Mechanics Bank (MCHB) Q1 2018 Earnings Report, Transcript and Summary

Good morning. And welcome to the HomeStreet, Inc., First Quarter 2018 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 Mark Mason, CEO. Please go ahead.

Hello, and thank you for joining us for our first quarter 2018 earnings call. Before we begin, I would like to remind you that our detailed earnings release was furnished yesterday to the SEC on Form 8-K and is available on our website at ir.homestreet.com under the news and market data link. In addition, a recording and a transcript of this call will be available at the same address following the call. 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 and housing supply that affect the demand for our mortgages and that impact our net interest margin and other aspects of our financial performance, the actions, findings or requirements of our regulators and general economic conditions that affect our net interest margins, borrower credit performance, loan origination volumes and the value of mortgage servicing rights. 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 detailed earnings release and in our SEC filings, including our most recent Annual Report on Form 10-Q as well as our various other SEC filings. 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 detailed earnings release available on our website. Please refer to our detailed earnings release for more discussion of our financial condition and results of operations. I would like to inform you that the company, its Directors and certain of its executive officers are participants in the solicitation of proxies from the company's shareholders in connection with the company's 2018 annual meeting of shareholders. The company filed and mailed a definitive proxy statement and proxy card with the SEC in connection with its solicitation of proxies for the 2018 annual meeting. Shareholders of the company are strongly encourage to read the proxy statement, the accompanying proxy card and all other documents filed with SEC carefully in their entirety as they contain important information. Information regarding the identity of the company's participants and their direct or indirect interest via security holdings or otherwise is set forth in the proxy statement and other materials filed by the company with the SEC, which can be found for free on the company's website www.homestreet.com in the section, Investor Relations or through the SEC's website at www.sec.gov. We will not take questions regarding or comment on the proxy contest with Blue Lion Capital on this call. Joining me today is our Chief Financial Officer, Mark Ruh. In just a moment, Mark will present our financial results. But first, I would like to give you an update on the results of operations and review our progress in executing our business strategy. The first quarter of 2018 we met many challenges. The limited supply of new and resale housing has become acute and is now become a nationwide phenomenon with many markets experiencing the lowest historic levels of new and resale housing ever observed. The U curve is flat and considerably to near historic lows. We have experienced higher levels of negative convexity in our servicing portfolio and in debt capital markets experienced periods of extreme low utility during the quarter. Additionally lower industry loan volumes substantially increased price competition in the quarter. These challenges meaningfully reduced our profit margins, mortgage loan volume and mortgage servicing income in the first quarter making the quarter that already reflects seasonally low volume more difficult, and driving an operating loss for mortgage banking segment in the quarter despite significant restructuring and cost reductions last year. Nevertheless we made substantial progress towards our growth and diversification goals. In the first quarter loans held for investment increased 6%. This growth was broad based with meaningful increases in all of our lines of business. Additionally credit volume continued to improve in the first quarter, with the ratio of non-performing assets to total assets falling to just 16 basis points, down to the fourth quarter's level of 23 basis points, representing our lowest absolute at relative levels of problem assets since 2006. Our early warning credit indicators continue to reflect strong fundamentals in all of our markets, which is not a surprising, given we do business in some of the strongest markets in the United States today. Job creation, unemployment, commercial and residential development activity and absorption, vacancies, cap rates and all other leading indicators of economic activity reflect strong growing economies in our primary markets. Recently we have observed [indiscernible] increases and slower in project absorption in the Seattle area. We believe these observations generally relate to the significant levels of new construction and that these projects will be absorbed in the normal course. HomeStreet's deposit growth was also stronger in the quarter, increasing also by 6%. Business deposits increased by 4.3%, deposits in our acquired branches increased by 4% and deposits in our de novo branches those opened within the past five years increased 9% in the quarter. To support our growth during the first quarter we opened three de novo retail deposit branches in new centers, in the Lake City areas Seattle, in Millcreek and the urban suburban of Seattle and in Gig Harbor which is near Tacoma. Commercial real estate loan sales decreased during the quarter, reflecting a seasonality of this business as well as a large number of commercial real estate loan originations closing late in the quarter. We expect commercial real estate loan sales increase in the latter half of year. The commercial and consumer banking segment finished the quarter with an efficiency ratio of 73%. Consistent with prior years we expect the efficiency ratio in this segment to improve as the year progresses, averaging under 70% for the year with the second half of the year lower than 65%. Our mortgage banking segment has been an important part of HomeStreet's success and we expect mortgage banking will continue to be a good contributor to our success going forward as we work through this challenging part of the mortgage cycle. In response to these ongoing challenges in our mortgage banking segment and our reduced expectations for growth, we took additional steps in April to improve our cost structure and efficiency. These actions include, releasing headcount and non-personnel related expenses in the commercial and consumer and the mortgage banking business units as well as corporate support functions. These reductions were tailored to reduce costs meaningfully while maintaining safe and sound risk management and the ability to meet our goals. The reduction included 86 full-time equivalent employees, which together with the non-personnel related cost cuts will result in an annualized reduction of our planned pre non-interest expense of $12.4 million. We appreciate the service of those employees affected by these efforts and believe the actions we've taken will be sufficiently to address our current challenges. We are however continuing to work on additional ways to improve our cost structure and efficiency. And now I'll turn it over to Mark who'll share the details of our financial results.

