HomeStreet, Inc.
Q4 2015 Earnings Call Transcript

Published: 28 Jan 2016

[Operator:]

Good day and welcome to the HomeStreet Fourth 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 Mark Mason, Chairman, President and CEO. Please go ahead.

[Mark K. Mason:]

Thank you, operator. Hello and thank you for joining us for our fourth quarter 2015 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 Web-site at ir.homestreet.com. In addition, a recording of this call will be made 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 would 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 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 earnings release available on our Web-site. Please refer to our earnings release for a more detailed discussion of our financial condition and results of operations. Joining me today is our Senior Executive Vice President and Chief Financial Officer, Melba Bartels. In just a moment, Melba will present our financial results, but first I'd like to give a brief update on our recent events and review our progress in executing our business strategy. During the quarter and over the course of 2015, we made significant progress on our strategy to grow and diversify earnings. While the most recent quarter was challenged by mortgage banking market that saw volumes decline seasonally and of course the impact of the recent update to TILA RESPA disclosures, the integrated mortgage disclosures or TRID for short, we are particularly proud of the achievements that we have made in our Commercial and Consumer Banking segment. The investment in growth that we have made there lays the foundation for a strong consistent earnings growth going forward. We expanded our Commercial and Consumer Banking business by closing on the acquisition of Simplicity Bank and acquiring one bank branch in Eastern Washington this year, 2015. Additionally, we expect to close on our acquisition of Orange County Business Bank next week. We are excited about the potential this acquisition offers us for expanding our business to Orange County, California and beyond. Our merger with Orange County Business Bank will provide HomeStreet access to Orange County and the greater Los Angeles area, one of the premier commercial and consumer banking markets in the United States. Orange County Business Bank is a business focused bank that serves businesses throughout the region and HomeStreet will be able to bring substantially more 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. We've been expanding in Southern California over the last three years, first through the opening of home loan centers in the region and through our merger with Simplicity Bank earlier last year. The Simplicity merger added seven retail bank branches in Los Angeles and San Bernardino counties to our retail branch network. These additions combined with our acquisition of Orange County Business Bank will provide us with the platform for building a full service commercial and consumer banking franchise in Southern California. Additionally in December, we acquired the AmericanWest Bank branch in Dayton, Washington. At closing, this branch had approximately $26 million in deposits and we received just under $5 million in related loans in the transaction. This acquisition increased our network of retail deposit branches in Eastern Washington to a total of five. We successfully launched HomeStreet Commercial Capital, a California-based commercial real estate group whose primary focus is to originate, pool and sell small balance commercial real estate loans, last year. We also hired an Orange County based group specializing in small business SBA lending. These groups should significantly increase the non-interest income component of our Commercial and Consumer Banking segment going forward as well as provide for additional opportunities to cross-sell other loan and deposit products. On our last quarterly earnings call, we announced our intention to apply for a conversion to a Washington state chartered commercial bank. We expect to have that application process completed in the next several weeks. Lastly, during the fourth quarter, as part of our annual strategic plan development with our Board of Directors, we discussed and evaluated our capital needs and concluded that instituting a regular dividend was not appropriate at this time given our strategic growth objectives and that we believe retaining this capital will create a superior return in the near term. Before Melba reviews our financial results, I will share some highlights from the year and the quarter. Total assets grew $1.4 billion in 2015 from $3.5 billion in 2014, finishing at $4.9 billion at year end. The Simplicity acquisition comprised $850 million of the year-over-year growth. Net income for the year excluding merger related items increased 82.9% from $24.2 million in 2014 to $44.3 million in 2015. Return on average tangible equity excluding merger related items increased from 8.8% in 2014 to 10.5% in 2015. Diluted earnings per share excluding merger related items increased 30% from $1.62 per share in 2014 to $2.11 per share in 2015. Tangible book value per share increased from $19.39 at the end of 2014 to $20.16 at the end of last year. Additionally, we grew our retail branch network by 11 branches, from 33 at the end of 2014 to 44 today. Seven of these branches were acquired from Simplicity, one came from our recent acquisition from AmericanWest, and we grew our standalone lending centers by 12 offices last year, from 58 to 70 today. We also closed and sold over $7 billion of mortgage loans during the year last year. Full-time employees ended 2015 at 2,139, up from 1,611 at the end of 2014. Our Commercial and Consumer Banking segment is becoming a significant part of the Company's earnings. Total revenue for the quarter increased by 8.2% from the third quarter and 50.4% from the fourth quarter of 2014 in this segment. In addition, net income excluding merger related items for this segment contributed 47.4% of our core net income for last year. Our fourth quarter Mortgage Banking segment net income declined to $301,000 from $3.2 million in the third quarter, reflecting the seasonal low point in the mortgage business as well as higher costs, in part associated with the new disclosure requirements. Closed loan volume in our single-family mortgage lending segment totaled $1.6 billion in the fourth quarter, compared with $1.9 billion in the third quarter. Interest rate lock commitments of $1.3 billion in the fourth quarter declined from $1.8 billion in the third quarter. The cost of preparing for the October 3 implementation of TRID has been more significant than we expected going into the quarter. We recently implemented TRID requirements that substantially increased our documentation requirements, and more importantly our responsibilities as the lender, further complicating our already substantial workflow and increasing our trading costs in the interim. The new rules have lengthened our time to close loans and added to our processing costs. In an abundance of caution, we made the determination to portfolios of jumbo non-conforming loans subject to these new requirements until we're confident that we are in complete compliance with the new rules and secondary market participants are satisfied with the quality of our production. Prior to the end of the fourth quarter, we had already begun selling these loans into the secondary market. In addition, we have already seen some improvements on our workflow and processes, and our vendors are providing updates to their software products supporting our origination process. However, we expect some of these added costs to continue in the near term until our software is fully compliant and our workflows are back to pre-TRID efficiencies. And last but certainly not least, we are proud to have been the recipient of the 2015 American Bankers Association Community Commitment Award. The award was given to HomeStreet in November for its activities in affordable housing. Now I'll turn the call over to Melba who will share some additional details on our financial results for the quarter.

