Mechanics Bank (MCHB) Q1 2016 Earnings Report, Transcript and Summary

Good day and welcome to the HomeStreet First Quarter 2016 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mark Mason, Chairman, President and CEO. Please go ahead.

Hello and thank you for joining us for our first quarter 2016 earnings call. Before we begin, I'd like to remind you that our earnings release was furnished this morning to the SEC on Form 8-K and is available on our Web site at ir.homestreet.com. In addition, a recording of this call will be available today at the same address. On today's call, we will make some forward-looking statements. Any statement that isn't a description of historical fact is probably forward-looking and is subject to many risks and uncertainties. Our actual performance may fall short of our expectations or we may take actions different from those we currently anticipate. Those factors include conditions affecting the mortgage markets such as changes in interest rates that affect the demand for our mortgages, the actions of our regulators, our ability to meet our internal operating targets and forecasts, and economic conditions that affect our net interest margins. Other factors that may cause actual results to differ from our expectations or that may cause us to deviate from our current plans are detailed in our SEC filings, including our quarterly reports on Form 10-Q and our Annual Report on Form 10-K for 2015, as well as our various other SEC reports. Additionally, information on any non-GAAP financial measures referenced in today's call, including a reconciliation of those measures to GAAP measures, may be found in our SEC filings and in the earnings release available on our Web site. 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 a brief update on our recent events and review our progress in executing our business strategy. During the quarter, we completed the acquisition of Orange County Business Bank located in Irvine, California. The acquisition closed on February 1, 2016 and with it we added $188.3 million in total assets, a $125 million in loans held for investment, $126.5 million in deposits and one additional branch located in Irvine, California. Given the merger date of February 1st only two months of combined results are reflected in results of operations for the quarter. We welcome Orange County Business Bank employees, customers and shareholders and we look forward to growing their business throughout Southern California. In addition to the Orange County Business Bank location we also opened two de-novo retail branches in the San Diego area one in Kearny Mesa and one in Mission Gorge. These branches are located in close proximity to an existing Kaiser Permanente Hospital and a new one under construction. These branches expand our service to Kaiser Permanente employees and allow us to more quickly grow deposits in a new market like San Diego. As a consequence of our Affinity relationship with Kaiser Permanente that came with our acquisition of Simplicity Bank last year. These openings bring our retail branch count in Southern California to 10 locations. We also opened a de-novo retail branch in Kaimuki, Hawaii, a suburb of Honolulu near Diamond Head. Additionally, we opened a single family home loan center in Mesa, Arizona and a commercial lending centers Spokane, Washington. Last but certainly not least, we are proud to announce that we have entered our ninth state with the opening of a commercial real estate lending center in Dallas, Texas. Earlier this month, we combined the leadership of our Seattle based commercial real estate lending group and HomeStreet Commercial Capital, our small balanced commercial real estate finance group located in Southern California, following the resignation of Randy Daniels, who has led our group here in Seattle since 2012. Bill Anderson has been named Executive Vice President, Commercial Real-Estate and will lead the combined groups that are the name HomeStreet Commercial Real Estate. Bill has 41 years of experience in commercial real estate lending throughout the Western United States and has a proven record of building strong teams of lending professional focused on providing exemplary customer service. On March 31, 2016, the Kroll Bond Rating Agency published a report assigning the Company BBB- rating at our holding company and BBB at the bank level for senior unsecured debt. These ratings confirm the progress we’ve made in repositioning and diversifying our business and add to our flexibility in managing the capital needs of the Company. With that accomplished, we anticipate issuing senior debt at the holding company sometime this quarter. On April 14, 2016, we executed a $20 million unsecured line of credit for our holding company. It is an annual revolver to assist us in managing our working capital and liquidity needs at the holding company. However, we may also utilize the line to provide capital to the bank as needed for the maintenance of target regulatory capital ratios. On February 20, 2016, we converted the charter for HomeStreet Bank from our Washington State-chartered savings bank to a Washington State-chartered commercial bank. The chartered change reflects the progress we’ve made in our evolution from a traditional throughout [ph] focused primarily on residential mortgage and construction lending to a full service commercial and consumer bank. Concurrent with the change in the bank’s charter, we converted HomeStreet Inc to a bank holding company and elected to become a financial holding company. Additionally, I would like to announce that in conjunction with the financial planning related to my upcoming divorce, I plan to exercise all of my vested stock options and sell the related shares. I plan to exercise the options and sell the shares in the next 30 days. My share is subject to vested stock options totaled 242,168 shares. After the sale, I would still own over 242,000 shares, representing approximately 1% of the Company’s outstanding common stock. In addition to which I have over 21,000 unvested shares of restricted stock units and a target of some 27,000 shares to a maximum of 40,000 plus shares of performance share units based upon the achievement of certain performance goals for the Company. This option exercise and planned sale in no way reflects any negative change in my views on the business or prospects of the Company. Before Melba reviews our financial results, I will share some highlights for the quarter. In the quarter, total assets grew $522.8 million to $5.4 billion. The Orange County Business Bank acquisition comprised $188.3 million of this quarter and the remaining growth was 62% organic. Net income for the quarter excluding merger related items increased 11.4% to $9.8 million from $8.8 million in the prior quarter. Return on average tangible equity excluding merger related items increased from 7.8% in the fourth quarter to 8.1% in the first quarter. Diluted earnings per share excluding merger related items increased 5% from 39% per share on the fourth quarter to $0.41 per share in the first quarter. Tangible book value per share increased from $20.16 at December 31st to $20.37 at March 31st. Full time equivalent employees into the first quarter at 2,264 employees, up from 2,139 at the end of prior quarter. Net income for the commercial and consumer banking segment excluding merger-related items totaled $4.9 million and contributed 50.1% of our core net income for the quarter. Asset quality continued to improve and remains strong. Non-performing assets to total assets declined to 0.43% in the first-quarter from 0.50% from the fourth quarter. Our first quarter mortgage banking segment net income increased to $4.9 million from $301,000 in the fourth quarter reflected an increase in interest rate lock and forward sale commitments and a decrease in close loan volume during the quarter. Closed loan volume in our single-family mortgage banking segment totaled $1.57 billion in the first quarter compared with $1.64 billion in the fourth interest. Interest rate lock and forward sales commitments of $1.8 billion in the first quarter increased from $1.3 billion in the fourth. The cost of the recently implemented TRID [ph] requirements had still adversely affected our results during the quarter. While our processing times for loans have begun to normalize, we have been carrying additional support staff to reduce processing time and facilitate compliance with TRID. During the second and third quarters, these additional support staff will be gradually reassigned to process the seasonal increase in volume. Lastly, we believe that our strategy to portfolio substantial portion of our non-performing loan production worked well in that we have experienced minimal investor issues due to TRID once we resume selling this production. And now, I'll turn it over to Melba who will share some additional details on our financial results for the quarter.

