76%.

I'll hit more on this on the next page, but there is only 1 bank out of the 81 with less risk-weighted asset intensity. Despite this low risk profile, our expected 2027 ROTC of 18% would rank second out of the 81 competitor banks.

Slide 7 is a new slide but key to our investment thesis. Because our deposits are so great and because we run our company so efficiently, both with expenses and from a capital management standpoint, we expect to achieve outstanding returns despite having nearly the lowest risk mix of assets in the country.

These charts provide a great visual, in my opinion, especially the risk weighted assets, the total assets comparison. The fact that we are strongly convicted of achieving a sub 50% efficiency ratio with an 18% ROTC, despite 59% risk-weighted assets and total assets, is a compelling reason to belong Mechanics Bank Corp.

Also, 59% will likely continue to decline in 2026 as auto loans run off and CRE loans are managed down. A few quick notes. First, we have brought in our 2027 guidance modestly from a 19% royalty to 18%, mostly due to the lower risk mix of earning assets on the balance sheet, including faster loan runoff than expected from the HomeStreet acquisition, which you could argue is a good thing.

We're relatively modest. We also no longer have the double count credit discount accretion as that was all recognized as income in this quarter. Also, because the balance sheet is getting a bit smaller as planned, along with the pending dust business line sale, which we had not budgeted for, we expect to have a dividend payout ratio to investors of over 100% of our net income in 2026.

In 2027 and beyond, we reiterate our long-term expectation of paying out approximately 80% of our net income as dividends to leave some capital to support our expected growth. To wrap up my section, let's turn to slide 8.

This slide summarizes our investment highlights. First and foremost, we have fantastic market share in very attractive West Coast markets with a branch footprint that's nearly impossible to replicate. We also expect to have industry leading profitability due to our great deposits and efficient business model, despite taking very little credit risk.

We are 100% core funded with no wholesale borrowings or broker deposits and are very well capitalized with a highly liquid balance sheet. We are efficient with our capital and plan to pay out substantial dividends, which would imply a very attractive yield at today's share price.

There's also strong alignment between our public and private investors as Ford Financial Fund owns 74% of the company. Finally, we have an experienced management team with a strong operating and M&A track record.

Overall, I feel great about the future prospects and mechanics and I'm thankful to be able to work with such a talented and hardworking group of people. With that, let me turn the call over to Nathan to dig into more detail on our 4th quarter results. Nathan.

Thank you, C.J. Given that CJ has already covered the key highlights of our 4th quarter results, I'm going to turn to slide 10 and begin with net interest income and margin. For the fourth quarter, net interest income increased $35.8 million or 24.6% to $181.5 million from $145.7 million in the third quarter of 2025.

Our net interest margin expanded 11 basis points to 3.47% driven primarily by higher loan yields on the multi-family and single-family residential loans acquired from HomeStreet, as well as lower deposit costs resulting from $603 million of higher cost CD runoff and the impact of the recent Federal Reserve rate cuts.

Our interest income in the quarter also included $13.1 million of discount accretion on loans acquired in the HomeStreet transaction and reflect the early adoption of ASU 2025-08, which eliminated the credit mark on non-PCD acquired loans and established the corresponding ACL and purchase accounting.

Of note, we still have $162 million of remaining discount on the acquired HomeStreet loans, which is mostly applied to multi-family and SFR loans and our accretion yields are similar to the market rates we are originating new loans at today.

Finally, when looking at the average earning asset mix, this slide shows the modest impact of the merger. We expect to continue to manage down our elevated cash balances over the coming quarters, supporting additional high cost CD runoff and allowing us to redeploy liquidity into profitable loan growth and selective investment purchases.

Turning to slide 11, our fourth quarter non-interest income decreased $31.3 million or 28.5% to $78.5 million from $109.8 million in the length quarter. This reflects the adjustment to the bargain purchase gain recognized on the HomeStreet acquisition, which totaled $55.1 million in the fourth quarter compared to the initial $90.4 million recognized in the third quarter.