[Melba A. Bartels:]

Thank you, Mark, and good morning everyone. Fourth quarter net income was $8.7 million or $0.39 per diluted share, compared with $10 million or $0.45 per diluted share for the prior quarter and $5.6 million or $0.38 per diluted share for the fourth quarter of 2014. The decrease in net income from the prior quarter was primarily due to lower net gain on mortgage origination and sale activities, as Mark has noted. 2015 net income was $41.3 million or $1.96 per diluted share, compared with $22.3 million or $1.49 per diluted share for 2014. Excluding after tax merger related items, core net income for the fourth quarter was $8.8 million or $0.39 per diluted share compared to $9.4 million or $0.42 per diluted share in the third quarter. Core net income for the year of 2015 was $44.3 million compared to $24.2 million for 2014. Net interest income for the quarter was $39.7 million compared to $39.6 million in the third quarter. Our net interest margin of 3.61 was a decrease of 6 basis points from the third quarter, due primarily to a decline in the amount of non-interest-bearing liabilities. Non-interest income decreased $2.1 million or 3.1% from the prior quarter, due primarily to lower net gain on loan origination and sale activities, offset somewhat by increases in mortgage servicing income. Net gain on mortgage loan origination and sale activities decreased $11.2 million from the prior quarter and mortgage servicing income increased $8.8 million due to increases in both net servicing income and risk management activities stemming from slower long-term prepayment speed expectations. Non-interest expense was $92.7 million in the fourth quarter compared to $92 million in the third quarter. Excluding merger related expenses, non-interest expense was $92 million compared to $91.6 million from the prior quarter. The increase was primarily due to higher general and administrative costs related to the reversal of foreclosure advances that were deemed to be uncollectable in the quarter. At December 31, Bank's Tier 1 leverage ratio was 9.45% and total risk-based capital was 13.91%. The consolidated company's Tier 1 leverage ratio was 9.94% and total risk-based capital ratio was 12.69%. These ratios reflect the implementation of Basel III requirements effective on January 1st of 2015. 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 $8.4 million in the quarter, compared to $6.8 in the prior quarter. Net income was higher primarily due to higher net interest income from the growth on our loans held for investment as well as higher gain on sale from the first sale of loans by HomeStreet Commercial Capital. Excluding after tax net merger related items, the segment recognized core net income of $8.5 million in the fourth quarter compared to $6.3 million in the prior quarter. The portfolio of loans held for investment increased 6% to $3.19 billion from $3.01 billion at September 30th. New commitments totaled $574.9 million compared to $416.6 million in the third quarter. We achieved this net growth in the loan portfolio against $346.5 million of portfolio runoff in the quarter. We recorded a $1.9 million provision for credit losses in the fourth quarter of 2015, compared to a provision of $700,000 recorded in the third quarter, reflecting the growth in the balances of loans held for investment. Credit quality remained strong with non-performing assets at 0.5% of total assets at year-end, and non-accrual loans at 0.53% of total loans. Non-performing assets were $24.7 million at quarter end compared to non-performing assets of $27.7 million at September 30th. We continued to enjoy positive charge-off experience with net recoveries of $872,000 in the quarter. Deposit balances were $3.2 billion at year-end, down