Mechanics Bank (MCHB) Q4 2021 Earnings Report, Transcript and Summary

Good day, and welcome to the HomeStreet Fourth Quarter Twenty Twenty One 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 and Chief Executive Officer. Please go ahead.

Hello and thank you for joining us for our 2021 fourth quarter and full year 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. 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 on our call today can be found in our earnings release and investor deck available on our website. 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?

Thank you, Mark. Good morning, everyone, and thank you for joining us. In the fourth quarter of 2021, our net income was $29 million or $1.43 per share as compared to net income of $27 million or a $1.31 per share in the third quarter of 2021. For the full year 2021, our net income was $115 million, or $5.46 per share, a record for the company. For the fourth quarter of 2021, our annualized return on average tangible equity was 17%. Our annualized return on average assets was 1.59% and our efficiency ratio was 62.2%. For the full year 2021, our return on average tangible equity was 16.8%, our return on average assets was 1.58%, and our efficiency ratio was 61.9%. Our net interest income in the fourth quarter was slightly lower than the third quarter due to a $2.1 million decrease in interest income derived from the PPP loans, which was substantially offset by higher levels of non-PPP loans. PPP loans caused our net interest margin to be hired by three basis points in the quarter. Excluding the impact of PPP loans, our net interest margin in the fourth quarter of 2021 was consistent with our net interest margin in the third quarter of 2021. As of December 31, 2021 outstanding PPP loans were only $38 million with deferred fees of $1 million. As a result of the continued favorable performance of our loan portfolio and the improving outlook of the impact of COVID 19 on our loan portfolio, we recorded a $6 million recovery of our allowance for credit losses in the fourth quarter of 2021. As we continue to have more clarity of the minimal impact COVID is having on our loan portfolio and with projected improvements in our economies, changes in the composition of our loan portfolio to higher credit quality assets and borrowing negative developments affecting our loan portfolio, we expect to recover additional amounts of our allowance for credit losses in future periods. Our ratio of non-performing assets to total assets improved to 18 basis points. our ratio of ACL to total loans with 88 basis points. The $4.3 million increase in non-interest income in the fourth quarter of 2021 as compared to the third quarter was primarily due to a $2.6 million increase in net gain on loan origination and sales activities due to a 2.73% gain realized on the sale of $244 million of permanent multifamily loans in the fourth quarter, which was partially offset by a lower volume of single family mortgage rate locks and an increased another non-interest income, which was due primarily to a $0.6 million gain on sale of REO in the fourth quarter. The $2.0 million increase in non-interest expenses in the fourth quarter of 2021 as compared to the third quarter was primarily due to higher general administrator and other costs partially offset by lower compensation and benefit costs. The lower level of compensation and benefit costs reflect a $1 million reversal of previously accrued medical benefits related to the positive experience in our self-insured medical program. Legal costs, which are included in general and administrative and other costs were $2.5 million higher in the fourth quarter of 2021 as compared to the third quarter due to the cost incurred on certain legal matters. During the fourth quarter of 2021, we repurchased 2% of our outstanding common stock and an average price of $51.17 per share and declared and paid a dividend of $0.25 per share. Since the beginning of 2021, we have repurchased 9% of our outstanding common stock. This is in addition to the 12% and 9% repurchased in 2019 and 2020 respectively. I will now turn the call over to Mark. Mark?

