HomeStreet, Inc.
Q3 2017 Earnings Call Transcript

Published: 25 Oct 2017

[Operator:]

Good afternoon. And welcome to the HomeStreet, Inc., Third Quarter 2017 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, Chairman and CEO. Please go ahead.

[Mark Mason:]

Hello and thank you for joining us for our third quarter 2017 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 Web site at ir.homestreet.com under the news and market data link. In addition, a recording of the transcript of this call will be available later today at the same address. On today's call, we will make some forward-looking statements. Any statement that isn't a description of historical fact is probably forward-looking and is subject to many risks and uncertainties. Our actual performance may fall short of our expectations, or we may take actions different from those we currently anticipate. Those factors include conditions affecting the mortgage market, such as changes in interest rates and housing supply that affect the demand for our mortgages and that impact on our net interest margin and other aspects of our financial performance. The actions, findings or requirements of our regulators, which could impact our growth plans, our ability to meet our internal operating targets and forecasts and implement our business strategy, 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 our SEC filings, including our most recent Quarterly 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 Web site. Please refer to our detailed earnings release for more discussion of our financial condition and results of operations. 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 results of our operations and review our progress in executing our business strategy. We are happy to report solid financial results for the third quarter, despite challenging mortgage market and cost related to restructuring of our mortgage banking business. We did, however, make significant progress on our strategy of growth and diversification toward our goal of becoming a leading West Coast regional bank. Before discussing our financial results, I would like to take a moment and express our heartfelt regret to those who have suffered from the effects of the recent California wildfires. The fires have impacted some of our customers, our employees and four of our single family lending offices. These four single family lending offices in Northern California were closed for a short period, but are now open again for business. Some of our customers’ homes and places of business were destroyed in the fires, along with the home of one of our employees. FEMA has declared many of the affected areas as disaster zones, and we are working with our affected customers to assist them in recovering as quickly as possible. On a more positive note, we are happy to report that our commercial and consumer banking segment achieved $14 million of net income for the third quarter, a record for that segment. Loans held for investment grew by 4% during the quarter, contributing to strong growth in net interest margin and $227.5 million of SBA and commercial real estate loans sold during the quarter, contributed to a sizable increase in non-interest income. The strong results brought our efficiency ratio for the segment down to 65% from 72% in the prior quarter. While total deposits decreased by 1.6% during the quarter due to several large account holders making seasonal withdrawals to meet cash needs, our de novo branches, specifically those opened since the beginning of 2012, grew deposits by 20% in the quarter. The ratio of non-performing assets to total assets ended September at just 28 basis points, down from the second quarter’s level of 30 basis points, representing our lowest absolute and 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 surprise, 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, almost without exception, reflects strong growing economies on our primary markets. In the quarter, we completed the acquisition of one retail deposit branch and related deposits in El Cajon, California, a fast growing suburb in Eastern San Diego County. We now have four retail deposit branches in San Diego County. We also opened a standalone single family lending center in North Scottville, Arizona, a suburb of the Greater Phoenix market. During the quarter, HomeStreet placed 80 on Fortune’s 100 fastest growing companies for 2017. The Fortune list ranks publicly traded companies according to a formula that takes into account revenue growth rate, earnings per share growth rate and three year annualized total return for the period, ending June 30, 2017. Being named on the list of Fortune’s fastest growing companies is an honor, and my thanks go to all of our hardworking colleagues that made this achievement possible. On our last call, we discussed the supply-demand imbalance in many of our major markets, adversely affecting our outlook for mortgage originations. The strong West Coast economies and local markets in which we operate are continuing to produce above average job and population growth, which in turn is causing a shortage of new and resale housing