from $3.3 billion at quarter end September 30th, primarily due to a 16.5% seasonal decline in non-interest-bearing accounts related to our mortgage customer escrow accounts. Property taxes for our borrowers are typically due during the fourth quarter. Segment non-interest expense was $29.5 million, an increase of $1.4 million from the prior quarter. Included in non-interest expense for the fourth quarter and third quarter of 2015 were merger related expenses of $754,000 and $437,000 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 branch banking network. Now I'd like to share some key points from our Mortgage Banking business segment. Net income for the Mortgage Banking segment was $301,000 in the fourth quarter, compared to net income of $3.2 million in the prior quarter. The $2.9 million decrease in net income from the third quarter was primarily due to lower net gain on single family mortgage loan origination and sale activities due to lower interest rate lock commitments during the quarter. Net gain on single family mortgage loan origination and sale activities in the fourth quarter was $43.5 million compared to $56 million in the prior quarter. Single family mortgage interest rate lock commitments totaled $1.3 billion in the fourth quarter, a decrease of $466.6 million or 25.8% from $1.8 billion in the third quarter. The gain on sale composite margin increased to 319 basis points in the quarter from 311 basis points in the third quarter, partially due to product mix. Single family mortgage closed loans totaled $1.6 billion in the quarter, a decrease of $285.4 million or close to 15% from $1.9 billion in the third quarter of 2015. The volume of interest rate lock commitments was lower than closed loans designated for sale by 18.7% this quarter, which negatively affects accounting earnings as a majority of mortgage revenue is recognized at interest rate lock while a majority of origination cost including commissions are recognized upon closing. If rate lock commitments during the fourth quarter would have equalled closed loan volume, it would have resulted in approximately $8.7 million higher gain on loan origination and sale revenue. Conversely, if closed loan volume had been the same as interest rate lock commitments, pre-tax income would have been approximately $3.8 million higher as a result of lower variable cost. Because of lower mortgage closed loan volume in the quarter, Mortgage Banking segment non-interest expense of $63.2 million decreased $733,000 or 1.2% from the prior quarter. This decrease was despite overall segment personnel growth reflecting the aforementioned expense of implementing TRID and expansion into new markets. We grew Mortgage Banking personnel by 1.4% in the quarter. Closed loans per loan officer declined in the quarter from 4.3 loans per officer compared to 5 loans per officer in the third quarter. Single family mortgage servicing income was $12.8 million in the quarter, an $8.7 million increase from the prior quarter. This increase was the result of $1.9 million in net servicing income for the fourth quarter combined with $6.8 million increase in risk management results. Single family mortgage servicing fees collected in the quarter increased primarily due to higher average balances in our loans serviced for other portfolio. The portfolio of single family loans serviced for others was $15.3 billion at year-end, compared to $14.3 billion at September 30. The $6.8 million increase in risk management results from the third quarter was a result of improved net risk management results primarily from slower long-term prepayment speed expectations. I'll now turn it back over to Mark to provide some insights on the general operating environment and outlook.

[Mark K. Mason:]