Thank you, John. HomeStreet, which celebrated its 100 year anniversary in 2021 for the first time achieved earnings in excess of $100 million. I love the symmetry. Our record $115 million of net income in 2021 reflected the success of our diversified business model, the benefits of our conservative credit culture and our continued focus on operating efficiency. Our portfolio loan origination levels remain strong with $795 million from originations in the fourth quarter and a record $3.3 billion for the full year. Excluding the impact of PPP loans and despite high levels of prepayments, our total loans grew 11% during 2021. In the fourth quarter, our single family mortgage loan volume decreased from third quarter levels as we returned to normal seasonal levels of activity. Historically fourth quarter single family lock volume is lower than loan closing volume, which reduces our mortgage banking net income. As the majority of our revenue is recognized upon interest rate lock, the majority of loan origination expenses are recognized at closing. This was particularly true in the fourth quarter. Looking forward to the first quarter of this year, we anticipate the lower normal seasonal volume of interest rate locks, but a balanced or higher volume of locks versus closings. The credit quality of our loan portfolio continued its strong performance in the fourth quarter and as John mentioned, greater clarity on the impact of COVID on our portfolio allowed us cover $6 million of our ACL in the quarter. As we head into the New Year, we believe HomeStreet has the ability to provide more consistent and less volatile earnings. Our mortgage banking revenues, which created significant volatility in the past were only 12% of our total revenues during the fourth quarter and are expected to normalize at a smaller share of total company revenue going forward. We are focused on growing our loan portfolio between 10% and 15% in the coming years, as a result of growth in our loan originations, lower prepayments and reduced portfolio loan sales. Accordingly, our net interest income is expected to be a larger and more consistent component of our revenues. While we expect growth in our portfolio, coming from all our business units, our commercial real estate loan originations primarily multifamily are expected to be the primary driver of our growth. Our efficiency ratio in the fourth quarter was consistent with the prior quarter at 62.2%. While the decline in mortgage banking, profitability and reduced sales of permanent multifamily loans is likely to result in upward pressure on our efficiency ratio through year this 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 believe we will improve our efficiency ratio to levels consistent with the last two years in the second half of this year. And next we believe we can reduce our efficiency ratio to below 60% and trending to the mid to high 50% range going forward. Based upon our continuing strong financial results and positive outlook, we repurchase $19 million of our common stock during the quarter and paid a $0.25 per share dividend. We anticipate continuing to efficiently retain capital for growth while returning excess capital to shareholders. With a completion of our $100 million subordinate notes offering this month, we access inexpensive capital to continue our stock repurchase program and support our future growth. In that regard and subject to our Board of Directors' review and approval and the non-objection of our regulators, we plan on reposing 75 million of our outstanding shares in the coming quarters. Additionally, given our consistently strong performance, the board of directors anticipate discussion and discussing an increase in our dividend in the first quarter this year. Of course, future declarations of the current or higher levels of dividends are subject to our financial condition and outlook at the time, as well as corporate governance, legal and regulatory requirements. To reiterate my comments from prior quarters, the investments we've made and the improvements on our efficiency and profitability have enabled us the opportunity to grow revenue without commensurate additions to personnel or other operating expenses. We previously told you that excluding recoveries of our allowance for credit losses and non-recurring items such as PPP loans and subject to any unforeseen adverse changes in the economy or our business, we believe we have the opportunity to continue to grow year-over-year earnings per share. We expect this to hold true as we consider our earnings per share prospects for 2022. We are planning on reduced sales of permanent multifamily loans, which combined with lower expected prepayments should support our guidance for growth and our held to investment portfolio this year, position the company for a meaningful increase in recurring earnings per share in 2023 versus 2022. Accordingly, we expect earnings in the first quarter of this year to be lower than the fourth quarter of last year, due to the absence of a permanent multifamily loan sale. Additionally, compensation expenses in the first quarter of each year are higher than the prior quarter due to merit increases, employer taxes and the 401k match. Given these expectations, we anticipate earnings in the first quarter to be the lowest of any quarter this year. So while quarter-to-quarter earnings this year may show some volatility depending upon the levels of sales of permanent multi-family loans, if any, as well as the seasonality of our mortgage banking revenues, as we move into the second half of 2022, we believe that our decision to increase loan retention the early part of this year will set a strong foundation for meaningful earnings growth after this year. As a result of our 2019 mortgage banking restructuring, and our initiative to improve operating efficiency and profitability, we have brought the company to a place where we can expect to achieve lower earnings volatility, higher profitability, and stronger earnings growth all of which have and we believe will continue to compare favorably to our regional banking peers going forward. We have made substantial progress and our shareholders have benefited. Our total shareholder return for one year, three years and five years, was 58%, 156% and 72% versus the KRX, which was 37%, 55% and 30% respectfully and I am very happy about the job we've been doing for our shareholders. Despite our recent stock price performance, I believe our relative valuation remains well below a level consistent with the current quality and profitability of our bank in relation to our peers. Before concluding, I want to recognize the recent bank Director Magazine 2022 Ranking Banking Report, which ranked our board of directors as one of the top 10 bank boards of all banks nationwide. As the Chairman of the Board, I'm particularly proud of that honor. Bank Director also recognized HomeStreet as one of the top 10 small regional banks nationally. And with that, this concludes our prepared comments today. We appreciate your attention, John, and I would be happy to answer any questions you have at this time.