Thank you, Mark. Good morning everyone and thank you again for joining us. I'll first talk about our consolidated results and then provide detail on a few operational segments. Regarding our consolidated results, net income for the first quarter was $5.9 million or $0.22 per diluted share compared to $34.9 million or $1.29 per diluted share for the fourth quarter of '17. Included in net income for the fourth quarter of '17 was a $23.3 million tax benefit resulting from the lowering of the corporate tax rates to 21% with the Finance Tax Cuts and Jobs Act. Included in net income, for the first quarter was $230,000 of recoveries related to our 2017 research plan and $39,000 of acquisition related recoveries, both net of tax. Excluding the impact of tax reform, restructuring charges and acquisition related expenses core net income for the first quarter was $5.6 million or $0.21 per diluted share compared to core net income of $11.5 million or $0.42 per diluted share for the fourth quarter of '17. Decrease in core net income from the prior quarter was primarily due to lower non-interest income, largely from lower net gain on lower retention sale activities in both our mortgage banking segments and our commercial and consumer banking segment. And lower mortgage servicing income, but somewhat offset by lower non-interest expenses. Net interest income decreased by $2.6 million to $48.5 million in the first quarter from $51.1 million in the fourth quarter of '17. This decrease in net interest income is primarily due to the lower balances of loans held for sale and the higher cost of funds. Our first quarter net interest margin of 3.25% decreased eight basis points from 3.33% in the fourth quarter of '17. This decrease in net interest margin is primarily due to an increase in the cost of interest bearing liabilities, specifically the cost of federal home loan bank advances which increased as the Fed funds rate increased by the Federal Reserve in March of this year. Non-interest expense excluding the impact of restructuring and acquisition related expenses decreased to $101.1 million in the first quarter from $107 million in the fourth quarter of '17. This decrease in non-interest expense was primarily from lower commission costs on lower closed single family mortgage loan volume and lower general and administrative expenses. Our effective tax rate was 24.5% in the first quarter and differs from our expected 21% to 22% tax rate range primarily due to the impact of a discrete item related to a prior period state tax net operating losses. I'll now discuss some key points regarding our commercial and consumer banking segment results. Commercial and consumer banking segment core net income was $10.2 million in the first quarter compared to core net income of $13.6 million in the fourth quarter of '17. Net interest income decreased $429,000 from the fourth quarter of '17 to $45.4 million primarily due to our cost of funds increasing at a greater rate net of asset yields, reflecting for the yield curve impacting our net interest income, despite our strong loan growth. The portfolio loans held for investment increased 6% to $4.8 million in the first quarter. Net loan growth was $250.9 million during the first quarter compared to a $190.8 million in the fourth quarter 2017. Segmented non-interest income decreased quarter-to-quarter to $7.1 million from $12.7 million. This decrease was primarily due to lower net gain loan sales, generally resulted from seasonally lower commercial real estate lower originations sales activities. Segment core non-interest expense was $38.3 million, a decrease of $323,000 in the fourth quarter of 2017. This decrease was primarily due to a variety of general administrative expense, cost reduction including marketing employee, hiring and loan processing expenses. Non-performing assets declined $11.2 million or 16 basis points of assets at March 31, compared to non-performing assets of $15.7 million or 23 basis points of assets at December 31. This decrease was primarily a result of a $4.2 million reduction in non-accrual loans related to the improved performance of loans to one-single private residential investor. We reported a $750,000 provision for credit losses in the first quarter compared to no provision in the fourth quarter. This increase in provision expense was primarily due to net portfolio of growth, somewhere offset by $580,000 of net recoveries during the first quarter. Deposit balances were $5 billion at March 31, an increase of $288 million from December 31, driven primarily by over a 4% increase in both business and retail deposit accounts. Deposits in our de novo branches or those opened within the past five years, increased 9% during the quarter. I'll now share some key points from our mortgage banking segment results. The mortgage banking segment core net loss in the first quarter was $4.6 million compared to core net loss of $2.1 million in the fourth quarter. This decrease in core earnings was due to lower gain on loan origination sale activities and lower loan servicing income, partially offset by lower commissions and related origination costs. Our decreased lower origination sale activity was primarily due to intense competitive pressures on deposit margin. Our gain on mortgage loan origination sales composite margin decrease 25 basis points to 304 basis points in the first quarter from 329 basis points in the fourth quarter. The decline in composite profit margin was primarily due to the competitive pressures but was also impacted by changes in the mix of purchase versus refinanced mortgages, government covered agency mortgages and the portion of loans sourced through our affiliate WMS. The volume of interest rate [indiscernible] at $1.6 billion was higher than closed loans held for sale by 8% this quarter. Note that single family interest rate volume being greater than closing in a given quarter has a positive effect on mortgage banking segment earnings as the majority of mortgage revenue is recognized as interest in March while majority of the costs including commissions are recognize upon closing. Single-family mortgage servicing income was $6.7 million in the first quarter, a decrease from $8.4 million in the fourth quarter. This decrease was primarily due to lower risk management results partially offset by higher servicing fees. The flattening yield curve and increase in negative convexity in our mortgage servicing portfolio has substantially reduced risk management result. Mortgage banking segment's core non-interest expense of $62.8 million decreased $5.8 million in the fourth quarter of 2017 primarily due to the reduction in closed loan in March. The restructuring steps we took in fall of 2017 and the implementation of our new loan origination system has resulted in lower direct origination expenses in mortgage and processes, particularly in plans with the requirements of dealer integrated disclosure regulation. Our portfolio of single-family loan service for others increased to $23.2 billion on forbearances at March 31, compared to $22.6 billion at December 31. The value of our mortgage servicing rights relative to the balance of loan serviced for others was 127 basis points at quarter end, an increase of 13 basis points compared to the prior quarter. I will now turn back over Mark Mason, to provide some additional insights on HomeStreet's outlook for the future.