I'd like to now discuss the national and regional economies as they influence our business today. 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. Strategically we are focused on the major markets of 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. Most recent Mortgage Bankers Association monthly forecast projects total loan originations to decrease 7% this year from the past year, an upward revision from its prior quarter forecast of a 9% decrease. However, our focus has always been on the purchase market. The Mortgage Bankers Association forecasts that purchased mortgage origination are projected to increase 13% this year over last year while refinancing mortgages are projected to decline by 32%. Despite the increase in short-term interest rates by the Federal Reserve in December, mortgage rates continue near historic lows, and nationally purchases are expected to comprise 67% of the mortgage volume this year. Housing starts for this year are expected to be up 11% over last year's levels. To give you some perspective, we are quoting a 30 year mortgage in the Puget Sound area at about 4% on September 30 last year, 4.125% at December 1 of last year and 4% last week, substantially the same. During the fourth quarter, purchases comprised 53% of originations nationally and 53% of originations in the Pacific Northwest. HomeStreet continues to perform at levels above the national and regional averages with purchases accounting for 70% of our closed loans and 67% of our 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 resale homes. Home price increases in Washington, Oregon and California based on FHFA data accelerated across the board in the latest quarter, with year-over-year increases ranging from 7.7% in California to 10.5% in Oregon. According to the most recent Case-Shiller 10-City Composite Home Price Index report, which measures the change in value of residential real estate in 10 metropolitan areas, the index gained 5.3% from a year earlier. Seattle gained 9.7% over the last 12 months, Portland gained 11.2%, San Francisco gained 11.1% and Los Angeles gained 6.2%. These are the strongest numbers in the nation today. Housing permits in Washington, Oregon and California while cyclical are running between 75% and 95% of their long-run average with only Washington having slightly surpassed the 30 year average level. The West Coast state economies continue to sustain much stronger relative job growth than the U.S. economy as a whole. The year-over-year growth rates for non-farm payroll employment over the last five quarters have averaged better than 3% in Washington, Oregon, Idaho and California, compared to approximately 2% for the nation. The faster job growth has now produced lower unemployment rates compared to the U.S. This is mainly due to stronger state population growth or people following jobs. Looking forward over the next three quarters in our Mortgage Banking segment, we currently anticipate mortgage lock volumes held for sale of approximately $1.7 billion and $2.3 billion in the first and second quarters of this year respectfully. We anticipate mortgage held for sale closing volumes of $1.6 billion and $2.3 billion in the first and second quarters of this year respectfully. 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 where closings exceed locks and vice versa, as we expect in the current quarter with a forecast of $1.7 billion and $1.6 billion respectfully for locked versus closed loan volume. Additionally, we expect our composite margin 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 TRID requirements. We expect the increased cost we experienced in the fourth quarter to continue at least in part through at least the next few quarters until our software vendors complete their updates and our manual adjustments, quality assurance and other workarounds normalize. For the full year, we expect mortgage loan lock and closing volumes of $8.1 billion. In our Commercial and Consumer Banking segment, over the next several quarters we expect to maintain net loan portfolio growth of between 4% and 5% quarterly. Going forward we generally expect that our consolidated net interest margin will remain at roughly 3.55% to 3.6% as per changes in market rates, prepayment speeds and other factors that would impact our margin. Our non-interest expenses we anticipate growing between 2% and 3% 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 closed loan volume and in relation to the timing of further investments in growth of both of our segments. This concludes our prepared comments. Thank you for your attention today. Melba and I would be happy to answer any questions you have at this time.

[Operator:]

[Operator Instructions] The first question comes from Paul Miller of FBR. Please go ahead.

[Paul Miller:]

Mark, you talked a lot about your loan growth in the quarter. Can you just, I mean [indiscernible], have you seen any – a lot of people are concerned about the credit quality out there across the board, especially in the commercial side. Are you seeing anything out in the Pacific Northwest that could concern you down the road?

[Mark K. Mason:]

People's greatest concern here related to potential bubbles that may be created in commercial real estate, particularly in the multifamily area, because we have had so much multifamily construction not just in Seattle and Puget Sound but in San Francisco, the Bay Area, additionally in Southern California. But when we look at the numbers today, much of that has been catch-up and has been consistent with job growth. We watch very closely probably almost 100 early warning indicators at our various businesses and very discreet ones in the commercial real estate area. And we still see growing strength. We do not yet see any indications of additional concessions, of any slowing of the velocity of rental increases and that's [indiscernible] we'll actually see softening. So I think that that point is out there in these markets at which there will be a crossover between demand and supply. Right now I think supply is not quite keeping pace with demand in most of these markets but there will be a time when that changes, and to date we have not seen it. We are being very careful about where we lend, particularly on construction, in the commercial and residential areas. We primarily lend in primary markets and strong secondary markets, and particularly on larger commercial real estate construction projects. We stay in primary Seattle, Portland and strong secondary markets to those areas. We are strong with track record developers with substantial portfolio cash flow, and so we would be very careful about our investments, not just in construction but commercial real estate overall. With respect to general commercial lending, we are in some of the best markets economically in the country and we don't really see weaknesses in any of the areas we lend into. We are not an energy lender as an example. So the recent changes in oil prices in the energy sector has not had a direct impact on us. Commodity prices have some impact. We do have some agriculture lending but it is pretty diversified and the folks that we lend to have very strong businesses. So overall we feel fortunate in that we do not see pockets of weakness yet. I think that our risk management and our forward-looking approach to risk management is going to give us an early look we hope, but right now we feel very good about credit quality in our markets and the strength with the economies.