Thank you, Mark, and good morning everyone. I'll first talk about our consolidated results and then provide detail on each of our segments. First quarter consolidated net income was 6.4 million or $0.27 per diluted share, compared with 8.7 million or $0.39 per diluted share for the prior quarter. The decrease in net income from the prior quarter was primarily due to the merger-related costs from the Orange County Business Bank acquisition. Excluding after-tax merger-related items core net income for the first quarter was 9.8 million or $0.41 per diluted share compared to 8.8 million or $0.39 per diluted share in the fourth quarter. This increase in core net income was primarily due to higher net gain on mortgage origination and sale activities partly offset by higher salaries and related costs. Net interest income was 40.7 million in the first quarter compared with 39.7 million in the fourth quarter of 2015. The increase was primarily due to the growth in average interest-earning assets specifically at 278.8 million for 8.9% increase in average loans held for investment. Our net interest margin was 3.55%, a decrease of 6 basis points from the fourth quarter half of which was due to the impact of purchase discounts and premiums from acquired loans and deposits with the remainder due to an increase in the cost of interest-bearing liabilities offset somewhat by an increase in non-interest bearing liabilities. While the Federal Reserve increased short-term rates in December, longer term rates have fallen since then placing pressure on our net interest margin. Non-interest income increased 6.3 million or 9.6% from the fourth quarter due primarily to higher net gain on loan origination sale activities offset somewhat by a decrease in mortgage servicing income. Net gain on mortgage loan origination and sale activities increased 14.6 million from the prior quarter and mortgage servicing income decreased 5.4 million due to lower risk management results stemming from higher long-term prepayment speed expectations offset somewhat by an increase in net servicing income. Non-interest expense was 101.4 million in the first quarter compared to 92.7 million in the fourth quarter, excluding merger-related expenses, non-interest expense was 96.2 million compared to 91.9 million in the fourth quarter an increase of 4.2 million. The increase in core expenses was primarily due to higher salaries and related cost due to the increase and employee headcount from the OCBB acquisition and organic growth initiatives during the quarter. Including a 1.5 million increase in FICA expenses due to the annual reset of limit at the start of the year. Upon the closing of the OCBB merger on February 1st, we implemented the first of the series were planned merger related operating cost reductions impacting the combined company. As non-integration critical employee began to depart. These reductions in personal and other now duplicative operating expenses have resulted in achievement of approximately 30% of the planned 60% of pre-merger run rate operating expenses in the first two months of combined operations. We expect to achieve substantially all planned cost savings by the end of the second quarter or this quarter. At March 31, the Bank's Tier 1 leverage ratio was 10.2% and total risk-based capital was 13.78%. The consolidated company's Tier 1 leverage ratio was 10.5% and total risk-based capital ratio was 12.05%. I'd now like to share some key points from our Commercial and Consumer Banking business segment results. The Commercial and Consumer Banking segment net income was 1.5 million in the quarter, compared to 8.4 million in the prior quarter. Excluding after tax net merger related items, the segment recognized core net income of $4.9 million in the first quarter compared to $8.5 million in the fourth quarter. Core net income was lower primarily due to the lower noninterest income and an increase in noninterest expenses. Segment noninterest income declined from 8.8 million in the fourth quarter of 2015 to 4.6 million in the first quarter due to lower gain on sale of loans primarily from our Fannie Mae DUS unit as well as lower gains on the sale of investment securities. Typically the first quarter is our seasonal low point for Fannie Mae DUS sales. Segment non-interest expense was $36.6 million, an increase of $7.1 million from the fourth quarter. Included in non-interest expense for the first quarter of this year and the fourth quarter of 2015 where merger related expenses of 5.2 million and 754,000 respectively. Excluding merger related expenses from both periods, the $2.6 million increase in expense is primarily due to higher headcount related to our acquisition of OCBB the growth of our branches and lending centers open during the quarter, as well as an increase in OREO expenses. We incurred a $393,000 write down of our commercial property in OREO in the quarter. We recorded a $1.4 million provision for credit losses in the first quarter compared to our provision of 1.9 million reported in the fourth quarter of 2015 reflecting the continued growth and balances of loans held for investment offset somewhat by continued recoveries during the