Mechanics Bank (MCHB) Q3 2021 Earnings Report, Transcript and Summary

00:03 Good day, and welcome to the HomeStreet Third Quarter Twenty Twenty One Earnings Call. All participants will be in a listen-only mode. [Operator Instructions]. On today’s presentation, there will be an opportunity to ask questions. Please note, that this event is being recorded. 00:26 Now I would now like to turn the call over to Mr. Mark Mason, Chairman and CEO. Please go ahead.

00:34 Hello and thank you for joining us for our third quarter twenty twenty one earnings call. Before we begin, I'd like to remind you that our detailed earnings release and an accompanying investor presentation were filed with the SEC on Form 8-K yesterday and are available on our website at ir.homestreet.com under the news and events link. In addition, a recording and a transcript of this call will be available at the same address following our call. 01:03 Please note that during 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, our investor deck and the risk factors disclosed in our other public filings. Additionally, reconciliations to non-GAAP measures referred to in our call today can be found on our earnings release and investor deck available on our website. 01:37 Joining me today is our Chief Financial Officer, John Michel. John will briefly discuss our financial results and then I'd like to give an update on our results of operations and our outlook going forward. John?

01:51 Thank you, Mark. Good morning, everyone, and thank you for joining us. In the third quarter of twenty twenty one, our net income was twenty seven million dollars or one point thirty one dollar per share as compared to net income of twenty nine million dollars or one point three seven dollars per share in the second quarter of twenty twenty one. 02:10 Our annualized return on tangible common equity for the third quarter was fifteen point six percent. Our annualized return on average assets was one point four eight percent and our efficiency ratio was sixty two point eight percent. Our net interest income in the third quarter was slightly lower than the second quarter due to a one point seven million dollars decrease, and interest income derived from PPP loans, which was partially offset by higher levels of non-PPP loans. 02:39 PPP loans caused our net interest margin to be higher by eleven basis points. Excluding the impact of PPP loans, our net interest margin in the third quarter of twenty twenty one was consistent with our net interest margin in the second quarter of twenty twenty one. As of September thirtieth twenty twenty one, outstanding PPP loans were seventy seven million dollars with deferred fees of two point four million dollars. 3:05 As a result of the continued favor performance of our loan portfolio and the improving outlook of the impact of COVID-19 on our loan portfolio, we recorded a five million dollars recovery of our allowance for credit losses in the third quarter of twenty twenty one. As we continue to have more clarity of the minimal impact COVID-19 is having on our loan portfolio and with projected improvements in our economies, we expect to recover additional amounts of our allowance for credit losses in future periods. 3:34 Our ratio of non-performing assets to total assets improved to twenty six basis points. Our ratio of ACL to total loans was one point zero six percent. The three point eight million dollars decrease in net gain or loan origination and sales activities in the third quarter of twenty twenty-one as compared to the second quarter of twenty twenty-one, was due primarily to a lower volume of single family mortgage rate locks and lower levels of CRE loans sold in the third quarter. 04:05 The zero point nine million dollars decrease in non-interest expense in the third quarter as compared to the second quarter, was primarily due to lower compensation costs, which were partially offset by higher general administrative and other expenses. The three point two million dollar decrease in compensation costs was primarily due to reduced commissions resulting from lower levels of loans closed in our single family mortgage operations and lower benefit costs to third quarter seasonality. 04:35 General administrative and other costs increased due to a one point nine million dollar reimbursement of legal costs, received from our insurance carrier in the second of twenty twenty one and higher marketing costs. During the third quarter of twenty twenty-one, we repurchased two percent of our outstanding common stock at an average price of forty point two six dollars per share and declared and paid a dividend of zero point two five dollars per share. Since the beginning of twenty twenty one, we have repurchased seven percent of our outstanding common stock. This is in addition to the twelve percent and nine percent repurchase in twenty nineteen and twenty twenty respectively. 5:13 I will now turn the call over to Mark.