Thank you, Mark. Looking forward to the next two quarters in our mortgage banking segment, we currently anticipate single family mortgage loss and forward sale commitment volume of $1.8 billion and $1.9 billion in the second and third quarters of this year, respectively. We anticipate mortgage held for sale closing volumes of $1.9 billion for both the second and third quarters. For the full year 2018, we now anticipate single family mortgage loan loss and held for sale commitments to total $6.7 billion and loan closing volume to total $6.9 billion. Additionally, we expect our mortgage composite profit margin to decline to a range of between 305 and 315 basis points during 2018. A decrease in our composite profit margin guidance reflects lower government and purchase mortgage originations as well as the current competitive environment. All of these issues have the potential to change positively in near term, for example as recently as January of this year, our composite profit margin was substantially higher than the average for the quarter. These mortgage loan volume and composite margin guidance estimates assume the continuance of current challenges of low, new and resale home inventory and competitive pressure on profit margins. We do expect some seasonal increase in volume during the mid-year fall buying season but at lower levels than previously anticipated. In our commercial and consumer banking segment, we anticipate higher levels of commercial real estate loan sales during the remainder of the year which will impact our average quarterly net loan growth. We continue to expect our 2018 quarterly loan portfolio growth to average between 2% and 4% for the remainder of the year. Reflecting the continued flattening of the yield curve and asset changes in market rates and loan prepayments fees, we expect our consolidated net interest margin to increase in the second quarter to a range of 3.25% to 3.35% and continue up to a range of 3.35% to 3.45% by the fourth quarter. During the second quarter we expect our total non-interest expense to increase given the seasonally higher closed mortgage loan expectations. However non-interest expenses in our commercial and consumer banking segment are expected to increase between 2% and 3% over the remainder of this year. Notwithstanding the increase in non-interest expense in the commercial and consumer banking segment we expect segment revenues to grow at more than twice the rate of the expense growth. For the remainder of 2018 we expect total non-interest expenses to grow between 1% and 2%. The growth rate of our total non-interest expenses will vary somewhat quarter-over-quarter driven by seasonality and cyclicality in our close mortgage loan volume. This concludes our prepared comments. Thank you for your attention today Mark and I will be happy to answer any questions you have at this time.

