Mechanics Bank (MCHB) Q4 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the HomeStreet, Inc. Fourth Quarter Earnings Update 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 Mark Mason, Chief Executive Officer. Please go ahead.

Thank you. Hello and thank you for joining us for our year end and fourth quarter 2016 earnings call. Before we begin, I would like to remind you that our earnings release was furnished yesterday to the SEC on Form 8-K and is available on our website in full form 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, and that impact our net interest margins and other aspects of our financial performance, the actions of our regulators, our ability to meet our internal operating targets and forecasts, and economic conditions that affect our net interest margins and businesses. Other factors that may cause actual results to differ from our expectations or that may cause us to deviate from our current plans are identified in our earnings release and detailed in our SEC filings, including 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 an update on recent events and review our progress in executing our business strategy. 2016 was a year of significant progress toward our strategic goal of becoming a significant west coast regional bank. While the most recent quarters was challenged for our mortgage banking business, both from the seasonal low point in origination volumes and the impact of financial market disruption stemming from the unexpected and sustained increase in interest rates. We are pleased with our full year mortgage banking segment and with our consolidated results. We started the year with total assets of $4.9 billion and 114 branches and lending centers. We ended the year with total assets $6.2 billion and 141 branches and lending centers. We continued our strategy of organic growth and investing in our commercial and consumer banking segment, resulting in greater diversification of portfolio and geography, increasing density in our existing markets, expanding into new markets and improving operating efficiency. On February 1st of last year we completed the acquisition of Orange County Business Bank. This acquisition increased our commercial banking business and gave us access to Orange County, a very important still growing Southern California market. On August 12th, we complete acquisition of both branches, including all loans, deposits, and certain other assets and liabilities of The Bank of Oswego, located in Lake Oswego, Oregon, an affluent suburb [ph] in Portland, Oregon. On November of 10th, we completed the acquisition of two retail deposit branches located in Granada Hills and Burbank California from Boston Private Bank and Trust. These branches were also each located near Kaiser Permanente facilities, one of our affinity partners. Additionally during the year we opened a number of de novo retail deposit branches and lending. We opened 6 retail deposit branches, 13 home loan centers, 3 commercial lending centers and a standalone consumer insurance agency office. Four of those retail deposit branches were opened in California, near Kaiser Permanente facilities. Last year we also began a significant investment in building our California Commercial Banking business. We hired a California market president and subsequent to year end, we announced the hiring of market president for San Diego and Orange Counties and Silicon Valley. Additionally, we have opened our first Northern California Commercial Banking office in San Jose, California. We planned to augment this office with our first retail deposit branch in Northern California during the third quarter of this year and in future hiring a credit and lending personnel as we build out our team in this large and growing market. We also positioned ourselves for future growth by diversifying and strengthening our capital base. In May we issued senior notes with net proceeds of $63.2 million and in December we issued approximately 2 million shares of common stock in an after market offering, netting proceeds of $58.6 million We were fortunate to be able to issue this stock quickly into unusual market demand fueled by the post-election rotation into banks and financial stocks and the inclusion of HomeStreet S&P 600 Index. Before Melba reviews our financial results, I'd like to share some highlights from the year. Net income for the year, excluding the acquisition-related items increased 41.6% to $62.8 million from $44.3 million last year. Total assets grew $1.3 billion or 27.6% during the year to $6.2 billion. Return on average tangible equity, excluding acquisition-related items was 11.7% for the year versus 9.8% last year. Diluted earnings per share, excluding acquisition-related items increased 20% from $2.11 per share to $2.53 per share. Tangible book value per share increased from $20.16 to $22.33 during the year. Net income from the commercial and consumer banking segment, excluding acquisition-related items increased 69% to $35.4 million for the year, compared with $21 million in 2015. Also the efficiency ratio, excluding acquisition-related items improved from 75% in 2015 to 69% in 2016, reflecting the ongoing operating leverage we are generating with growth and maturing of our commercial and consumer banking activities. Loans held for investment increased $626.3 million, or 19.6% during the year to $3.8 billion. New portfolio loan originations, acquisitions and advances during the year totaled $2.3 billion. However net loan growth was somewhat impacted by payoffs and sales of $1.7 billion during the year. The ratio of non-performing assets to total assets ended December at zero, or 0.41% down from the third quarters ratio of zero 0.52% and December 2015's ratio 0.50%, reflecting continued excellent loan quality. Additionally, our early warning credit indicators are continuing to show strong fundamentals in all of our markets. Deposits [ph] increased $1.2 billion or 37% during the year to $4.4 billion and non-interest-bearing commercial and consumer deposits grew $167.1 million or 45% during the year. Our mortgage banking segment net income increased to $27.4 million in 2016 and $23.3 million in 2015. However, the segment reported net loss was $9.8 million during the fourth quarter, compared with net income of $17.6 million during the third quarter. The fourth quarters results were significantly impacted by market changes that adversely impacted our rate lock volume, close loan volume and risk management results. During the fourth quarter the financial markets were impacted by dramatic increases in long-term treasury rates beginning after the presidential election and an increase in short-term interest rates by the Federal Reserve in December. Higher interest rates drove lower than forecasted mortgage volume and interest rate lock commitments and a lower-level of pipeline fallout, which in turn resulted in a higher than expected volume of closed loans. Both of these volume changes had a negative impact on earnings, as most of our mortgage origination revenue is earned at interest rate lock commitments and most of our mortgage origination expense is recognized at closing. The unexpected and sustained increase in interest rates also resulted in asymmetrical changes in valuation between hedging derivatives and servicing valuations. This market dislocation reduce the value of our hedging derivatives to a greater extent than the value of our mortgage servicing rights increased in the quarter, resulting in lower risk management results. Closed loan volume in our single-family Mortgage Banking segment $2.5 billion in the fourth quarter, compared to $2.6 billion in the third. Closed loan volume for the year increased 25% to $9.0 billion, compared with $7.2 billion in 2015. Interest rate lock and forward sale commitments of $1.8 billion in the fourth quarter decreased from $2.7 billion in the third quarter. Interest rate lock and forward sale commitments for the year totaled $8.6 billion, compared with $6.9 billion in 2015. And now, I'll turn it over to Melba, who will share additional details on our financial results.