[Paul Miller:]

And then on the investment securities, this is the first time that we have seen a material selling of the securities. Was that just redeploying some capital or could you give us some thoughts behind that?

[Mark K. Mason:]

That was largely adjusting the composition of the portfolio. We adjusted in particular our concentration in municipal bonds. We are fortunate to have purchased many of them at attractive yields. And so as we rebalanced, we simply recognized sort of that gain that existed in those CI and equity anyway. So all we did is realizing something that was already intangible book value.

[Paul Miller:]

But going forward, can we see this type of percentage in your balance sheet or will there be continued some adjustments going as you see opportunities?

[Mark K. Mason:]

I think there will always be some management of the composition. The absolute size of the portfolio you should see grow commensurate with the balance sheet and we target a number of between 12% and 14% of assets for that portfolio. It's primarily a liquidity portfolio but we manage it really in two pieces. One piece, the amount of securities we need to hold for collateral purposes for trading, and because of our hedging activities that's a fairly substantial number. And on the balance which is purely liquidity securities, we manage to what we believe is a superior return for a very well run diversified portfolio.

[Operator:]

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

[Jeff Rulis:]

Mark, you walked us through some of the volume expectations for Q1 and Q2. I appreciate that. Maybe if we could take just a broader view of looking at mortgage origination in 2015. You put up 236 million. I guess broadly speaking your expectations for the full year of 2016, a lot of variables, but maybe a high-level view of your expectations this year?

[Mark K. Mason:]

Sure. And when we talk about mortgage origination in particular, the vast majority of that we originate for resale, primarily conventional conforming government mortgages, Fannie, Freddie, Ginnie Mae securitization. We do put some single-family mortgage volume into the balance sheet. Part of that is HELOCs, part of that are closing seconds, part of that are single closed custom home construction loans. Next year – over the next couple of quarters in mortgage origination volume held for sale, from our prepared comments, I stated we expect mortgage loan locks for the first and second quarters of $1.7 billion and $2.3 billion and for the full year $8.1 billion. Closings, we are expecting $1.6 billion in the first quarter and $2.3 billion in the second quarter, and again $8.1 billion in closings for the full year. So we are not expecting any imbalance in the full year, just seasonally imbalances between locks and closings during the quarter. The balance sheet originations of single-family loans will total somewhere around $600 million, we are sort of expecting this year, with equal parts of home equity lending and close-in either single closed construction or seconds, closing seconds. That's the smallest part of our balance sheet additions expected next year. The vast majority of our 3% to 4% net growth per quarter in the held for investment portfolio is expected to come from commercial loans and the strong contributions from commercial real estate, from residential construction lending and general C&I lending as well. And in total, that amount of balance sheet lending will exceed $2 billion to hit that type of 4% to 5% quarterly growth net of what we expect to be some still very strong runoff. And part of the reason for the strong runoff has to do with construction lending. Particularly in the residential area, our construction loans are lasting on average about 200 days. They are not being fully drawn and they are being repaid very quickly because of the general inventory shortage in the markets in which we lend. And so the amount of lending that we have to do to create the type of growth that we plan strategically is very substantial from all of those groups.

[Jeff Rulis:]

I guess I was trying to get to the correlation between the mortgage origination, just the fee income line item alone versus some of the comments you made on the operating expense, just ultimately what on an efficiency standpoint – you kind of stated your expectations for noninterest expense growth, how does that play out for the full year? And more specifically, I'm just talking about the fee side of the mortgage business as it relates to the expense growth.

[Mark K. Mason:]

The mortgage segment, of course seasonality plays a big part because of the impact of commissions and other sales incentives as it relates to changes in loan closing volume. To a lesser extent the pattern of growth in offices and personnel have some impact on that. So you will see the absolute dollar value of expenses rise in the second and third quarters and fall in the fourth and first quarters, all else being equal.

