Mechanics Bank (MCHB) Q3 2016 Earnings Report, Transcript and Summary

Good day and welcome to the HomeStreet Third Quarter 2016 Earnings Conference Call. All participants will be in 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 Mr. Mark Mason, Chief Executive Officer. Please go ahead.

Hello and thank you for joining us for our third quarter 2016 earnings call. Before we begin, I'd like to remind you that our earnings release was furnished yesterday to the SEC on Form 8-K and is available on our website at ir.homestreet.com. In addition, a recording of this call will be available later today at the same address. On today's call, we will make some forward-looking statements. Any statement that 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 website. Please refer to our earnings release for a more detailed discussion of our financial condition and results of operations. Joining me today is our Senior Executive Vice President and Chief Financial Officer, Melba Bartels. In just a moment, Melba will present our financial results, but first I'd like to give you a brief update on our recent events and review our progress in executing our business strategy. In July we announced the hiring of Ed Schultz as our Executive Vice President of Commercial Banking for The State of California. California is a very important state for us from a growth perspective and Ed comes to us with a successful career of senior leadership in Commercial Banking in California and a track record of building successful commercial lending teams. We’re happy to have Ed’s help in this important initiative for HomeStreet. fluid suburb (0:07:27): We also opened a new retail deposit branch in Riverside California. This location is half a block away from a large Kaiser Permanente Medical Center and represents the most recent expansion of our relationship with the employees of Kaiser Permanente. The proximity to this Kaiser facility allowed us to open up a branch in a new market where HomeStreet is relatively unknown. The Kaiser employee base there provides us a built-in population of customers with whom we already have existing relationships. Additionally the previously announced pending acquisition of two retail deposit branches located in Granada Hills and Burbank California from Boston Private Bank and Trust is scheduled to close next month. These branches have approximately $110 million in deposits today. These branches are also each located near Kaiser Permanente facilities and will increase the number of our retail deposit branches in Southern California to 13. Additionally during the quarter we opened three standalone home loan centers two of which are in Arizona and one in Sherman Oaks California. This expansion was offset by the closing of one standalone home loan center in San Rafael California. Finally I’d like to take a moment and address our retail branch incentive compensation practices. In contrast to the retail incentive compensation practices at Wells Fargo our culture is based on serving the customers needs as expressed by the customer. While our branch management, not platform personnel, have incentives involving net new deposit accounts we have no quotas or minimum expectations and these incentives are a small minority of the incentives available to these personnel. The preponderance of our retail branch incentives relate to net new deposit balances. Our branch personnel are incented primarily to attract and retain business deposit balances and those balances must be seasoned and these results are audited by our management personnel for authenticity and accuracy. Additionally we do not today and never have had incentives based upon the number of accounts per customer. For your knowledge we have never had an incident of an employee gaining our incentive system by boarding the accounts not authorized by the customer. We do have an effective system of incentives for cross selling referrals but the referring employee has no ability to influence the outcome of the referral after it's made and the incentives are not paid unless the customer is served and the product is provided. In summary the foundation of our corporate culture is to serve the customers needs as expressed by that customer not to push unwanted or unneeded products and our incentive programs will reflect this culture. Before Melba reviews our financial results, I would like to share some highlights from the quarter. Net income for the quarter excluding acquisition-related items increased 25% to $28 million from $22 million in the prior quarter. This represents a new record for HomeStreet. Total assets grew $285 million or 5% in the quarter to $6.2 billion. Annualized return on average tangible equity excluding acquisition-related items was 20% in the quarter. Diluted earnings per share excluding acquisition-related items increased 24% from $0.90 per share in the second quarter to $1.12 per share in the third quarter. Tangible book value per share increased from $21.38 at June 30, to $22.45 at September 30. Net income for the Commercial And Consumer banking segment excluding acquisition-related items totaled $10.5 million a record for this segment, since we began reporting it separately in 2013. Also operating efficiency excluding acquisition-related items was 64.5% for the quarter reflecting the ongoing operating leverage we have generated with growth and the maturing of our Commercial and Consumer banking activities. Loans held for investment increased $66.5 million or 1.8% during the quarter to $3.8 billion. New portfolio loan commitments during the quarter remained strong and totaled $601 million in the quarter. However net loan growth was adversely impacted by lower levels of loans funded during the quarter. Originations totaled $350 million for the quarter as compared to $440 million in the second quarter. The ratio of non-performing assets to total assets ended the quarter at 0.52% a slight increase from the second quarter’s level of 0.45% but still reflecting excellent loan quality and our early warning credit indicators are continuing to show strong fundamentals in all of our markets. Our third quarter Mortgage Banking segment net income increased to $17.6 million from $14.7 million in the second quarter reflecting the continued low interest rate environment in driving a increase in mortgage originations and another quarter of strong servicing revenue, risk management results and the continued leveraging of our servicing platform as we grow our servicing portfolio. Closed loan volume in our single-family Mortgage Banking segment totaled $2.6 billion in the third quarter compared with $2.3 billion in the second quarter. Interest rate lock and forward sale commitments of $2.7 billion in the third quarter increased from $2.4 billion in the second quarter. Churn remains a challenge for us and minor manual edits are required on most loans resulting in increased time and cost to close loans as we continue to carry a higher percentage of support staff to sales staff that we believe is optimal. We prioritize purchase transactions in order to meet our customers closing schedules and the increase in refinance volumes have strained our resources somewhat. The expected seasonal slowdown in the fourth quarter and our conversion to a new loan origination system early next year should improve our efficiencies and lower costs once fully implemented. And now I will turn the call over to Melba who will share additional details on our financial results for the quarter.