05:17 Thank you, John. HomeStreet's results for the third quarter continued our outstanding results for the year. Our results reflect our diversified business model, the benefits of our conservative credit culture and continuing focused on operating efficiency. Our loan origination levels remained strong with eight zero four million dollars of originations and excluding the impact of PPP loans and despite continuing high levels of prepayments. Our total loans grew at an annualized rate of nineteen percent during the quarter, and nine percent year-to-date. 05:52 As expected, our single family mortgage loan volume and profit margins decreased from second quarter levels and our revenue has now declined to near normal levels. The credit quality of our loan portfolio continued its strong performance. As John mentioned, greater clarity on the impact of COVID on our portfolio allowed us to recover five million dollars of our ACL. 06:18 The second consecutive quarter, our mortgage banking revenue comprised only seventeen percent of total revenue and less than eight percent of our net income. We continue to anticipate a slight decrease in our origination and gain on sales activities over the next few quarters. Due to increasing revenues from other operations. We expect the revenue contributions from our single family mortgage banking business to represent an even smaller share of total company revenue going forward. 06:53 We expect our overall net interest margin to continue to benefit in the fourth quarter of twenty twenty one from the forgiveness of PPP loans. Looking forward, with the Federal Reserve indicating that short term interest rates will remain low for the foreseeable future. We expect our net interest margin excluding the impact of PPP loans, to remain level as the benefit of our deposits continuing to reprice downward, is expected to offset any decline in the yields on our portfolio loans. 07:24 As I’ve mentioned previously, we continue to increase our commercial real estate loan originations, primarily multifamily, both for sale and for our portfolio. The strong fundamentals and demand in our markets and our successful platform has supported this initiative. These continuing high levels of loan production are expected to result in ten percent to fifteen percent growth in our loan portfolio next year and beyond with a commensurate increase in net interest income. 07:58 Our efficiency ratio in the third quarter was consistent with the prior quarter at sixty two point eight percent. While the expected decline in mortgage banking profitability is likely to result in upward pressure on our efficiency ratio through mid-next year. We anticipate that as a result of loan portfolio growth and related increases in net interest income and our ability to leverage our existing operating infrastructure, we have the opportunity to improve our efficiency ratio to approximately sixty percent in the second half of next year and ultimately, to the mid to high fifty percent range beyond that. 08:41 Based upon our continuing strong financial results and positive outlook, we repurchased fifteen million dollars of our common stock during the quarter and paid a zero point two five dollars per share dividend, which today equates to a yield of approximately two-point three percent on the market value of our common stock. We anticipate continuing to efficiently retain capital for growth, while returning excess capital to shareholders. In that regard and subject to our Board of Directors review and approval and the non-objection of our regulators, we plan on repurchasing twenty million dollars of our outstanding shares in the fourth quarter. 09:21 Additionally, given our consistently strong performance, the Board of directors anticipates discussing an increase in our dividend in the first quarter of next year. Of course, future declarations of the current or higher levels of dividends are subject to our financial condition and future outlook at that time as well as corporate governance, legal and regulatory requirements. 09:48 Last quarter, we disclosed that we were evaluating the use of securitizations as a tool to enable us to originate multifamily permanent loans to our full potential. To uncap individual borrower lending limits and to improve our capital efficiency and retain the servicing on these loans and that we planned on completing our first securitization this year. 10:13 While we continue to evaluate the use of securitizations. We have instead agreed to execute a whole loan sale in the fourth quarter due to extremely favorable prices available in the secondary market today. Looking forward to through twenty twenty two, we expect lower levels of portfolio loan sales either through home loan sales or securitization, as we plan to retain loans in our portfolio to generate increasing levels of net interest income. 10:46 Since going public in twenty twelve, HomeStreet has been executing the strategy to convert from a legacy thrift to a full service commercial and consumer bank. This conversion focused on the development of commercial lending and deposit product lines and more recently reducing the size of our single-family mortgage banking business. 11:07 S&T has recently recognized our successful conversion. And HomeStreet’s global industry classification standard code will be changed from a thrifts and mortgage finance institution to a regional bank effective as of November the first of this year. This change may qualify HomeStreet for inclusion in certain regional bank indexes that currently exclude us. 11:36 To reiterate my comments from last quarter, the investments that we have made and the improvements in our efficiency and profitability, have provided us with the operating leverage that will enable us the opportunity to grow revenue and in turn earnings without commensurate additions to personnel or other operating expenses. And while quarter to quarter earnings may show some degree of volatility, excluding recoveries of our allowance for credit losses and excluding with non-recurring items, such as PPP loans and expense recoveries and of course, subject to any unforeseen changes in the economy in our business. We believe, we have the opportunity to continue to grow year-over-year earnings per share over the next few years. 12:23 Specifically, we believe that current estimates understate our possible earnings per share over the next few years. Given our performance in relation to peers, and my forward-looking comments today, I believe our stock is significantly undervalued. Today, we trade at a meaningful discount to our peers and price to earnings or tangible book value basis. Specifically, based upon multiples of twenty twenty two consensus earnings estimates, today, the median of our peers, trade at over thirty percent higher than HomeStreet. Historically, this discount was largely attributed to high levels of mortgage banking revenues and earnings and its associated volatility. Historically, this was accurate with mortgage banking revenues exceeding fifty percent of total revenues. However, even at the height of last year's mortgage refinancing, our mortgage banking revenues never exceeded thirty two percent of total revenues. And the last two quarters of mortgage banking revenue represented only seventeen percent of revenues and less than eight percent of the bottom line. Today, in a meaningful discount associated with Mortgage Banking and volatility is unwarranted. And I believe our shares represent a tremendous opportunity for investors. 13:52 The best way for me to describe the current state of affairs at HomeStreet is that while we are pleased to have achieve strong operating results and total shareholder returns over the prior decade. This is not the same HomeStreet of ten years ago. Nor is it the same HomeStreet of even three years ago. What we have been able to accomplish with our effective reorganization is to have brought the company to a place where we can expect to achieve lower earnings volatility, higher operational profitability and stronger earnings growth. All of which we believe should compare very favorably to our regional banking peers going forward. 14:34 With that, this concludes our prepared comments today. We appreciate your attention and John, and I would be happy to answer any questions you have at this time.