We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from Jeff Rulis with D.A. Davidson. Please go ahead.

Thanks good morning. Just a couple on the headcount reduction, are those 86 employees have really been let go as today or is that a Q2 event?

All of those reductions are in April yes.

Okay, and so the mortgage quarter end employee count of 1307 does not reflect. Those additional 37 have been subsequent to quarter end, is that correct?

That's correct.

Okay and I guess within the expense save is there any I guess severance offset to that. And I guess if there were any portion of layoffs that were sort of self-selecting in that process?

We have had attrition in both of our business segments that reduced the need for reduction in force. But that's more true in the mortgage segment. Unfortunately that also includes some significant loan originators due to competitive recruiting pressure. The numbers that we cite in the expense reduction details our all affirmative reduction in headcount.

Okay. And maybe I was not clear. Is there any severance offset, is there an increase in expense or is that 12.4 a net number?

The $12.4 million is

Is our annual run rate. There is going to be a severance expense in the second quarter, is going to be quite small, it's only about $400,000.

What was that number?

About $400,000, it will be a small number.

Okay. And I would anticipate the annualized number I guess to hit the run rate in - and we got your guidance on the seasonal increase in expenses. But that would take effect in 2Q.

That's frankly with respect to mortgage origination commissions primarily.

Okay. And then maybe last one on the expense from here. Is that all comp line then, I mean can we back into the per employee I guess comp line. Or is there other cost saves outside of the compensation line that is associated with the 12.4?

Yeah good question Jeff. Actually of the $12.4 million annualized breakdown is $9.1 million of that is salaries related employment costs and then other expenses are $3.3 million.

And the other will just be support or facilities?

It's an bucket [ph] of all sorts of different things, very top rated expense it is. It's going to be consultants, camps, NCC or other items in that, it's all have for $3.3 million. We got a detailed breakdown for the amount of context later. But I'm having this detail right here.

That's a high level enough, I appreciate it. Then maybe last question for Mark Ruh. The tax rate - so the one quarter - was that a one quarter thing or is the new plans on tax rate going forward at 24.5 or are we back down to that 21 to 22?

We're looking like we'd be in that range, that was a onetime event that 27 to 24 [ph].

Okay, I'll step back. Thanks.

The next question comes from Tim O'Brien with Sandler O'Neill. Please go ahead.

Good morning.

Good morning, Tim.

Good morning Mark and Mark. Question for Mark Ruh. Mark, can you give a little bit of color on there was a mix change on the liability front. I know that the cost of interest bearing liability is 10 basis points. But there were some neutralization by non-costing liabilities. As at least my take from the table, can you talk a little bit about that, and what the outlook there specifically is on the funding side going forward for I don't know pricing pressure in the marketplace and what that might mean for your cost of funds?

Well, again I think on the yield statement in our release here. Again you can see the FDI deposit bearing liabilities increased 10 basis points. As you can see we continue to have pretty big pressure from Federal Home Loan Bank. They charged from last quarter this quarter 138 basis points to 170 basis points. So we're working to deemphasize the use of kind of home loan bank. These activity using repos in this current quarter and in the quarter around $25 million balance in repos. I mean outlook again, I guess my guess is good as anybody's as how fast yield curve is going to be and how that's rates are going to increase. But again we're positive is that against only feel relatively low beta compared to this years in our deposit rates. So we have a pretty good handle on that, again you can see that really kind of getting, as we called out is events that are Home Loan Banking events.