Thank you Mark and good morning everyone. I'd like to first talk about our consolidated results and then I’ll provide detail on each of our segments. Third quarter net income was $27.7 million or $1.11 per diluted share, compared to $21.7 million or $0.87 per diluted share for the prior quarter. The increase in net income from the prior quarter was primarily due to a $7 million increase in the net gain on mortgage loan origination and sales and $2.3 million increase in net interest income. Excluding after-tax acquisition related items core net income for the third quarter was $28 million or $1.12 per diluted share compared to $22.4 million or $0.90 per diluted share in the second quarter. Acquisition related expenses totaled $512,000 for the quarter primarily due to the expenses related to the Bank of Oswego acquisition completed in the quarter. Net income for the nine months of 2016 was $55.9 million or $2.27 per diluted share compared to $32.6 million or $1.58 per diluted share for the same period in 2015. The increase period over period was primarily due to $23.4 million higher net interest income. $49.7 million higher net gain on mortgage loan origination sale activities and $24.9 million higher mortgage servicing income partially offset by $41.4 million higher salaries and related expenses. Average loans held for investment grew by 32.1% from the year ago period from $2.7 billion to $3.6 billion. Excluding after tax acquisition related items core net income for the first nine months of 2016 was $60.2 million or $2.45 per diluted share compared to $35.5 million or $1.72 per diluted share for the first nine months of 2015. Included in the non-core items for the first nine months of 2016 was $6.7 million of acquisition related expenses compared with $15.8 million of acquisition related expenses and $7.3 million bargain purchase gain for the same period of 2015. Net interest income was $46.8 million in the third quarter compared to $44.5 million in the second quarter. The increase was primarily due to higher interest income from the growth in average interest earning assets, specifically a higher balance of loans held for sale stemming from the increased Mortgage Banking production this quarter and a higher balance of investment securities as we temporarily invested the capital from our May debt raise until it is redeployed into future loan growth. Our net interest margin was 3.34%, a decrease of 14 basis points from the second quarter, due to a shift in asset mix reflecting lower yielding investment securities and loans held for sale and the higher cost of funds primarily from the full quarter’s impact of our long-term debt issuance. Average interest earning assets increased by a larger amount than average interest earning liabilities increasing the impact of non-interest bearing sources to 17 basis points in the third quarter from 15 basis points in the second. Non-interest income increased $9.3 million or 9% from the prior quarter due primarily to higher net gain on loan originations and sale activities, as well as an increase in mortgage servicing income. Net gain on mortgage loan origination and sale activities increased $7 million and mortgage servicing income increased $1.4 million from the prior quarter. Non-interest expense was $114.4 million in the third quarter compared to $111 million in the second quarter. Excluding acquisition-related expenses, non-interest expense was $113.9 million compared to $110 million in the second quarter, an increase of $3.9 million. The increase in core expenses was primarily due to higher commissions paid as a result of the 17.1% increase in single family close loan volumes. At September 30, the bank’s Tier 1 leverage ratio was 9.91% and total risk based capital was 14.41%. The consolidated Company’s Tier 1 leverage ratio was 9.52% and a total risk based capital ratio was 12.25%. 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 $10.1 million in the quarter compared to $7.1 million in the prior quarter. Excluding after tax net acquisition related items, the segment recognized core net income of $10.5 million in the third quarter compared to $7.7 million in the second quarter. Growth in core net income was driven by improved operating efficiencies as revenues increased and expenses declined. Core return on average tangible equity for the segment was 9.1% for the quarter compared to 7.4% in the prior quarter. Net interest income increased to $39.3 million in the third quarter from $38.4 million in the second, primarily due to increases in loans held for investment and investment securities. Segment