Good afternoon and welcome to the HomeStreet Second Quarter 2020 Earnings 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, Chairman, President and CEO. Please, go ahead.

Hello and thank you for joining us for our second quarter 2020 earnings call. Before we begin, I'd like to remind you that our detailed earnings release was furnished yesterday afternoon and an accompanying investor presentation was filed this morning to the SEC on Form 8-K and are available on our website at ir.homestreet.com under the News & Events link. In addition, a recording and a transcript will be available at the same address following our call. Please note that in the course of our call today, we may make certain predictive statements that reflect our current views and expectations about the company's performance and financial results. These are likely forward-looking statements that are made subject to the safe harbor statements included in yesterday's earnings release, the investor deck and the risk factors disclosed in our other public filings. Additionally, reconciliations to non-GAAP measures referred on our call today can be found in our earnings release available on our website. Joining me today is our new Chief Financial Officer, John Michel. On behalf of the entire organization, I would like to welcome John to the team. You may have noticed that John is already making some changes to our financial reporting. Our earnings release has a new look and format and we hope that these changes will make it easier for investors to quickly understand the important things to know about our performance. Of course, we're always open to feedback from investors on changes we can make to advance that goal. John will briefly discuss our financial results and then I'd like to give an update on our response to the current COVID-19 pandemic and related credit status, a few comments on our results of operations and our outlook going forward. John?

Thank you, Mark. Good morning everyone and thank you again for joining us. It is great to be a member of the HomeStreet team. Before I comment on earnings, I want to let everyone know, we filed an amended press release this morning to correct an error in the presentation related to the efficiency ratios on page four. The actual efficiency ratios for the last five quarters are 62.6%, 68.5%, 74.8%, 75.9% and 82.4%. In the second quarter of 2020, our net income was $18.9 million, or $0.81 per share, with core income of $20.2 million or $0.86 per share and pre-provision core income before income taxes of $32 million. This compares to net income, core income and pre-provision core income before taxes of $7.1 million, $8.1 million and $24.1 million respectively in the first quarter of 2020. Net interest income was higher in the second quarter of 2020 when compared to the first quarter of 2020, due to an increase in interest-earning assets and an increase in our net interest margin to 3.12%. This increase in our net interest margin was due to decreased funding cost, which was only partially offset by decreases in our yields on interest-earning assets. At the end of the second quarter our cost of deposits was 51 basis points. Due to adverse economic conditions related to the COVID-19 pandemic, we recorded additional provisions during the first six months of 2020 for credit losses as an estimate of potential impact of these conditions on our loan portfolio. The provision for credit losses was $6.5 million for the second quarter of 2020, as compared to $14.0 million in the first quarter of 2020. As we have not experienced any meaningful adverse changes in our non-accrual or adversely classified loans, our provision for credit losses for the…

Thank you, John. I am very proud of what we accomplished at HomeStreet during the second quarter. Strong mortgage banking profitability, significantly lower cost of deposits, and the impact of our focus on cost efficiency contributed to solid financial performance. I would like to thank all of our employees for their hard work, delivering these exceptional results under very difficult circumstances. This pandemic illustrates the need for community banks, such as HomeStreet. Consumers and small businesses have struggled to access and understand federal aid programs, such as the Paycheck Protection Program. These customers have been best served in the crisis by the level of customer service community banks provide. Many of our larger competitors were unable to provide this needed support, given the breadth of the crisis. As a consequence, we've welcomed many new individual and small business customers to HomeStreet during this crisis. Although the effects of the global pandemic continue and the long-term impacts are yet to be fully realized, we are encouraged by the performance of our loan portfolio to this point. Our commercial business loan portfolio, which contains lines of credit and term loans, has by design limited concentrations by industry in order to help limit our risk of exposure to any one part of the market. Additionally, we have generally avoided lending to riskier industries, like hospitality and leisure, travel, food service, fitness, energy and entertainment. This conservatism has served us well in the pandemic. The remainder of our loan portfolio is secured by conservatively underwritten, high-quality real estate and some of the strongest and previously fastest-growing economies in the nation. As a result, our loan portfolio is performing well relative to peers. As of June 30, our commercial business loans granted forbearance. 88% of them have completed their forbearance period and have resumed regular…

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

Thanks. Good morning.