14:46 And I'll begin the question-and-answer session. [Operator Instructions] First question comes from Jeff Rulis - D.A. Davidson. Please go ahead.

15:13 Good morning.

15:14 Hey, Jeff.

15:15 Hey, Jeff.

15:16 Question on the gain on sale projections in twenty two, you've got sort of flattish fee income expectations just trying to see what that line item year-over-year, maybe you could just detail a little bit more of what you see with the gain on sale item?

15:38 Obviously, we expect gain on sales of single-family mortgage loans to decline from this year, right? I mean, earlier this year, we still had much more meaningful levels of refinancing activity so absent a meaningful decline in mortgage rates we are expecting the revenues next year in the single-family mortgage banking area to look a lot more like the second half of this year. So, you can see there would be a noticeable decline in those revenues. Additionally, given my earlier statements that we are planning to sell less multifamily loans next year either by whole loan sale or securitization, those revenues are expected to decline also. 16:32 We are expecting to continue to grow our multifamily Fannie Mae DUS Business and of course, those are all loan sales securitizations, we're expecting those related revenues to rise that mitigates those declines somewhat, but you could foresee these revenues declining if you sort of mix up all of those comment by twenty five percent to say have third of this year's gain on sale value.

17:05 for this year, yes. So just to add the third quarter revenue numbers probably are pretty consistent from a single-family perspective in terms of going forward and looking on a go forward basis to not be substantially different either up or down from there. The other thing I want to point out is as we go through in this mortgage banking revenues, as a prepayment speed declined, we would expect some uptick in our loan servicing revenue on the single-family mortgage side, all said some of that, yes.

17:30 Right. It’s counter cyclical, I know Jeff, you've looked at our results for a long time and seen that. Our servicing results have been pretty poor, and they always are during falling rate. Right high levels of repayment speeds, which create high levels of decay or amortization of servicing rights. Also when looking at these third quarter results, we didn't have a multifamily loan sale, right. So you really need to look at both third and fourth quarters to get a realistic run rate going forward. 18:03 And as we mentioned, we've agreed to have a whole loan sale of multifamily loans in the fourth quarter at premiums that were sufficient to keep us from securitizing, so we're expecting that to be a strong loan sale.

18:22 Got you. And is the housekeeping item maybe John, what were the PPP balances at quarter end?