quarter. The portfolio of loans held for investment growth increased 10.3% or $331.6 million to 3.55 billion from 3.22 billion at December 31st. The acquisition of Orange County business bank contributed approximately 125.8 million or a 37.9% of the quarterly growth. New loan commitments totaled 469.2 million and originations totaled 317.9 million during the quarter. Credit quality remained strong with non-performing assets at 0.43% of total assets at March 31st, and non-accrual loans at 0.45% of total loans. Non-performing assets were $23.3 million at quarter end compared to non-performing assets of $24.7 million at December 31st. We continued to enjoy positive charge-off experience with net recoveries of $364,000 in the quarter. Deposit balances were $3.8 million at March 31st, up from $3.2 billion on December 31st. The acquisition of Orange County business bank comprised 126.5 million or 21.4% of the 591.1 million growth in deposits during the quarter. Growth was primarily in non-interest bearing and other transaction and savings deposits with some growth in certificates of deposit to support the strong asset growth in the company. A portion of the non-interest bearing deposit growth is related to insurance and property tax escrow deposits for our mortgage servicing customers and loan payoff funds that we received that have not yet been remitted to investors stemming from the elevated refinance activity during the quarter. Excluding the impact of Orange County Business Bank transaction accounts grew by 5.6% during the quarter. Notably, our de novo brand strategy resulted in 17.9% deposit growth for just those branches during the quarter. I’d now like to share some key points from our mortgage banking business segment results. Net income for the mortgage banking segment was $4.9 million in the first quarter compared to net income of $301,000 in the fourth quarter. The $4.5 million increase in net income from the fourth quarter was primarily due to higher net gain on single family mortgage loan origination and sale activities due to higher interest rate lock and forward sale commitments during the quarter. Single family mortgage interest rate lock and forward sale commitments totaled $1.8 billion in the quarter, an increase of $463.5 million or 34.6% from $1.3 billion in the fourth quarter. Net gain on single family mortgage loan origination and sale activities in the first quarter was $59.5 million compared to $43.5 million in the prior quarter. The gain on sale composite margin increased to 336 basis points in the first quarter from 319 basis points in the prior quarter, primarily due to higher composition of refinances in our interest rate lock and forward sale commitment volume. Single family mortgage close loans totaled $1.57 billion in the first quarter, a decrease of $75.6 million or 4.5% from $1.65 billion in the fourth quarter of 2015. The volume of interest rate lock and forward sale commitments was higher than closed loans designated for sale by 14.7% this quarter, which positively affects reported earnings as a majority of the mortgage revenue is recognized an interest rate lock while the majority of origination cost including commissions are recognized upon closing. If rate lock and forward sale commitments during the fourth quarter would have equaled close loan volume, it would have resulted in approximately $6.9 million lower gain on loan origination and sale revenue. Conversely as closed loan volume have been the same as interest rate lock in forward sale commitments pretax income would have been approximately $2.7 million lower as a result of higher variable cost. Despite lower mortgage close loan volume in the quarter, the mortgage banking segment non-interest expense of $64.7 million increased $1.5 million or 2.4% from the fourth quarter. This increase was due to overall segment growth of personnel and offices from expansion into new markets and the cost of the added support staff to comply with TRID requirements that Mark had previously mentioned. Overall, we grew mortgage banking personnel by 3.8% in the quarter and closed loans per loan officer declined in the quarter to 3.8 loans per officer compared to 4.3 loans per officer in the fourth quarter. Single family mortgage servicing income was $7.3 million in the first quarter, a $5.5 million decrease from the fourth quarter of 2015. This decrease was the result of $5.9 million decrease in risk management results in the first quarter, somewhat offset by $462,000 increase in collected servicing fee income. Single family mortgage servicing fees collected in the first quarter of 2016 increased primarily due to higher average balances in our loan service or other portfolio. The portfolio of single family loan service for others was $16 billion at March 31st compared to $15.3 billion at December 31st. The $5.9 million decrease in risk management results from the fourth quarter was the result of the decrease in fair value of mortgage servicing rights due primarily to changes in prepayment expectations, somewhat offset by net hedging gains. I’ll now turn it back over to Mark to provide some insights on the general operating environment and outlook.