and in turn lower purchase mortgage originations. These conditions, along with lower demand for refinance mortgages in the current rate environment, have adversely impacted the profitability of our mortgage banking segment. As we discussed last quarter, we do not see any near term catalyst that would result in meaningful improvement in new or resale home inventories. Accordingly, to improve operational efficiency and overall profitability in the third quarter, we took meaningful steps to restructure the capacity, cost structure and management of our mortgage origination business. The restructuring include a reduction in force of 60 full time equivalent employees, substantially all of which was completed in the third quarter, resulting in pretax severance cost of $245,000 recorded in the quarter. Included in the previously announced reduction for us was 41 full time equivalent employees that occurred in the second quarter, and net voluntary attrition since the beginning of the second quarter, totaling 32 full time equivalent employees. The mortgage banking segment will have reduced full time equivalent employees by 133 by the end of the fourth quarter. We expect annual pre tax expense savings of approximately $9.4 million as a result of this reduction in personnel. These personnel reductions are primarily concentrated on operations and support functions, and represent a 9% decline in total full time equivalent employees in the mortgage banking segment since March 31, 2017, and an 18% decline in operation roles in this segment. Additionally, we closed two single-family lending offices, consolidated three additional offices in the nearby offices, and reduced lease space in three other offices. One additional single family lending office will be closed during the fourth quarter, and this closure is expected to have non-material impact on fourth quarter financial performance. The changes to these eight office locations in the third quarter resulted in pretax charges of approximately $3.3 million, but are expected result in pretax occupancy expense savings going forward of approximately $1 million per year. We also streamline single family lending senior leadership, resulting in the elimination of two regional manager positions. From this, we incurred an additional pretax severance cost of approximately $300,000, and we expect annual pretax expense savings going forward of approximately $1.2 million. We also modified certain compensation plans, resulting in expected pretax expense savings of approximately $1.7 million per year. In summary, the third quarter mortgage banking segment pretax restructuring charges were $3.9 million and were comprised of severance costs of approximately $545,000 and real estate related charges of approximately $3.3 million or $2.5 million in total after tax. Absent these charges, the mortgage banking segment would have recognized net income of $2.4 million. The total expected annual pre tax expense savings related to mortgage banking segment restructuring including reduction in force that occurred during the second quarter of 2017, is estimated to be $13.2 million. Our mortgage banking segment remains an important part of HomeStreet’s heritage and business, going forward. Our retail focus, broad product mix and competitive pricing, continue to attract some of the best retail originators in our markets and reinforce our position as a top purchase mortgage originator in the pacific North West during the third quarter of this year. We believe that these restructuring steps will align our cost structure with our current production opportunities, and return the profitability of the mortgage banking segment to the levels that we expect. While these cost savings estimates are based on lower industry expectations for mortgage loan volume, we also took the opportunity to improve our cost structure such that we do not expected an increase in volume even if it were return to recent highs, would require an increase in expenses to the level that we've previously recorded in the segment. Lastly, we are happy to report that on September 27th, the federal banking regulatory agencies issued a joint notice of proposed rulemaking, regarding several proposed simplifications of Basel III capital rules. If adopted as currently drafted, these proposed changes would significantly benefit our mortgage banking business model by reducing the amount of regulatory capital that will be required to be held related to our mortgage servicing assets. Other proposed changes, if adopted, would require small increase in capital related to commercial and residential acquisition development and construction lending activity, and would offset a small portion of the benefit we would expect to receive with respect to our mortgage servicing assets under the proposed rules. Final rules have yet to be published, following the comment period. But if they are adopted without any material changes to the current proposal, we would expect to benefit from a reduction in regulatory capital requirements beginning in 2018. I would now turn it over to Mark who will share the details of our financial results.