[Jeff Rulis:]

I guess moving on, on the funding side with the loan to deposit ratio not hitting really 100%, I guess any programs in place to cultivate more deposits or is that a focus in the coming year?

[Mark K. Mason:]

It's always a focus. Our deposits have had some volatility last few quarters really related to some large depositors. We have some large escrow companies and some other large customers with seasonal deposit patterns. We expect those deposits to grow again along with our mortgage related deposits. They are very seasonal as well if you think about the growth pattern of escrow deposits in relation to the timing of the property taxes and insurance payments. But beyond that we have a portfolio of young branches now, each of which has an expected growth pattern until they hit sort of maturity at about five years by our expectations. If you look at the composition of branches in growth, it comprises over a third of our branches today that will continue growing for several years, plus we expect to open several more branches this year, in addition to which we expect to raise some money in the time deposit market today if we have the need to mitigate differences between expected core deposit growth and total deposit growth. For us maintaining a level of non-core funding below 30% of our funding is a key target for us and we manage that through growing core deposits of course but balancing at times with time deposits. We've not had to do that much. If you look at the history of the Company, we have reduced loans on time deposits very substantially. We'll have to see how the market reacts as interest rates rise and the cost of deposits rises as well.

[Operator:]

The next question comes from Jackie Chimera of KBW. Please go ahead.

[Jacqueline Chimera:]

I've been having some problems with my headset. Can you hear me okay?

[Mark K. Mason:]

We can, yes.

[Jacqueline Chimera:]

Great. Just one last quick one on the deposits. What kind of a role has Simplicity played in that and has it accounted for any of the runoff or perhaps some of the growth that you've been having?

[Melba A. Bartels:]

This is Melba. If you're looking at Page 26 of the earnings release, you can see I think the three quarter trend from first quarter of 2015 declining, and that reflects a runoff from the Simplicity acquisition as you mentioned, particularly on the ending balances which from March 31 to December 31 were down about 7.4% related to Simplicity. That has stabilized in the fourth quarter and the majority of that occurred in the second quarter and the subsequent full quarter to the acquisition that closed in March of 2015. If we exclude the Simplicity impact, you would actually see our retail deposits up 5% over that same time frame. So it had an impact, although that level of impact as I mentioned stabilizing this past quarter.

[Jacqueline Chimera:]

Okay, so 2Q-3Q declines were impacted by Simplicity and then 4Q was impacted by the movement of large escrow accounts primarily?

[Melba A. Bartels:]

That's right, and those are in two places. Again on Page 26, you see that in two places, one is in the NOW accounts which is where our title company sell their escrow balances and the other is in non-interest-bearing accounts which is where our customer escrow balances are held.

[Mark K. Mason:]

Mortgage escrow.

[Melba A. Bartels:]

Mortgage escrow, yes.

[Jacqueline Chimera:]

Thank you, that's very helpful. A question on the taxes. If you could just provide some color on why that rate was lower in the quarter and what you expect the future rate to be?

[Melba A. Bartels:]

Absolutely. So during the quarter, of course we reflected our estimate for the full year on an effective tax basis which is at 27.4%, and that differs from our expected marginal rate of 36.4% due to a couple of very large discrete items during the year, one related to acquisition of Simplicity, the other related to the recent Dayton branch acquisition. So the bargain purchase gains that we recognized over the course of the year actually contributed to the reduction of the marginal rate to the effective rate of close to 5% or 4.8%. And then I think as was mentioned earlier related to security sales during the fourth quarter that release of valuation adjustment out of OCI also benefited our tax rate by about 1.9%. So those discrete items certainly impacted the full year and true-up in the fourth quarter. In addition, we typically see between 2% to 3% benefit from tax exempt interest income as well related to the marginal rate.

[Mark K. Mason:]

So going forward in 2016, we expect the effective rate of…

[Melba A. Bartels:]

Between 33% and 34%.

[Jacqueline Chimera:]

Okay. So absent – the rate would have been around that absent securities sales…

[Melba A. Bartels:]

And the bargain purchase gain, yes.

[Jacqueline Chimera:]

Okay, thank you. That's also very helpful. Mark, can you just provide a bit of an update for us on your expectations for FTE adds and maybe LPO and branch out throughout the year? You had mentioned some [novel] [ph] activity that you might be looking into and how that's varied, if it does vary, from your conversations in past quarters?