I’d like to now discuss the national and regional economies as they influence our business today. First, I’d like to remind everyone that we’re fortunate to operate in some of the most attractive market areas in the United States. Strategically we’re focused on the major markets in the Western United States, which today enjoy lower employment and substantially higher rates of population growth, job creation, commercial and residential construction and real estate value appreciation than the remainder of the country. Most recent Mortgage Bankers Association monthly forecast projects total loan originations to decrease 4.4% this year over the past year, a slight upward revision from its prior quarter forecast of 7.1% decrease. However, our focus has always been on the purchase market. The Mortgage Bankers Association forecasts that purchased mortgage origination are projected to increase 10% this year over last year while refinancing mortgages are projected to decline by 22%. Despite the increase in short-term interest rates by the Federal Reserve in December, mortgage rates have fallen and continue near historic lows, and nationally purchases are expected to comprise 62% of loan volume this year. Housing starts for this year are expected to be up 10.9% over 2015 levels. During the first quarter, purchasers comprised 53% of originations nationally and 49% originations in the Pacific Northwest. HomeStreet continues to perform at levels above the national and regional averages with purchasers accounting for 62% of our closed loans and 59% of our interest rate lock and forward sale commitments in the quarter. Our applications for purchase mortgages have increased 55% during the first quarter from 629 million in January to 975 million in March. The pace of housing permits has doubled nationally since 2009 while the pace in Washington is up 2.5 times and California is up 3 times since that time. Oregon matched the national average and Idaho was slightly weaker at 1.75 times. Home price increases in Washington, Oregon and California based on FHFA data accelerated across the board in the latest quarter, with year-over-year rates ranging from 7.7% in California to 10.5% in Oregon. According to the most recent Case-Shiller 10-City Composite Home Price Index report, which measures the change in value of residential real estate in 10 metropolitan areas, the index gained 4.6% from a year earlier. Seattle gained 11.0% over the last 12 months and Portland gained 11.9%. San Francisco gained 9.3%, Los Angeles gained 6.8%, and Dallas, Texas gained 9.0%. The rate of job growth in Washington, Oregon, California and Idaho averaged more than 3% last year, a full percentage point above the U.S. growth rate. The average unemployment rate in the same four states fell by 1 percentage point between 2014 and 2015 slightly more than the national decline even as new jobseekers migrated to the faster growing states. People are now following jobs again, until recently this staple of economic recovery was absent. The outlook for the economies in the four Pacific Northwest states based upon the latest forecast from the respective state forecasting agencies calls for continued but generally slower job growth lower unemployment rates and further increases in housing activity. Looking forward over the next three quarters in our mortgage banking segment, we currently anticipate mortgage loan lock and forward sale commitment volume of possibly $2.3 billion in both the second and third quarters and $1.8 billion in the fourth quarter of this year. We anticipate mortgage loans held for sale closing volumes of $2.3 billion, $2.4 billion and $2.1 billion in the second, third and fourth quarters of this year respectively. The seasonality is expected to produce greater variation in report results due to the timing of recognition related revenues and expenses and the expected imbalance between locks and closing. This imbalance is expected negatively impacted the quarters where closing exceed locks and vice versa. Additionally, we expect our composite margin to come back down to a range of between 315 and 325 basis points over that period as the increase refinancing activity we experienced in the first quarter wanes. As I mentioned earlier, our results in future quarters could to be further impacted by TRID requirements. We expect the increased cost we experienced in the first quarter to continue through the next several quarters until our software vendors complete their updates and our manual adjustments and enhance quality assurance audit procedures normalize. In our commercial and consumer banking segment over the next three quarters, we expect net loan portfolio growth to approximate 4% to 6% quarterly. Going forward we generally expect that our consolidated net interest margin to trend down to the 3.45% to 3.40% level by the fourth quarter reflecting now a flatter yield curve, absent changes in market rates, and prepayment fees. Our non-interest expenses are expected to grow on average approximately 3% 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 further investments in growth of both of our segments. This concludes our prepared comments. As always we appreciate your patience and attention today. Melba and I would be happy to answer any questions you have at this time. Operator if you would pull for questions.

