Mechanics Bank (MCHB) Q1 2013 Earnings Report, Transcript and Summary

Tim Coffey - FIG Partners

Unidentified Participant Kevin Ross - Akon (ph) Ren Vaughan - Salomon Whitney

Good afternoon and welcome to the HomeStreet, Q1 2013 earnings conference call. All participants will be in listen-only mode. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Mark Mason. Please go ahead sir. Mark Mason Thank you. Hello and thank you for joining us today for our first quarter 2013 earnings call. I’ll begin with a few highlights from the quarter, followed by a more detailed discussion of our results, after which we’d be happy to take your questions. Before we begin I’d like to remind you that our first quarter earnings release has been furnished this morning with the SEC on Form 8-K and is available on our website at ir.homestreet.com. In addition, the recording will be available at the same address approximately one hour after this call. In our call this morning we will make some forward-looking statements. And these statements that is in a description of historical fact is arguably forward-looking and these statements are subject to many risks and uncertainties. Actual performance may differ and there is assurance that the company’s performance will occur in the manner we project. Factors that may cause actual results to different materially from expectations are detailed in our SEC filings, including our 2012 Annual Report on Form 10-K and our various Quarterly Reports on Form 10-Q and our 8-K filings. Additionally information on any non-GAAP financial measures referenced in today’s call, including a reconciliation of those measures to GAAP measures also may be found in our SEC filings and in the earnings release available on our website. I’d now like to begin by highlighting a few metrics and recent events from the quarter. HomeStreet reported net income of $10.9 million or $0.74 per diluted share. Our pretax income was…

Thank you. (Operator Instructions). Our first question is Paul Miller, FBR. Please go ahead sir.

Thank you very much. I don’t know if you mentioned this as one of the things I missed at the very beginning. But can you talk a little bit about what your gain on sale is today relative to the first quarter so far since you pretty much finished up the month already?

Sure. Surprisingly our margins are slightly better than the quarter as a whole. With the recent decrease in long-term rates there’s been a widening of the primary, secondary spread and pricing in our markets has improved. Through April it looks like our composite margin is going to rise from what was about 412 basis points, excluding the impact of valuation adjustment to something closer to 450 basis points up to date. Now we can’t assure you that this is going to continue through the rest of the quarter, but for the month we had a very good month, not only in application volume as I mentioned earlier with the locks, kind of the estimate will be about $580 million for the month, but with profit margins as well. Paul Miller – FBR: And then on the headcount, the 119 people, can you talk about where you want – is this the bulk of your new hires for the year or is this the pace its going to continue for the next couple of quarters.

Its probably the larger part of our non-mortgage hiring, though we still have some open positions as we have to continue to add to infrastructure as total volume in the business changes. But in the single family area, we expect continue hiring through the end of the year at about the same pace. There is a potential though that we may lose some personnel if refinancing volume falls at a greater pace than we expect. So we’ll have to see how the market plays out, but I would expect our mortgage related hiring to continue at the same pace for year-end and beyond. Paul Miller – FBR: Of the 119, what was mortgage bank and what was the regular bank?

Of the 119, the mortgage bank was about 88 personnel and the remainder were infrastructure and lending people on the commercial side. Paul Miller – FBR: And then how many commercial lenders do have currently?

In all three of groups the number in front of me, I think its about 22 to 25. Paul Miller – FBR: Okay and is that headcount expected to go up or you are comfortable with that headcount right now?

We are comfortable currently in residential construction. In commercial lending we are going to add about three more people to a new more reputed sales lending office we are going to be opening in the second quarter. And in the commercial real estate area we’ll probably add a couple more people in the remainder of this year, but mostly we’re set. Paul Miller – FBR: Okay. Hey, thank a lot Mark.

Thanks Paul.

Our next question is Jim Fowler, Harvest Capital. Please go ahead.

What’s been the individual drivers of that $3 million, $2.1 million gain versus last quarter. Are they more related to housing cost appreciation and therefore somewhat doable or was it a change in rates, where there might be some of that caught back in the first quarter, given where we see the ten year treasures.