Thank you Mark. Good morning, everyone. I'd like to first talk about our consolidated results and then provide detail on each of our segments. Net income for the fourth quarter was $2.3 million or $0.09 per diluted share, compared to $27.7 million, or $1.11 per diluted share for the third quarter. The decrease in net income from the prior quarter was primarily due to a $24.8 million decrease in gain on mortgage loan origination and sales and $14.5 million decrease in mortgage servicing income, partially offset by a $1.3 million increase in net interest income. Excluding after tax acquisition related items, core net income for the fourth quarter was $2.6 million or $0.10 per diluted share, compared to $28 million or $1.12 per diluted share in the prior quarter. Acquisition related expenses totaled $401,000 for the quarter primarily due to the expenses related to the two branches we acquired from Boston Private completed during the quarter. Net income for 2016 was $58.2 million or $2.34 per diluted share, compared to $41.3 million or $1.96 per diluted share for 2015. The increase year-over-year was primarily due to $70.9 million higher gain on mortgage loan origination sale activities, $31.7 million higher net interest income, and $111.5 million higher mortgage servicing income partially offset by $62.8 million in higher salaries and related expenses. Excluding after tax acquisition related items, core net income for 2016 was $62.8 million or $2.53 per diluted share, compared to $44.3 million or $2.11 per diluted share for 2015. Included in non-core items for 2016 was $7.1 million of acquisition related expenses compared to $16.6 million of acquisition related expenses and $7.7 million bargain purchase gain for the same period of 2015. Average loans held for investment grew by 29.4% from the year ago period from $2.8 billion to $3.7 billion [ph]. Net interest income was $48.1 million in the fourth quarter, compared to $46.8 million in the third. The increase was primarily due to higher interest income stemming from the change in the mix of our earning assets. Average balances for the quarter reflected a greater mix of higher yield in commercial and multifamily real estate loans, and home equity loans and a decrease in lower yielding securities and single family loans held for sale. Our net interest margin for the quarter was 3.42%, an increase of 8 basis points from the prior quarter, due to asset mix shifts, due to higher yielding loan types, increasing our asset yield by 10 basis points, offset somewhat by a 2 basis points increase in deposit cost. The impact of non-interest bearing sources remained unchanged quarter-over-quarter at 15 basis points. Non-interest income decreased $38.5 million from the prior quarter due primarily to lower gains on loan originations and sale activities, as well as a decrease in mortgage servicing income. Gain on mortgage loan origination and sale activities declined by $24.8 million and mortgage servicing income declined by $14.5 million from the prior quarter. Non-interest expense was $117.5 million in the fourth quarter compared to $114.4 million in the third quarter. Excluding acquisition-related expenses, non-interest expense was $117.1 million compared to $113.9 million for the third quarter, an increase of $3.3 million. This increase in core expenses was primarily due to salaries and related cost from incentives attributable to higher commercial real estate loan production volume, as well as higher headcount. Also included in the fourth quarter was an accrual four $500,000 non-tax deductible for a settlement announced last week during week with the FCC. At December 31, the bank’s loan leverage ratio was 10.24% and the total risk based capital was 14.8%. The consolidated company’s Tier 1 leverage ratio was 9.87% and total risk based capital ratio was 12.56%. 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 $12 billion in the quarter compared to $10.1 million in the prior quarter. Excluding after tax net acquisition related items, the segment recognized core net income of $12.3 million in the fourth quarter compared to $10.5 million in the third quarter. Growth in core net income was driven by an increased in net interest income, a decline in provision for loan losses, and an increase in non-interest income, somewhat offset by an increase in non-interest expenses. Net interest income increased to $40.6 million in the fourth quarter from $39.3 million in the third, primarily due to the shift in asset mix from lower yielding single-family loans held for investment and to higher yielding multifamily and commercial real estate loans and home equity loans. Segment non-interest income increased from $9.8 million to $13.1 million during the quarter. This $3.3 million increase was primarily due to $2.4 million gain on sale of $143 million of available for sale securities., repositioning the securities portfolio to lower duration securities, and a $2.7 million gain on a sale of approximately $67 million of adjustable rate single family loans to accelerate portfolio diversification, offset somewhat by a lower level of prepayment fees selected in the fourth quarter versus the third quarter. Segment non-interest expense was $35.5 million, an increase of $3.3 million from the third quarter. Included in non-interest expense for the third and fourth quarters of 2016 were acquisition related expenses of $512,000 and $401,000 respectively. Excluding acquisition related expenses from both periods, the $3.4 million increase in expense was primarily due to higher incentive expense attributable to higher commercial real estate loan production. We recorded a $350,000 net provision for credit losses in the fourth quarter, compared to a provision of $1.3 million recorded in the third quarter, reflecting a net reduction in non-performing assets and lower specific reserves on impaired loans. We experienced net charge-offs of $319,000 during the quarter. Growth charge-offs during the quarter totaled $902,000 primarily from one single family permanent loan charged-offs during the quarter. Recoveries totaled $583,000 during the same period. The portfolio of loans held for