[Operator Instructions] The first question comes from Paul Miller of FBR Company. Please go ahead.

On the OCBB acquisition right that closed in the quarter what type of cost saves and headcount can we expect to come out over the next quarter or two from that acquisition?

We carried approximately $700,000 of additional cost in the first quarter that is going to come out completely in the second quarter fully annualized, that's a little more than 700,000 because there was only two or three months so were expecting something closer to about a million dollars a quarter going forward. In terms of headcount I think that's in the 8 to 10 range, but there is also technology cost and other services that are duplicate that are being eliminated during the quarter.

And on your -- and you opened up six branches in the quarter that definitely adds the headcount what is your plan for this year -- I mean do you have -- what are your long-term plans on opening up branches over the next year or two?

I would expect a minimum of one branch a quarter depending upon the pace of our permitting and been opportunistic we have purchased some branches and deposits, that number is likely higher. This year it will be slightly higher because of the pattern that one we at leased and identified facilities and when those facilities get permitted and built out and so on so I would expect this year for our branch openings to be somewhere between six and seven on the retail side.

And then what geographies are you putting them in? Are you putting them all in Seattle or you opening a lot up and you are down now in Orange County, San Diego I mean where exactly you are opening up the branches?

I would expect to see them both in Southern California and in the greater Seattle area we still have many submarkets in greater Seattle and [Indiscernible] for that matter that we would like to be in, where that pacing has sort of been established. In Southern California we are taking the opportunity to work with Kaiser Permanente to identify locations both where we have existing customers that may not be served by physical branch and in that regard we have some 38 soon to be 48 ATMs in Kaiser Permanente locations many of which are not served by physical branch and so like the two branch opening this quarter in Southern California where they are taking the opportunity to enter a new markets where we would like to have a full service banking presence but have sort of the tailwind of a built-in customer base from the consumer group at Kaiser Permanente. This strategy has really been working for us if you look at the deposit growth trend over the last several quarters it has been very positive on the retail side and in fact our new or de novo retail branches that we have opened since 2012 are growing at about three times the pace of the overall bank right now. So, we’re pretty happy with the strategy at this point.

The next question comes from Jacque Chimera of KBW. Please go ahead.

I wonder, Melba if you might have where the individual line items for the M&A cost came from, just in terms of maybe what was in compensation and occupancy and other items like that?

I can provide that to you Jacque. In terms of the details it's primarily in salary and related expenses as well as in legal and consulting expenses.

We can provide you [multiple speakers].

We can provide the specifics.

And Mark what are you plans for Dallas?

Long-term, all we have done is open a commercial real estate lending office there. Dallas is in our strategy, Dallas I mean the group of the state of Texas is in our strategy long-term. As the Washington State-chartered financial institution, we’re subject to Washington State revenue base tax, a business and occupancy tax, under which we get a first mortgage deduction, which is pretty valuable to us. It’s worth about $2 million of tax per year. For so long as we operate only in 10 states or less, it's an interesting law here that protects the local and state banks. So we have identified 10 states that we expect to do business in long-term and Texas is included in that 10 state total. We hope to be in the mortgage business and the banking business in Texas on a comprehensive basis at some point today though we just have a commercial real estate lending office.

So at some point in the future might you look to M&A similar to what you did with Simplicity to help extend your presence there?

Yes.

And what is your 10 states that you’d like to be in?

Well, today we do business physically and obviously the Hawaiian Islands, Washington, Oregon, Idaho, Colorado, Utah, Arizona, California and now Texas.

I meant -- you said the Texas is your ninth state so I am just wondering if you’re willing to share what the 10 states that you’re looking to?

Well, it could be Nevada, it could be Alaska.

So open for whatever presents itself to you?

Yes.

And then can you provide an update on -- you gave great color last quarter on the heat maps that you look at in terms of what’s going on in your economies and difference within those micro economies and what you’re watching? And just kind of what you’re seeing if there has been any change from last quarter?