[Operator instructions] The first question comes from Jeff Rulis with D.A. Davidson. Please go ahead.

Thanks. Just had a couple questions on the guidance slide, just to dig into the margin assumptions a little bit and Mark, I appreciate the commentary on expectations, but just margin you mentioned some stability or stable outlook, two to three quarters out. Does that include any rates or feds assumption within that?

No, it doesn't. We are -- we're lousy prognosticators or forecasters of fed time inter-fed movements. So obviously that could have an impact, generally a positive, a impact near term, right? Given the adjustable rate loans we have and given the historical lag and repricing deposits.

Okay. And then just following up on the non-interest income line, you mentioned decreasing, and I get that Q1 maybe lower than Q4, pretty decent volatility in the game from origination. So could you characterize that any further are about as you have stepped down in Q1, the expectation for non-interest income, for the balance or how it relates to at least in magnitude full year or within the range of quarterly in '21?

We will see -- we'll see a decline. We have some offsetting or mitigations expected. We're expecting our loan servicing income as an example to perform better this year because of lower prepayments and in turn lower decay of our MSRs. But our single family related gain on sale will be, we expect a little lower in part because of lower volume. If you look at first quarter over first quarter, first quarter of 2021 was still a pretty strong quarter both in volume and in gain on sale. Additionally, we are not anticipating a sale of commercial real estate loans of multifamily loans, portfolio loans in the first quarter. Those two differences should make for a meaningful difference or decline in gain on sale -- first, say first quarter over first quarter. The first quarter of 2021, I believe our gain on sale line was over of $30 million, right. And it came down to as low as $17 million in the third quarter because there was no portfolio quality multifamily loan sale in third quarter, but third quarter still had higher levels of single family volume. So if you look at the third quarter level of say a little over $17 million, third quarter of '21, we expect the first quarter of '22 to be lower than that.

Yeah. I think that Jeff, just the biggest difference between the fourth quarter and the first quarter is going to be the multifamily and per sale that we did in the fourth quarter. Otherwise the single family levels in the first quarter from a revenue perspective are probably going to be somewhat consistent with the fourth quarter.

Okay. Very helpful

Because of seasonality.

Right. Okay. That helps frame that up. I appreciate I'll step back.

The next question comes from Woody Lay with KBW. Please go ahead.

Hey, thanks for taking my question guys. One, of the start off looking at expenses, so your guidance calls for them to be slightly increasing over the coming quarters, but I'm just trying to figure out the base of expenses for that guidance. Is that off the reported number of roughly $54 million or is that, looking at the core number, I know you had some outside litigation expensive, you stripped that out. It's around $51.5 million. Really just looking for some guidance on ex quarter's expenses.

Yeah. I was going to say there's two items in the fourth quarter looking at that perspective that will impact going forward. One is we had the million dollar recovery on our insurance and the compensation and benefits. And two, we had some additional legal costs in the fourth quarter that we do not expect to be recurring. Those were the two biggest items that are not being carried forward or are non-recurring from that perspective. And I think Mark also mentioned the fact that our compensation expenses in the first quarter compared to the fourth quarter are always higher for the reasons he's stated. So I think the guidance that we provided and Mark has provided in the past is kind of a run rate of around $54 million plus on a quarterly basis and obviously fluctuates up and down based on a little bit of seasonality.