non-interest income increased from $8.2 million to $9.8 million primarily due to higher pre-payment fees collected during the quarter. Segment non-interest expense was $32.2 million, a decrease of $1.9 million from the prior quarter. Included in non-interest expense for the second and third quarters of 2016 were acquisition related expenses of $1 million and $512,000 respectively. Excluding acquisition related expenses from both periods, the $1.4 million decrease in expense is primarily due to lower incentive compensation. We recorded a $1.3 million provision for credit losses in the third quarter of 2016 compared to a provision of $1.1 million recorded in the second quarter reflecting continued growth in the balance of loans held for investment and lower recoveries relative to the prior period. The portfolio of loans held for investment growth increased 1.8% or $65 million to $3.8 billion in the third quarter. New loan commitments totaled $601 million and originations totaled $349.9 million during the quarter. While pay-offs and pay-downs during the third quarter were consistent with prior quarters originations in advances were somewhat lighter resulting in lower net loan growth. We expect this to reverse itself going forward as our pipeline of loan originations remains strong. Credit quality remained strong with non-performing assets at 0.52% of total assets as of September 30, and non-accrual loans at 0.68% of total loans. Non-performing assets were $32.4 million at quarter end compared to non-performing assets of $26.4 million at June 30. The increase was primarily due to an increase in single family and commercial non-accrual loans offset somewhat by a decrease in other real estate owned. We experienced net charge-offs of $18,000 during the quarter. Growth charge-offs during the quarter totaled $398,000 primarily from two home equity loans that were originated during 2006 and 2007. Recoveries for the quarter totaled $308,000. Deposit balances were $4.5 billion at September 30, up from $4.2 billion on June 30. Transaction accounts increased 5% during the quarter. Total non-interest bearing accounts including deposits related to our mortgage servicing customer increased 19% during the quarter. Notably, our de novo branches those opened since the beginning of 2012 grew deposits by 34.6% during the period. Deposits in our acquired retail branches increased 11.1% during the quarter. Out of which the deposits acquired from Bank of Oswego accounted for 4.2% of the quarterly growth. I’d now like to share some key points from our Mortgage Banking business segment results. Net income for the Mortgage Banking segment was $17.6 million in the third quarter compared to net income of $14.7 million in the second quarter. The $2.9 million increase in net income from the second quarter was primarily due to higher gain on single family mortgage loan origination and sale activities due to higher interest rate lock and forward sale commitments during the quarter. Return on average equity for this segment was 68.4% for the third compared to 62.8% for the prior. Gain on single family mortgage loan origination sale activities in the third quarter was $88.9 million compared to $81 million in the prior quarter. Single family mortgage interest rate lock and forward sale commitments totaled $2.7 billion in the third quarter, an increase of $327.9 million or 13.9% from $2.4 billion in the second quarter. The gain on sale composite margin declined to 330 basis points in the third quarter from 347 basis points in the second quarter. Single family mortgage closed loans totaled $2.6 billion in the third quarter, an increase of $386.3 million or 17.1% from $2.3 billion in the second quarter. Mortgage Banking segment non-interest expense of $82.2 million increased by $5.3 million or 6.9% from the second quarter. This increase was primarily due to higher commissions and incentives due to increased closed loan volumes. Overall, we grew Mortgage Banking personnel by 5.3% in the quarter. Closed loans increased in the quarter to 5.7 loans per loan officer compared to 5.3 loans per loan officer in the second quarter. Single family mortgage servicing income was $11.8 million in the third quarter, a decrease of $179,000 from the prior quarter. The portfolio of single family loan service for others was $18.2 billion at September 30 compared to $17.1 billion at June 30 which accounted for the $1.1 million increase in single family mortgage servicing fees collected during the quarter. I’ll now turn it back over to Mark to provide some insights on the general operating environment and outlook.