Well, first I’d refer you to the table on page 21 on of our earnings release. That details the components of mortgage servicing income. See that table that reconciles to the $3.1 million net revenue number. If you are looking at the lower part of that section, the risk management section, those are the two numbers, a $3.579 million gain in fair value to MSR and offsetting that $2.5 million loss on our hedges and Darrell van Amen, our Treasurer is with this morning. Darrell could you speak to the drives of the increase in value, because the things that Jim’s talking about are actually decreasing and prepayments need increasing issues. But we had a net increase in value for the quarter.

Correct. So during the fourth quarter we had experienced an acceleration and expected prepayments fees by those items, which you had just pointed out. But as we’ve done the modeling and brought those into the current quarter, we didn’t see a acceleration in prepayments based on an increase in housing prices. What we did see is our rates had kicked up for the most part in the quarter and if you look at period-to-period, rates are a little bit elevated, especially the primary mortgage rage as compared to the fourth quarter. And if I can draw your attention to the line on that same page, changes in fair value of single family are going to start due to model of amortization. That resale, a little over $1 million from $6.2 million to $5.1 million, that is what we expect prepayments seem to be going forward. So the higher rates actually reduce expected or future prepayments going forward. So we do see an increase in value due to increased mortgage rates and we also see a slowing of prepayments fees based on the fees and accessibility of our current that became the serving book.

So, Darrell this is Jim. In that general rates and passive yields on MBS decrease, doesn’t mean the mortgage rates followed. In fact mortgage rates are slightly up relative to that change, and so it had actually the offset on prepayments fees.

Yes, I mean that’s my questions. Your hedge performance was fairly constant December versus March, but your risk management picked up $1.1 million. My question is, during the quarter, from the fourth quarter to the first quarter, is that increase in risk management due to the impact at housing prices or due to more related to the change in interest rates. I’m just wondering if there is any sort of claw back of that in the second quarter give that we’ve seen rates rally, which sounds like it going to be somewhat offset with continued housing prices, increases.

I don’t think we expect it at this juncture, certainly not through April right. Through April our valuation versus hedge results are about flat.

Right. And then I wanted to just, I think you said this; I just wanted to clarity it. If I’m simply looking at the mortgage, the secondary mortgage gains as a percentage of locks, it was a take out to the 4.3 for the quarter. It looks like it was 223 basis points versus 313 last quarter. Is that 223, are you indicating that 223 has been fairly stable through the month of April. I’m just looking at locks versus secondary market execution.

Right. In answering the question that Paul Miller just asked, I think what I suggest was that the total of the composite was slightly higher, maybe 450 basis points and within that number the secondary piece is the primary driver for that difference. I will say also that servicing is going up in value.

I was going to ask. So it’s not all capitalizing the increase in the capitalization factor. You’re also seeing it in cash execution.

We are, right, and that difference is probably 75% in the secondary piece, about 25% in higher servicing value.

Right. I appreciate it. Thanks a lot.

(Operator Instructions). Our next question is Tim Coffey, FIG Partners. Please go ahead.

Thank you. Good morning Mark.

Hi Tim.

As we look at kind of the overall non-interest expense trend for the rest of the year, would you anticipate that your levels in the first quarter were probably the lowest of the year?

Good question. Yes, expect – I’d say generally yes. One, as a consequence of expected substantially higher mortgage volume in the middle of the year, in the second and third quarters, loan officer commissions will drive higher non-interest expense in total. By the time we hit the fourth quarter, we would expect somewhat higher expenses related to additional branches and personnel, even if all else were equal, so generally I would say yes. Having said that, marketing expenses in the first quarter will be our highest level of the year by perhaps $1 million. We came out of the year with a very large part of our marketing budget dedicated to the first quarter and a change in logo and television commercials and a number of thing to really jumpstart our effort to improve our name recognition and keep it sound and less any declines over the range of the year. So again, it’s a number that’s highly dependent on loan volume, mortgage loan volume with respect to commissions and then to a lesser extent the trend in personnel.

