HomeStreet, Inc.
Q3 2015 Earnings Call Transcript

Published: 27 Oct 2015

[Operator:]

Good afternoon and welcome to the HomeStreet Incorporated Third Quarter 2015 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 Mr. Mark Mason, Chairman, President and Chief Executive Officer. Please go ahead.

[Mark Mason:]

Hello and thank you for joining us for our third quarter earnings call. Before we begin, I’d like to remind you that our earnings release was furnished this morning to the SEC on Form 8-K and is available on our website at ir.homestreet.com. In addition, a recording of this call will be available 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 markets such as changes in interest rates that affect the demand for our mortgages, the actions of our regulators, our ability to meet our internal operating targets and forecasts, and economic conditions that affect our net interest margins. Other factors that may cause actual results to differ from our expectations or that may cause us to deviate from our current plans are detailed in our SEC filings, including our quarterly reports on Form 10-Q and our Annual Report on Form 10-K for 2014, as well as our various other SEC reports. Additionally, information of 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 earnings release available on our website. First I’d like to introduce our new Chief Financial Officer, Melba Bartels. Melba came to HomeStreet from JPMorgan Chase where she was the Chief Financial Officer of the $60 billion Automobile Finance and Student Lending Division. Prior to that she managed Corporate Financial Planning and Analysis for Washington Mutual in Seattle. So she knows our business and our markets and we are thrilled that Melba has joined our company. She will be joining me in presenting this update today. Today, I’ll give a brief update on recent events and review our progress in executing our business strategy and Melba will present our financial results. Please refer to our earnings release for a more detailed discussion of our financial condition and results of operations. In the third quarter we made significant progress on our strategy to grow and diversify earnings. In the quarter, we expanded our commercial and consumer banking business organically by opening two de novo bank branches in Greater Seattle. We are also acquiring a branches in Central Washington and we recently announced that we have entered into a definitive agreement to acquire Orange County Business Bank located in Irvine, California. This proposed transaction is expected to close in the first quarter of next year. We’ve been expanding in Southern California over the last three years. First with the opening of home loan centers in the region and recently through our merger with Simplicity Bank earlier this year. The Simplicity merger added seven retail bank branches in the Los Angeles and San Bernardino Counties to our retail branch network. These additions have provided us with the platform for doing a full service commercial and consumer banking franchise in Southern California. Our merger with Orange County Business Bank will provide HomeStreet access to one of the premier Southern California commercial and consumer banking markets. Orange County Business Bank serves businesses throughout the region and this merger will provide Orange County Business Bank for substantial additional products and services to better serve their customers including higher loan limits and a broader menu of commercial and consumer loan, deposit, investment and insurance services. Additionally in August, we agreed to acquire the AmericanWest Bank branch in Dayton, Washington. As of June of this year the Dayton branch had approximately $27.1 million in deposits and we’ll be receiving it approximately $4.4 million in related loans in the transaction. These deposits represent approximately 24% of the deposits in the market area. And we’ve received all necessary regulatory approvals and we expect to close the acquisition in December. This acquisition will increase our network of retail deposit branches in Eastern Washington to a total of five. In the third quarter, we also built mortgage banking market share by continuing to opportunistically hire teams of strong originators in new and existing markets in the Western United States adding production offices in Glendora, San Diego, San Luis Obispo, Chico and Riverside, California. Reflecting with success of growing and diversifying our banking business, we are in the process of applying for a conversion to Washington State-Chartered Commercial Bank. We expect to complete this charter conversion by the end of this year. Before Melba reviews our financial results, I will share some highlights in the quarter. Reflecting our overall progress year-to-date return on average shareholders’ equity excluding merger related items was 11% through the third quarter, compared to 8.5% last year. Return on average assets excluding merger related items was 1.07% through the third quarter, compared with 0.77% last year at this time. Our commercial and consumer banking segment had core net income of $6.3 million for the third quarter, compared to core net income of $5 million for the second quarter this year. This improvement reflects our ongoing expectations and consistent growth and improved returns in this segment. After closing a record volume of $2.02 billion and our single-family mortgage lending segment in the second quarter, we continued strong production with $1.93 billion and closed loan volume in the third quarter. Unfortunately lower profit margins on mortgage origination and higher costs in part associated with new disclosure requirements reduced our third quarter mortgage banking segment net income to $3.2 million, down from $9.5 million in the second quarter. The cost of preparing for the October 3 of limitation of the TILA RESPA integrated mortgage disclosures has been more significant than we expected. To support the implementation of software upgrades, training and implementation we added additional personnel in the third quarter, increasing our cost to manufacture loans. The recently implemented trig requirements have substantially increased our documentation requirements and responsibilities further complicating our already substantial workflow and increasing our training costs in the interim. The new rules have substantially lengthened our time to close loans and added to our processing costs. We expect these added costs to continue in the near time and where possible we are adjusting our prices to compensate for these costs. However it is not certain that our competitors will increase market price sufficiently to cover these new industry costs. Now I’ll turn it over to Melba who will share some additional details of our financial results for the quarter.