Thank you Melba. I’d like to now discuss the national and regional economies as they influence our business today. First, we’re fortunate to operate in some of the most attractive market areas in the United States today. Strategically, we are focused on the major markets in the Western United States, which today enjoy lower unemployment and substantially higher rates of population growth, job creation, commercial and residential construction and real estate value appreciation in the remainder of the country. The major markets that we focus on are substantially larger than most of the other markets in the United States which gives us ample opportunity to grow. The most recent Mortgage Bankers Association monthly forecast projects total loan originations to increase 12.8% this year over last year, and to decline by 16.2% next year. The forecasted declined from 2016 to 2017 is driven by a 47% decline in expected refinancing volume, however, the forecasted decline in refinanced volume should impact our business to the degree it will nationally as our focus has always been on the purchase market. The Mortgage Bankers Association forecasts that purchased mortgage originations are projected to increase 10.6% next year. Despite the increase in short-term interest rates by the Federal Reserve last December, long-term interest rates have fallen this year along with mortgage rates and continue near historic lows. While the 10-year treasury yield has increased somewhat since it fell to a record low of 1.3% following the Brexit vote. It continues to remain low on an absolute basis at approximately 1.7%. These low rates should continue to support housing affordability and keep demand of re-financing high. Nationally purchases are expected to comprise 54% of mortgage loan volume this year and 70% next year. Housing starts nationally for this year are expected to be up 8.5% from 2016 to 2017. It is worth noting that housing starts have not yet fully recovered from their lows during the recession and are expected to approach their long led average level of 1.4 million units by the fourth quarter of 2018. During the third quarter, purchases comprised 53% of originations nationally and 51% of originations in the Pacific Northwest. HomeStreet continues to perform at levels above the national and regional averages with purchases accounting for 64% of our closed loans and 53% of our interest rate lock and forward sale commitments in the quarter. Home price increases in the Washington, Oregon and California based on FHFA data continue to remain strong in the latest quarter, with year-over-year rates ranging from 7.2% in California to 11.7% 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 4.2% from a year earlier. Seattle gained 11.2% over the last 12 months. Portland 12.4%, San Francisco 6%, and Los Angeles gained 5.5%. The rate of job growth in Washington, Oregon, and California averaged more than 3% last quarter, 72% higher than the US growth rate of 1.8%. The average unemployment rate in the same three states averaged 5.2% last quarter slightly more than the national average of 4.9%. This elevated level of unemployment in our markets is influenced by our growing labor mobility. In areas of strong job growth migration of workers to areas where job opportunities are greater tends to hold up unemployment rates. Looking forward to the next two quarters in our Mortgage Banking segment, we currently anticipate single-family mortgage loan lock and forward loan sale commitment volume to be $2 billion in the fourth quarter and $2.1 billion in the first quarter of next year. We anticipate mortgage held for sale closing volumes of $2.4 billion and $1.8 billion during the same periods respectively. We are entering our seasonally slower mortgage production period as the fourth and first quarters are typically the slowest for mortgage originations and the second and third quarters typically the strongest. In addition as we continue to close the elevated level of interest rate lock in the forward commitments our Mortgage Banking results will be negatively impacted due to closings exceeding locks. This earning impact due to the difference between recognizing revenues and expenses due to the imbalance of timing of locks and closings should reverse again as we enter into seasonal mortgage production increases in the middle of next year. Looking to 2017, we anticipate an increase in single-family mortgage loan lock and forward sale commitments to total $9.3 billion and loan closing volume to total $9.4 billion next year. These volumes will be subject to the typical seasonality we experienced. Volumes will also to be highly depended on the housing markets in which we do business, local economic conditions, affecting employment, growth and wages as well as prevailing interest rates. Additionally we expect our mortgage composite profit margin to come back down to a range of between 315 and 325 basis points over the next few quarters and stay within that range next year. We expect the increased TRID related costs we experienced in the third to continue through the next several quarters until we complete the installations of our new loan origination system early next year. In our Commercial and Consumer Banking segment, we expect quarterly net loan portfolio growth to approximate 4% to 6% a quarter next year. Reflecting the continued flatness to the yield curve and consistent with our guidance last quarter, we expect our consolidated net interest margin to trend between 3.30% to 3.35% during the next two quarters and continuing through next year, absent changes in market rates, and low prepayment fees. Reflecting the seasonal peak of origination in sale activities we believe that non-interest expense growth in the third quarter represented a peak for the year. Therefore we do not expect our non-interest expense to meaningfully increase in the fourth quarter. In fact we expect non-interest expense to decline somewhat from the third quarter levels. During 2017, our non-interest expenses are expected to grow on average of approximately 2% per quarter, reflecting the continued investment in our growth and infrastructure. This growth rate will vary somewhat quarter-over-quarter driven by seasonality in our single-family closed loan volume and in relation to the timing of further investments in growth in both of our segments. This concludes our prepared comments today. We thank you for your patience and attention. Melba and I would be happy to answer any questions you have at this time. Operator?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jeff Rulis of D. A. Davidson. Please go ahead.