Okay. What impact if any will the change in accounting on the interest rate market have going forward?

On average it will follow us to an equal increase or gain. Not in total, just by timing, right, because there is still a range of valuation methodology in the marketplace. We moved our methodology closer to the majority of similar companies to recognize a substantial amount more of the gain created at lock date and so we essentially end up accelerating more gain into the day of lock as opposed to the date of closing. So if you look at a year in total, and your locks equal to your closings, you would have no net effect between periods to the extent that locks are greater in closings, you will show higher composite margin.

Okay. And if you look at kind of the commercial portfolio of the steps you are holding for investments, where are yields on new loans that are being added to the portfolio right now, in relation to your average loan yield for the quarter.

That’s another great question. The yields are actually hanging in there pretty well. Some portion of those additions are single family mortgages. Those are substantially jumbos. Darrell do you have some actually numbers by loan type?

Yes. If you look at single family as you pointed out, primary jumbos are fixed rates in the jumbo product. They are coming on and they’ve been pretty static for the first quarter. They are yielding about 425 and then of course our arm’s about 295. If you look at the other component, say the commercial, the remaining loans held for investment, the commercial component, those yields are about 425 in terms of note rates coming on the books for the quarter. So (inaudible), they’ve held up pretty well for this quarter as well.

Okay. If we talk about the jumbo market, it seems like it started to unlock a little bit in the secondary by-site. Does that have any impact for your operations going forward?

I’m sorry Tim; I was looking at a piece of paper on yields. Could you give me the question again?

Yes, the jumbo market seems to be unlocking a little bit. Does that have any impact on your operations going forward?

It does and that we have been reluctant to put a substantial amount of fixed rate jumbo loans on our balance sheet because of the added interest rate risk. And while we have put some on during this period, we haven’t been as competitive in the market place as we would like to be. Recently we have formed relationships with some folks in the secondary market, who have allowed us to substantially improve our pricing to the marketplace. Beyond that we are the in the process of becoming rated in order to participate in full securitizations of these jumbo loans and hopefully longer term, our volume will increase to the extent that we can do our own stand alone to securities.

Okay, but this is more of a long-term strategy then.

Yes, though more recently we are selling a lot more reserves into the secondary market at reasonable gains, but much better pricing to the customers.

All right. I think that was all my questions. Thanks.

(Operator Instructions). We do have a question; Arthur Mackey, a Private Investor. Please go ahead.

Yes, I was just wondering if you anticipate increasing the dividend in the future?

Well, thanks. As a stockholder, I’m sure interested in that question. As you can tell when deciding on the size of the initial dividend, we were conservative and I know that shareholders would like to see a much higher payout ratio, given our level of capital. Starting out initiating a dividend, at the same time that you’re coming off of a regulatory order, conservatism is the more important factor in your analysis and your proposal to the regulators. And so in initiating the dividend, we want to make sure that everyone, more specifically our regulators were comfortable that the dividend string that we were initiating would be sustainable. And I would tell you that we are very interested in increasing the level of dividend. The timing of that is going to be subject to our Broad of Directors and our regulators comfort with an increasing level of dividend, and of course sustained and stable profitability and so it is our intention to do that. The timing of that I can’t be sure.

All right. Thank you very much.

Thank you.

Our next question is (Inaudible), JPP Consulting. Please go ahead.

Yes. Just one; one of my questions was answered. But I just wanted to see, given your stages of on the expansion and maybe your marketing things to the California market or the latest one in Hawaii.