[Melba Bartels:]

Thank you Mark and good morning everyone. Third quarter net income was 10 million or $0.45 per diluted share, compared with 12.4 million or $0.56 per diluted share for the second quarter of 2015 and 5 million or $0.33 per diluted share for the third quarter of 2014. The decrease in net income for the quarter was primarily due to lower net gain on mortgage origination and sale activities as Mark had noted. Excluding after tax merger related revenue and expenses, core net income for the third quarter was 9.4 million or $0.42 per diluted share compared to 14.5 million or $0.65 per diluted share in the second quarter. Net interest income was 39.6 million in the third quarter compared to 38.2 million in the second quarter of 2015. Our net interest margin was 3.67% an increase of 4 basis points over the second quarter, due primarily to ongoing changes in the composition of the loan portfolio through organic origination of commercial loans. Non-interest income decreased $5.5 million or 8% from the second quarter, due primarily to lower net gain on loan origination and sale activities. Net gain on mortgage loan origination and sale activities decreased $12.1 million from the prior quarter and increased 20.2 million from the third quarter of 2014. Non-interest expense was 92 million in the third quarter compared with 92.3 million in the second quarter. Excluding merger related expenses non-interest expense was 91.6 million compared with 89.1 million for the second quarter. The increase was primarily due to higher salaries and related costs from the increased headcount. At September 30th the bank's tier 1 leverage ratio was 9.69% and total risk based capital was 14.15%. These ratios reflect the implementation of Basel III requirements on January 1st. I'd now like to share some key points from our commercial and consumer banking business segment results. The commercial and consumer banking segment net income was 6.8 million in the third quarter compared to 2.9 in the second quarter. Net income was higher due to higher net interest income on higher average balances of loans during the third quarter, gain on sale of investment securities and lower merger related items. Excluding after tax net merger related items the segment recognized core net income of 6.3 million in the third quarter compared to 5 million in the second quarter. We recorded 700,000 in provision for credit losses in the third quarter '15 compared to a provision of 500,000 recorded in the second quarter of 2015. The portfolio of loans held for investment increased 3.9% to 3.01 billion from 2.9 billion at June 30th, an increase of a $112.3 million. Net commitment totaled $417 million compared with 313 million in the second quarter. We achieved this net growth in the loan portfolio despite continuing high portfolio runoffs of approximately 32.1% annualized in the quarter. Credit quality remains strong with non-performing assets at 56 basis points of total assets at September 30th, and non-accrual loans of 64 basis points of total loans. Non-performing assets were 27.7 million at quarter end compared to non-performing assets of 32.7 million at June 30th. We continue to enjoy positive charge-off experience with net recoveries of 739,000 in the quarter. Deposit balances were 3.31 billion at September 30th down slightly from 3.32 billion at June 30th, primarily due to a 4.5% decline in certificates and deposits. Segment non-interest expense was $28.1 million, a decrease of $1.2 million from the second quarter. Included in non-interest expense for the third quarter and second