investment growth increased 1.4% remaining at $3.8 billion in the fourth quarter. Permanent [ph] commercial and multi family real estate loan balances increased by 12.6%, somewhat offset by reductions in the balances of single family mortgages and commercial and residential construction loans. New loan commitments totaled $704 million and originations totaled $425.5 million during the quarter. Pay-offs and pay-downs and sales increased from $474.9 million in the third quarter to $530.2 million in the fourth quarter, which included the sales of single family loans previously mentioned. Credit quality remained strong with non-performing assets at 0.41% of total assets at December 31, and non-accrual loans at 0.53% of total loans. Non-performing assets were $25.8 million at quarter end, compared to non-performing assets of $32.4 million at September 30. The decrease was largely due to a decline in single family and commercial real estate and commercial non-accrual loans, as well as a decrease in single family OREO. Deposit balance for the quarter were $4.4 billion at December 31, down somewhat from $4.5 billion on September 30. A decline in deposits was primarily due to $162.2 million decline in our other non-interest bearing balances, offset somewhat by increases in non-interest bearing checking and savings balances, and net increases in total interest bearing transaction balances. Our non-interest bearing accounts are primarily related to our mortgage servicing portfolio and well fluctuates seasonally as insurance and property tax payments are due. Total transaction and savings deposits grew – excuse me, $93.1 million or 3.3% in the quarter, primarily as a result of our acquisition and deposits from Boston Private. Notably, our de novo branches stores opened since the beginning of 2012 grew deposits by 16.8% during the quarter. Deposits in our acquired retail branches increased 12.6% during the quarter, of which a $106 are deposits acquired from Boston Private accounted for 83.3% of this quarterly growth. I’d now like to share some key points from our mortgage banking business segment results. The net loss for the mortgage banking segment was $9.8 million in the fourth quarter compared to net income of $17.6 million in the third quarter. The $27.4 million decrease in net income from the third quarter was primarily due to lower gain on single family mortgage loan origination and sale activities due to lower rate lock and forward sale commitments during the quarter and an elevated level of closed loan volume due to lower pipeline fallout, which resulted in creating a significant imbalance between revenues and expenses. Additionally, negative risk management results offset somewhat by higher servicing income contributed to the segments net loss for the quarter. Gain on single family mortgage loan origination and sale activities in the fourth quarter was $61.1 million compared to $88.9 million in the prior quarter. Single family mortgage interest rate lock and forward sale commitments totaled $1.8 billion in the fourth quarter, a decrease of $923.7 million or 34.4% from $2.7 billion in the third quarter. Single family mortgage closed loans totaled $2.5 billion in the quarter, a decrease of $133.3 million or 5% from $2.6 billion in the prior quarter. The gain on sale composite margin remained unchanged from the prior quarter at 334 basis points. The volume of interest rate lock and forward sale commitments was lower than closed loans [indiscernible] sales by 42.4% this quarter, which negatively affects reported earnings, as the majority of mortgage revenue is recognized at interest rate lock, while the majority of origination cost, including commissions are recognized upon closing. If rate lock and forward sale commitments during the quarter would have equal close loan volumes, it would have resulted in approximately $14.7 million higher net income for the segment. Similarly, closed loan volumes had been the same as interest lock and forward sale commitments, net income would have been approximately %6.1 million higher, as a result of lower variable cost. As Mark previously mentioned, the sharp increase in interest rate during the fourth quarter resulted in lower than forecasted interest rate lock commitments and a higher level of pull through pipelines, which resulted in more closed loan volume than expected. These combined factors contributed to lower revenue and higher expenses than expected in the segment results. Mortgage Banking segment non-interest expense of $82.1 million decreased 172,000 from the third quarter. This decrease was primarily due to lower commissions and incentives due to the decline in closed loan volumes, offset somewhat by the cost of implementing our new loan origination system. Overall, we grew Mortgage Banking personnel by 4.8% in the quarter. Closed loans decreased in the quarter to 5.3 loans per loan officer compared to 5.7 loans per loan officer in the third quarter. Single family mortgage servicing income was a loss of $984,000 in the fourth quarter, as compared with revenue of $11.8 million in the third quarter. The quarterly results were comprised of $3.9 million of net servicing income and $4.9 million of risk management loss. The unexpected and sustained increase in interest rates during the quarter resulted in asymmetrical changes in valuations between hedging derivatives and servicing valuations. This market dislocation reduced the value of our hedging derivatives to greater extent than the value of our mortgage servicing rights increased in the quarter, resulting in lower risk management results. Our portfolio of single family loan service for others was $19.5 billion at year end, compared to $18.2 million at September 30 and the value of our mortgage servicing rates increased to 116 basis points from 82 basis points in the prior 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, notwithstanding the discipline was also the fourth quarter, we are extremely proud of our full year results and are excited about our prospects for achieving the growth and diversification goals of our strategic plan. We believe that our ability to achieve our goals are unaffected