Thanks, good morning.

Good morning Jeff.

A question on the – just on the credit quality and I don’t know if this is Melba or Mark but on the – Melba touched on just sort of the single family credits that popped up. I guess is there any sort of common theme with those or region that you identified?

There really isn’t a – it is actually a bit of hangover issue from the recession. Several of the builders that the company banks pre-recession maintain fleets and rental properties they would commonly retain a certain portion of their production and hold it for rental. These portfolios, some of which were quite troubled during the recession and most of that has been worked out. We have one of those that we put on non-accrual this quarter because of overall credit problems the borrowers are having. We are fully secured however and the property’s cash flow but because of the uncertainties surrounding the insolvency action that the client is coming through we put it non-accrual. So lot of locations on the portfolio as a whole additionally the commercial area we downgraded and put our non-accrual couple of agriculture credits, we don’t think those represent a trend in that portfolio they were specific issues related to those two borrowers and so we think that the downgrades and the slight up tick in non performers is really not indicative of a new trend.

So Mark on the residential credit those were – there is no other that might meet that category or that criteria you kind of ring fence that group?

We have a couple of other portfolios of that type but they are all pretty strongly cash flowing and we don’t have concerns about them.

Okay. And just a question on - in your filings on the inquiry on the fair value hedge accounting. Is that inquiry largely complete and maybe what accounting adjustments have you made?

This SEC inquiry relates to the disclosure we made back in the third, fourth quarter of 2014 while we discovered that we have some errors in valuations and accounting for a pretty small – orphaned commercial loan program it is pretty common program whereby the bank would originate a 10-year fixed-rate commercial real estate loan, swap it to floating and the borrower would be responsible in the event of pre-payment for any loss on the swap pretty common program. It was pretty small here at the bank and because of that it didn’t get the accounting and treasury attention it deserved to really get the numbers right. The accounting error part that was immaterial but the math or the error potential could have been material. And so we have recognized it as a material to control weakness at that time, fully disclosed all that, did all the analysis work with our auditors to make sure there wasn’t some restatement or something recordable. It was immaterial in all cases but we made the disclosure of the circumstances. And the SEC was interested in understanding the back ground to it and how it occurred, we have not completed that process with the SEC yet. But I am confident there is not going to be any material impact on the Company from resolving that inquiry, how it is resolved and I am hoping to resolve it here in the next several months. But again I have no reason to believe there is any material outcome or impact on recovery.

So this didn't have anything to do on the – I guess fair value accounting or hedge accounting and the single family MSR it was all commercial?

Yes, it was looking to – nothing to do with our servicing hedging or pipeline hedging on the single family side. Only with respect to this – I mean relatively small it was about $30 million of loans outstanding at the time, very small commercial real estate hedge program.

Got it. Thanks, Mark.

Sure.

Our next question will come from Paul Miller of FBR and Company. Please go ahead.

Okay. How you doing? You had a fantastic quarter, as almost I think back to [indiscernible] almost 70% mix between Mortgage Banking and Commercial Bank. But your Commercial bank went from $10 million up from a rough $7 million last quarter. How much of that is would you consider normal and what do you – right now if we got into a normal refi cycle? What do you think your mix shift would be?

We believe we are running about 50-50 right now normalized for refinancing volume and profit. In the quarter, we did have a higher level prepayment penalty income in the commercial real estate area and that increased earnings to the segment after-tax is a little more than $1 million roughly, so normalized maybe that's $9.1 million or $9 million quarter. It shows well relative to the prior quarter and still shows strong improvement in operating leverage as well, which is obviously one of our primary goals in the business not just growing it, but making it appropriately efficient. Our mix in succeeding years should continue to change. I think we should get to sort of a 60/40 mix within 12 months or so. And more beyond that and that's without any additional acquisitions or substantial growth that we are expecting in California Commercial Banking. So we're hoping that mix continues to change positively.