And then the cost savings through year end and the $12.4 million that's very helpful information, is that pretty much, are a point here where strategic changes and adjustments that are have been determined made by the Board and management, is that what we're going to run where or is there something more that you guys have planning or in the works here that could continue to effect the mortgage unit here going forward? Are we in a state of dynamic change here or are we - have we reached the static point where the changes that have been made should get you through the end of the year the way that in a best way possible for shareholders?

I don't think that we believe we are finished with opportunities to improve the cost structure the mortgage of that. We have taken actions, we believe we can take immediately and maintain the risk management and origination capacity necessary for the current environment. We continue to view opportunities to downsize real estate of certain offices, potentially consolidate others and so I say that it's a dynamic environment.

That makes sense, it sounds like you'd be opportunistic. And then the last question is, can you remind me and I know I can get it out of the table but the net production number for the quarter for held for investment loans was in the $200 million range, I know I have got it in my notes I just don't spot it?

The additions for the quarter should be in the table..

Yeah, sorry about you guys gave that and it's here, I was going to use that as the basis for a question, I guess my question is this. Of that how much was originated by HomeStreet bankers and were there any purchases to that, because there is a line item in I guess the production table that suggested it some of that could have been purchased?

Yeah, it's, unfortunately it's kind of very wide, you read the earnings release on page 13, there is a go forward of the portfolio, and there is a lot of - purchases and advances.

Yeah, that was it, that's what I spotted.

The lion's share of that is - on existing commitments that also embodies purchases as an example from our affiliate mortgage services the portfolio of loans that they originate for us appears purchases. I don't have that number in front of us, but it's been running about $50 million a quarter roughly.

So maybe just, maybe you could break those out going forward at some point where we see the purchase versus the advances and kind that might be useful to folks. Just a suggestion Mark and Mark, thanks for answering my questions.

Thanks Tim.

The next question comes from Tim Coffey with FIG Partners. Please go ahead.

Hey good morning gentlemen.

Hey Tim.

I am trying to get an idea on expenses associated with mortgage business, can you give me an idea of what the typical expense base is on managing the MSR portfolio?

So first the question on the definition of managing the portfolio, right. We have treasury activities, the hedge activities and then we have servicing, right. So which is as you expect processing payments, processing defaults foreclosures and the like. Are you referring to the entirety of that activity or simply the treasury?

The entirety of the activity come from assuming one of the less volatile of the expense in the mortgage banking considering the origination activity.

That's true. We have not broken out those numbers separately in public filings and so we're not in a position to do that at this point. I would tell you that the servicing, the cost for loan to service is among most efficient in the United States not because we have such a large portfolio. We've about $23 billion under servicing today by UPB but it's because of very high credit quality right, we have very low delinquencies, very low defaults, it is on a cost per loan basis I think it's running $11. I'm sorry asking our treasurers sitting here.

I think it's depending on which product it is about $100 per year for a loan.

Right. And we're servicing in terms of total loans…?

106,000.

106,000 loans, does that help?

It does, did you say a $100 per loan?

Yeah.

$100 per month.

Yes.

Now that's the servicing, plus some other cost which gives an allocation of treasury and management and so on.

Okay great. And then do you have any - what the gain on sale margin was for the commercial real estate loans sold in the quarter and kind of any kind of color on whether how those margins moved in the recent quarter?

Sure do.

We didn't have a lot of sales in the quarter.

We always have lot of U.S., correct? And the SPA, so we didn't have non-[indiscernible] commercial real estate loan sales in the quarter into our SPA sales and then maybe U.S. sales.

Okay I thought I heard comments that - the prepared comments that you might look into sell more of these share A loans in the coming quarters so I'm trying to get a handle on what the delta might be in terms of what lands in non-interest income?

If you look at the last half of last year, the run rate on west commercial real estate loan sale was meaningfully higher but that's seasonally true each year, right. If seems each year that year-over-year demand for the product is substantially lower. We believe that has generally to do with people working on the loan origination activity in the early part of the year and begin to supplement in the latter part of the year, and so loan volume and currently loan pricing improves. Our average gain on those sales non-U.S. commercial real estate loan sales was in the range of 2% to 2.5% roughly, if that helps?

Yeah, does, thank you very much. And then I didn't see the press release but do you have a number for performing TDRs?