Good morning.

The margin position seems fairly favorable amongst peers. I wanted to circle back Mark your expectations for margins to increases. Is that exclusive of the PPP impact?

No that's inclusive of the PPP income.

Okay, okay. So on a core basis, pretty steady and then just hoping to include a little benefit from PPP?

No. On a core basis improving. The PPP impact will be declining, right as forgiveness occurs, right and those balances decline. Obviously, that has some impact but the effective margin on PPP loans for us I think is in the high twos at this time. And in our case, we have not sought to accelerate PPP fees. We still have well over $9 million of PPP fees to be recognized out of the $9.5 million of total fees.

Yes. As you say, we do expect some benefit from the amortization of the loan forgiveness, but we don't expect that to happen until late fourth quarter and then first and second quarter of next year. So over the next six months, we see our core earnings, even though we have PPP downward in price because they're lower-yielding loans but we don't see the benefit of the forgiveness of the loans until the second – first and second quarter of next year.

So also Jeff, our deposit costs are continuing to decline at a meaningful level even past the end of June. At this point in July, our cost of deposits is approximately 45 basis points just to put that in perspective.

No, I think I framed that poorly. Anticipating that sort of PPP is a headwind today and was sort of suggesting that towards the end of the year or maybe early next becomes a tailwind, do you – maybe John, do you have the basis point impact of PPP, what that was impact to margin in the quarter on a negative basis?

I do not have that calculated but I'll be glad to get it and get it back to you.

Okay. No problem. Thanks. The non-accrual adds market that you outlined some commercial credits that were sort of non-COVID related and acquired. What segments were those in from a business standpoint?

They were dental practice loans of the type that we refer to as dental service organizations, where investors have aggregated practices and centralized business management operations. That is a growing trend in the dental industry. We had acquired a small portfolio of those loans last year and we've had a couple of problems.

Okay. I would say that the core dentists that you've underwritten and I think stopped early deferrals, the balance of those were pretty favorable as we've opened up. Is that true that that group has done fairly well on the whole?

Really well. And perhaps we should have highlighted that a little more, but we went with the large numbers, which are so overwhelmingly positive as to reopening -- regrowing revenues. Our dental practices are currently operating at between 70% and 80% of normalized revenue according to our survey. And the vast majority except for a small handful are not anticipating any need for further forbearance. They're back making regular payments. We have precious few delinquencies and it's just a very, very solid piece of the landscape today. And in fact if you look at the level of dental loans with outstanding forbearances, it's fallen to under $4 million and eight borrowers at the end of June. And as we sit here today of course, I think that they're either gone or almost all gone.

Got it. Okay. Last one on the reserve, you've framed up the methodology. Just trying to -- whether that's versus peers or that's fair or not, it seems more guided by kind of current credit health rather than future potential risks. I wanted to kind of get into the reserve build methodology, I guess the metrics that you see that are underlying that are more qualitative. Kind of what are the inputs on that side that would suggest that you've got a pretty comfortable reserve?

So, I appreciate that question. We tried to frame it in the comments and maybe we didn't do as good a job as we could have. But pretty simply, we while we're cautiously optimistic about the portfolio and in particular the commercial loans that we have granted forbearance is on, we're fortunate that we can continue to provide comfortably in what I would really call an abundance of caution towards uncertainty. We feel quite good about the regular CECL-reserving process relative to single-family mortgages and home equity lines of credit. Those probabilities of default and loss given default, those numbers came out of last recession, right? And so, those are sort of acid tested for loss potential. However, the opposite has really been true with respect to commercial loans substantially in C&I loans, owner-occupied real estate loans and to a lesser extent regular commercial real estate permanent loans. And so, we approached the question of uncertainty by judgmentally increasing the probability of default really significantly for those loan types for which we have provided forbearances. Whether or not they have completed them we're paying again regardless for the total pool of forbearances for commercial business loans, owner-occupied real estate loans and those few number of permanent commercial real estate loans that we provide forbearance to. And roughly, John provided those probabilities in his comments, I'll find the numbers here, but it was...

