HomeStreet, Inc.
Q4 2017 Earnings Call Transcript

Published: 24 Jan 2018

[Operator:]

Good day. And welcome to the HomeStreet, Inc., Year End 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 Chief Executive Officer. Please go ahead.

[Mark Mason:]

Hello and thank you for joining us for our year-end and fourth 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 website at ir.homestreet.com under the news and market data link. In addition, a recording and the transcript of this call will be available 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 markets, such as changes in interest rates and housing supply that affect the demand for our mortgages and that impact our net interest margin and other aspects of our financial performance, the actions, findings or requirements of our regulators and general economic conditions that affect our net interest margins, borrower credit performance, loan origination volumes and the value of mortgage servicing rights. Other factors that may cause actual results to differ from our expectations or that may cause us to deviate from our current plans, are identified in our detailed earnings release and 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 website. 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 operations and review our progress in executing our business strategy. In 2017, we continued executing our growth and diversification strategy toward our goal of building regional bank with representation in major coastal markets of the western United States. And I'm very proud of the progress our dedicated HomeStreet management and employees have made in such a short period of time. I’m happy to report net income for the fourth quarter of $34.9 million or $1.29 per diluted share which included a $23.3 million benefit from lower corporate tax rate as a result of the signing of the Tax Cuts and Jobs Act in December. Excluding the impact of tax reform, core net income for the fourth quarter was $11.5 million or $0.42 per diluted share. Highlighting our progress last year, our Commercial and Consumer Banking segment achieved record net income, increasing by 32% from $35.4 million in 2016 to $46.6 million in 2017, excluding the impact of tax reform and acquisition related expenses. We accomplished this growth organically without the benefit of the whole bank acquisition during 2017. Our acquisitions of the Yakima National Bank and Fortune Bank in 2013, Simplicity Bank in 2015 and Orange County Business Bank and the Bank of Oswego 2016 contributed to these accomplishments. These acquisitions provided us with new markets, customers, product lines and employees that made our success in 2017 possible. The Commercial and Consumer Banking segment finished the second half of 2017 with an efficiency ratio of 65% compared to the first half of 72%. We expect this trend of decreasing the efficiency ratio to continue in 2018 and beyond. To support our growth in 2017, we opened three de novo retail deposit branches in California and Washington. We also acquired one retail deposit branch in California. Despite our significant growth since our IPO, we have conservatively managed the amount of credit risk we assume. This approach, while resulting in somewhat lower asset yields than others, has allowed us to produce superior asset quality metrics that we have shown today. We finished the year with a ratio of non-performing assets to total assets of just 23 basis points, down from the third quarter’s level of 28 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 of leading indicators of economic activity reflect strong growing economies in our primary markets. Additionally, we recorded $3.1 million of net credit recoveries during 2017, reflecting the strength of our markets and the solid problem asset mitigation strategies we deployed during the recession. We don’t anticipate these recovery levels are sustainable. And while we anticipate potential future recoveries, we expect loan loss provisions to normalize going forward. Given the increased price expectations of bank sellers over the past year, we were not able to complete any bank acquisitions last year. And while we are open to future acquisitions, we are focused on optimizing our investments in current markets and products emphasizing the profitable growth and diversification of our business. We are planning to open three additional retail deposit branches in early 2018. For some time now, we have discussed the low levels of new and retail loan inventory in many of our major markets and the negative impact of this supply demand imbalance on our mortgage originations. The strong West Coast economies and major markets in which we operate are continuing to produce above average job and population growth, which in turn is causing the shortage of new and resale housing and in turn lower purchase mortgage originations. These conditions, along with the seasonal slowdown in home buying activity and lower demand for refinance mortgages in the current rate environment, have continued to adversely impact the profitability of our Mortgage Banking segment. We still do not see any near-term catalysts that would result in meaningful improvement in new or resale home inventories. Accordingly, to improve operational efficiency and overall profitability in the second and third quarters of 2017, we took meaningful steps to restructure the capacity, cost structure, and management of our mortgage origination business. As a result, direct origination expenses are meaningfully lower in the fourth quarter and the implementation of our new loan origination system during 2017 created opportunities for additional operating efficiencies going forward. We anticipate these actions and our focus on optimizing our Mortgage Banking capacity within our existing geographic footprint, should result in continuing improvement in our Mortgage Banking results subject to the cyclical and seasonal challenges of managing this line of business. Our Mortgage Banking segment has been an important part of HomeStreet’s success. And without it, we could not have produced earnings and capital required to grow and diversify our business to this point. Mortgage Banking will continue to be an important contributor to our success 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 one of the leading mortgage lenders in the west. Lastly, I’m sure you are aware of recent SEC filings made by Blue Lion Capital and its principal Charles Griege, seeking representation of our Board of Directors and suggesting changes to our strategy and operations. After meeting with Mr. Griege and discussing his views on our business strategy and his qualifications as a Director, the Board unanimously decided to decline Mr. Griege’s request to join our Board. The Board concluded the issues of greatest concern to Mr. Griege are best addressed with the Company’s current strategic plan, which has thus far produced extraordinary growth, diversification, and shareholder value since our IPO in 2012 and transformed HomeStreet from a troubled thrift into a regional community bank with a diversified array of products and services doing business in the best markets in the nation. As with other