I think they are substantially all performing and the number, $72.79, yeah, those are TDRs yeah total TDRs. Those are substantially outperforming.

Okay. All right well those were my questions. Thank you very much.

Thanks Tim.

The next question comes from Jackie Bohlen with KBW. Please go ahead.

Hi guys good morning.

Hi Jackie.

Looking to focus in a little bit more on headcount just given the moving parts on understanding where we started at March 31 and then the 86 reduction that took place in April. How are you thinking about future headcount throughout 2018 in the two segments, just understanding that it sounds like there's going to be some attrition, maybe more so at mortgage banking and then any potential de novo aspirations that you have and just other items that you see impacting headcount through the year?

We did opened three new de novo retail deposit branches in the first quarter. That is our complement for the year. We're not expecting to add any additional deposit branches perhaps until the latter half of the year in the fourth quarter. And it's unclear when those will open in the fourth quarter or in the first quarter of next year. So our additions to headcount over the remainder of the year, of course headcount will decrease in the second quarter as a consequence of the headcount reduction that we disclosed today. And we have few open positions across the company that are likely to be filled over the ensuing two quarters. And so you'll see at least by the plan smaller number of additions somewhere in the range of 20 in the third quarter or maybe 10 in the fourth quarter on currently open positions.

And are most of those in the commercial bank?

Yes, absolutely. Or support functions.

Okay. And then do you anticipate attrition to be somewhat of an offset to that?

Yes. The attrition in critical positions will be refilled.

Okay. Fair enough. And then you mentioned that briefly already, but the areas that you're looking at for other potential areas to trend some expenses, it sounds like that could be primarily in occupancy expense and other related areas?

Yes. Yes. That's sort of vague answer. That's way I'm slightly hesitating. I think all of our expense line items are subject to continuous consideration. We are thoughtful about risk management and safety and soundness and about our ability to support our diversification efforts. So we've been careful to not create risk and unwanted risk or the same liability to be successful. But all those decisions of course are subject to review. And so it's work in process.

Understood. And then just lastly, if you could provide an update on how you're thinking about capital planning and management?

Well we have reduced our expectations for growth last quarter. And despite more significant growth in the first quarter than we expected we are still expecting lower quarterly growth going forward. And this lower growth has reduced capital lease. Of course low earnings don't help that equation, but at this juncture, we're not anticipating a need for capital this year. And beyond it's sort of the dynamic question based upon our success or lack thereof.

Okay. Thanks, Mark. I'll step back now.

Thank you.

[Operator Instructions] Next question comes from Steve Moss with B. Riley FBR. Please go ahead.

Hey Mark, and Mark. This is Al West [ph] filling for Steve today. Just a quick question on the portfolio. How is the duration changed since the fourth quarter? And then any update on the variable versus fixed mix would be helpful. Thank you.

Sure. No material changes in the fixed versus variable composition portfolio. About a third of our portfolio roughly continues to be truly fixed. The remainder has varying levels of term structure and duration, that fluctuates. In terms of duration, since the end of last year, asset duration has extended a little, right from say 2.2 years to about 2.3 years right so not only materially though as rates rise that creates some asset extension.

Got it thank you.

The next question comes from Henry Coffey with Wedbush. Please go ahead.

Yes good afternoon everyone and thank you for taking my question. Two areas of focus first, just in general is it all defense, or are there parts of the business that you would describe as more where there's more offense going on in terms of growth in loan production and the like and then a second question.

I think you can clearly define that by segment today. if you look at those numbers in commercial and consumer banking segment 6% portfolio growth, 6% deposit growth, 4% or 4.5% business deposit growth, those are clearly numbers that relate to the investments we've made over the years in growing our business. On mortgage side and this is clearly a top market with a confluence of negative events whether they be flattening yield curve, shrinking available home inventories mortgage convexity in our servicing portfolio, all those were negative events that force us into defensive posture regarding running that business. And that should be easy to delineate.

I mean if I had sat down with you five years ago and said here's the plan building market share, a direct retail origination ARM in one of the best markets in the country would probably be a good idea, is there anything you can do to really preserve the value of that business and then fund new pass growth with say new products such as non-QM and jumbo lending or is it really just you kind of have to live out the cycle?