See, yes it's 60% for the business loans, 35% for owner-occupied and 50% for non-owner-occupied CRE.

Right. So we applied that expectation of default. We believe, the loss given default numbers or severity in our CECL calculations are still reasonably appropriate. We think at this point, those numbers are extremely conservative. We just don't choose commercial business loans or pure lines of credit and term loans. We are reserved for 60% of them to default at a meaningful loss given default which I think is...

Roughly 30%.

Roughly 30% loss potential. When today, we see almost all of them out of their forbearance period and paying again. So, we feel like our reserves relative to our pool of risk are really conservatively stated today subject to uncertainty.

Yes. And the other aspect I want to mention is that we do look at updated economic forecasts from Moody's in terms of evaluating our qualitative factors and have included the most recent valuations from Moody's in terms of economic forecast and that's contemplated in the calculations of our reserve.

At the most severe level. Yes. I hope that's clear.

Yes. No, thanks for the color.

And Jeff, I did get back. It's roughly three to five basis points negative impact from the PPP loans in the second quarter.

Appreciate it. Thanks John.

Okay.

Our next question comes from Steve Moss with B. Riley FBR. Please go ahead.

Hi. Good morning.

Good morning, Steve.

Good morning, Steve.

Maybe starting on the loan pipeline here a little more optimistic than some others with regard to lending opportunities. Just kind of curious as to -- you kind of mentioned the types of loans, but what you're seeing for loan yields and kind of what maybe extra underwriting standards or covenants you guys are requiring these days?

Sure. Look yields are low, right? I mean, given the absolute level of rates and the yield curve yields are still low. Competition for loans maybe less in terms of active lenders, but those that are active are very competitive as to rates. Our commercial real -- for example, our commercial real estate multi-family perm loans are averaging somewhere between…

I think it's 350 to…

340 to 370, I think is safe, right?

Yes. Yes.

We are -- our general commercial business loan pipeline, of course, we suspended early on. We've reopened the pipeline on a limited basis to industries and businesses that have limited impact from the pandemic. That is not as competitive, but of course everything is based upon much lower variable index levels, right? So spreads are consistent to larger, but the absolute level of rates of course is lower. Having said that, C&I originations are 4.25% to 5% as an absolute number. Construction loans, obviously, in the residential construction area, we're still actively lending. Those yields are still prime plus one generally to 1.5. And we're generally getting point in fees. So the effective yield is over 5% typically. And of course, the mortgage industry is what it is. I mean, you may see in the media 30-year mortgages at around 3%, but with loan-level price adjustment the average is generally higher in the 3.25% to say 3.35% range. If that helps with a little absolute color on, right?

Absolutely. That does. Thank you for that. And on expenses here, Mark you mentioned IT expense is coming down meaningfully in the beginning of next year I believe. Just kind of curious as to maybe a little bit more color on that and kind of how you're thinking about the efficiency ratio in 2021.

Well, we are just finishing negotiating our largest core systems contract -- renegotiating for an early renewal and our mortgage origination system contract. I don't want to say too much about those until we have completed and executed the agreements, but we are going to get most of what we hoped for. It is a reality when you request to renegotiate a contract early, you will not get the full price benefit you would have of going to maturity and putting it out for proposal. However, we have a significant need to get benefit as soon as possible. And we think that the present value of the difference is not that meaningful, right? Getting it early is important. We are getting meaningful double-digit reductions in the cost of these contracts. In fact, our mortgage origination contract is going to go down by more than half. Our core systems contract a meaningful double-digit reduction. And just as important particularly in our core service agreement, we are getting significant improvements in our service-level agreements and penalties. And additional requirements that will help us provide more consistent and better service to our customers, right? So comprehensively, we feel very good about the work that we've done with our core service provider, they work productively with us more recently. I know that I voiced some criticism earlier. But more recently they have done a good job in working with us and we're happy with where we're ending up. Q – Steve Moss: Okay. That's helpful. And then in terms of just the deferrals here it's a good healthy decline on the commercial side. Just kind of curious what is -- I mean CRE non-owner didn't move much in the consumer portfolio. I'm assuming you had three more months to go. Just kind of curious…