by the events of the fourth quarter and we are optimistic about 2017 and beyond. We are fortunate to operate in some of those attractive market areas in the United States today. These markets enjoy lower unemployment and substantially higher rates of population growth, job creation, commercial and residential construction and real estate value appreciation than the remainder of the country. The major markets that we focus on are substantially larger then most of the other markets in the United States, which gives us the opportunity to grow meaningfully without the necessity of acquiring a significant market share. Together, Washington, Oregon, Idaho and California account for 15% of the United States economy measured by employment, yet these markets have contributed 23% of the increase in jobs through the third quarter of last year. Over the last five quarters, the year-over-year employment growth rates for these states have averaged 3.1% compared with 1.9% for the nations as a whole. The most recent mortgage bankers association monthly forecast projects total loan originations to decrease 17.3% this year over last year, by increased by 1.6% in 2018. The forecasted decline from 2016 to 2017 is driven by a 47% decline in expected refinancing volume. However, we do not expect the forecast to decline and refinance volume to impact our business to this degree, as our origination forecasts has always been on the purchase market. The mortgage bankers association forecasts that purchased mortgage originations are projected to increase 10.3% this year and 7.8% next year. During the third quarter, purchases comprised 49% of originations nationally and 44% originations in the Pacific Northwest. HomeStreet continues to perform at levels above the national and regional averages, with purchases accounting for 57% of our close loans and 63% of our interest rate lock and forward sale commitments in the quarter. Despite the increase in long-term interest rates in the fourth quarter, interest rates remain low on an absolute basis. While the 10-year treasury yield has increased since it fell to a record low 1.3% following the Brexit vote. It continues to remain low on an absolute basis at about 2.4%. These low rates should continue to support housing affordability. Nationally purchases are expected to comprise 70% of loan volume this 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 not expected to approach their long-term average level of 1.4 million units until the fourth quarter of 2018. On the commercial side Seattle's office market absorbed 1.4 million square feet of office space in the third quarter. One of only three markets in the United States to absorb more than 1 million square feet. And our office vacancy ended the third quarter at 9.4%, the first time it was below 10% since the recession. There was a 4.7 million square feet of single family and multi family or multi tenant space under construction in the Seattle area placing it fifth in the nation today. Portland absorbed over 115,000 square feet of office space in the fourth quarter and asking rents averaged $25.88 per square foot, up from $24.41 in the third quarter and 23.49% - I am sorry, $23.49 in the year ago period. Vacancy ended the quarter at 10.3%, compared to 10.2% in the year ago period. Stable vacancy and increase in rents are supporting robust construction, with 1.1 million square feet of office space currently under construction there. In Los Angeles almost 512,000 square feet of positive net absorption in the fourth quarter marked the 14th straight quarter of net occupancy gains. Vacancy fell to 13.6% compared to 14.4% in the year ago period. The construction pipeline is at 2.3 million square feet, up from 2.2 million in the prior quarter. Average asking rents in the fourth quarter were $37.20 per square foot, unchanged with the prior quarter, but higher than the $36.02 [ph] per square foot asked during the year ago period. Looking forward to the next two quarters in our mortgage banking segment, we currently anticipate single-family mortgage lock and forward sale commitment volume of $1.8 billion in the first quarter and $2.8 billion in the second quarter of this year. We anticipate mortgage held for sale closing volumes of $1.9 billion and $2.7 billion during the same periods respectively. We are in 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. For the full year of 2017, we anticipate single-family mortgage loan lock and forward sale commitments to total $9.3 billion and loan closing volume to total $9.4 billion. These volumes will be subjected to the typical seasonality we experience. Generally lower volumes in the first and fourth quarters in the year and higher volumes in the second and third quarters. Volumes will also be highly dependent on inventory levels and 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 two quarters and stay within that range during the year. We expect the increased TRID -related cost we have been experiencing last year to continue through the next several quarters until we complete installation of the new loan origination system later this year In our Commercial and Consumer Banking segment, we expect average quarterly led net loan portfolio growth to approximate 4% to 6%during this year. Reflecting the increase in interest rates and the steeping of the yield curve, and absent changes in market rates and loan prepayments fees, we expect our consolidated net interest margin to trend between 3.20% and 3.25% during the next two quarters, as we temporarily invest the proceeds of our common stock offering in lower yielding securities. We expect that our net interest margin will increase to between 3.35% and 3.40% in the second half of 2017, as higher yielding loans are originated. During 2017, our non-interest expenses are expected to grow on average, approximately 2% per quarter, reflecting the continued investment in our growth and infrastructure. This growth 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 both of our segments. This concludes our prepared comments. Thank you for your attention today. Melba and I would be happy to answer any questions you have at this time.