The only thing I would add to that comment is while the non-interest income in the quarter will get benefit from higher prepaid fees. We do continue to expect non-interest income overall to remain fairly stable at the current quarter levels as we anticipate higher best sales in the current quarter.

Right. Now just…

Higher DUS sales, is that considered mortgage bank or considered commercial bank.

That's to the commercial bank, for all the commercial real estate activities are in the commercial consumer segment.

Yes.

So that gain on sale activity from the origination in sale of Fannie Mae DUS loans is in the non-mortgage banking segment. And we're expecting the solid quarter, the fourth quarter typically in that business that is the highest quarter of the year. It's good because it falls off pretty significantly the first quarter, but we're expecting strong next quarter.

And then speaking about M&A, you've been very active acquirer of banks, are you taking a break here a little bit or are you still looking to add in some footprints and if you are what footprints would you really like to move it?

We still are an active, I would say value hitter of opportunities both in whole bank and branch opportunities, obviously deposit gathering is important to us at this growth rate. We worked on several this year, obviously that were not announced. We are currently are looking at several. I can't really probabilities on any of them other than just say, we remain actively involved in the properties that come to market that we can afford. Even trading better recently there are some of the best banks that will sell, that for us to purchase would just be to dilutive to our shareholders. And so the situation we can’t get involved in, we have been able to find solid properties that we can improve and add to our network and I expect we're going to continue to.

Is there any footprints would you – I mean is it the Los Angeles market? Or is it just wherever you find an opportunity?

Obviously we favor as we’ve discussed the larger population area, so the coastal large metropolitan markets, we constantly look in from Southern California from spot out at San Diego up through the Bay Area, the Portland metropolitan area the [indiscernible] quarter – obviously up through Seattle. Those are all favored, we would look at anything in Hawaii. But we have other markets that we are ultimately interested in that are quite as large from Phoenix to Salt Lake City to Boise to Denver and perhaps someday to Texas.

Okay. Hey, thanks a lot Mark.

Thanks, Paul.

Our next question will come from Jackie Boland of KBW. Please go ahead.

Hi, good morning.

Good morning.

Good morning.

Just to clarify the 60/40 is 60 commercial, 40 mortgage, right.

Correct. I'm sorry if that wasn't clear.

Okay. It may have been I was writing quickly. And did any of the theory prepayments that impacted fee income – did any of that impact loan growth in the quarter?

Well, sure, because they were sizable loans, prepayments fees in the quarter remain high and we are running in excess of 20% annualized rate each of the last several quarters. I don't think that we thought that prepayment speed was high enough to call it out in terms of where it's been running, but it remains fast I think that's true for everyone today.

And just revisiting the comment during prepared remarks that prepays had remained relatively constant on a quarterly basis. What was different in the loans that prepaid this quarter versus last quarter that drove the increase in fee income?

Most of it was – of the unusual prepayments it was related to one fairly sizable commercial real estate loan that was restructured during the recession. And it was a sizable prepayment penalty because of a pretty favorable structure that we negotiated to get the loan through the recession. And the property and the borrowers were covered to the extent they could get a much better rate. And they did it was a sizable prepayment penalty, but the economic values of them doing it was larger.

And Jackie I would just say that, that was called out as a primary driver for the commercial consumer bank in terms of servicing income, but overall I think it really didn't stand out on a consolidated basis.

Okay, thank you. That's very helpful. And as I'm looking at the NIM and just thinking about it in light of the I know we had the full quarter impact of the senior notes in there. Are we nearing a bottom for that and could we see it go up from here just as you deploy some of that liquidity into loans and out of help for sale in investments?

So we did give guidance right in terms of our forward look on NIM between 330 to 335, which at the top end would be pretty stable, so where we ended the quarter last quarter, so and I would expect for the next quarter to remain around that level and trend down over the course of the year. So there will be some offsetting factors in that.

But by trending down it's within that…

Within that range, exactly…

And you’re the 330 to 335 guidance that you provided did that assume a remix of earning assets or over the quarters?

It does it. It assumes [indiscernible] ratings into loans held for investment.

Okay, okay. And then just lastly – and if we look at where guidance was for lock volume last quarter versus where it ended the quarter. I guess what changed, what drove the strength that you saw was a just pounding the payment and having a lot better results than you are anticipating any change in the environment?