So you have some things go in both directions, right? The absence of non-recurring expenses like illegal accrual but the absence of a credit on health benefits. So I would take that slightly phrase to heart, if you just look at the overall number quarter over quarter.

Yeah. Okay. That's helpful. And then in the expense guidance you talk about expenses incurred to support loan portfolio growth. Is that signaling you'll look to be active on the hiring front or is that really just higher expenses for retaining current employees?

We don't think we're going to have materially higher expenses to generate the additional loan volume. We are not anticipating a significant level of hiring, though we do have a fair number of open positions, that we've had open for some time. So, we expect our FTE count to go up, probably in the 20 to 30 FTE range, which would kind of get us back to where we were earlier in the year, last year; but not really over that. And, and we'll be lucky to hire those folks frankly, in this market.

Yes. That makes sense. And then the last for me, is another great quarter on the loan growth run. Could you just give some color on loan prepayment levels in the fourth quarter and sort of, I know you said a couple times that you expect prepayment levels to -- to drop down in 2022. Are you seeing any on to that so far?

Boy, the fourth quarter prepayment rate was pretty consistent with third quarter, but a lot better than the second quarter. And, yet the one thing we know about prepayment and prepayment speeds is you, can only prepay a loan once, right. And there is a burn-out factor that begins occurring. And we're starting to -- we're starting to see that in some loan types.

Yeah. I think the single family definitely recognize that a significant decrease in prepayment on a single family on the multifamily, we're seeing a trend, slightly going down and we expect that to continue going into next year to be more stable and consistent with what historically multifamily has, which is a pretty base level of prepayments. It's not a wide range when you're looking at multifamily portfolios based on our experience.

Now, obviously the Fannie Mae have a lot to do with that, both on the short-end and the long-end with quantitative easing, so kind of remains to be seen about the total impact.

The next question comes from Steve Moss with B. Riley Securities, please go ahead.

All right; Good morning guys. Maybe just time out loan sales a little further. Is it just that you guys do not expect just to be clear, you guys don't expect to do a loan sale in the first quarter? Will that carry on throughout the year or just, how do we think about, commercial real estate loan sales for 2023 relative to the -- what was it? [indiscernible] $773 million number for the, for full year '21?

Well, it it's something that we're just going to watch in terms of our ability to meet our growth targets, first of all, in our portfolio. Remember we, we always have Fannie Mae DUS loan sales and we're hoping for a stronger year, this year with respect to those sales. We're not --we have decided not to do multifamily sale in the first quarter. We could have one in the second quarter based upon our success. I would say that our preference is to retain loans today. In that regard, we are expecting our commercial real estate concentrations to go up somewhat, as we retain more multifamily loans. So it remains to be seen if we're successful in originating the amount of loans we hope to and we haven't really missed our target for several years, even though the target keeps going up. If we're successful, we will probably have a loan sale could be second quarter, could be later to the extent that we have higher prepayments or less originations, that loan sale may be deferred or eliminated this year.

Yeah, I think Steve, one of the important things we remember and we kind of mentioned that last quarter is, well, we're providing of 10% to 15% in the first year, especially 2022. We're going to be looking at being much closer to the higher end of that range and that's kind of our goal and that's why Mark's answer is kind of dependent on conditions.

Okay. That's, that's helpful. And then just maybe in terms of loan pricing these days, I know there's PPP noise and stuff, but just kind of curious as to, where, what you're seeing for loan pricing and just thinking about loan yields here, going forward.

Well, it's still a competitive mark. You still have single family and mortgage is in the, say three, four to three, five range. Multifamily is about three and a quarter. CNI continues to be very competitive in the low threes, today.

Okay. Okay. That's, that's helpful. And then in terms of just, thinking about, funding costs and asset sensitivity, I heard the, don't want to guess on Fed rate hikes and stuff, but just kind of curious as to, what you're thinking for the deposit rates in a Fed hike or with a Fed hiker too. If you think you'll see any movement, if at all?