Sure, we do watch very closely. When you do the amount of complete real estate related lending that we do, and the amount of construction lending in particular that we do, we have to pay very close attention to the balance of supply and demand in these markets. The direction of rental rates absorption, velocity, cap rate movement, all these things that have a bearing on our collateral and getting repaid timely. And as I mentioned earlier, we operate in the best markets in the United States. And we focus on the primary markets or the strong secondary markets to lend in. So those markets today continue to be characterized as having inventory shortages of literally all property types today, not simply single family housing, new and used inventories, those inventories range from a partial month to less than three months in all of our markets, rental, availability. While there has been tremendous new construction of multifamily housing in all of these markets, there continues to be shortages, because of job growth and migration and now office shortage. We’ve been waiting to see the office market solidify. The office vacancy in the City of Seattle is down to 8%, that was well over 20% at the height of the recession. You see similar deficits of available office in the major markets in Portland, The Bay Area of California and in the major markets in California as well. We now see for the first time speculative construction in new high-rise offices not just here in Seattle, but there are notable projects in San Francisco and California and Portland as well. So our markets are characterized in the real estate areas by shortages and deficits of demand to supply. Job growth continues to be strong, I think we quoted some of those numbers earlier. In our line of site, all of the early warning indicators that we follow are stable-to-improving, so we feel quite good about the risk that we underwrite every day in lending. I hope that helps.

The next question comes from Ryan Zacharia of Jacobs Asset Management. Please go ahead.

Marks, thanks for taking the question, just helps me understand a little bit the profitability of mortgage origination excluding servicing, it looks like the origination piece kind of broke even this quarter and that was with the favorable lock versus closed dynamics, so can just maybe provide a little bit color on that?

We did better than breakeven for the quarter. I Think that if you bear with me for a second, I can give you a view of origination only profitability.

Also the servicing total was 7.3 million between the core servicing income and the net gain on the servicing and hedges and the profitability of the segment on a pretax basis was 7.4 million for the entire segment?

Right so origination for the segment earned pretax 3.4 million.

I am not sure I understand that, so the pretax income in the mortgage banking segment was $7.4 million doesn't that include the servicing income?

It does, so servicing and pretax for the quarter was about 3.9 million roughly and the balance was origination.

So when you're looking at the mortgage servicing income, if you're looking at page 28 on the earnings release that is just the income compliance.

That's just revenue right.

Right, that's just revenue that isn't net income or free tax income.

The offset to that is being your cost to service which is over $3.5 million?

No direct cost are about 2.5 million, but we have corporate allocations. So we fully allocate and absorb each business unit.

Yes, I typically see with the amortization reflecting the cost to service because your MSRs are held net of the servicing cost, but that answers the question.

The next question comes from Jeff Rulis of D. A. Davidson. Please go ahead.

Mark you've touched on a little of this on your economic discussion, but more specifically on the multifamily segment you've seen some operators in the region selling a lot of that production and a lot of it from a risk management standpoint. I guess if you could maybe outlined what your thoughts on that segment in terms of credit quality outlook and if you're seeing strain within that and granted that could be regional and I'd be interested to hear that color, but just thoughts on the multifamily segment in general?

Sure, in our markets and I have qualify everything with that caveat. The performance of the collateral is just amazingly good. Right, when we look at the actual build out and achievement of brands versus performance in multifamily construction. They're typically 10% to 15% of above pro forma rents, the absorption typically 50% to 60% of the pro forma absorption just as a generalization. In terms of availability I think I commented earlier there still is a deficit of inventory to demand. From our own risk management, so that's collateral performance and that's primary and strong secondary markets to right so when we’re talking about performance its core Seattle, core Portland, strong markets next to these, these markets are characterize by growing employment falling unemployment, right all the things that you would expect to contribute to that performance. In terms of our balance sheet risk management we have target diversification by not only loan types but collateral types as well multifamily we have always had a larger allocation to then other asset types because of its long-term performance and so we will always carry to somewhat higher balance of either construction or permanent lending having said that our origination volume and origination capability far out strips our ability ultimately to hold a 100% of our production and so you will see us this year selling larger proportion of the production mostly centered in the small balance production that our operation previously called HomeStreet Commercial Capital generates we expect to sell about two-thirds actually of that small balance production this year either into the secondary market or potentially going forward through securitization.

Okay thanks Mark for that color and then maybe a less dynamic question on the just a merger of costs. I think you targeted 6.8 and you recognized 5.2 in the quarters, are you guys are ahead of plan or would you recognize that balance next quarter what kind of where you at there?