Well, as I said earlier, it’s our intention to continue to expand our foot print. As good a market as Puget Sound is, we are already a substantial mortgage originator in Puget Sound and while that market share is going to increase over time, our opportunities as substantially broader than that in attracting really high performing great groups of people in other states. And so we’ve started down California, we had a significant opportunity to bring on really high performing team. The leader of that team was Wells Fargo’s most prolific purchase mortgage originator and we are quite happy to bring them on. And so it means that we are going to ultimately build a larger presence in Southern California and hopefully Northern California as well. The Hawaii market is one that we’ve been in for over 20 years, both as a bank, I’m sorry, 30 years, both as a bank and a mortgage originator and one that today we don’t have as great a market share as we have Puget Sound and we think we have a substantial opportunity to improve and so we are going to aggressively grow our personnel in that market. That’s an unusual market in that. The support for home values in that market is really an international support and their housing prices have rebounded just as quickly as our other markets and our generally more stable. And so we expect to expand our mortgage banking presence there, but ultimately our general banking presence as well. We intend to also expand our mortgage business into the other contagious western states, Arizona, Uttar, Colorado and others over the next few years, as opportunities present themselves.

Okay, and if I could just ask one more follow-on?

Yes.

As far as the California, Southern California and approximately Northern California. What did you see your timeline on that for the expansion.

Well, I can’t say exactly, because we don’t open our offices on a schedule as to when we’d like to see them. We bring groups of originators on as we identify them. And there is a pretty significant pipeline of opportunities in that regard, but we try to let the market tell us where we should grow based upon the quality of the individuals we hire and not simply target markets. And so I think as I said earlier, we expect to continue hiring in that business at the current pace, the most recent phase and so we grew sort 10% in production personnel in the first quarter and I would expect to see a similar number, but not a similar percent as sort of quarterly going forward.

Okay. Thank you. That’s all my questions.

Our next question is Kevin Ross, Akon (ph). Please go ahead.

Hi Mark. How do you think about a share buyback program versus increasing a dividend as you look to return capital shareholders in the future?

We don’t currently anticipate a buyback program. We would like to utilize our excess capital to grow the balance sheet and to acquire some smaller institutions, to accelerate our diversification efforts. If we are not successfully and we continue to accrete capital at the current rates; that’s a topic that we would revisit.

Okay, great, and then a follow on for what you were just talking about. Could you comment about the M&A activity in the northwest. What you are seeing and what’s your perception of pricing of deals that have been announced?

I think activity is picking up; at least discussions are. I think pricing is increasing somewhat, which is probably what’s helping the discussions. Though we still see deals being done that are pretty dilutive and we are fairly disciplined about our evaluations. We have to return at least a 15% rate of return on investments like that and we hold ourselves to hopefully under a four-year delusion payback period from that _. So some deals that recently have been, we were outside those parameters and so I guess that tells you people the way to spend more on deals. But we have been in discussions with a number of small institutions for some period of time. I can’t give any probabilities regarding actually competing the transaction, but those discussions have picked up in the last few months.

Great. One last one if I could Mark. Can you talk a bit about the multi-family market and are you getting more traction with your DUS license.

We are and even more successful recently on the front end of that. We have had some significant success in the construction area of a range of sizes, of apartment construction projects with agreement on the backend to do Fannie Mae takeout loans. And so we are hoping that that leads to both, higher average on balance sheet balances, but also an increase in our Fannie Mae business as well.

Great. Thank you.

Our next question will be Ren Vaughan, Salomon Whitney. Please go ahead.

Mark, good morning on your end. How are you?

Very good, Ren. How are you sir?

Good. Everybody else stole my thunder, the last three or four guys. I just wanted to say hello, no problem, thanks. Sorry.

I have a hard time believing anyone could steel your thunder Ren.

I have a hard time too my friend. They must be some placed locked in my brain, steeling my question, no problem. How’s the weather out there today. Don’t answer, its raining, right?

Its cloudy and rainy and periodically sunny like.

There you go. Say hello to Darrell for me. Enjoy your day.

Thank you sir.

Having no further questions, 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 very much again for your patience and your questions today. Look forward to talking to you at the end of next quarter.

The conference is now concluded. Thank you for attending today’s presentation you may now disconnect.