shareholders, we continue to offer to engage with Mr. Griege regarding his ideas for maximizing shareholders value. The Board continues to welcome shareholder feedback both from Blue Lion and from our broader shareholder base. However in anticipation of a possible proxy contest, we’re not going to comment further or take any questions on this matter on this call. And now, I will 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 operating segments. Regarding our consolidated results. Net income for the fourth quarter was $34.9 million or $1.29 per diluted share compared to $13.8 million or $0.51 per diluted share for the third quarter of 2017. Included in net income for the fourth quarter was a previously disclosed $23.3 million tax benefit, resulting from the lowering of the corporate tax rate 21% with the signing of the Tax Cuts and Jobs Act in December 2017. This $23.3 million tax benefit was the net result of a $4.2 million tax expense recognized in our Commercial and Consumer Banking segment as this segment was in a net deferred tax assets position, and $27.5 million tax benefit recognized in our Mortgage Banking segment as this segment was in a net deferred tax liability position at year-end. Excluding the impact of tax reform, restructuring charges and acquisition-related expenses, core net income for the fourth quarter was $11.5 million or $0.42 per diluted share compared to core net income of $16.6 million or $0.61 per diluted share for the third quarter of 2017. The decrease in core net income from the prior quarter was primarily due to lower non-interest income, largely from lower net gain on lower origination and sale activities in our Mortgage Banking segment, somewhat offset by higher net interest income in our Commercial and Consumer Banking segment and lower noninterest expenses. Included in core net income for the quarter was a $399,000 net loss on sale of investment securities. This net loss was primarily from the sale of securities acquired in previous mergers, the structure of which was not consistent with our current security strategy, and we recognize the associated loss is prior to the new tax rate taking effect. Net interest income increased by $239,000 million to $51.1 million in the fourth quarter from $50.8 million in the third quarter. This increase in net interest income is primarily due to the higher balances of loan held for investments in our Commercial and Consumer Banking segment. Our fourth quarter net interest margin of 3.33% decreased 7 basis points from 3.40% in the third quarter. This decrease in net interest margin is primarily due to an increase in the cost of interest bearing liabilities. Specifically, the cost of federal home loan bank advances which rose ahead of the December fed fund rate increase by the Federal Reserve. Noninterest expense, excluding the impact of restructuring and acquisition-related expenses, decreased from $110.5 million in the third quarter of 2017 to a $107 million in the fourth quarter of 2017. This decrease in noninterest expense was primarily from our Mortgage Banking segment due to a lower base salary expense run rate after the recent restructuring of this segment and from lower Mortgage Banking commissions. I'll now discuss some key points regarding our Commercial and Consumer Banking segment results. Commercial and Consumer Banking segment core net income was $13.6 million in the fourth quarter compared to core net income of $14.2 million in the third quarter. Segment noninterest income increased quarter-to-quarter to $12.7 million from $12 million. This increase was primarily due to higher gain from commercial real estate loan sales, partially offset by lower commercial prepayment fees, lower gains from SBA loans, loan sales during the quarter and previously mentioned net loss on the sale of securities. Segment core non-interest expense was $38.6 million, an increase of $1.8 million from the third quarter of 2017. This increase was primarily due to $497,000 charge related to the closure of a southern California lending office. The portfolio of loans held for investment increased 4% to $4.5 billion in the fourth quarter. Net loan growth was $190.8 million in the fourth quarter compared to $155.8 million in the third quarter. Non-performing assets declined to $15.7 million at December 31st compared to non-performing assets of $18.8 million at September 30th. This decrease was primarily a result of a $3 million reduction in other real estate owned. We reported no provision for loan losses in the fourth quarter compared to $250,000 in the third quarter. This decrease in provision expense was primarily due to continued improvement in credit quality and lower expected loss rates, combined with $921,000 of net recovery during the fourth quarter. Deposit balances were $4.8 billion at December 31st, an increase of $90.5 million from September 30th, driven primarily by increase in business money market accounts. Deposits in our de novo branches or those opened in the past five years, increased 6% during the quarter. I'll now share some key points from our Mortgage Banking segment results. The Mortgage Banking segment core net loss in the fourth quarter was $2.1 million compared to core net income of $2.4 million in the third quarter. This decrease in core earnings was due to lower gain on loan origination and sale activities, partially offset by lower salaries and related costs, both as a result of lower lending volume. The volume of interest rate lock and forward sale commitments was lower than closed loans designated for sale by 19% this quarter. Note that single family interest rate lock being less than closings in a given quarter negatively affects segment earnings as the majority of mortgage revenue is recognized at interest rate lock while majority of origination costs including commitments are recognized upon closing. The gain on mortgage loan organization sale composite margin decreased to 329 basis points in the fourth quarter from 342 basis points in the third quarter. The decrease was primarily due to a slight shift in our origination mix to lower margin products and generally lower and conforming conventional loan pricing among the agencies. Mortgage Banking segment non-interest expense of $68.1 million decreased $9.4 million from the third quarter. This decrease was primarily due to a reduction in closed loan volume, but also due to the reduction in headcount as other capacity and cost reduction changes implemented in the second and third quarters. Single family mortgage servicing income was $8.4 million in the fourth quarter, an increase from $7.4 million in the third quarter. This increase was primarily due to increased net servicing income on a larger servicing portfolio and improved risk management results. Our portfolio single family loan serviced for other increased to $22.6 million of unpaid balance at December 31, compared to $21.9 billion at December 31. The value of our mortgage servicing assets relative to the balance of loan serviced for others was 140 basis points at quarter end. I will now turn back over Mark Mason, to provide some additional insights on HomeStreet's general operating environment and our outlook for the future.