We expect that we will recognized the majority of them in the first quarter and so we actually outperformed our expectations.

Okay, so what we have left $200,000 maybe, second quarter. Something small.

Very small.

Okay, great. Thank you.

The next question comes from Tim O'Brien of Sandler O'Neill and Partners. Please go ahead.

Hey mark you mention the kind of the targeted outlook for net interest margin through the remainder of the year. Did you say 340 to 345?

Yes.

Okay, thanks. And do you have a kind of targeted goal for deposit growth through the end of the year?

We do internally I mean I think it's safe to assume that given our guidance on loan growth that means to be supported primarily with deposit growth. Right, I mean we are like around a 100% loan to deposits and we don’t intend to go too far over that right so it's important we grow our deposits consistent with our loan growth.

Makes sense to me. And what you did this quarter in terms of organic deposit growth I saw CDs were up but looks like a 100 million maybe on an average basis though and the cost there was a little bit higher and I think that kind of played in that overall cost to deposits. So what's the strategy can you kind of dig in a little bit as far as what you needed to this quarter and what you might continue to do here going forward with regard to put adding time deposits perhaps or where is the best opportunity to find the most attractive sort of kind of funding that you want and need to support balance sheet growth.

Well, obviously we have to be focused on funding right when you look at our strategy for growth part of that funding strategy will have to be made up with time deposits we are seeking to keep that composition from rising much though that assumes it has the total growth the absolute total with time deposits as well will grow. More importantly though our branch opening activity and retail strategy along with our commercial banking strategy is expected to grow the lion share of the deposits going forward. We may add to that with acquisitions we have in the past of branches and deposits and that’s an opportunistic activity. Obviously, M&A can help that funding equation as well and we continue to look at deals that exist in the marketplaces in which we’re interested. And so, I would expect that that -- the answer to that lies both in organic growth and in M&A.

So looking at the end of quarter balances on a linked quarter basis, it looks like CDs were out -- were 732 at the end of ’15 and 901 at the end of first quarter. Were the CD additions this quarter, was that predominantly retail that you’ve any brokered CDs or?

It was, there was a retail component, there was -- I’m going to go with what I’d call it well it is an institutional component. And there is an institution of peer to peer market for CDs that was a substantial part and then about a 100 million of that was brokered.

And then did you guys purchase any commercial real estate loans this quarter? Or was it all in house originated?

It's all in house directly originated. We are not --.

[Multiple speakers] any business obviously.

I’m sorry, what?

Besides the Orange County Business Bank purchase that is, but --.

That’s right, I was excluding that. Yes, our strategy does not include nor need secondary market purchases of any loan type.

And no one intent than to use next year at some point to get involved there, it's all going to be in house generated?

It will be, but let me say about syndicated loans. At some point, we will have some syndicated lending activity. To-date I think, now that I think about we did do one small syndicated participation and I think that will be operated in this [indiscernible] when really attractive deals come across the valve, our business is primarily direct to the customers.

And out of curiosity, the loans production that you’d like to see take place out of the new Dallas office, I mean essentially what’s the niche you’re going after there?

So that’s purely commercial real estate, permanent commercial real estate lending and primarily multifamily.

Did you hire somebody local and build the office around that? Is that how that --?

It's a local originator, right, but local originator but with the western states book of business.

[Operator Instructions] The next question comes from Tim Coffey of FIG Partners. Please go ahead.

I want to talk about the efficiency ratios and the different business units. So look at the commercial and consumer banking segments against the backdrop of additional branch expansions already and those you have planned. How should we think about the core efficiency ratio?

Thank you for asking that. I’ve been beating up my internal people about how we report. If you look at our core efficiency ratios, I think we quoted it.

It's on page 17 on the earnings release.

So this ratio excludes M&A related expenses and so it is more core there are some other non-recurring things even things like intangibles amortization that other people do not include in their calculation of operating efficiency that we still do actually. We’re expecting this ratio, the core ratio, to fall to the low 60% range by the fourth quarter of this year, mid to low 60%.

Yes. So keep in mind in this quarter we had the overhang still from the remaining OCBB expenses that we will ring out, I should say that probably in first quarter relative to this quarter that will come. We also had five new office opened in the quarter so that impact it.

And addition FICO expenses.

And additional FICO expenses, now you will see in the second quarter obviously the full quarter impact of some of those additional offices from the first quarter. But as Mark mentioned as we move throughout the course of the year, we anticipate the efficiency ratio improving quite a bit.

And then so the revenue side of that efficiency ratio just going to be on balance sheet growth rate since you?