[Mark Ruh:]

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 our two segments. Regarding our consolidated results. Net income for the third quarter was $13.8 million or $0.51 per diluted share compared to $11.2 million or $0.41 per diluted share for the second quarter of '17. The increase in net income from the prior quarter was primarily due to higher net interest income attributable to the growth in loans, both held for investments and held for sale, and due to higher SBA and commercial real estate net gain on sale revenue, both being partially offset by higher non-interest expense due to restructuring charges and mortgage banking segment. Total pretax restructuring charges in our mortgage banking segment were $3.9 million and acquisition related costs were $353,000. Excluding restructuring charges and acquisition related costs, core net income was $16.6 million or $0.61 per diluted share in the third quarter compared to $11.4 million or $0.42 per diluted share in the second quarter. The return on average tangible shareholders equity was 8.5% in the third quarter compared to 7% in the second quarter. Excluding the after tax impact of restructuring and acquisition related expenses, the core return on average tangible shareholders’ equity was 10.2% in the third quarter compared to 7.1% in the second quarter. Net interest income increased by $3.9 million to $50.8 million in the third quarter from $46.9 million in the second quarter. Our net interest margin of 3.40% increased 11 basis points from 3.29% in the second quarter. These increases are primarily due to the higher balances of both loans held for investment and loans held for sale, somewhat offset by higher rates on deposits and favorable home loan bank borrowing. Net interest income increased by $2.8 million to $83.9 million in the third quarter compared to $81 million in the second quarter, primarily due to $5.1 million quarter-to-quarter increase and a net gain sales from SBA and commercial real estate loans somewhat offset by lower other non-interest income being driven by lower prepayment penalty fee income. Non-interest expense was $114.7 million in the third quarter compared to $111.2 million in the second quarter of '17. This increase in non-interest expense is primarily due to the previously mentioned $3.9 million expense related to the mortgage banking segment’s restructuring. At September 30th, the Bank's Tier 1 leverage ratio was 9.83% while the total risk-based capital ratio was 13.78%. The consolidated Company Tier 1 leverage ratio was 9.29%, while the total risk-based capital ratio was 11.54%. I'll now discuss some key points regarding our Commercial and Consumer Banking segment results. Commercial and Consumer Banking segment net income was $14 million in the third quarter compared to $9.4 million in the second quarter. Net interest income increased to $45.3 million in the third quarter from $42.4 million in the second quarter, primarily due to both higher rates and balances of loans held for investments during the period. Segment non-interest income increased quarter-to-quarter to $12 million from $8.3 million. This $3.7 million increase was primarily due to higher gains from both SBA and commercial real-estate longer retention and sale activities, partially offset by lower commercial loan prepayment penalty fees during the quarter. Segment non-interest expense was $37.2 million, an increase of $529,000 from the second quarter '17. This increase was primarily due to higher incentive cost, driven by increased loan production. We recorded a provision for loan losses in the third quarter of $250,000 compared to $500,000 in the second quarter. This decrease in provision expense was primarily due to continued improvements in credit quality and lower expected loss rates combined with $475,000 of net recoveries during the third quarter. Our net recoveries of $475,000 during the quarter compared to net recoveries of $928,000 in the second quarter. Gross recoveries during the third quarter were $748,000 with gross charge-offs of only $273,000 during the same period. The portfolio of loans held for investment increased 4% to $4.3 billion in the third quarter. Net loan growth was $165.8 million during the third quarter compared to $196.9 million in the second quarter. Non-performing assets were $18.8 million at September 30th compared to non-performing assets of $20.1 million at June 30th. This decrease was a result of a decline in both non-accrual loans and other real-estate owned. Deposit balances for the quarter were $4.7 billion at September 30th, a decrease of $77.3 million from June 30th due to several large depositors withdrawing funds during the quarter to meet seasonal cash needs. However, our non- interest bearing demand deposits, which include mortgage banking servicing accounts, increased by $72.1 million for the quarter. Note that mortgage banking and servicing deposits will fluctuate seasonally due to timing of mortgage prepayments, insurance and property taxes. I'll now share some key points for our Mortgage Banking business segment results. The Mortgage Banking segment net loss in the third quarter, after $3.8 million of pretax restructuring charges, was $123,000 compared to net income of $1.8 million in the second quarter. Excluding the after tax restructuring charges of $2.5 million in the third quarter and $67,000 in the second quarter, core net income for the mortgage banking segment was $2.4 million in the third quarter compared to $1.8 million in the second quarter. As Mark previously stated, the mortgage banking and restructuring charges were comprised of $3.3 million in real-estate related charges and $545,000 in severance costs. Going forward, we do not believe that there will be any material additional charges related to the remaining components of the previously disclosed restructuring plan. Gain on single family mortgage banking origination and sale activity in the third quarter was $64 million compared to $64.2 million in the second quarter. Single family mortgage interest rate lock and forward sales commitments totaled $1.9 billion in the third quarter, a decrease of $77.8 million from $2 billion in the second quarter. Single family mortgage closed loans totaled $2 billion in the third quarter, an increase of $23.6 million from the second quarter. We are continuing to gain efficiencies from the implication of our new loan origination system, and from the migration of our mortgage pipeline from our prior loan origination system. The volume of interest rate lock and forward sales commitment was lower than closed loan that held for sale by 8% this quarter, which negatively affects reported earnings. As the majority of mortgage revenue is recognize at interest rate lock, while majority of origination costs, including commissions are recognized upon closing. The gain on loan origination and sale and positive margin increased to 342 basis points in the third quarter from 331 basis points in the second quarter. The 11 basis point increase was primarily due to benefits of competitive secondary market pricing amongst the government related mortgage agencies. Mortgage banking non-interest expense of $77.5 million increased $2.9 million in the second quarter. This increase was primarily due to the $3.9 million restructuring charges previously disclosed. Without these restructuring charges, non-interest expense would have decreased. Closed loans decreased in the third quarter to 4.3 loans per loan officer per month from 4.4 loans for loan officer per month in the second quarter. Single family mortgage servicing income was $7.4 million in the third quarter, a decrease from $7.9 million in the second quarter. This was primarily due to lower risk management results. Our third quarter results were comprised of $5.6 million of net servicing income and $1.8 million of risk management income. Our portfolio of single family loans service for others increased to $21.9 billion of unpaid principal balances at September compared to $21.1 billion of unpaid principal balances at June 30th. The value on our mortgage serving assets, relative to the balance of loans served for others, was 112 basis points at quarter end. I will now turn it back over to Mark Mason to provide some additional insights on HomeStreet’s general operating environment and our outlook for the future.