[Mark Mason:]

Thank you, Mark. In an effort to shorten our prepared comments this quarter, I will not be commenting on the health of the regional economies in which we do business, as we have in the past. If you would like current data, please contact, Gerhard Erdelji our Investor Relations Officer who can provide you with an update. Looking forward to the next two quarters in our Mortgage Banking segment, we currently anticipate single family mortgage loan lock and forward sale commitment volume of $1.7 billion and $2.1 billion in the first and second quarters of this year, respectively. We anticipate mortgage held for sale closing volumes of $1.5 billion and $2.1 billion during the same periods. For the full year 2018, we anticipate single family mortgage loan lock held for sale commitments to total $7.2 billion and loan closing volume to total $7.4 billion. Additionally, we expect our mortgage composite profit margin to decline to a range of between 315 and 325 basis points during 2018. In our Commercial and Consumer Banking segment, we expect our average quarterly loan portfolio growth to range from 2% to 4% per quarter for the year of 2018. Reflecting the continued flattening of yield curve and absent changes in market rates and loan prepayments fees, we expect our consolidated net interest margin to decrease to a range of 3.25% to 3.35% for the first and second quarters of this year. As our loan portfolio continues to grow and reprice upwards, we expect the net interest margin to increase to a range of 3.35% to 3.45% in the third and fourth quarters of this year. For the first quarter of this year, our net interest expenses are expected to decrease, given the seasonality of lower single family closed loans. For the remainder of 2018, we expect non-interest expenses to grow on average 1% per quarter, reflecting our focus on optimizing the profitable growth of HomeStreet. The growth rate of our total non-interest expenses will vary somewhat quarter-over-quarter, driven by seasonality and cyclicality in our single-family closed loan volume, and in relation to the timing of further investments in growth. Additionally, as a result of federal tax reform, we expect our estimated effective tax rate to fall to be between 21% and 22% for 2018. This concludes our prepared comments. Thank you for your attention today. Mark and I would be happy to answer any questions you have at this time.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from Jessica Levi-Ribner with B Riley FBR. Please go ahead.