But I would say one of the key factors is percent of refi volume in the quarter in the industry in total. So in the second quarter and I think Mark touched on this our industry loss volume was 35% refi in the third quarter that went up to 47%. So of course that increased our overall production quite a bit.

And we did not anticipate it, when giving guidance.

Okay. That makes sense. Thanks guys. I'll step back now.

Thanks, Jackie.

Our next question will come from Tim Coffey of FIG Partners. Please go ahead.

Hey, good morning, everybody.

Hey, Tim.

Good morning.

Mark, the growth of the commercial portfolio and the deposits that you're bringing and on that side, is that going to have any positive effect on your deposit costs going forward you think?

Well, that's part of our goals right? Ultimately, yes. Business customers tend to have higher levels and higher composition of non-interest-bearing deposits, interest-bearing deposits. It is a significant goal to grow the balance of our C&I business and related deposits. We are getting better at it, but of course these are still small portfolios relative to the whole. And so we expect that will have a positive impact on our relative deposit cost. It already is having some benefit how quickly we can do that is subject to some uncertainty at this point. I think our track record though of growth both in the business accounts and notably consumer accounts through our de novo branching that track record is very strong I don't know if you got the statistic in our prepared remarks that our new branch our de novo deposits grew almost 40% in the quarter. To me that's a spectacular number and a material part of that growth is in non-interest-bearing accounts.

Okay I didn’t and that was actually my follow-up do you see those de novo branches becoming profitable on standalone basis fairly soon?

Many of them are. The oldest that you can call it over the first in de novo branch that we opened post IPO has total deposits in excess of $35 million. So unless you get above say $15 to $20 million they are above breakeven.

Okay great. And then on the dust sales going forward obviously you had a pretty – very good second quarter slower sales this last quarter what are we looking at for say 4Q and 1Q?

More in 4Q and less in 1Q. I don't have a solid estimate for you right now because we're actually negotiating with Fannie Mae as to what we can deliver in the quarter. They have to manage their origination cap pretty closely and for that reason I'm not sure yet what the reasonable range – of sales which for our financial results both are important right because that gain on sale we don’t recognize it until sale in that category of loans because we carried them at lower cost to the market as opposed to our single family mortgage loans held for sale at fair value. So we’ve recognized a lot of revenue at origination. In this case we’ve recognized most of it on the Fannie Mae commercial real estate loans mostly loans upon ultimate sale and securitization to Fannie.

Alright thanks, those were my question.

Thank you. Tim.

Our next question will come from Tim O’Brien of Sandler O'Neill partners. Please go ahead. Tim O’Brien: Good morning Mark and Melba

Good morning

Good morning Tim O’Brien: Mark I think you probably gave guidance on this but I was listening but I missed it. Did you give held for investment loan growth guidance for 4Q or 4Q, 1Q in 2017?

We did and Time it hasn’t changed, we still. Tim O’Brien: 5% per quarter.

4% to 6% somewhere in that range obviously this last quarter we are lower approximately 2% but we still are monitoring and believe that we are going to be able to deliver 4% to 6% a quarter loans held for investment growth on average. Tim O’Brien: And can you give a little bit of either quantitative or qualitative color on your outlook for growth in the construction loan book for coming quarters, or 2017 or just stopped on that Mark where you guys stand with that and how much more building there is an opportunity to do there?

Our markets are so strong as you know Tim you are in the Bay area we just I think we hit a new record for Cranes in the city of Seattle at 53 cranes, and the city of Seattle is not that big. We can see most of those outside our windows so commercial construction here continues to be very strong and not just a multifamily. The office market is strong, office vacancies are about 8% in the city of Seattle today. The multifamily market continues to be very, very strong despite a lot of deliveries over the last several years. So we will be involved continue to be involved mostly in multifamily construction and commercial side in the greater Seattle and Puget Sound area as well as the greater Portland area. We haven’t done much commercial construction – in fact I am not sure we’ve done a project here in California but we're likely to next year and in single-family residential construction this year we will originate we believe somewhere in excess of $600 million it is a very strong year up almost up almost 100% from the prior year. And those loans are still turning over very, very quickly and not being fully drawn out as well. So that business we expect to grow next year as well and we originate in excess of $600 million this year that number is [indiscernible] next year. And those loans are across a larger regional market not just Puget Sound and Greater Portland we also have a very strong business in the greater-Boise area as well as Salt Lake City, which remains one of the busiest homebuilding areas in the United States. And then Southern California and we have two projects in the White Island again. So it’s a solid business that has some regional diversity as well. Tim O’Brien: And maybe Melba you might have this. Did you guys disclose or can you tell me what your new commitments per construction were in third quarter?