[Mark Mason:]

Thank you, Mark. I’d like to now discuss the national and regional economies as they influence our business today. We remain fortunate to operate in some of the most attractive market areas in the United States today. These markets enjoy lower unemployment and substantially higher rates of population growth, job creation, commercial and real estate construction, and real estate value appreciation than the remainder of the country. The major markets they’ll be focused on are substantially larger than most of the other markets in the United States, which gives us the opportunity to grow meaningfully without the necessity of acquiring a significant market share. Together, the most distinguishing feature of the Washington, Oregon, Idaho, and California economies continues to be their superior job growth compared to the national economy. According to the most recent case show data, Seattle's home prices increased by 13.5% over the past 12 months, Portland increased by 7.6%, San Francisco by 6.7% and Los Angeles by 6.1% compared to the 20 city composite increase of 6.8%. Rental prices have continued the same trend. According to Zillow, annual rents for the year ended august 31st have increased 5.4% in the Seattle, 4.3% in Portland and 4.4% in Los Angeles compared to 1.9% nationally. San Francisco rents have actually decreased by 0.6% since last year, but are still the highest in the nation. Ironically, growth in these markets is one of the drivers of our decreased outlook for the home mortgage market and the catalyst for our restructuring. Population growth is outpacing the ability of the western housing markets to keep up the demand for homes. According to national association of home builders, total residential building permits increased 8% nationally and 12% in the west for the year ended August 31st. Permits increased 11% in the Seattle area but this was primarily due to multifamily permits, which increased 18%. Single family permits increased only 2%. The Portland market’s difference was even more pronounced with multifamily permits increasing by 31%, but single family permits decreasing by 12% for a total increase of 9%. Nevertheless, we believe these conditions improve the outlook for our consumer commercial real estate, construction and commercial lending and deposit operations. With Seattle, Portland and Orange County office vacancy rates of 9.9%, 10% and 10.6% respectively, are all well below the national average of 13.6%, suggesting a continued positive outlook for our commercial real estate lending, both permit and construction, as well as our general commercial lending. You may be aware that Amazon has recently announced its intention to open the second headquarters location. They have committed to their existing presence in Seattle, so we do not believe that their initiative will have an adverse impact on our market. In fact, they have recently announced their intention to occupy six floors of the historic Macy’s building in Downtown Seattle. In total, Amazon is either building or is preleased an additional 2.4 million square feet of office space in Seattle. Looking forward to the next few quarters in our mortgage banking segment, we currently anticipate single family mortgage loan lock and forward sale commitment volume of $1.7 billion and $1.8 billion in the fourth quarter of this year, and the first quarter of next year respectively. We anticipate mortgage held for sale closing volumes of $1.8 billion and $1.6 billion during the same periods, respectively. For the full year of 2018, we now anticipate single family mortgage loan lock and forward sale commitments to total $7.7 billion and loan closing volume to total $7.8 billion. These volumes will also be highly depended on inventory levels in the housing markets in which we do business, global economic conditions affecting the permit growth and wages as well as prevailing interest rates. Additionally, we now expect our mortgage composite profit margin to decline to a range of between 315 and 325 basis points over the next few quarters. For the full year of 2018, we expect the mortgage deposit profit margin to average in the range of 318 to 328 basis points. In our commercial and consumer banking segment, given the growth we have achieved since our IPO, we are lowering our expected average quarterly net loan portfolio growth to 2% to 4% per quarter for the year 2018, and going forward. This is a reflection of our current size and not a reflection of our market opportunity. Reflecting the continued flattening of the yield curve and absent changes in market rates and loan prepayments fees, we expect our consolidated net interest margin to decrease from the 3.4% margin in the third quarter to a range of 3.35% to 3.40% for the fourth quarter. As our loan portfolio continues to grow and reprice upwards, we expect the net interest margin to increase to a range of 3.40% to 2.45%, starting in the first quarter of next year and remaining within that range throughout 2018. For the fourth quarter of 2017, our net interest expenses are expected to decrease, given the lower single family closed loan guidance, and absence of the restricting charges we recognized in the third quarter. For 2018, we expect non-interest expenses to grow on average 1.5% per quarter, reflecting the continuing investment in our growth in infrastructure. The growth rate of our total non-interest expenses will vary at somewhat quarter-over-quarter, driven by seasonality and cyclicality in single family closed loan volume, and in relation to the timing of further investments and growth. This concludes our prepared comments. We thank you for your attention today and Mark and I will be happy to answer any questions you have after this time. Operator?

[Operator:]

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.

[Jeff Rulis:]

Question, Mark Mason, on the -- maybe just to comment on the morale of the company and employees, given the restructuring efforts?