[Jessica Levi-Ribner:]

Hey, good afternoon. Thanks for taking my question. Can you talk a little bit about your expected loan growth going forward, which areas in the commercial platform you’re looking at, and maybe on the mortgage side as well?

[Mark Mason:]

Sure. The composition of our lending has been relatively consistent. We are of course a very significant real estate lender, whether it’d be single-family mortgage, both for sale and for retention in the loan portfolio; commercial real estate, both permit loans and construction lending; residential construction lending which is mostly vertical construction; some integrated vertical land; and commercial and industrial lending which grew meaningfully last year but still represents a smaller part of our total originations; and growing but still quite small amount of consumer lending, general consumer lending including term loans and secured and unsecured lending. And the proportionality of that is going to vary somewhat as our commercial and industrial lending grows over time and begins to occupy a larger place in the balance sheet.

[Jessica Levi-Ribner:]

Okay. And is there any type of loan types that you are shying away from, just given the credit backdrop or anything like that?

[Mark Mason:]

We have not been a lender and generally entity value, C&I lending, leverage lending, some of the riskier C&I loan types. We have generally been stayed in the middle of the street with a view and a concern about consistent asset quality. We are watching the commercial real estate markets very careful in which we do business. We are obviously a significant commercial real estate lender, both multi-family and other commercial targets but in particular are focused on multi-family, both for our balance sheet, for resale to other institutions and to Fannie Mae. And many of our markets have experienced significant construction and along with significant job growth, population growth. And we are watching very carefully to identify when that growth will slow and when it will be trying to moderate that lending. To this point, I think consistent with my earlier comments, we still see very strong economic leading indicators and current ratios in these markets. Very, very recently, we've seen slowing in apartment rates in the Greater Seattle area. In fact I believe, in the month of December we actually saw the first month-over-month decrease in rental rates in Greater Seattle. We're watching that closely. And whether that’s as a consequence of larger deliveries of new buildings which we consistently see a great deal of or whether that may represent a turn in the supply demand balance. So, we watch maybe a 100 of these indicators consistently for indications of softening or turning market. But that would be an area not yet of concern to us but of caution I would say.

[Jessica Levi-Ribner:]

Okay. And then, my other question, just to go back to the -- I know spoke a little bit about the mortgage restructuring that you guys have gone through. Do you think that there is maybe a little bit more cost that you can get out of the business or some way that you can augment the business, given your thoughts around the origination opportunity or maybe a softer origination opportunity in your markets?

[Mark Mason:]

For us, the focus is on optimizing individual offices. Now, whether that be expenses or effectiveness with the teams. We closed or consolidated several offices in the third quarter. We continue to evaluate the performance of all of the branches and all of the loan officers for that matter. And by the time we are likely to identify an office that is not making the grade. And like all businesses, you always have a range of performance and our job is to monitor that performance and either have a you plan for improvement of performance or make tough decisions about staying in that business or region. And so that’s an ongoing process. The market will largely determine our decisions there based upon the performance. And so, it’s a constant part of what we do to evaluate month and month, probably business as a whole, the components of the business. And I think we have a number of opportunities for work flow, efficiency improvement. And the last year we spent much of the year installing and integrating a new loan origination system which has substantial opportunities for efficiency improvement, many of those we’ve already realized. We're just now closing the final loans in our prior loan origination system. So, we will soon begin -- the duplicated costs for example of running two software systems and then moving on to realize all the benefits of that integration. So, I think we have lots of opportunities.

[Operator:]

The next question comes from Jeff Rulis with D. A. Davidson. Please go ahead.

[Jeff Rulis:]

I guess, the reduction in the full year guidance on margin for 2018 is that a product, is that funding cost increases that you're seeing?