quarter 2015 were merger related expenses of $437,000 and $3.2 million respectively. Excluding merger related expenses from both periods the increase in expense is due to the continued growth of our commercial real estate and commercial business lending units and the expansion of our bank branching network. I’d now like to share some key points from our mortgage banking business segment results. Net income for the mortgage banking segment was $3.2 million in the third quarter of 2015 compared to net income of $9.5 million in the second quarter of 2015. The $6.4 million decrease in net income from the second quarter of 2015 was primarily due to lower net gain on single family mortgage loan origination and sale activities, due to lower service in origination values and lower secondary market gains. Net gain on single family mortgage loan origination and sale activities in the third quarter of 2015 was $56 million compared to $67.5 million in the second quarter of 2015. Single family mortgage interest rate lock commitments net of estimated fall out totaled $1.81 billion in the third quarter of 2015 a decrease of $76.2 million or 4% from $1.88 billion in the second quarter of 2015. Single family mortgage closed loans totaled $1.93 billion in the third quarter, a decrease of $89 million or 4.4% from $2.02 billion in the second quarter of 2015. A combined pipeline of interest rate lock commitments net of estimated fall out and mortgage loans held-for-sale was $1.5 billion at quarter end compared to $1.65 billion at the end of the second quarter. The volume of interest rate lock commitment was lower than closed loans designated for sale by 7% this quarter, which negatively effects account in earnings because of majority of mortgage revenues recognized at interest rate lock, well a majority of origination cost including commissions are recognized upon closing. If rate lock commitments during the third quarter would have equal to closed loan volume it would have resulted in approximately $3.5 million higher gain on loan origination sale revenue, conversely if closed loan volume had been the same as interest rate lock commitments, pre-tax income would have been approximately $1.6 million higher as a result of lower variable cost. Despite lower mortgage closed loan volume in the quarter, mortgage banking segment, non-interest expense of $63.9 million increased $861,000 or 1.4% from the second quarter, this increase was a result of overall segment personal growth reflecting afore mention expense of implement in trade and expansion into new markets. We grew mortgage banking personnel by 7% in the quarter, closed loans per loan officer decline in the quarter to five per loans per officer compared to 5.3 loans in the second quarter. Single family mortgage servicing income was $4.1 million in the quarter a $2.9 million increase from the second quarter of 2015. The increase was the result of $1 million improvement in servicing fees collected in the third quarter combined with improved risk management results. Single family mortgage servicing fees collected in third quarter of 2015 increase primarily due to higher average balances in our loans serviced for other portfolio. Despite higher servicing income this quarter, we continue to suffer higher prepayments fees and related higher amortization of MSR, mortgage servicing rights. The portfolio of single family loans service for other was $14.3 billion at September 30th, compared to $13 billion at June 30th. I’ll now turn it back over to Mark to provide some insights on the general operating environment and outlook.