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

Question on the single-family mortgages that are held in portfolio. It looks like those balances were down 10% in 2016. Any expectation for a similar drop in 2017?

Part of the drop in this year was a sale of single family and mortgages to approximately $70 million in the fourth quarter, so that has an impact on balances. I would expect by composition to continue to see that portion it would be held for investment portfolio, comprises single family mortgage to drop as a percentage of the portfolio, though continue to grow generally.

Got it. Did you have sales in Q2 and Q3 as you had a declining balance there as well?

No, I think that that’s the height of the prepayment double that we had during the year.

Got you. Okay. A couple of housekeeping items. Maybe from Melba. One, the tax rate expectation for 2017 and two, the SEC fine, that $500,000, was that in the general and administrative line item?

Yes. It was, the second question I'll take first, the 500,000 was in G&A and in terms of our tax rate expectation for 2017, I don’t want to be too precise, but I would say around 34.5%. So somewhere between 34% and 35%.

Okay. And maybe one last one on overall credit quality. A good trend in the NPA number a little lighter net growth on the loan side. First on credit, some overall comments about trends you think you will see in 2017 and how you expect the provision for that?

Obviously, we like many of us we have been enjoying an excellent credit environment and we remain pretty cautious underwriters, trying to stay in the middle of the market and generally competing on price and not credit. So we are expecting going forward to continue to enjoy solid credit. Having said that, because of our expected growth in our loans held for investment portfolio, I would expect provisioning to follow that growth at approximately the same coverage levels that we run at today and I am talking about our coverage on non-purchased loans, which I believe is around 108 basis points roughly, we can give that number to you later Jeff. But if you look at portfolio of growth, organic growth expectations and consider we are going to have to provide upfront 100 basis points or so, that should generally reflect our provisioning going forward.

The not only thing that I would add to that is, as you can see from our results, for the full year we did enjoy a net recovery, over the course of the year I wouldn’t anticipate that we would have that same level going into this year.

Okay. Thank you.

Our next question will come from Jackie Boland with KBW.

Hi, good morning.

Hi, Jackie.

Melba just to clarify I mentioned that the settlement was in G&A. But was that captured in the commercial banking segment?

Yes, I would have been.

Okay, thank you. And then also to clarify Mark, with the no change to the outlook in terms of close and loss volumes versus what you had discussed on the third quarter's call, just so I understand it correctly. That is because as you look out and look forward, you are not forecasting a high level of refis, you are just looking to the purchase market?

That’s correct. And when we were forecasting last year, even before the run-up in rates, we were expecting a rate rise and an end to the refinancing volume we were experiencing at the time. So, our total number next year hasn't changed on either locks or closing. We changed somewhat the seasonality numbers, so I think we're a little lower in the first quarter, than our prior guidance about maybe $100 million. But we think we're going to make that up in the middle of the year.

Okay, that is helpful. And then sorry it went out of my head. I'm going to get back in the queue. Sorry about that.

Thanks, Jackie.

Our next question is from Paul Miller with FBR and Company.

Yes. On the M&A front, I know you've done a great job on building out the California franchise. And I'm just wondering given that the new, with Trump winning and better valuations are you seeing more people talking to you? And what geographies are you really focusing on? Are you continuing to focus on the California markets? And are you looking at picking up mortgage companies are just retail banks?

Thanks, Paul. It’s hard to say what the impact of higher valuations of public banks is going to do for total M&A activity. I think that you know, we've been at this for a while and as we get farther away from the recessions, those smaller institutions which have not been able to generate sizable returns, cover the cost of capital and or have ageing management teams continue to consider transactions and partnership. And I think that to the extent, you know, we're another year in, and there is the prospect and I'll say the prospect of better valuations, I think that we are going to – we already have and we're going to see more transactions this year, until they are contracted for and closed thoughts, they just remain possibilities.

And then the…

In terms of locations, we continue to focus on California currently. We are always interested in the Pacific Northwest and the markets that we are in. Puget Sound, Portland and the larger greater markets. We have also have considered transactions in Phoenix, Salt Lake City and in Colorado. And we – if we find the right transaction in any of those areas we would. With respect to commercial banking and mortgage because of our long-term goal of reducing the concentration in mortgage banking income, in the company's income, not only we back to more organic growth, but that's much slower to make an acquisitions, we do not expect to make any acquisitions in the mortgage banking area.

Okay. And then employment. I mean, you guys have been averaging roughly adding about 100 people a quarter. I think some of that is factored in with some of the acquisitions that you made, and some of that is organic. I believe some of that is on the commercial bank and some on the retail mortgage bank. Can you give us your philosophy on hiring people? And should that start to flatten out at this point or should we continue to expect greater employment?

We on the growth side, we tend to be opportunistic, right. So if you think about branch acquisitions, like we required two branches in the fourth quarter for Boston Private, opportunistic opportunity. In terms of mortgage banking production growth, also opportunistic, we find teams of high-quality originators in new markets, we hire them in mass as a team, but they come up sort of when they come up. Infill or expansion in existing markets in the mortgage business, we are continuous in the market for personnel, but we also have attrition, we'll offset that. So most of our growth comes from new teams on the mortgage banking side. We also are having to grow our infrastructure and as we grow towards the $10 billion asset level, absent a changes in DFAST requirements, we are building infrastructure and it’s a simple ratio of exercise in some of support departments, like in resources, IT and some of these other service departments, we have to simply grow personnel as we grow total personnel to support the growth. So you'll see lumpiness in that growth of personnel, but it's somewhat dependent on our opportunities for growth in the business segments.