[Mark Mason:]

It is in large part yield curve driven, because the FHLB in particular surprised us by front running the reserve increases and they’ve shown a pattern of doing that recently at least in our district. That will normalize of course. But, if the fed continues to raise and the FHLB continues to front run, we're likely to continue to experience some of that compression. Now, over time, the loan portfolio catches up. We have a fair amount of monthly adjusted loans and another significant amount of periodic adjustments for which there is some delay in the impact of rising rates. And over time, that's going to catch up.

[Jeff Rulis:]

I guess, another angle there is your success on growing interest bearing deposits. Looking at the average balances, they're down in Q4, seasonality, I guess talk about any programs to kind of build the core funding base?

[Mark Mason:]

Sure. There is seasonality. Some of our larger commercial customers draw down at the end of the year. You may look back at last year's fourth quarter comments. We had similar experiences with some of our larger customers. Our real funding opportunity though is continuing to grow the deposits at the de novo branches we've opened over the last five years and those that we expect to open in the coming years. And those activities have produced the greatest amount of deposit growth in our system. And we're very happy with our ability to identify strong markets to open those branches in, our ability to grow deposits of those branches consistent with a deposit growth ramp that gets us to profitability in the expected period of time. And the lion share, the far lion share of our de novo branches that we've opened are meaningfully above that long-term slope. So, we expect that's going to continue to be one of the primary drivers of deposit growth. As our C&I business grows and other small business lending grows, that growth -- that’s going to contribute to growth in commercial deposits as well.

[Jeff Rulis:]

Got you. And Mark, just one quick last one on the -- I missed, you talked about closed loan volume in 1Q and 2Q. Is that 2.1 and 1.5, respectively?

[Mark Ruh:]

1.5 and 2.1. So, closing volume 1.5 and 2.1 during the first to second quarter.

[Jeff Rulis:]

And the lock was in comparatively...

[Mark Ruh:]

1.7 and .2.1. 1.7 first quarter, 2.1 second quarter for lock.

[Jeff Rulis:]

Got you, okay. Thank you.

[Mark Mason:]

Thank you.

[Operator:]

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

[Tim Coffey:]

Mark, as we kind of look at page 25 of the press release, the Commercial and Consumer Banking segment, five quarter loan roll forward. The line of purchases and advances, can you provide any kind of breakdown between those two?

[Mark Mason:]

[Multiple speakers] Purchases would be single family loans we acquire from primarily our joint venture, Windermere Mortgage Services. They are technically purchases from another entity. But the lion share of that line item are advances on lines of credit previously originated. New loan originations would be up on the originations line. Sorry if that's a little complicated.

[Tim Coffey:]

Yes. I was just trying to get breakdown on that. And so, what do you attribute -- obviously lion share of those are advances. What do you attribute that to? Is it coming from specific market? I'm assuming you do different types of lines of credit. Is there a typical product that's coming from right now?

[Mark Mason:]

Well, it’s sort of across the board. If you think about our lending, part of that comes from draws on construction loans, which are very large numbers. Part of that is draws on revolving lines of credit. And those two categories made up the lion share. If you’re interested in the breakdown, we could probably provide that later, if you get with Gerhard.

[Tim Coffey:]

Sure, okay. And then, the line below that the payoffs, pay-downs and sales. I should be able to back into what the sales number is off of other pages in the press release, is there more towards than that?

[Mark Mason:]

No, you should, though -- if this balance is loans held for investment, some of our sales go directly into loans held for sale. Of course, they would never enter that total. We do sell some loans out of the portfolio. So, there may be a reconciliation from total loan sales to that line item. And in terms of pay-offs, we have fairly high loan turnover in our portfolio. One is a consequence of construction lending. If you think about the very short duration of residential construction, today those loans average about 200 days in duration. So there’s a lot of churn in that portfolio. Additionally, loan types like single-family mortgages, in particular jumbo non-conforming mortgages have relatively high prepayments fees, surprisingly high. And we have been running as a portfolio in excess of 20% annual CPR through years now, and sometimes as high as 25% or 26%.

[Tim Coffey:]

Okay. I want to come back to the jumbo market. But yes, as we were talking about loan growth expectations going forward, are we kind of talking about just originations, are we talking of the entire thing with the advances and payoffs and sales and everything?