[Mark Mason:]

Well, it's clear any type of restructuring has a significant impact on various areas of the business right, particularly the people impacted of course. And we spent a lot of time before eliminating any position, right. We spent a fair amount of money and time recruiting these people. They are all high quality people, typically doing a very good job. And so, having to exit them is not a positive experience. It is a reality though of the mortgage banking business that from time-to-time the volume of operations personnel may have to decline. And that is sometimes driven by catalyst like rising interest rates obviously of lower refinancing volume. Sometimes it comes as a consequence of advances in technology and efficiency. In this case, part of our opportunity was driven in fact by increases in efficiency as a consequence of our new loan origination system. And so, while it is hard on morale to say good bye to people who have worked well and done a good job, for those remaining in the business, it is a positive statement regarding our commitment to the business. Our commitment to improving the efficiency and profitability of the business, which at the end of the day, secures jobs. And the people in that segment are very proud of their accomplishments. They are very proud of their growth and surprisingly, resilient in the face of changes, like we're discussing. So, I would say now that we're on the back end of the personnel changes and the decisions on branches that the folks in our business are very focused. And I think the morale is surprisingly good, but thank you for that question.

[Jeff Rulis:]

And for either of you just a more technical question on mapping this through the income statement, I just want to make sure I had the numbers correct. In Q3, the 3.9 could be -- the 3.3 is that in the occupancy line and then the 5.45 in salaries?

[Mark Ruh:]

Yes, that is correct.

[Jeff Rulis:]

And then going forward, I guess, if it’s 13.2 for the year I’ll call it 3.3, I guess the 3 or 3.1 of that would be out of the salaries and then the balance out of occupancy?

[Mark Ruh:]

Again, we talked about that. We have about again, Mark mentioned, in the spread given the pretax occupancy expense savings going forward will be about $1 million per year. And again that’s of course over the occupancy. And then course would be the savings on salaries and personnel again will be in the service related costs.

[Mark Mason:]

$9.4 million, right, pre tax.

[Jeff Rulis:]

Right, that’s close enough. Got you. May be one last one, I guess, M&A going forward in light of the restructuring effort does that augment the strategy in what you're looking for, particularly if additional more mortgage heavy operations were to come available?

[Mark Mason:]

So we’ve been very careful of one not to acquire banks with material mortgage origination activities. We have plenty and our goal is to reduce reliance on mortgage related income. So, I would not expect, absent some unusual opportunity, to acquire an institution with any material mortgage operations. Our strategy, with respect to growing the commercial consumer business, remains unchanged. We're committed to growing, primarily within our footprint, which means the large west coast markets, growing the commercial related lines of business, growing all types of deposits, consumer and commercial, and that strategy remains unchanged.

[Operator:]

Our next question comes from Jessica Levi-Ribner with FBR. Please go ahead.

[Jessica Levi-Ribner:]

Thanks so much for taking my question. Just a couple of here from me, the first is can you quantify how much capital the capital simplification standards would free up for you? And how does that change the way you're thinking about the business and maybe asset mix?

[Mark Ruh:]

I’ll take the first question. We have definitely done estimates, so it’s very exciting news as you can imagine when you had mortgage servicing assets size that we have, so we’re very excited about that. Our estimates we right now will free up approximately $70 million to $75 million in capital that we hold against the mortgage servicing assets. So it's a big deal, [Indiscernible] markets are going to [Indiscernible].

[Mark Mason:]

Obviously, it impacts our capital planning. And ultimately should impact the return on equity of the mortgage segment, because less capital will be committed to carry in that business, which already has in the normal course a very good ROE, that should go up. Most important in the short-term, it reduces our need to augment capital for growth. So what we may have planned in the next year to be necessary to continue growing in the prior growth rates was going to be mitigated by this change if indeed it gets finalized on the basis currently proposed.

[Mark Ruh:]

It’s especially they’re like getting, for us getting we’ll call it a free capital raise. It’s amazing what it’s done for us, so we had very transformative and very positive for HomeStreet.

[Jessica Levi-Ribner:]

And could -- it certainly sounds like it. And could that capital be put towards the commercial bank, and would that increase your guidance from 2% to 4% quarterly asset growth there?

[Mark Mason:]

We may indeed grow more than that. I think that the management team felt it appropriate at the size we’re at to lower the guidance a little bit. Denominators are getting much larger than what we’ve [guided] [ph] 4% to 6% of quarter growth. And I think it's realistic to reduce expectations a little bit. Even though last quarter, we grown in the 4%, and we do have very powerful origination capability. But tempering that somewhat it is our ability to grow deposits as quickly in a market where deposit costs are growing, and need for deposits is likely to tighten with market liquidity or industry liquidity going down. And so we just thought better to lower expectations a little. It doesn’t mean that some quarters we may not exceed that guidance but there are other quarters we may not make the guidance. And so, that’s where we think the guidance should be. As a matter of capital planning, that’s a little bit of an opportunistic question. And last year, we took the opportunity in a very good market for most equities within particular bank equities at the end of the year to raise some capital. We’ll probably be filing another ATM prospectus in the next quarter or so. Not that we’re ready to raise capital, but being ready for another period of opportunistic valuation and that could allow us to grow faster. Because again, we are not limited by origination capability or infrastructure or markets by any means, we’re limited by our ability to fund and provide capital.