Looking at trying to model out the expense base. Especially the salaries and related costs, and I get it that you want to open up more retail branches in a purchase market and things like that. But should be looking at your expense base? I mean what kind of growth would you put on the expense base? Especially salaries and overall expenses as you open up new branches?

It depends on the branch, a retail deposit branch requires about 4.5 FTE each, mortgage production branches can vary from one or two people in a satellite office to as many as 20 or 25 or more originators and operations personnel in a large mortgage branch. Infrastructure people they sort move up ratio with our business and I don’t have a ratio for you there, but we can try to sort of develop ones as we think about it. The important part about expense growth is it should always be substantially less then revenue growth and we - our business plan on earnings growth on the mortgage side in our commercial and consumer business largely involves operating leverage continuing to improve our efficiency ratio through growth of revenues exceeding growth and expenses.

And I guess, your expenses came in right around $117 million. Should we be maintaining that throughout? Or what type of growth should we put on that number?

So for the quarter I think expense growth in total was – it’s about 2.7% and our forward guidance and again while, as Mark mentioned, it will be lumpy when you look at it as averaging around 2% per quarter.

Okay. That helps, guys. Thank you very much.

Thanks, Paul.

Yes.

Our next call is from Tim Coffey with FIG Partners. Please go ahead.

Morning, Mark. Morning, Melba.

Hey, Tim.

Good morning.

Mark I want to circle back on your expectations for the mortgage business in 2017. Relative to the guidance from last quarter, what gives you more confidence that we will see a more robust mortgage market in the second half of the year?

Well, in part, you have the annual home buying season and this is year end year out consistent that we have substantially higher levels of purchase volume in the second quarter and the third quarter, following in the fourth and first quarter. And we have no reason to believe that pattern is going to be different this year. The biggest challenge frankly in our markets it’s not demand, its inventory. Seattle in December was known the most impacted market in the United States in terms of demand versus supply, now fortunately we don’t really operate in Seattle. But there is so much economic activity, wage growth, home price appreciation in the west that home inventories are low. So my only caveat to our forecasts of volume is, it could be impacted by inventory levels. Having said that, we believe home turnover is poised to begin improving again. Post-recession we've been running about 5% a year, some quarter 7%, existing home resale versus the long-term average at 10% a year. Recovery in that number alone would support to improve our numbers. So I think we're confident that home buying season is going to come and go again this year, the question – the outstanding question is going to be inventory levels.

Okay. And did you change your expectations for producers at all since last quarter?

No, because remember our focus when hiring producers is to hire producers with a track record of focusing on the purchase market. So while we always have some attrition on producers that don’t continue their track record and trend before we hire them, the [indiscernible] focused and people we will be hiring this year will be similarly purchased focused and so we're confident they will do as well they are going to [indiscernible] role out.

Okay. Thank you those are my questions.

Thanks, Tim.

Next question is from Tim O’Brien with Sandler O'Neill and Partners. Please go ahead. Tim O’Brien: Good morning.

Hey, Tim.

Good morning. Tim O’Brien: Hey, Mark, you gave the updated MBA guidance down 17% for 2017, was that correct?

Let me check, I think that was…

In total.

In total. Tim O’Brien: So for the full country. Did you also give regional for Pac Northwest? Did they break that out or do you have any indication of overall production for the Pac Northwest for 2017?

You know, unfortunately, we have begged the MBA for that for several years and they do not provide a regional forecast. They will provide monthly regional actual closings, right, you can sort of track that during the year. but they don’t give a regional forecast. Now it is our expectation that regionally our markets will do better on the purchase side. Tim O’Brien: Yes…

10% [ph] my prior comments about inventory. Tim O’Brien: And then do you happen to also track new houses brought to market and do you have a ballpark number of number of new houses that were brought to market in 2016? And can you give us an estimate of the number of houses that are under construction, being built that should come to market in 2017? So in other words is production volume picking up in the Pac Northwest? Are people getting their entitlements in place and is the pipeline getting built for new product to come onto the market that will support your purchase business.