Right. No, I think that back. The other significant item in the quarter was really the absence of any material loans sales or securities gain, right. So if you look at the fourth quarter as an example, we had eight point some billion dollars of non-interest income most of which $7 million or so which was related to sales of Fannie Mae DUS loan or SBA loans. We had very little of that activity in the first quarter, but we expect to have a substantial amount of that activities for the remainder of the year. So you have two affects both a change in operating expenses and a pretty substantial increase in revenue, driving that change that expected changes in operating efficiency ratio.

Okay, are there any plans branch consolidations on the consumer or commercial banking side?

Consolidations, no, I mean we have not -- we don't expect acquire any that would be consolidatable and those open are in new markets.

Okay so kind of the run rate for expenses on the commercial and consumer side as expected to go up then?

It will but not as quickly as revenue, right. So expect that operating leverage to not only improve earnings but the ratios related to them like the operating efficiency.

And speaking of the loan sales, do you have any expectations for loan sales this year out of that CRE [ph] division?

Yes, we're expecting somewhere in excess of $200 million.

What are the prevailing premiums on those or gain on sales for those?

Obviously depends on the market, market timing and when we've seen premiums run from let's say the 2 percent to 3 plus percent.

And then my last question on the net interest margin, how much of that say I guess decline from here is the result of higher cost of deposits?

So when you look at our net interest income sensitivity, we do see that we have more liabilities re-funding and re-pricing in zero the three months and we do assets, so a number of that is our federal home loan bank advances re-pricing and then the remainder would be to higher cost of deposits.

And we have a follow-up from Tim O'Brien of Sandler O'Neill & Partners. Please go ahead.

Just real quickly on the Fannie Mae DUS loans, Melba you've mentioned that first quarter was a lower water point for that what's the kind of range of revenue quarterly revenue you expect to see here and through the remainder of the year?

That going to be -- it could be lumpy, when we first say right, the timing of not just the origination but the sale of the loan may not be really even.

Yes, I would say so Mark mentioned as well right the last quarter was a high water mark with respect to that non-interest income coming through that segment and the first quarter as a low water market. So I think it's fair and reasonable to take the average of the two quarters in terms of expectations going forward.

Right so this quarter that number was down in the sort of one point --.

So in total in addition to the DUS sales the other multifamily sales as well.

So depending upon the level of activity that number could range from $2 million to $5 million depending upon the quarter?

Including multi?

Including multi, right, so all and including SBA.

Next is a question from Bill Dezellem of Tieton Capital Management. Please go ahead.

A couple of questions first of all relative to your DUS sales are been down in the first quarter versus the fourth quarter and having virtually none this quarter, can you tell us why that was and if it's pricing or something else going on?

Sure. It's a little bit typical seasonality, the fourth quarter typically has a lot of activity loans that investors or buyers of property or people refinancing want to get concluded by yearend so there is always a rush to close as much of the pipeline as possible for customer purposes as well as our own. And typically in the first quarter there are not as many sale transactions, people are just starting the year and activities is seasonally slower and so we expect the remainder of the year to be more typical seasonally with higher activity. But the fourth quarter is always busier and the first quarter is typically smaller.

And then secondarily what's the timing for when you anticipate your additional commercial expenses that you've been incurring here this quarter to turn into earnings accretive?

So for the Orange County business bank acquisition we are still expecting that acquisition to be accretive this year some 3% we will have some transition expenses in the second quarter, but by the end of the second quarter all of the expense savings will have been realized and so from third quarter forward we should get the run rate we expect out of that acquisition.

And then additional expenses that you've just -- people you've been hiring and it looks like that their cost was greater than the revenues that they generated here in the quarter and just wondering when you think that will all reverse?

So with respect to de novo branch openings that occurs over a more linked the time frame right because it's related to the acquisition of deposits in the marketplace. I mean typically we expect branches to be breaking even depending on how you calculate the interest rate associated with deposits and about two years, fully I would say fully funded or fully grown I guess and about five years. Our branches have been running ahead of that number, typically, I think in all the two cases are well ahead of the deposit acquisition pace that we expect. So with respect to new branches that is that's the time frame. With respect to other positions that may relate to corporate infrastructure they may not be positions but they may have to be added as a consequence of our growth, so that what's adds are related to current growth in other areas that might be in compliance or legal or county finance some of these areas, human resources that ultimately becomes sort of size denominated. Our lending centers however are expected to be profitable within a couple of months of opening so any of our expansion expenses invested in new lending centers whether they’d be single family, home building or commercial real estate are expected to be profitable in a relatively short period of time.

Thank you.

This concludes our question-and-answer-session. I would like to turn the conference back over to Mark Mason for any closing remarks.

Again we appreciate your patience, your attention this morning, all the great questions. We look forward to talking to you again next quarter. Thank you.

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