[Mark Mason:]

Well, you kind of need to add those lines together, if you think about it, Tim. When you originate a line of credit, it may not get drawn on for several quarters, right. In current quarter may have draws of prior quarter originations. So, when we are talking 2% to 4%, we are talking change in balances. It is a consequence of commitment origination activity during the current quarter or prior quarters.

[Tim Coffey:]

Yes.

[Mark Mason:]

It is truly change in balance we are talking about.

[Tim Coffey:]

And I know it’s early to be talking about this but since the tax reform package has passed, are you seeing any changes in the jumbo mortgage market?

[Mark Mason:]

I think it’s a little early to tell. We saw a rush of activity in December, right, as people were looking a possible decrease in deductibility right from $1 million to $750,000. But, the reality is the market goes on. And for those people who can afford jumbo sized mortgage -- jumbo mortgage sized loans, it’s not going to meaningfully change their affordability. Many of the jumbo mortgages that we would otherwise originate, we are able to structure into conforming balances with an accompanying home equity line of credit. It’s a great way for us to give someone a lower collective composite rate. And it’s great for us in building our home equity portfolio. So, there’s a number of things going on in the jumbo market. But I think that tax reform, at least in our large markets where we have such a significant balance of available loans for sale to demand, we don’t think tax reform is going to have a meaningful impact on loan volume. Inventory is the biggest issue.

[Tim Coffey:]

Okay. And given what’s happened to rates year-to-date, is there any kind of color you can give us on how that’s impacted your hedging activity?

[Mark Mason:]

Well, as a general matter, when rates rise quickly, that’s bad for hedging. And when rates fall quickly, that’s typically good for hedging, because of what happens to basis, right. We always run some basis risk in our hedging activities, more so our servicing hedging, much less so our pipeline -- mortgage pipeline hedging. Within our servicing hedging, we hedge with a variety of instruments, swaps based upon LIBOR and of course right there you have the basis risk between LIBOR and mortgage rates. PBA [ph] securities which have close to the same basis as mortgages but there are small differences, and euro-dollar futures which of course have basis differences. So, if you look at the composition of the hedge, we have meaningful basis risk. And as long as basis differences stay within reasonably range, our hedge works very, very good. When you have meaningful changes in rates that can impact your hedges also obviously positively or negatively. And historically our hedges not performed as well during periods of rising rates. That difference has not been that meaningful. We're still, we believe, the most effective hedger of servicing assets in the United States. We track the results of all of the public company reporters who report that activity. And again last year, every quarter and for the full year last year we were again, the most effective, I guess that’s the right way to say that hedging those assets. But, it is true, in periods of rising rate, our hedge historically has not performed quite as well.

[Operator:]

Next question comes from Tim O’Brien with Sandler O'Neill. Please go ahead.

[Tim O’Brien:]

So, one question I have for you on the margin guidance, you gave -- that was down a little bit relative to the guidance that you gave on the last quarter call. Is there any rate move assumptions baked into that guidance for you guys?

[Mark Mason:]

No, there is not. We found we're not good predicting the timing or magnitude of rate moves. So, further rate moves could impact those results, but that depends on what also happens to the curve. So, to the extent the curves steepens or flattens, that has a more significant impact on the net interest margin than simply rate move.

[Tim O’Brien:]

Understood. And then the other question I have for you on that is, sensitivity analysis in that modeling, can you give us any updated color on that? You guys do that quarterly, don’t you or is that an annual thing? I forgot.

[Mark Mason:]

We do it quarterly and our position, our sensitivity...

[Tim O’Brien:]

Call it up 100 basis-point, Mark, do you have just that one number?

[Mark Mason:]

I don’t have it at my fingertips. Let me ask my genius crew here. We can get back to you Tim on that obviously.

[Tim O’Brien:]

I will follow-up with the genius there, the other genius, one of them.

[Mark Mason:]

All right….

[Tim O’Brien:]

No. That’s okay, Mark. You can’t have it all, like, I mean, there is a lot of detail in your business. One other question, can you give a little color on the C&I growth? You had nice C&I -- or excuse me, commercial growth. I'm assuming that those are lines of credit. Is that a fair assumption that went from 246 million to 265 million?