As C.J mentioned earlier, the fourth quarter gain was due to the updated thus intangible valuation. The remaining changes were driven by the full quarter impact of legacy HomeStreet non-interest income, including gain on sale loans, servicing income, service charges, and other fee-based revenues.

Turning to slide 12, non-interest expense for the fourth quarter decreased $33.8 million or 20.7% to $129.5 million from $163.3 million in the length quarter. Merger related costs were $3.5 million, significantly lower than the $63.9 million recorded in the prior quarter and included severance, merger related professional services and contract termination costs.

Excluding these one-time expenses, non-interest expenses increased $26.5 million, primarily due to the full quarter impact of operating expenses associated with Legacy HomeStreet. We have now incurred a substantial majority of the merger-related costs tied to the HomeStreet transaction, including severance and changing control obligations, professional services and contract terminations.

Looking ahead into 2026, we expect both our reported and core non-interest expense to decline as merger and integration activities wind down and as we continue to execute on the operational efficiencies associated with the combined franchise.

Turning to slide 13, fourth quarter loan interest income increased $50.8 million or 35.8% to $192.6 million from $141.8 million in the length quarter. This increase was driven by the full quarter impact of the loans acquired from HomeStreet.

Loan yields increased 17 basis points during the quarter to 5.3%, reflecting higher yields on the acquired multi-family and SFR portfolios and continued repricing across the legacy mechanics loan book. Multi-family and SFR yields increased 45 basis points and 53 basis points respectively during the quarter. At December 31, our loan portfolio totaled $14.2 billion. Our CRE concentration ratio decreased to 344% in the fourth quarter from 360% at the end of the third quarter, driven by reduction in CRE balances.

Turning to slide 14, our commercial real estate portfolio remains well diversified and continues to reflect our long-standing focus on lower risk multi-family lending. Multi-family represents approximately 69% of the total CRE portfolio with an average loan size of $4.1 million, an average LTV of 56%, and an average debt coverage ratio of 1.48 times.

The remainder of the CRE portfolio is broadly distributed across retail, office, industrial, hotel and mixed-use categories, each with modest exposure and conservative credit characteristics. We also continue to manage down the higher risk segments of the Legacy HomeStreet portfolio.

During the quarter, we sold approximately $39 million in UPB or $70 million in commitments of Legacy HomeStreet syndicated NDFI loans at close to par, and we expect to continue running off the remaining balances over time.

Turning to slide 15, you can see both legacy mechanics asset quality trends and the impact of the home Street merger. Mechanics has historically maintained excellent credit quality with minimal non-auto charge-offs and a very low level of non-performing assets.

As shown on the slide, the majority of our historical charge-offs were auto-related, and as mentioned earlier, that portfolio is in runoff and continues to outperform expectations. The increase in the non-auto charge offs in the fourth quarter was due to a charge-off of a legacy HomeStreet acquired loan that had a specific reserve established, and the actual charge-off was slightly lower than the original anticipated loss.

At December 31, non-performing assets represented 0.14% of total assets, down from 0.23% in the third quarter. The decrease reflects improvements in both the legacy mechanics and acquired HomeStreet portfolios.

Loan loss reserves to total loans held for investment were 1.08% at quarter end compared to 1.16% in the prior quarter, reflecting updated reserve levels following the previously mentioned specific charge off, continued runoff of our auto loan portfolio and continued improvements in credit performance.

Turning to slide 16, securities interest income increased $9.2 million or 23% $to 49.6 million from $40.3 million in the third quarter. The increase was driven by higher balances and yields following the HomeStreet acquisition, as well as recent purchases of agency CMO floaters at attractive spreads.

The overall securities portfolio increased by $476 million during the quarter, including approximately $400 million of agency CMO purchases. The average yield on the securities portfolio increased 10 basis points from the prior quarter, reflecting the full quarter impact of the acquired HomeStreet securities and the benefit of new purchases at higher rates.