[Mark Mason:]

I’d like to now discuss the national and regional economies as they influence our business. First I would like to remind everyone that we are fortunate to operate in some of the most attractive market areas in the United States today. We are focused on the major markets in the western United States, which today enjoy lower unemployment and substantially higher rates of population growth, job creation, commercial and residential construction and real estate value appreciation than the remainder of the country. The most recent Mortgage Bankers Association monthly forecast projects total loan originations to increase 15% this year over the prior year, a downward revision from its prior quarter forecast of 20%. Mortgage rates continue to near historic lows and nationally purchases are expected to comprise 57% of volume this year. Housing starts for 2015 are expected to be up 11% over 2014 levels. MD&A currently forecasts an additional 12% growth in housing starts next year. During the third quarter, purchases comprised 63% of originations nationally and 60% of originations in the Pacific Northwest. HomeStreet continues to perform at levels above the national and regional averages, with purchases accounting for 75% of our closed loans and 70% over interest rate lock commitments in the quarter. While our purchase composition is strong the overall home sales market remains well below historic levels due to low inventories of new and resell homes. Since the third quarter of last year, job creation in Washington, Oregon, and California has averaged 3% on an annualized basis a full percentage point faster growth than in the national economy. Since 2011, unemployment rates in the northwest states in California have been cut by over 40%. Housing permits though volatile due to multi-family swings have largely trended higher in Washington and California in recent quarters, but more level in Oregon and Idaho. Since the recession loan however the permitting rate has doubled in Oregon and Idaho matching the national performance while climbing more than 2.5 times in Washington and tripling in California. Over the last four quarters year-over-year home price appreciation based on FHFA data has ranged from 5.3% in Idaho also the national rate to between 6% and 8% in Washington, California and Oregon. In Washington multi-family permits are expected to average 53% of total permits for the year. In California multi-family permits are expected to total 55% of total permits. Seattle is ranked in 2015 by the Urban Land Institute in the top 10 regions in overall real estate market prospects for investment, development and home building. Seattle ranked sixth in technology and energy employment concentrations and overall job creation in the last two years. Looking forward over the next three quarters in our Mortgage Banking segment, we currently anticipate mortgage loan loss volumes held for sale of approximately 1.5 billion, 1.8 billion and 2.3 billion in the fourth, first and second quarters of next year respectively. We anticipate mortgage held for sale closing volumes of 1.8 billion, 1.6 billion and 2.3 billion in the fourth, first and second quarters of next year respectively. This seasonality is expected to produce greater variation in accounting results due to the timing of recognition of related revenues and expenses and the expected imbalance between locks and closings. This imbalance is expected to negatively impact the quarters we are closing between locks and vice versa as we expect in the current quarter with a forecast of $1.5 billion and $1.8 billion respectively for lock versus close loan volume. Based on these expectations some analysts' current estimates for the fourth quarter appear high. Additionally, we expect our composite margin to continue to range between 315 and 325 basis points over that period. As I mentioned earlier, our results in future quarters could be further impacted by TRIG requirements. We expect the increased costs, we experience in the third quarter to continue at least three different quarter. For the full year next year we expect mortgage loan lock and mortgage loan held for sale closings up $8.3 billion and $8.2 billion respectively. In our commercial and consumer banking segment, over the next three quarters, we continue to expect net loan portfolio growth to approximate 4% to 5% quarterly and our net interest margin to remain at roughly the 3.6% level, absent changes in market rates and prepayment speed. Going forward, we generally expect the consolidated non-interest expense will grow approximately 2% per quarter reflecting the continued investment in our growth and infrastructure. This growth rate will vary somewhat quarter-over-quarter driven by seasonality in our single-family close loan volume and relation to further investments in growth in both of our segments. Despite this extended guidance and caution regarding certain fourth quarter analyst estimates, we are generally comfortable with analysts' 2016 full year consensus estimates. I'm sharing this extended guidance with you this morning to assist investors and to emphasize the seasonal changes in mortgage origination activity. Of course this guidance is dependent upon many factors, including but not limited to those I mentioned earlier, in particular changes in the mortgage and real estate markets and general interest rates. This concludes our prepared comments, we thank you for your attention today. And Melba and I will be happy to answer any questions you have at this time. Operator?

[Operator:]

Thank you, we will now begin the question and answer session. [Operator Instructions] And our first question comes from Paul Miller from FBR and Co, please go ahead.

[Paul Miller:]

Thank you very much, hey Mark on the community end, on the consumer bank, you continue to show improvement in those earnings I believe it was like you showed a net segment analysis profit of $6.2 million. Is that a good run rate going forward or should that continue to grow, I know you've done a lot of hiring on that institution specially in the lending side.

[Mark Mason:]

As I mentioned in my earlier comments we are expecting from here forward for our results in that segment to grow not just in bottom line but in a efficiency in producing revenues. So we think that we've gotten past some of the scale challenges that we've had in the past in terms of the relative size of the loan portfolios and the operating expenses of the various lending units. The additions of Simplicity and soon Orange County Business Bank has already shown substantial improvement, provide a substantial improvement and we expect more going forward. So we feel like this quarter is a good baseline to revenue and expenses, understanding that revenues will grow as the portfolio grows and expenses will grow somewhat as we continue to open branches and we have personnel building out the platform.