[Mark Mason:]

Yes. I mean, we had a much better year from a commitment standpoint, commitment’s growth We’ve been investing a lot in pursuit of growing our C&I composition. And the originations were up, commitment originations were up meaningfully from the prior year, maybe not a 100% but probably not 80%.

[Tim O’Brien:]

Would you happen to have those numbers? That’s a good -- that’s a really valuable piece of data for -- that validates your commercial strategy and effort, investment. In all ways, shapes, or forms, that’s a great milestone for us to have. Would have happen to have the total commitments created on commercial for 2017 versus 2016. that progress.

[Mark Mason:]

Again, I don’t have it on my fingertips except through the third quarter because we’ve published that in our investor deck, both changes in balances and changes in commitments by quarter. So, we will be publishing that within the next week and.

[Tim O’Brien:]

Okay. And that will be through year-end?

[Mark Mason:]

That will be through year-end, correct.

[Tim O’Brien:]

Okay, great. I will get it then. And then, how about this, do you have utilization rate on commercial lines of credit? And this is kind working of the Tim's question earlier. Do you have that the C&I utilization rate number at the end of the year, relative to last quarter end, start of the year, call it, start of quarter, excuse me.

[Mark Ruh:]

We're going to have to get back. We haven’t detailed operations report, since we don’t it all on our fingertips right now for the business units.

[Tim O’Brien:]

And so, would you characterize the growth from -- just under 20 million in commercial business growth to be -- how much of that was new loans versus new production in the quarter versus increased draws.

[Mark Mason:]

That's the new product. Now, some of that was draws on commitments in the second quarter that were drawn in the third. But, it's second half of the year activity.

[Tim O’Brien:]

And those lines -- that business, again the leader of that business is based of San Jose, right or is that…

[Mark Mason:]

No, here in Seattle.

[Tim O’Brien:]

My bad. There is a California president too that's doing the same thing, but targeting California businesses, right?

[Mark Mason:]

Actually, it's a same person now. You may have missed our press release a couple of months ago. The fellow Ed Schultz that we hired to build our California commercial lending business has been promoted to lead all of our commercial lending businesses and our retail franchise both in the Pacific Northwest and California, well, all franchises including Hawaii. And so that change in leadership was effective January 1. His name is Ed Schultz.

[Tim O’Brien:]

Okay, great. And then, just shifting gears, you talked about office consolidation closures. None of those were branches. I'm going to assume those were all loan production offices. Is that a fair assumption or is that…?

[Mark Mason:]

The offices that we closed in the fourth quarter was an SBA lending office that we consolidated into our Orange County Business Bank office in Irvine.

[Tim O’Brien:]

And in the third quarter, those were predominantly, no branches were closed last year, were there?

[Mark Mason:]

Well, we closed several mortgage production...

[Tim O’Brien:]

No branches though?

[Mark Mason:]

No.

[Tim O’Brien:]

And then that leads in to this other question. Do you guys have kind of a baseline number range of branches that you plan to open in 2018? You might have mentioned it earlier, but just to remind me.

[Mark Mason:]

As I mentioned on the call, we plan to open 3 retail deposit branches in currently 2018.

[Tim O’Brien:]

And that's it for the full year or that's it so far, that's the plan so far?

[Mark Mason:]

Correct.

[Operator:]

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

[Jackie Bohlen:]

Shifting over to capital management. And just if you could provide an update, Mark, on how you're thinking about capital management inclusive of potential dividends and everything, just in light of the bump to TCE from DTL [ph] write up, and then also the lower tax rate going forward?