We did not specifically talk to construction in terms of the commitment, but we could follow-up with you on that. Tim O’Brien: That would be great. And just relative to the second quarter. Are you pretty optimistic about fourth quarter pipeline there as well?

We are – we are the appetite for new homes, apartments, office is so strong here in these areas. We’re fortunately able to really choose the people we work with – in the areas we work in to the extent that we feel super comfortable with the credit, with the projected absorption of this construction and it’s been a great business for us. Tim O’Brien: Thanks for the color guys.

[Operator Instructions] Our next question will come from Bill Dezellem of Tieton Capital Management. Please go ahead.

Thank you. That’s Tieton Capital. First of all, would you talk about the shift in mix to refi is jumping from I think 35-ish to roughly 47% here in the Q3. What do you feel drove that?

Well its interest rate driven I mean, if you look at the 10-year treasury rate during the quarter, you will see there was a couple of pretty significant rallies where the rate fell pretty substantially and it remains at a historically low rate. So despite it being up a little from the lows during the prior quarter our refinancing volume continues to be above normal for us. And normal for us is about 25% to 30% of our production. There’s always some one refinancing in every interest rate environment. Our environment today is characterized by lower rates and a great deal of more equity. If you think about our earlier comments regarding home price appreciation in our markets many people have created a substantial amount of equity that they are now using for traditional purposes like debt refinancing, home-improvement, automobile purchases investments. And so we’re seeing a little more activity in cash out refinance not just rate in term of refi’s.

That was helpful, Mark. What I was really driving that is in past periods where refi’s have been strong. If I remember right it’s been a smaller percentage of your mix and you’ve really been able to hold that back down. Now maybe that was capacity constraints and now you didn’t have the same degree of constraint. I’m wondering if there is some variables in there that you can’t specifically highlight.

Well, it’s hard to predict Bill, earlier this year we had a pretty substantial rate rally in January and February if you remember. And in some of those months our refinance percentage got as high as 60% to 70%. So the percentage could be much higher it is seasonally dependent though right? The second and third quarters much higher purchase volume, if we had this same type of refinance volume in the first and fourth quarter that would make a composition of refi’s as a percentage much higher, right. So it somewhat dependent upon where it occurs, it’s also dependent upon what we call, burnout, right. When you have low rates for a certain period of time and you’ve refinanced a great deal of the people who would economically benefit with the refi, you’ll start to see burnout an ever lower levels of refinancing despite low rates. We’re never quite sure where were going to hit that because despite you being able to look at, let’s say our servicing portfolio and say there is a certain percentage of people who would have an economic benefit they never all refinanced for a variety of reasons. It may have to do with qualification, then paying attention to whole bunch of reasons. So the absolute level of refinancing is hard to predict at any time.

Great. Points are well taken. And then two additional questions. First of all when you discuss the – what appears to be somewhat consistent up trend in the securities portfolio. And then now you are consulting fees always small do continue to go up and hopefully you can explain what’s going on behind the scenes there please.

Sure. Specifically with respect to the securities portfolio Melba discussed earlier our short-term utilization the capital that we’ve raised from downstream to the bank from our second quarter bond offerings that utilization will be moved ultimately from the securities portfolio to the loan portfolio as we utilize that capital for the intended purposes of growing our long-term balance sheet. So we have a slightly higher percentage of assets in securities today than on a normalized basis. In terms of consulting expenses we utilize consultants for a lot of different things here. Some of the largest costs today are in healthiness implement our new origination system in the single-family area. But we have consultants working on a variety of projects next year related to mostly infrastructure. There maybe systems projects or operations related projects that were investing in to grow and improve the infrastructure and risk management as we grow the company. And these expenses – you love to cut them back and avoid them but given the requirements of growth they are a necessity right now.

Thank you, Mark.

You bet. Thanks, Bill.

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Mason for any closing remarks.

Again we appreciate your patience and your great questions today. Obviously we’re pleased with the results this quarter and looking forward to talking to you in the next quarter. Thank you.

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