[Paul Miller:]

And then can you talk a little bit about your M&A strategy right now, I mean the Simplicity mergers, that's probably the big one. But then you did OCBB and is that the new, are you just looking for a little fill-ins at this point or is there any major areas that you would love to get a foothold in?

[Mark Mason:]

Well yes theoretically we shop in all of the markets we'd ultimately like to be in. I think it's fair to say that we have tiers of interest, the top tier being of course in [indiscernible] where we have the most opportunity for consolidation and efficient mergers but obviously in Southern California we're focused on building out a full platform there and our operations currently don't reflect that. So we're very interested in both of those markets. The next tier would be other significant markets, the rest of California, and the bay area and the middle of the state, we're starting to see in the hi-fi corridor through Oregon and Washington and then some of the other centers of population in the rest of the western states. But given where we're trading particularly today relative to tangible book value it is hard for us to do some of the more expensive acquisitions in terms of premiums and tangible book value. That's not to say that we wouldn't entertain larger somewhat more expensive acquisitions if well placed and of a size that would accelerate substantially our diversification interest. Recently we've put more focused on transactions that more easily fit our acquisition criteria. And so I'd say you know for the time being we're still probably in this zone of properties. But if the right opportunity came along in a larger transaction that would accomplish all of our diversification objectives we would have to consider it.

[Operator:]

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

[Jeff Rulis:]

Maybe a quick one for Melba on the margin -- was there -- could you break out any accretion benefit you saw on Q2 versus Q3?

[Melba Bartels:]

Accretion relative to the recent merger?

[Mark Mason:]

I assume you mean accretion of the marks on [simplicity in the] prior mergers Jeff?

[Jeff Rulis:]

Correct. What it did add to the margin -- was that sort of flat quarter-to-quarter?

[Melba Bartels:]

Okay. Jeff, I do not have at my fingertips, I’ll have to follow-up with you on that.

[Mark Mason:]

But I would say because the second quarter was a full quarter of operations -- for second and third quarters, were full quarters after the simplicity closing on March 1st, I would expect the impact to be relatively flat. Now what we are experiencing is some acceleration from prepayments, but I don't think it's a material change quarter-over-quarter.

[Jeff Rulis:]

Okay. And then Mark on your non-interest expense outlook kind of 2% growth in the quarter, would that include the acquisition coming on board in Q1, you are going to soak that in or would that be just legacy and then we add for that platform in Q1?

[Mark Mason:]

I think that's an ongoing expectation. I don't know that the closing of loans kind of business bank is going to materially change that number in the first quarter.

[Melba Bartels:]

Now of course we would excluding in specific merger related expenses related to OCBB in that run rate, but Mark's correct it wouldn’t materially change the 2% guidance.

[Jeff Rulis:]

Okay. Got it, and then Mark could just those -- just jot down the lock and held for sale origination expectations for ‘16 was that 83 and 82 respectively?

[Mark Mason:]

That's correct, I think its 82 locks and 83 closing, I am checking my notes.

[Melba Bartels:]

83 locks and 82 closing.

[Jeff Rulis:]

And I guess how does that compared to ‘15, if you kind of annualize Q4 or your expectations to close the year?

[Mark Mason:]

We -- so we are going to add, 15 and 16 locks and closings to our year-to-date numbers, which would give us about 71 in locks and 73 in closings for 2015.

[Jeff Rulis:]

Got it, is this kind of backing into that your comments on [comfortability] with consensus you are looking for an increase in originations, I guess the MBA forecast for ‘16 is down 10% that basically balling that all up you intend to outperform the general demand on originations just from better execution or [boots] on the ground?

[Mark Mason:]

Two things, one as I mentioned earlier, we have a substantially higher purchase concentration than the nation as a whole, so the MD&A numbers reflect the national numbers, next year the MD&A is forecasting growth in purchase originations of -- I think it's around 12% roughly, so we should outperform the country without any growth in capacity simply on higher purchase composition, but in addition to that we expect the ongoing growth in origination capacity by hiring more teams in individual loan officers, next year as has been our strategy. So the combination of those two we think should result in growth from 71 to 82 billion in locks next year and similar in closings.