Our next question comes from Matthew Clark with Piper Sandler. Please go ahead. Q – Matthew Clark: Hi, good morning. A – Mark Mason: Good morning. Q – Matthew Clark: I appreciate the color on the rates by product. But do you have a weighted average rate on new production in the quarter excluding PPP, or what do you expect kind of the weighted average rate to be based on what you plan to originate in the back half? A – John Mitchell: When you say back half are you talking about the second half of 2020? Q – Matthew Clark: Yes. A – John Mitchell: Okay. So what we expect current and future rates to be? A – Mark Mason: Look we don't make rate predictions. So any future expectation we would base on this quarter, right? Weighted average rate for all originations let me ask my guys here if we have that. That – it's probably a number we don't have.

Again, the multifamily market, I mentioned earlier is roughly at the current time 340 to 370 and kind of talked about the other rates it depends on the volumes we have of H1.

In terms of note rates – okay. So it's going to be impacted by the PPP loans, right? So there's an anomaly this quarter. I mean, our average rate this quarter is probably in the 2.5% range, but that's after having originated $300 million of 1% coupon loans right. Excluding that, it's probably in the –

High 3s.

High 3s. Yeah. High 3s.

And we can work look at that better Matthew as we get to the data.

No worries. I'm trying to get an incremental margin to give us some visibility knowing the spot rate on deposits. And I assume on the security side, I guess with as cash flows come in, if you are buying something what's kind of the way the average rate there?

Let me ask the treasurer sitting here.

250 between 240 and 260 right now is what we're looking at. But we are not – with the growth in the or the decline in the balance sheet with the prepayments our liquidity is such that we're trying to deploy those into loans. So we're not purchasing much right now.

Yeah. It was so as our securities portfolio is going to shrink a rise in the year.

Right now, we're going to hold it flat we're going to repay its cash flows. So we're not going to utilize any excess liquidity for the securities book.

Okay. Great. And then maybe shifting gears to expenses. Can you quantify, how much of that $30 million in mortgage-related revenue? I guess, how much was offset by expenses mortgage expense?

Now, we don't break out segments any longer, Matt.

Figured, I give it a shot.

We talked about this on the last call. Didn't we? So, sneaky there. I'm sorry look, when we discontinued the segment simplified the company, we made the decision to not essentially sub-report that segment. And I understand from an analyst standpoint, particularly when you have these substantial changes in volume and profitability, it makes your modeling a little harder. But I'm so impressed with how intelligent you folks are. I'm sure, you'll get it right.

Great. And then just on the share repurchase I guess, what's your sense for the timing to receive non-objection? And how aggressive might you be in retiring that new $25 million program?

I'm hopeful that, the non-objection will come promptly let's say within two weeks. As you would expect, I have pre-discussed the possibility of us making the request with our regulators. And I believe that, they are based on those discussions favorably inclined, but that's not, an approval nor a non-objection and we have a process to go through and they have their own considerations. And so I'm hopeful that, we receive that within a couple of weeks.

And then from a perspective of repurchasing, we would be aggressively in the market especially at a relative price compared to our book value – tangible book value.

Right. And our current daily maximum recently was running at about 30,000 shares a day. And it's very hard for us to get that many. We've been averaging 17,000, 18,000 shares a day if that helps.

Yeah. Great. Thank you.

Got it.

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

Hi. Good morning.

Hey, Jackie.

Mark, I wondered if you could give an update on just real estate plans. The IT update has been great, but I know that real estate is another area of focus for you. And last quarter you gave some great color on issues that you're seeing in the market which is trying to divest some of that. So I wondered where that stood? And also just an update on if you've changed, how you think about your overall footprint just in terms of both office space and branches in light of what you've learned through the pandemic?