Yes. In my comments when you check the transcript, you'll see I cited that housing starts nationally are expected to be up 8.5% this year and I think its going to be higher. Housing starts in our various markets, bear with me and I'll give you a number, I have permits, which have been running in Washington state, in 2015 its about 38,000 permits a quarter level, in 2016 that was probably up to around 40,000 a quarter, peaking into the second quarter its 44,000. And in California permits were running - are running about a 100,000 a quarter with a low of about $97,000 in second quarter of last year. The forecast in Washington is that total housing permits will grow from 40,000 in total for the state to – in 2016 stable this year on starts growing 18 to 41,000 and [indiscernible] California. Tim O’Brien: Okay. That is per quarter you said 40,000 per quarter.

Yes, and I am sorry, do have the California forecast on housing permits… Tim O’Brien: Its okay, Mark. I don’t need the California, I am more curious about Pac Northwest. …

Okay. Tim O’Brien: Just because it’s kind of where the rubber meets the road. So I got Pac North. That is good color on that. But we will see flat to increased permits and it starts and such so that's a positive for you guys. And then one other question I have for you. Is the two hires that you announced in California these market presidents, can you give a little bit of color or background on the kind of commercial banking business that they did? Who they led? How big the portfolios of the groups were that they had? And just give some color on why these guys came aboard and what you think they can do here? I guess the timing and impact on C&I?

Sure. These gentlemen came from with backgrounds of institutions like, Comerica Union Bank they have led teams of – at the local level you know, 5 to 25 or more originators by office. Their focus is been in the middle market and in Northern California in part agricultural and technology as well. So they have experience not only in our middle market, business market, but in some of the area's of concentration, as an example in the Northern California market. And they have long track records of successfully building teams and portfolios. Tim O’Brien: Thanks for answering my questions.

Thanks, Tim.

Our next question is from Jackie Boland of KBW. Go ahead.

Hi. Sorry about that earlier. I just wanted to get a little bit of clarity on the ARM sale that occurred in the quarter. Was that captured in the commercial banking activity line item? Under origination and sales?

That sale is the fourth quarter was sort of a one-off sale. We were working with Freddie Mac on some interest they had in a certain type of loan and it helped us a little accelerate you know, the changing the changing composition of the portfolio and given the challenges of the quarter, it seemed a good time to execute on some people accomplish more on those objectives. But that’s not a day in day out goal for us to sell out of the portfolio.

And maybe just some added color on your expectations for small balance CRE sales and the Fannie Mae DUS product?

Sure. We've had a fantastic Fannie Mae DUS last year. Fortunately or unfortunately some of that carried over into the fourth quarter, I believe we closed about $375 million of Fannie Mae DUS originations. One of my people may correct me. I'm sorry, $325 million this year, which is high for the company. We were hoping for $400 million, but we carried over some of that to next year. We are hoping to do as well or better this next year, as you know Fannie Mae is multi family program, it’s a very good program, from time to time we're out in the market on pricing. And that’s more so on the larger loans, we are trying to concentrate on smaller loans in our markets and so we're hoping for a similar or better year next year. In terms of sales of small balanced commercial real estate loans, I believe we're hoping to originate and sell a little over $200 of that product this year, that can be subject to a lot of uncertainty in the secondary market. There as we try to understand buyers appetite for additional levels of commercial real estate in this environment.

And how does that $200 million compare to what was sold this year?

This year we sold…

I am sure of the exact [indiscernible] other sold this year is $157 million that is not all HBC.

All right, still over $100 million, but we'll have to get back to you on the exact number.

Okay. So basically normalized for the one off sale of the ARM portfolio. But then expect growth in the CRE sales depending on market conditions and then potentially as well or better in the Fannie Mae DUS is that a good way to characterize it?

Fair enough.

Yes. Jackie, I would just add, in terms of – you look at the non-interest income trend line for our commercial consumer banking segment, recall last quarter we had kind of high level or prepayment related to one loan in that quarter, that was about a [indiscernible], it benefited that quarter.

Pre-payment fees.

Pre-payment fees. And this quarter both the single family gain on sale that we discussed, as well as the AFS sale would be represented in that number. So it just seem for those two and then in anticipation of increased sales over the course of the – each quarter this year, I think you can start to see a trend.

Okay. That’s very helpful. Thank you.

Thank you.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Mike Mason for any closing remarks.

Thank you, everyone how joined us on the call today. We appreciate your patience and taking the time to dial in and ask questions. Looking forward to talking to you next quarter.

This conference is now concluded. Thank you for attending today's presentation. You may disconnect.