[Mark Ruh:]

And Jessica just to make sure we answer your questions. The way I think about that capital is once we free it up from our mortgage banking segment, yes, we would internally -- we look the way manage capital between segments. Yes, we would deploying that over to the commercial and consumer banking segments.

[Jessica Levi-Ribner:]

Okay great. And then just to kind piggyback of your remark. In terms of deposits, do you have a deposit growth strategy that you're hunting deposits? Or is it just your normal core strategy of growing your deposit base and your outreach there?

[Mark Mason:]

So, our strategy continues to be the same. On the commercial side, its growth in commercial deposits consistent with the growth in the commercial customer base; and our investment in commercial lenders and growth in loan offices and so on. On the consumer side, it involves opening additional de novo branches, purchasing branches as we did this last quarter from other institutions; a limited use of promotional accounts, money market and CD accounts in selected markets, mostly associated with opening branches. And that strategy has served us well to this point if you look at the average annual organic growth rate in deposits it's been very close to our loan portfolio and growth rate. And so, we think that that strategy is going to be sufficient to fund our growth on the pace that we're projecting it.

[Jessica Levi-Ribner:]

And one last one for me is just kind of what kind of competition you've seen on both the mortgage side and also the commercial loan side? In terms of larger players coming into the market, or is competition stayed constant?

[Mark Mason:]

For us at our size, we compete with essentially everybody. We compete with the smallest community banks because we bank very small businesses. We compete with middle market banks across the board at all product types. And we compete with the National banks, substantially for consumers and at the lower end of their commercial banking businesses. We essentially compete with everywhere, which means the competition is unchanged. It's significant. It's broad. And we are in the markets of interest even for national banks who do not have deposit taking activities in our markets, they all have lending offices. So we compete not only with regionally headquarter located banks, but others nationally. And as a consequence in part because of competition, in part because of our fairly conservative credit closure, we compete on price. We seek to compete on price and on credit. And that positions us well to compete with all of those parties, because we can price with the national banks on any product. And of course those prices are substantially superior, generally to community banks and some of the regional banks. And so, we feel like we're well positioned structurally to compete, but the competition is fears.

[Mark Ruh:]

And I think with respect to mortgage bank, we continue in the purchase market generally to be in Pacific Northwest, being Ohio, Oregon, Washington generally be number one. And aggregating with our aggregate purchase and refi, we generally are number two only behind Wells Fargo. So we have definitely maintained our position with respect to the other competitive landscape in the mortgage, single family mortgage side of our business…

[Mark Mason:]

Which means we have to be ultra-competitive in our pricing, but our structure set up to do that day-in-day-out, it’s one of the reasons we attract people. Not only do have the widest menu available products, including all of the important portfolio products like custom home construction loans and in general non-performing loans, but we have great pricing and great services. So we still feel like we’re well positioned to compete.

[Operator:]

Our next question is from Jackie Boland with KBW. Please go ahead.

[Jackie Boland:]

Just curious as to what kind of rate environments and potential fed fund increases you’re looking out for the 2018 NIM guidance?

[Mark Mason:]

Would you say what kind of…

[Mark Ruh:]

Four year curve -- what are we expecting when we’re forecasting our guidance in terms of changes…

[Mark Mason:]

Well, actually right now, we generally I mean in the short-term, we generally when we model we run static is what we do. I think that’s generally what we’ve done here. We know that we are not great at forecasting the interest rates. So when we’re forecasting volumes and interest margins, we are forecasting based upon curve rates.

[Jackie Boland:]

And on a theoretical basis, if we were to guide, assuming that the curve doesn’t flatten, if we were to get additional rate increases they maybe went in December and then one or two next year. How would you anticipate the net interest margin at the commercial bank level to perform?