The decision to purchase $400 million of CMO floaters during the quarter was because of our effort to better match our rate sensitive deposits, which have increased from the HomeStreet acquisition with floating rate assets and thus reduced interest rate risk.

Turning to slide 17. Total deposits decreased $428 million during the fourth quarter to $19 billion reflecting $603 million of planned runoff and higher cost time deposits, partially offset by $210 million of growth and interest-bearing demand and money market balances.

Our cost of deposits declined two basis points to 1.43% in the quarter, driven by lower money market rates and the continued runoff of the higher cost home street time deposits. As C.J mentioned earlier, our spot cost of deposits was 1.3% at December 31, which I will discuss in more detail in a moment.

Non-interest-bearing deposits represented 35% of total deposits at December 31, consistent with our historical mix. The modest shift in mix throughout the year reflects the merger as HomeStreet's non-interest-bearing deposits were proportionately lower than legacy mechanics.

Turning to slide 18, you can see the stratification of our deposit base across consumer, business, and public sector customers. The mix remains well diversified and highly granular, with consumer and small business deposits representing the vast majority of our funding.

Relationship age continues to be a key strength with an average tenure of roughly 18 years across the deposit base and our spot cost of deposits ended the quarter at 1.3%. Overall, the stability and depth of these long tenured relationships continue to support our low cost funding profile and strong liquidity position.

Turning to slide 19. We remain well capitalized following the HomeStreet merger with capital ratios comfortably above regulatory minimums and internal policy levels. At December 31, our tier one leverage ratio was 8.6%, and we continue to maintain a strong capital position supported by robust earnings and balance sheet liquidity.

Our available liquidity totaled approximately $17 billion at quarter end, an increase of $2.2 billion compared to September 30, driven by additional Home Street acquired assets that were pledged to the FHLB and Federal Reserve during the quarter.

That concludes my overview of our fourth quarter results. With that, I'll hand things over to Carl before opening up the line for your questions. Carl.

Thank you, Nathan, and good morning. Just a couple of quick closing comments. We are now five months post-close the HomeStreet transaction. And we could not be more pleased with the new mechanics Bank at this juncture.

In my 40 plus years of banking Moet, seldom do we have the opportunity to combine a great strategic acquisition with an equally outstanding economic outcome. Typically one outcome is skewed versus the other.

As C.J and Nathan have outlined the fourth quarter performance this morning, the economics of this transaction are clearly evident. We were pleased with the closing purchase price of $265 million. And we have now recorded a bargain purchase gain in both the third and fourth quarters totaling $146 million. So you can do the math on consideration.

Additionally, we now have a full West Coast footprint spanning from San Diego to Seattle. A franchise with significant market presence and enviable scarcity value. The other point I would make in closing is the experience and alignment that management has with all of our stakeholders.

We are not just management but we also represent the ownership of this company. Both public shareholders as well as our limited partners. Being both owners as well as operators with the greatest alignment of interest we could possibly have with each of you.

And with that, I believe we are now ready to open it up for your questions.

(Operator Instructions)

Woody Ley, KBW.

Hey, guys. Thanks for taking my questions. Wanted to start on the net interest margin outlook and I appreciate the color on the spot cost of deposits. It would seem to imply we should get a pretty nice step up in the next quarter. How are you all thinking about, kind of that starting area for the first -- for the first quarter, and the level of NIM expansion we could expect over the coming year?

Good morning, Wood Lay. Nice to talk to you today. Yeah, I agree with you. I do expect to have a NIM pickup, in the first quarter. I'd say something like 10 basis points to 15 basis points roughly is kind of how I'm thinking about it and by the end of the year I'd expecting them to get to the kind of 3.75-ish range, so it's come down a little bit where we thought it'd be mostly due to long-term rates that actually come down, since our deal model a bit, benefited us in the sense of lower interest rate marks and higher bargain purchase gain.