18:28 They were at seventy seven million dollars and the deferred fees were about two point five. Our expectations are, is that through the fourth quarter, we continued some forgiveness activity and then we don't expect anything materially to be affecting next year's results on the PPP side, be small benefit.

18:47 Got you.

18:48 Also…

18:49 Go ahead.

18:51 So I'll also just kind of to be on the revenue question, we believe that revenue loss is going to be made up by other revenue increases, primarily greater net interest income and all of these things together, we believe along with continuing repurchases that we are not going to see a diminution in earnings per share next year, right despite the broad estimates that exist in hand.

19:26 Yeah. If you look at our numbers, our expectations because of the declining balances this year due to PPP loans, is not only do we expect our year over year balance to increase by ten percent to fifteen percent, but we expect our average balance of loans to increase by a similar level next year also?

19:46 And that ten percent to fifteen percent include the loans held for sale.

19:49 The ten percent to fifteen percent the loans held for sale tend, it would not include that from the perspective of going forward. The loans held for sale will kind of be more fluctuating and historically we've been pretty consistent because we have a loan sale on a quarterly basis. In the future that will be more fluctuating because we are going to necessarily do one on a quarterly basis going forward.

20:09 So right the ten percent to fifteen percent is just loans held for investment.

20:14 Okay. Got it. And the nineteen percent annualized loan growth in the quarter, would you include the held for sale? Please?

20:21 Yeah, we did include the held for, yes, because we did – if you look at the held for sale between the second quarter and the third quarter, there was a big jump because of reclassification so to get that annualized number, we did include all the loans. That's why we also included the loans for the whole year, and that run rate was nine percent That's why I want to make sure we're clarifying everybody what the growth is. But we have strong growth when you pull back PPP loans in terms of our overall portfolio.

20:45 Got you. Thanks for clarifying. I'll step back. Thank you.

20:49 Thanks, Jeff.

20:49 Thanks, Jeff.

20:54 [Operator Instructions] next question from Steve Moss from B. Riley Securities. Go ahead, please.

21:04 Hi good morning.

21:05 Hey, good morning.

21:06 Good morning, Steve.

21:08 Maybe just following up on loan pipeline being strong here. I hear you guys on multifamily originations, obviously, the kind of curious, you saw some growth here in the quarter and construction and even, other spots just kind of how you thinking about the mix in terms of the growth going forward?

21:28 We have a very strong pipeline, particularly in the commercial real estate area, the multifamily area. Obviously, in the single-family mortgage area we're coming into the seasonally lower volume period and the fourth quarter tends to be a period seasonally where you're drawing down the pipeline. So, we will exit the fourth quarter at least in the single-family area with a smaller pipeline than we enter. That may not be true in the commercial area, it still remains to be to be seen. Obviously loan rates continue to be attractive and in some areas like the Fannie Mae DUS area, recent changes in the lending caps for Fannie Mae and Freddie Mac in the multifamily area. Have spurred great originations there. 22:27 The change in administration has been good for the agencies with respect to multifamily lending caps, those caps were increased about ten percent from twenty twenty one cap and the agencies have become much more competitive since those announcements. So we're expecting much stronger agency lending through the end of the year and at least next year.

22:55 And one other thing too is our single-family loans originated for portfolio have been strong this year and we continue to have pretty strong results next year, just the level of prepayments have been so high as last two and a half. Has been hard to keep pace with it. We expect with prepayments going down next year that we expect our single-family portfolio to continue to actually to start growing next year?

23:19 It's been right off since we downsize the business.

23:23 Right, right. Exactly. Okay. That's helpful. And then in terms of just loan pricing, kind of curious as to where rates are in terms of what's coming on the books these days versus what the rate of what is rolling off?

23:42 Well, I mean, that’s still, that condition hasn't changed, right? I mean loans that are prepaid or prepaying for a reason, right? And so let me see if I can give you some runoff note rates, in the aggregate in the third quarter. Let me pick up…

24:09 That's what we originate that.

24:12 Right. I'm looking for the runoff.

24:13 The runoff this year?

24:16 We ran loans off. Actually, it appears balanced, but it's not really. In total, we ran off loads at about a three thirty eight spread and replaced them with three thirty nine, but that's not true by category, right? If you look at, for example, single-family loans, the loans that prepaid were three point nine three percent and the loans we added are three point three six percent right. I mean, that puts a perspective what happens with runoff.