[Jeff Rulis:]

Then I guess just last one not to beat it up here, but with that composite margin of 315 to 325, I’m not -- wasn’t clear if that was for the full year or just for the next three quarters. But I guess the idea is that originations from your perspective were set to increase in ’16, but maybe a lighter composite margin. Is that directionally correct?

[Mark Mason:]

The 315 to 325 is we think good for the whole year. We think it's somewhat seasonal typically as volume drops, margins drop, as originators stretch to do more volume. So we would see the year, I think slightly higher margins in the second and third quarter, slightly lower in the first and fourth quarters, but averaging around that 315 to 325 range.

[Operator:]

Our quarter comes from Jackie Chimera with KBW. Please go ahead.

[Jackie Chimera:]

So information services cost were up in the quarter. Is that related to the higher regulation and disclosure that you discussed or is that something different?

[Mark Mason:]

In part. So as we continue to improve our infrastructure here, sometimes as expenses are a little lumpy. So we have an ongoing series of implementation in the software systems in the various lending groups and I think this reflects somewhat lumpiness there and the [work on trade].

[Jackie Chimera:]

Okay. So some of it will be ongoing at last over the next couple of quarters, but others of it will just be quarterly fluctuations based on timing. Is that a good way to think about it?

[Mark Mason:]

Yes.

[Jackie Chimera:]

And then a question on the yield on securities in the quarter. The line item has been a little bit lumpy over the past couple of quarters. Has there been a change in premium amortization that might be impacting it or something else that I may not be thinking as?

[Mark Mason:]

Well to that idea is what’s impacting it. We have a fairly sizeable composition of mortgage backed securities in our securities portfolio with higher prepayment speeds or [predated] speeds that have been pretty volatile, I mean if you think at the first quarter very high, second quarter not so high, third quarter high again and under the prescribed accounting here which is a retrospective recalculation of [right to] date amortization, it provides unfortunately some pretty significant swings and yield on that portion of our portfolio and that’s what you see.

[Jackie Chimera:]

Can you [open up] the dollar amount of 2Q versus 3Q for your premium amount?

[Mark Mason:]

I do not have, but we can provide that later.

[Jackie Chimera:]

Okay, great. Then just one last one. So you had mentioned changing over to become a Washington State Bank. Would you at that point in time become a bank holding company as well?

[Mark Mason:]

That’s correct. I think they are called financial holding companies in the Federal Reserve vernacular.

[Operator:]

Our next question comes from Russell Gunther from Macquarie. Please go ahead.

[Russell Gunther:]

I just appreciate the guide on continued commercial growth expectations of 4% to 5%. You guys exceeded outperform the high end of that range in this quarter. Just want to get a sense for what you expect to be able to kind of drive continued 4% to 5% range and maybe why we shouldn’t expect continued outperformance given all the investment in the Southern California franchise?

[Mark Mason:]

Well in terms of lending, we have some pretty strong existing lending groups that we’ve been building for several years. But you may remember earlier in the year also we brought on two new groups in Southern California, a new SBA lending group and a small balance commercial mortgage group. Between the addition of those groups Orange County Business Bank and continued growth in the Pacific Northwest and our existing commercial lines, we feel pretty comfortable we are going to be able to maintain that kind of pace albeit on a larger base. I mean the denominator is growing. And because of that we're going to continue to be well diversified and predictably strong.

[Russell Gunther:]

Great. Thanks for that Mark. I just wanted to kind of circle up on the commercial loans this quarter, saw that balance decline a little bit, others were strong. Is there any seasonality in that number that just coincidence that kind of trends down in the third quarter, could you just give a little color on the dynamics within the C&I line this quarter?

[Mark Mason:]

Yes, I don't think it’s seasonality, I think we suffer similar to everyone else in that business in that there's not enough business to go around and with lower rates term lending has gotten refinanced at a much higher pace. Companies are not borrowing as much as they used to, so line utilization for all of us is down. I think you're just seeing some volatility there, we're expecting growth in that line item.