But it has caused a little bit of increased prepay on some of the restructuring we did back in '24 of our AFS portfolio, so it's -- I kind of think it's going to be a healthy margin expansion this year, probably by the end of the year getting around 3.75%. Subject to interest rates, right? We've got -- [two] rate cuts are assumed this year and obviously movements in the yield curve can have a significant effect on any bank, so.

Yeah. Maybe shifting over to expenses. I think, I just wanted to clarify, I think the last quarter you all talked about a run rate of 450. I mean, assuming that included the CDI.

Yeah, it did.

Yeah, okay.

And then. Sorry, go ahead.

No, you can go.

Yeah. So it did include the CDI. We actually are advertising CDI a bit faster than I thought we would be doing, based on my modeling and so I thought let's just focus on the core cash [NIE], which is $430 million which we're on track to hit, with CDI -- our CDI, I think this for 20.

This past quarter I think was something like $7 million. So we've got a lot of CDI amortization embedded in our in our earnings but that is a -- it's it doesn't affect. Net that out, that's what your tangible capital generation is. So you look at the headline earnings but the capital generation underneath that is significantly higher because we do have a lot of CDI coming through the interest income statement.

Yeah. And then maybe just last for me looking at -- looking at your dividend targets and I know this is all preliminary and subject to the Board and regulatory approval but when you think about a payout ratio of over 100%, we started talking about over an 80%. Could you sort of walk through the toggle between where you expect the payout to come over the year on a percentage basis and why you're comfortable having it over 100%.

Yeah. So we have a lot going on with the bank. We had the announced thus sale to fifth, third, which is proceeding very well and if and when that closes, that will likely free up an additional $70 million-ish of tangible capital, which we'd expect to return in the second quarter dividend but we recognized due to accounting rules, some of that gain in the fourth quarter and so as such the earnings showed up in the fourth quarter, but the capital is going to show up in 2026 and so that's the basic calculation around why the payout ratio is going to be over 100%.

You also combine that with the fact that the bank's getting a bit smaller due to the high cost CD runoff and the auto loan runoff that's allowing us to kind of free up leverage capital. And so we're focused on trying to return excess capital above an 8.25% leverage ratio, one quarter in arrears. That's where you see the calculation for the $92 million expected.

Dividend $0.39 a share in the first quarter. We'd expect the dividend in the second quarter to be pretty significantly higher than that due to the additional capital from the Dus sale. So that's why as we get into the back half of the year, I think the payout ratio should get back down towards the 80% range, but the beginning of the year is a bit noisy. It's a good thing. It's capital return but there are some moving pieces that we're working through.

Yeah, I appreciate you walking me through that. Thanks for taking all my questions.

Thank you, Woody.

(Operator Instructions)

I would now like to pass the call back to C.J. Johnson for any closing remarks.

Alright, thank you, operator, and everyone that joined us this morning. To conclude, we reported strong results for the fourth quarter and our integration of Home Street is proceeding as planned. We remain on track to deliver our cost savings expectations and provide a smooth transition to HomeStreet's customers and employees.

Through our acquisition, we've created the third largest community bank in California and the fourth largest on the West coast with a branch footprint that's nearly impossible to replicate. We expect to achieve industry leading profitability due to our outstanding deposit franchise and efficient business model, despite taking very little credit risk.

We are also 100% core funded with no wholesale borrowings or broker deposits and have robust capital levels with a highly liquid balance sheet. We are efficient with our capital and plan to pay out substantial dividends which would imply an attractive yield at today's share price. We sincerely appreciate your interest in mechanics and I look forward to updating you on our progress of the company on our first quarter call in April. Thanks again for your time today.

Ladies and gentlemen, thank you for attending today's call. This now concludes the conference. Please enjoy the rest of your day. You may not disconnect.