There's a lot of topics in that question.

Sorry.

No let me -- and I'll try not to politicize my answer. We have excess space. Much of our excess space is here in Seattle at our corporate headquarters. We have been trying to sublease approximately three floors of space here for some time. We have nibbled away at that. And we leased a whole floor and portions of another floor. However the current environment is not conducive to leasing Class A commercial office space right now. And accordingly, we reserved against our obligations this last quarter approximately $1.6 million expecting lower sublease rates and higher levels of tenant improvement allowances...

And longer time frame.

At a longer time to before we get it leased up. So from a financial results standpoint, we have made our current position a little more conservative. We hope that that is going to be enough to accomplish getting that space absorbed remains to be seen. The -- our view of our space requirements obviously is subject to continuing reconsideration on a number of basis. One, if we end up more permanently having some of our employees work from home, obviously that decreases space needs. If we move to in some functions more of a hoteling concept with partial time at home, obviously that would as well. On the other hand the pandemic has increased spacing requirements. And of course and that goes either way with increasing the amount of space per FTE that you need to safely work in this COVID environment. So what's the net of that? I don't know. Those are all issues in front of us to sort out. There's also a question of where do we need space. It has been a popular question to me. I do biweekly all-employee calls with our employees. And one of the more popular questions during this period has been are we reconsidering moving our corporate headquarters out of Seattle. I don't know if you've been keeping track of what's going on here in Seattle. I know that the national news has carried a lot of video of demonstrations and protests and vandalism and political unrest here in the city. What you may have not heard though are some of the initiatives that the current City Council has pursued during the pandemic, which include the imposition of a highly paid employee tax on employees who make more than $150,000 per year. That tax is expected and not all the…

Okay. So it sounds like cost saves to come depending on the environment and longer term potentially more meaningful cost saves and changes to be determined maybe once we reach whatever the new normal is going to look like and you kind of figure out what the best long-term plan goes. Is that a...

Fair enough.

Okay.

Yeah.

Okay. Thank you. And then just one last one for me. John I just wanted to clarify. So in terms of the PPP loans there's no amortization taking place on a quarterly basis of balances that remain on sheet and you plan to accelerate the full amount of the fee at payoff. Do I understand that correctly?

No. The amortization is occurring over a two year time frame and some of them are going to be five year because the recent terms were extended, but mostly over a two year time frame. So we're getting an effective yield on them roughly about 2%. And then -- but we don't expect forgiveness which would be accelerating a lot of those fees to start occurring until the fourth quarter and then the first two quarters the next year.

So we did not see as such of some banks and calculated an effective yield anticipating a forgiveness scenario, right? We took a little more of a conservative approach. Yeah.

Okay. So it's a straight amortization of the fees. And then as you get the payoffs you'll accelerate whatever portion remains of that at that point in time.

That's correct.

Okay. Great. Thank you.

Thanks, Jackie.

[Operator Instructions] Our next question comes from David Ederer with HomeStreet. Please go ahead.

Yes. Mark, I don't have a comment. However, question -- but I do have a comment. And that is thank you to you and John for - and your entire team for truly a superb quarter.

Thank you, Dave. For those of you on the line, David Ederer is a recently retired Chairman Emeritus of HomeStreet Bank who has served us well for a very, very long time. Thank you, Dave.

You bet. Thank you. End of Q&A

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

Thank you all for your patience and listening to our prepared remarks and asking us great questions. Obviously, we are very optimistic and excited about our prospects at this juncture. We understand there's a lot of uncertainty. We think that we have been very cautious and conservative in our reserving toward that uncertainty. Even understanding that none of us really know how everything is going to play out right here. But we feel like we are just very fortunate that the way we have built our loan portfolio and run our business the conservatism with which we have underwritten loans is finally really showing itself. I appreciate your time today. Look forward to talking to you next quarter.

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