[Russell Gunther:]

Okay, that's great, and then just on consumer loans, the single family continue to trend down a little bit, home equity balances have been kind of steadily increasing. Could you give us a sense for your thoughts around what you're going to continue to portfolio there?

[Mark Mason:]

Sure. On the single family front, we seek to portfolio certain classes of single family assets. Home equity loans as you mentioned in that, that business has been growing, for us it has always been a very fine business and even during the recession our [hillock] portfolio never got above 4% delinquent, so the company has a proven record of strong credit quality in that product, and it appears that product is great from an interest rate risk standpoint in that it's floating rate instrument. Additionally we portfolio custom home construction loans, these are loans that in a single close start as loans for individuals to build custom homes, they will into a permanent loan, because we're not interested in hedging them for those long periods of time and then reselling them we keep them in our portfolio. They do tend to have historically somewhat higher prepayment speed so that mitigates somewhat the rate risk in that category. And then beyond that other fixed junior liens and some non-conforming jumbos that we don't sell in pools and other non-jumbo loans that make sense. That makes up the remainder of that line item. We're expecting in the longer term to get our single family loan concentration down below a third of the portfolio. So we're a little above that now still but down substantially from when single family loans made up almost 60% of the portfolio. So we're looking for a little lower concentration going forward, but it's another one of those great product lines to have, you can really meet all your portfolio growth when you'd like with single family loans which continue to have better yields than commercial loans.

[Russell Gunther:]

I appreciate that, and then just with regard to the forward guidance, you know particularly as it relates to expenses and maybe try and tie everything altogether, is there an efficiency ratio target you're thinking about for 2016 and if we can think about it maybe on an rising Fed fund scenario.

[Mark Mason:]

Sure. We are expecting our efficiency ratio to trend below 80% next year and in the best quarters hopefully approximating something close to 75% overall, but very different from a segment standpoint, the mortgage business should run between 75% and 85% efficiency, the commercial and consumer business we ultimately hope to get below 60%. That's not going to happen next year but we're going to make tremendous progress towards those numbers next year.

[Operator:]

[Operator Instructions] Our next question comes from Tim Coffey of FIG Partners, please go ahead.

[Tim Coffey:]

Thanks, morning Mark, morning Melba. Can you give us some color on the declines in the deposit portfolio over the last two quarters?

[Mark Mason:]

Sure. In the current quarter the primary reason for decline was a decline in term deposits. If you look at the quarter-over-quarter detail which is page 26 of our earnings release.

[Tim Coffey:]

Okay, any specific reasons, I mean we just…

[Mark Mason:]

Well its mostly brokered deposits, brokered CDs that ran off that we didn’t need to replace.

[Tim Coffey:]

Okay, would you expect more then forward quarters?

[Mark Mason:]

You know, it's going to depend on a lot of things, right lending volume, our success in gathering core deposits, to the extent that we can’t fulfill our funding needs in that manner or that we get to a level of FHLB borrowings we don't want to exceed, we may have to go back in to the time deposit market. I would expect ultimately that line item to grow consistent with the overall growth and maybe a little more depending upon funding needs.

[Unidentified Analyst:]

Okay. And then on the construction lending that you’ve seen the strength in that is there any particular market where you find the most opportunities?

[Mark Mason:]

In our markets, there is so much construction going on, I wouldn’t cite anyone as being stronger than the others, of course most of our construction business is in the Pacific Northwest, on the commercial side, most of the construction is in primary or strong secondary markets surrounding Seattle and Portland. We do have a broader home building business with strength in Utah and the Salt Lake City area, which is a very strong home building market today, and in Southern California, which again from Central Southern California where there is available land, it's quite a strong market. So it's traditionally been the same for us, we have not really extended commercial construction yet, outside of the Pacific Northwest, though we expect to next year, sometime and these are all very, very strong markets with lots of opportunity, so we sort of picking our spots.

[Tim Coffey:]

Okay. As you expand commercial construction outside of the Pacific Northwest, would that entail hiring new lending teams or do you already have people in place for that?