[Mark Mason:]

We have been fortunate to realize unexpected increase in capital as a consequence of the tax reform act, because there is very significant deferred tax liability position that we have maintained as a consequence of having significant mortgage servicing rights. That was hopeful. Ironically as of year-end, it actually didn't have a beneficial impact on our risk-based capital ratios because that very deferred tax liability is an offset to the carrying value of the mortgage servicing assets for determination for regulatory capital purposes of how much is includable in capital. So, we actually had to in effect to write off more regulatory capital for risk based capital purposes. However, that condition is expected to reverse as soon as we propose changes in Basel III based limitations on mortgage servicing assets in regulatory capital. This is subject of notice of proposed rulemaking change that was published last year. The comment period on that NPR ended on December 26. We’re told that the agencies are reviewing the comments and considering the actions to be taken to make permanent those proposed rule changes. That rule change should provide us $70 million to $75 million of additional tier 1 risk-based capital. And so, those ratios will improve meaningfully. So, a combination of those two things. We should realize, by that I mean 23 some million dollars in additional tier 1 capital associated with the December benefit that we recorded due to tax reform and the anticipated or expected rule-making change with respect to MSR -- caps on MSR assets, it gives us a meaningful boost to regulatory capital relative to what we have previously expected to come into the year with. In addition to strong earnings, obviously primarily from our Commercial and Consumer Banking segment, we’re beginning to be in a position where we can discuss with the Board the potential for instituting a regular dividend. And the Board has that on its agenda to discuss. We want to make sure that the rule making change is actually made permanent and that we understand the benefits of that change. But we have waited to institute regular dividend until we had built a sufficiently large, durable and consistent stream of earnings from our non-mortgage businesses. And we think it’s time to have that discussion with the Board. And when the Board makes a determination on that question, we will of course share it, share with the public. As on capital plan, it relates to capital needs going forward. Our growth rate is still likely to require capital. And in that regard.0 at some future point, potentially before the end of this year, we may return to the capital markets for either debt or equity to support that growth rate. But it’s going to be dependent on growth, it’s going to be dependent on earnings. And so the timing is a little uncertain as to the magnitude now.

[Jackie Bohlen:]

Okay. Thanks for the update. That’s wonderful color on that. Quick follow-up on the NIM guidance that you provided, does that include adjustments related to the potentially equivalent yields and the impacts that the new tax rate will have on those?

[Mark Mason:]

Yes.

[Jackie Bohlen:]

Okay. And what -- how much, if you have it, in basis points, would that impact lower the margin by?

[Mark Mason:]

That’s a tougher analysis here. We’d have to think about that a little bit.

[Jackie Bohlen:]

Okay, fair enough. And then, just one last one. Other non-interest income was a little bit higher in the quarter. Was there anything unusual in that line item?

[Mark Mason:]

Not unusual, just greater volumes. If you look at the sales of -- you’re talking of decade, it’s $3.196 million, [ph] other non-interest income, correct?

[Jackie Bohlen:]

I don’t have my model exactly in front of me, but it’s just that last line item, they’re not with incumbents within any -- the multi-family sales or anything like that. Yes, the 3.196. Yes.

[Mark Ruh:]

Yes. We had some amortization, SBA amortization income classified into that, some of the big items were our usual FHLB dividend end up $400,000, we got some prepayments fees, actually fairly large this quarter, $606,000. So, I know that number does fluctuate. Those are some of the big items, 606, prepayments fees Federal Home Loan Bank or 49 SBA reclassification 311…

[Mark Mason:]

And prepayment fees historically were included in interest income. So, you are seeing a little higher other non-interest income in part by that change in geography.

[Mark Ruh:]

We also have our investment services unit there and that has generally produced low in summer and into the fall but it picked up in the fourth quarter and that was $619,000 as well.

[Jackie Bohlen:]

So, given the change in the accounting treatment and some of the unique items that you had in the quarter, how should we think about normalized run rate heading into 1Q?

[Mark Ruh:]

If you look at what you saw in the third quarter, I think it’s generally what you are -- in that 1.7 to 2.5 band, I think it’s more like it, so we typically go see. So, forward in the first quarter, it’s hard to predict, there are some unusual items in there that come and go. I think sort of that 1.7 to 2.5 will probably get you there pretty well.

[Mark Mason:]

Thank you. In response to Tim's earlier question about 100 basis-point move in rates on our parallel shock sharp analysis which everyone is familiar with, that creates about a 1% to 1.25% positive change. All right. Thank you.

[Operator:]

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

[Mark Mason:]

Thank you all for joining us today for our fourth quarter and year-end call. We appreciate your patience. We appreciate the analysts’ questions. Look forward to talking to you again next quarter.

[Operator:]

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