[Mark Mason:]

The same or better typically. If yield curve doesn’t flatten -- our enemy is the flattening yield curve. In part because of our mortgage loans held for sale. If you think about it, these are loans that are yielding mortgage rents net of hedging costs. But they’re being funded with short-term money, like less than 30 day money. So every time that fed increase these and mortgage rates don’t increase commensurately, you get a squeeze in the net interest margin in that loans held for sale warehouse, which at times going to be billion dollars right. So that’s meaningful. If the curve rises parallel, mortgage rates will rise commensurate with short-term rate and will maintain or perhaps even grow if this curve steepens that portion of the net interest margin. A wild card is deposit cost. To-date deposit cost increases or the beta that most banks have been experiencing has been relatively low, our beta has been very low. So that continues to be a question that will be answered in the future somewhat, we don’t really know. So typically, as long as the curve rises in a parallel fashion or better, our margins should be same or better.

[Mark Ruh:]

And Jackie, just to follow up a little bit, I guess, I want to make sure, I may have misunderstood your question. I mean, again, right now in our current forecast again we’re using the September 30th yield curve and that’s really what our…

[Mark Mason:]

We might buy forwards…

[Mark Ruh:]

And including buying forward, but again, we are not forecasting a rate increase. As Mark said, we’re not very predacious when that’s going to happen. So we just -- we assume that basically the yield curve now the yield curve that we’re going to be using going forward. That’s how we make them up. Thanks.

[Jackie Boland:]

That’s very helpful, thank you. I too am not a great rate forecaster. And then Mark Mason, just to follow-up from your M&A comments, I understood that you‘re not interested in looking at acquisition targets that have a mortgage banking platform. Does that though process carryover to a bank that might have a large mortgage platform that's not for sale, where they portfolio those loans?

[Mark Ruh:]

Let me answer it clearly. We would not exclude a bank that had a meaningful or material mortgage portfolio program, we have one, right. And that portfolio is one of the most consistent earners at the bank. It typically earns between 14% and 18% ROE quarter-to-quarter at very low losses and is a good contributor to bottom line. If there were an opportunity with a similar portfolio that would not necessarily be a negative. Though, in fairness, we are looking for commercial assets and liabilities, and its issues are concentrated in those assets and liabilities.

[Jackie Boland:]

So your comments were more geared towards somebody who was originating margins just purely to the sales not for portfolio?

[Mark Mason:]

Correct because that's the business as we probably know that produces cyclicality and seasonality, and the volatility that we’re trying to dilute with diversification.

[Mark Ruh:]

And we can certainly grow it at our own organically, should we chose that we would not be in the market or transaction.

[Jackie Boland:]

And then just lastly, obviously, really strong sales volume in the CRE and SBA space in the quarter. Was that originally generated as held for sale, or did any of that come out as the held for investment portfolio. And I apologize if I missed any of that in your prepared remarks.

[Mark Mason:]

The SBA loans, because they’re essentially split, they get originated into held for investment classification. And then the ensured portion is split and sold. And so it never starts an held for sale position. The commercial real-estate loans are designated for sale post origination based upon the different interest or characteristics that buyers might be interested in, at the time. So those also have come out of the held for investment portfolio. The Fannie Mae DUS loans, the multifamily loans are originated in Fannie Mae those are held for sale loans.

[Jackie Boland:]

So it wasn’t necessarily the small balance CRE group that drove all of the CRE sales that you placed in the quarter, there were some that came out of the portfolio?

[Mark Mason:]

Well, the small balance CRE group originates to the portfolio and then periodically we sell some of the loans.

[Mark Ruh:]

And everything goes into held for investment and opportunistically what we have the right transaction, we move it from held for investment over to held for sale and then it exists out. And we’re going to view this portfolio generated as held, is held by the bank and held for sale and then we return to bank to the U.S. facility and get securitized to Fannie.

[Jackie Boland:]

And so would you just categorize the strength this quarter as opportunistic in terms of what sales you were able to accomplish and perhaps not, we won't see the same level of strengths in the future, or is this the new ongoing run rate?

[Mark Mason:]

I wish you with the ongoing run rate. I think in fairness it’s a little seasonal. If you look at prior years with third and fourth quarters, has historically been the low significant for SBA lending and loans sales and Fannie Mae, the U.S. lending loan sales, which I think is going to remain true. With respect to the small balance CRE business, let me try to take the seasonal, it’s lumpy. It really -- the market volume rises and falls in these non-agency small balance CRE loans, based upon the appetite of the market, which means other banks, the insurance companies and credit unions. And it really works in inverse to those banks origination activities. And if they find that they are not meeting their growth targets, the origination targets, they will look to the market to supplement by buying loans. And starting in the second quarter and continuing through the third quarter. And today, there has been increased interest. So I don’t if you can call it seasonal or cyclical, or periodic. But it's lumpy. And so in total, I would say that the activity in the third quarters will be higher than the average quarter, and we shouldn’t forecast necessarily based upon this level. As we grow, the average loan quarter-to-quarter will also grow, but I think this quarter was a little outsized. Hopefully that makes sense.