[Mark Mason:]

We mostly have the people in place for that in Southern California, for example we hired a strong team of originators that today are focused on small balanced commercial permanent mortgage lending, but those folks also have construction bridge and other expertise, so our ability to extend that product down there, substantially exists with perhaps a few additions.

[Tim Coffey:]

Okay. And with the potential for a higher rate environment, how is that going to change your hedging strategy on the mortgage service and portfolio?

[Mark Mason:]

It doesn’t change our strategy, we don't trade that hedge to position it for rising or falling rates, that would be speculative and we know that we are not great predictors of interest rate movements. The economists aren't either, so we keep that flat to either direction of potential movement, so we use the same instruments we’ve generally used before, and we will keep that profile flat on either end of the potential movement, so far it's been a good place to be.

[Tim Coffey:]

Yes, of course so far. And then the estimates for your locks and closed loan production the next, at least the next quarter, how much of that is seasonal and how much of that is TRID related?

[Mark Mason:]

All seasonal, just because we as manufacturers of loans have a new disclosure standard, that doesn’t change market demand for mortgages, so our lock volume in the application volume will be what the season allows, it's our job to get it closed timely, in light of the new standards.

[Operator:]

Our next question comes from Tim O'Brien from Sandler O'Neill & Partners. Please go ahead.

[Tim O'Brien:]

Couple of questions around credit, look like TDR balances came down this quarter nicely accruing TDR maybe that's not so nice. Can you give a little color there?

[Mark Mason:]

Sure, we have held a balance sheet of TDR since the recession that has been until recently a little more than $100 million. Most of that number $75 million or so has been in single family loans that were modified during the recession, they have performed very, very well and as you can see there is only a small amount of non-accruing single family loans. The biggest part of the change quarter-over-quarter came not in the single-family loan segment, but in commercial loan TDR portfolio and we had one large $15 million loan that had been performing and had been a permanent TDR as a consequence of modification during the recession that prepaid during the quarter. And so that accounts for the significant difference in commercial real estate accruing TDRs. If you look on page 24 there is a large detail of those amounts.

[Tim O'Brien:]

That’s great color, thanks. And on the credit performance, it’s been really solid. I notice just a slight uptick in 30 to 89-day past due loans sequentially. Can you talk a little bit about that, is that even a blip that registered on your radar screen?

[Mark Mason:]

It has though, we don’t think it’s meaningful or indicative of a new trend. Some of these delinquencies came from the portfolio that we acquired in the simplicity acquisition. And so they are centered generally in Southern California, but given our review of those delinquencies, we think that they will substantially cure and it represents a little volatility I would say at this juncture and we’re going to watch it.

[Tim O'Brien:]

And then last question it looked like another nice recovery of a previously charge-off. What’s the outlook for additional recoveries going forward?

[Mark Mason:]

I think we're still going to experience some out of the single-family portfolio. I don’t know if that’s a really material number, because we only have so much left to recover against. We do have some deficiency notes still outstanding from the clean-up of the construction portfolio. Again I don’t think there is going to be really material recoveries there. We have some, we’re going to see in the fourth quarter we think, I don’t think it’s a seven figure number, but until we realize them and put the money in the bank we’re not sure. So look I think the real issue in charge-offs is we don’t see credit deteriorating in the near-term based upon everything we see and while we’ll have some minor recoveries, what we're really expecting is relatively low charge-off experience in the near-term. In the longer term, we’ve been discussing this internally ourselves as we do strategic planning, it's really hard to predict a change in the credit environment even looking out two to three years, because we don’t have any precursors to really know. At some point, we will go through another credit cycle. As you know this recovery has been elongated, I think that’s going to be true of the credit cycle as well, everything we know today. And we are fortunate, we are in some of the strongest economic markets in the United States and that is going to be helpful with respect to credit as well.

[Tim O'Brien:]

It seems like every cycle has its own unique triggers.

[Mark Mason:]

Sure. And there will be a new one I’m sure.

[Operator:]

Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Mason for any closing remarks.

[Mark Mason:]

Well, thank you operator and thanks to everyone who joined us on the call today. Melba and I appreciate your patience during our prepared remarks and your great questions. Have a great day.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.