24:50 The one thing that's affecting this too is the PPP loans or some of the runoff we have. And so those loan rates were low at one right.

24:57 Right. That's what makes the aggregate low…

24:58 Yes.

24:58 But in the ongoing portfolios, the multifamily perm portfolio plus the non-residential CRE perm portfolio, we ran off at four point two one percent and we added at three two two, right. So, These trends continue. This is the same experience all of our peers are having. Fortunately, our funding costs, continue to fall and in the aggregate we believe we're able to maintain our core net interest margin.

25:34 Okay. That's helpful. And then, in terms of Mark you talk about capital deployment, going up twenty million dollars here, likely on the buyback. Just kind of, I take that to be your signaling, sustained profitability closer to this quarter's current level. Just kind of curious on how you guys are thinking about it, especially as we think about twenty twenty two?

26:01 Well, that's a great question. We have been fairly aggressive with our buyback program, though, we have been careful during the pandemic to structure our buyback program so that buybacks during the quarter have generally not exceeded what we've earned into the quarter in conjunction with dividends. So distributions if you will. 26:35And we were sensitive to that relationship as the pandemic has extended to return – to return – to maintain a somewhat higher level of capital then we would target in a normal course and going forward, as the pandemic across my fingers on this one, as the pandemic ends, it doesn’t extend, you may see us extend the buyback activity beyond current earnings in conjunction with dividends. That would have the impact of reducing our capital ratios somewhat. Not significantly, but little beyond on current levels, which means that relative to capital earnings, our buyback program maybe slightly elevated.

27:45 Okay. Great. That's helpful. Thank you very much.

27:51 Thank you, Steve.

27:53 Great. Thanks Steve.

27:58 This concludes our question-and-answer session. And I'd like to turn the call back over. It's the Mark Mason for final remarks, please go ahead, sir.

28:07 We appreciate Well, before we leave, we're looking at the queue. Does Jeff Rulis have another question, are we looking at the Queue. Operator, can you check?

28:23 One moment? Yes, so I'll get them back in. Give me a moment, please. All right, our next question will be from Jeff Rulis follow-up from D. A. Davidson. Please go ahead.

28:37 Sorry, guys. Not to hold everyone up, but just a quick question on the EPS being understated. I think a big piece of expectations might be at least year-over-year twenty one versus twenty two is on the provision year-to-date a nine million dollars recapture added. Are you excluding that in that conversation? Just wanted to kind of get your sense. And if you're including, I guess any expectations you have on the provision line for twenty two are relevant?

29:11 Great and thanks for asking that question. We are anticipating again absent changes in COVID related risk or our other credit risk. We are anticipating further drawdowns in our ACL next year. If we realize what I would consider a normal – a full normalization of that credit risk related to COVID next year, we would likely normalize our ACL levels or coverage levels if you will, which would anticipate us recovering the remainder of provisions we established against pandemic related risk offset by growth in the portfolio and whatever other adjustments we might feel are needed to adequately state our ACL in relation to obviously the new standards. But if you consider that we've had a growing composition of multifamily loans in our held for investment portfolio and that potential impact on the ACL, our ACL could end up at or slightly lower relatively to where we were pre-pandemic. 30:52 We have not had losses in multifamily loans as an institution as simple statement. And our relative credit risk when you consider our high composition of real estate related lending and the hard collateral conservatively underwritten comes with it. We have a lot of safety in our ACL coverage and so, our next year's comments do contain the assumption that we will recover all or substantially all of the pandemic related provisions from twenty twenty offset by portfolio growth.

31:41 Got it. So if you are growing loans ten percent to fifteen percent in twenty two, we could see continued drawdown of reserves in twenty two. So be it that the provision line is in that benefit versus an extent.

31:53 Yes. That's correct.

31:57 Okay. Thank you, guys.

31:58 You got it.

32:02 Thank you. That will conclude our question-and-answer session. We'll go to Mr. Mark Mason now for closing remarks. Thank you. Mark?

32:08 Thank you, operator. And thank you to everyone who joined us today for your attendance and patience in our prepared comments and the great Q&A. We look forward to talking to you next quarter.

32:24 Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.