[Operator:]

[Operator Instructions] Our next question comes from Tim O’Brien with Sandler O'Neill. Please go ahead.

[Tim O’Brien:]

First question I have for you, just to piggyback on what Jacky was talking about with regard to loan sales in commercial and consumers. So you guys sold $227 million in loans to the secondary market this quarter. So was any of that SBA in that -- how much of it was SBA? And now would be in the other bucket, right -- obviously, not multifamily DUS?

[Mark Mason:]

Yes, that would be in the other bucket. That is correct.

[Tim O’Brien:]

And then you alluded to the $67 million of that other bucket of the $125 million was single family, from the single family portfolio this quarter, right, in the foot note?

[Mark Mason:]

So you’re looking at foot note five correct, Tim?

[Tim O’Brien:]

Yes, so $67 million was single family?

[Mark Mason:]

Yes, that was second quarter.

[Tim O’Brien:]

Let's start with this. So the $125 million, 493 sold of other loans sold in the third quarter, that $125 million number?

[Mark Mason:]

Right, so this footnote five, if you read the full note as we mentioned the fourth quarter -- the fourth quarter 2016. So you see…

[Tim O’Brien:]

Yes. Can you give the breakdown of the parts that were attributed that contribute to that $125 million in total sales? How much was single family, how much was other multi, and how much was SBA? Just some along those lines just a sense of it. And even if you don’t, even if you can’t nail it directly, just what was the biggest piece maybe?

[Mark Mason:]

First, there was no single family loans in the number. It’s all in their SBA were small balance commercial real estate.

[Mark Ruh:]

I know, I don’t have the appropriate number in front of me. I’d say the SBA is around 30-ish. I have to look it up, but that’s a approximate and doing this for memories, don’t have that scheduled in front of me?

[Tim O’Brien:]

I guess, the other question I have for you is. I mean, just looking at this. Is it fair to say that that portfolio of other loans held for sale was depleted a little bit as far as that channel that work-through this particular channel looking at the fourth quarter. Are you guys -- you also talk about kind of lumpiness or seasonality in this segment, extending through typically being the second half of a year. How is the fourth quarter look? I guess, again to reiterate what Jackie asked, kind of in light how much in loan sales you have this quarter and what kind production you had, and what’s left in the tank?

[Mark Mason:]

If I understand your question, Tim. First with respect to small balance commercial real estate loans, we are originating substantially more than we have sold. So there is no shortage of inventory. Those numbers depend really on buyer interest. And from quarter-to-quarter, it’s a little hard to gauge. It’s pretty strong right now. And the fourth quarter could have another $30 million to $50 million of those types of sales in the quarter. At this juncture, I’m not comfortable predicting with any reasonable amount of accuracy with that number might be. And we will have SBA loan sales in the quarter as well. I do not believe next quarter will be as high as this quarter. It will not be as low as the second quarter. If you look at the second quarter back, it was about $25 million. But I don’t think it is going to approach the third quarter levels. I know that’s a big range, so I apologize.

[Tim O’Brien:]

No, that’s okay. I mean you take your best shot. As far as pricing and what you guys booked on gains this quarter, I mean that was considerably stronger than the second quarter number. So obviously, that’s a reflection of again appetite demand. People were willing to pay up in the September quarter. That momentum rose into the fourth quarter at least at the start as well. So demand is there and pricing appetite willingness to pay up. Did that persists into October as well?

[Mark Mason:]

Well, the appetite does. The pricing on SBA loan sales continues to be spectacular. The last sale that we completed, the range of premiums was 10% to 14%. Now, we are going to keep all of that because anything over 10% get split 50-50 with the SBA, which is probably fair. So SBA loan sales gains -- pricing remains very good. Commercial real estate saw -- small balance commercial real estate, I think those gains will be a little softer as rates have risen and that has a direct impact on the premiums, you get for loans originated pre-rising rates, right. So those gains will probably be 50 basis points lower if they were averaging, let's say, 250 basis points in the third quarter, maybe 1.75 to 2 or little over 2, something like that in the fourth quarter. So we'll have to see how that goes.

[Mark Ruh:]

The appetite may fix that or not…

[Tim O’Brien:]

And then last question, just to clean up the $7.7 billion, $7.8 billion rate lock in closed loan volume numbers for next year. That was for next year or 12 months next four quarters, including 4Q. Was that 2018?

[Mark Mason:]

That's 2018, yes.

[Mark Ruh:]

And that's only origination in sale of mortgages held for sale.

[Operator:]

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

[Mark Mason:]

Thank you all again for your patience. Thank you for the great questions by the analyst that cover the Company. We appreciate the coverage. Look forward to talking to you all next quarter. Thank you.

[Operator:]

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