Well, that's the important question isn't it? You can react to cyclical changes in a cyclical business by using those periods to improve the efficiency of your business. The effect of this the product desirability or you can simply go around or get out of the business. We are trying to navigate this very tough period of time by preserving our ability to do the best part of the business and trim whatever the offices, personnel or products that have the poorest future outlook. It is very challenging to have so many aspects of this business go against the industry at the same time and you can't really list of all them on this call but as an example the aggregate level of government mortgage originations and in particular average originations of the United States has fallen dramatically as a percent of market. That's a consequence of a lot of things but most significantly including as they chase an ability to get their insurance cost down including the additional insurance premium. It is not as competitive as some of our LTV and credit qualifying products in the general market including with the agencies. The secondary market for products that describe the strength between primary mortgage rates and secondary mortgage rates has shrunk dramatically. That's a direct correlation to competition, where originators are willing to originated loans at with shrinking volume of loans available to be made and over capacity of originators and lenders. This is another thing that has to be worked down overtime. There will be more market participants leaving this business over the next period of time. We've seen some novo ones recently in media. What we don't realize is the number of independents that are shutting our doors or reducing headcount. And so this is not a static situation. Cyclically historically capacity will shrink to available volume. Margins will improve and the business will reenter into more profitable things and strategically it's our challenge to find a way that is right for us, as it relates to our longer term strategic plan to navigate this part of the cycle to put the capital to improve profitability and to make this business the right format for HomeStreet is very challenging. But it is a business that we try not to forget has provided substantial capital and earnings, even since our initial public offering, that has provided a substantial amount of capital, that has allowed us to grow this bank at an average 26% rage over the last six years and allowed us to make great strides to a very large full service commercial service bank and it's a very tough period of time. We're doing our best to navigate it, to minimize progress we're making in commercial bank and hopefully we will find the right answer as we move through that. Thanks for the question.

No, it's understandable. The other question is sort of more technical, I was just looking at your last five quarters in terms of servicing income and then the other four you had one part of your equation or the other resulted in a positive fair value mark. Either you had strong MSR write ups with limited hedging losses or you had small MSR write-downs with positive hedging gains. And then in this quarter you had substantial MSR write-up which is sort of what just based on the numbers we would have expected, but a greater than that hedging losses, is that a limited dynamic or was that a change in how you position around hedging or is the four quarters I worked and then this quarter you were able to bring any of that gain to the bottom line?

Right. One of main challenges I referred to, mortgage rate volatility produces a substantial amount more transactions and rebalancing of our hedge. That alone has a transaction cost, just being a big asset spread, every time you have to reposition something. Additionally as the yield curve flattens our outright earning on derivatives we use to hedge the servicing assets shrinks in absolute sense, we think of the spread between our average duration in the servicing portfolio or key reiteration of the hedging ends which is in the sort of 750 a year range. We'll look at how much the spread between monthly rates and those tenners has flattened that's too a loss associated income to us. In addition to which the convexity in our servicing portfolio has risen as we have built the servicing portfolio over the last year or two, such that as rates go back and forth it is range of volatility - back and forth across your hedgeable amount and every time it goes one way to the other you are making transactions. And all of this has resulted in a less efficient or less effective hedge and a lower earning hedge and is that condition is going to exist for a little while, until one of several things changes. One, mortgage rates rise meaningfully and we have refill the servicing portfolio at higher average mortgage. Two, mortgage rates fall. We see like to our spreads it has been placed as the rates in the market versus rates in our portfolio that produces this type of pension costs. What we originated what rates we are originating that have a big impact on this equation. Then we find ourselves unfortunately at this point sometime with hedging results that are not early is good for us. I will tell you though, Henry. We still have the best hedging results of any large public servicers whose results we can track. And we measure that on a relative basis. Risk management results as a percent of being the entry fee of loans serviced. And we are all suffering right now as a consequence of these various metrics. So the question, because we know that it's also is subject to cyclical change going forward. And it's one of the very challenging aspect of the business at this point. Sorry about the extended answer.

No, no. I mean that's very helpful. So just a simple question, you are servicing this in house, right?

Yes.

Okay. Thank you very much for your answers to my questions.

Thank you.

This concludes our question-and-answer session and also concludes the conference. Thank you for attending today's presentation. You may now disconnect.