That's a great question. I mean, historically our deposit beta has been in the 40%, 45% range, but that history was also dominated by many years of, of like 20% annual growth where we had to utilize promotional money market and CD deposits to fund that growth in part. And our decision to stop growing for a couple of years allowed us to run-off the most interest rate, sensitive depositors and re-orient our core depositors toward lower deposit rates relative to our peers. And we are going to try to hold that strategy going forward. So our EBITDA may be different. We hope lower. We're going to be as interested as you are to see, to see how it works out.

I think one thing too different than in the past, Steve is our level of wholesale borrowing is almost nominal in terms of that, and that tends to reprice quicker than deposits too. So when we're looking at this, this, especially this next coming year, we don't see a lot of pressure on our rates from that perspective because of the low level of wholesale borrowing we have, and then there's a hell lot of liquidity in the market still. So we don't see a lot of pressure on rates, even if Fed raises rates a couple times.

Right. And then maybe just in terms of liquid on your balance sheet do we think about, keeping the investment security portfolio more or less stable here, or, would you look to do maybe a little bit of a remix towards loans here as we go forward?

We try to stay pretty loaned up. If you look at our history, particularly in relation to our peers recently, our loan deposit ratio has remained fairly consistent and fairly high between 90% and 100%. We seek to keep our liquidity at about 15% of assets. We have some liquidity or securities needs, that have to do with collateral. We have a fairly large hedging program that requires collateral. So part of that liquidity and the securities portfolio are, is pledged as collateral, but we don't intend to grow our securities portfolio beyond its need. We intend to stay loaned up.

The next question comes from Matthew Clark with Piper Sandler. Please go ahead.

Hey, good morning guys. I wanted to hone in on the commercial, the CNI and CRE loans sold in terms of this year, relative to last, I think you did a $773 million in '21. How should we think about that level of those levels of that level of sales the year relative to last?

That's a great question and, and really somewhat to prior questions about sales and timing and probability. As we think internally, we have considered reducing that number meaningfully, if we have a loan sale. And so we've been thinking about numbers that maybe half of that number this year, but it's not assured that we will have a loan sale. So for your purposes, I know that's not real clear guidance, but if we have a loan sale we're expecting it to be probably a one-time event as opposed to a multi quarter event, probably in the second half of the year, again, wanting to see if we're going to outperform and the sizing being meaningfully less maybe half.

Okay, thank you. And then on the reserve coverage ratio, I know most of your growth is coming from multifamily. You've got a 24 basis point reserve on multifamily given the quality of that asset class, but it would also suggest that your reserve could come down a decent amount from here. And it sounds like you're looking for negative provisioning to persist in the near-term, I guess. How should, I guess, how -- where would you, where would you expect that coverage ratio to bottom? I guess what's your comfort level and, what's the, what's the ratio that you wouldn't want it to go below? I know it's, that's a simplified question. Simple question, but with a lot more complex assumptions, but…

Yeah, I, I think -- I think from, our perspective, we can probably address it more from the perspective of the provisioning. I think in the first half of this year, we still anticipate having recoveries, as we mentioned, we think it will then stabilize. And then as we look into '23 and '24, probably having normal provisioning for the growth in the portfolio is probably the way I would, I would rephrase that. We don't have a set number we're going down to, but I can tell you that our, we still have excess reserves from our COVID provisioning. And I can also tell you because of the shift in the, the structure of our portfolio to the lower credit, I mean the lower credit risk multifamily portfolio that we are freeing up reserves that way. It's a new world still with this diesel analysis and going through the process and we're still learning from that as I'm sure everybody else is. But that's kind of where we're looking at in the near-term and the longer term.

Okay. And then just the housekeeping item, do you happen to have the PPP loan balance at the end of the year and how much?

Yeah, I did mention that in, in my comments, it was about $38 million I think was the number that we have left of balances and only less than a million dollars in, in terms of the fees -- fees left. So, apologize, $38 million in a million dollars. So we don't expect any significant impact from the PPP loan amortization because we think that will be spread out over six to nine months.

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

Thank you all for joining us today. We look forward to speaking with you again. Next quarter.

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