[Mark K. Mason:]

Sure. We do expect to continue to grow personnel, mostly as a consequence of new deposit branches and new mortgagee LPOs. We will be adding a few people still in infrastructure at corporate. One of Melba's primary goals is to prepare us to go above 10 billion at some point. So we are focused on our infrastructure here, the quality of our controls and preparing for some future date to live up to some higher standards from our regulators. Our expected adds this year will be in the range of 10% to 15% of personnel we believe, dependent upon the pace of branch openings. We expect to open at least five and perhaps as many as nine new deposit branches this year, more concentrated in Southern California. Some of that is associated with our affiliation now with [indiscernible] that came from our acquisition of Simplicity Bank, and of course more infill here in Puget Sound.

[Jacqueline Chimera:]

And understanding that this is very early in the year, do you have a sense of general timing of when you might open some of that, would it be more geared towards the first half or the second half?

[Mark K. Mason:]

It will be more geared towards the latter half of the year, though I would expect two to three branches in the first half of the year.

[Jacqueline Chimera:]

Okay, so some inflaming growth in the first half but ramping up towards the year-end?

[Mark K. Mason:]

Yes, which is consistent with revenue growth, fortunately.

[Jacqueline Chimera:]

Always nice to balance those two. Okay, I'll step back now. Thanks guys.

[Operator:]

The next question comes from Russell Gunther of Macquarie. Please go ahead.

[Russell Gunther:]

I appreciate the commentary on loan growth as it relates to magnitude and mix. Just want to talk about in the context of your recently closed deal and the pending acquisition in the first quarter. As you look at integrating those two deals, how do you expect them to prove, do you expect them to prove accretive to that overall growth rate, particularly within the commercial bucket?

[Mark K. Mason:]

Absolutely we do. I think that that accretion or that contribution to growth is going to grow over the next couple of years. Particularly with respect to Simplicity, that was exclusively a consumer bank on the deposit side and on the lending side their only commercial products were small balance commercial mortgages. And the businesses were very good but that doesn't anywhere near to our interest in being a full-service commercial and consumer bank. So we are having to add personnel, change certain personnel as we integrate into Simplicity as an example more commercial products, not simply on the deposit side but the lending side. We are going to invest in commercial banking personnel in Southern California in a more significant way this year in hiring teams of lenders and treasury and cash management personnel to build what is not in either of these groups yet, and that is a more substantial group of commercial lenders. And while Orange County Business Bank has a very fine business, it is small in relation to the market. And so we're going to take the opportunity to add to that business, to integrate the markets around the Simplicity branches and build a much more substantial business. But that will take a little time.

[Russell Gunther:]

Certainly. I appreciate the help with that. And then how do we or how are you thinking about translating this increased commercial growth expectation that we saw in this quarter, but as it relates to providing for growth? So provision was up a little bit this quarter, charge-offs remain in recovery mode, how are you thinking about the provision going forward, particularly as you think about the robust loan growth expectation you just put out there, and do you have a forward look that you could share?

[Mark K. Mason:]

Provision is going to go up as we grow the portfolio. And so last year's provisions were substantially mitigated by recoveries. That recovery benefit is substantially over. Our provisioning for the coming year will grow with the portfolio, and given our anticipated portfolio growth, that means provisioning growth will be more substantial. Last year our total provision was about $6.1 million. I would expect that number to almost double this year by having the benefit of recoveries and given the anticipated growth in the [indiscernible] portfolio.

[Russell Gunther:]

Okay great. Thanks Mark. And then just lastly on the expense guide, the 2% to 3% per quarter, does that include the impact of TRID that you were laying out, or I guess said another way, will that 2% to 3% decline throughout the year as the TRID cost becomes less?

[Mark K. Mason:]

We sort of look at it as we're not going to have to increase our expenses as loan volume grows this year in the segment. Essentially the reductions in TRID expenses, or another way to look at it, improvement in efficiency and processing, will serve to mitigate the need to add personnel as we grow the loan volume this year. So instead of [indiscernible] reductions in absolute numbers, I would expect to see the efficiency improvement.

[Melba A. Bartels:]

I would also just want to reinforce that the guidance of 2% to 3% per quarter is on average throughout the year. So not necessarily 2% to 3% every quarter but on average over the course of the year, recognizing that we have seasonal highs and lows in the mortgage business and that our investment [indiscernible] in growth is lumpy as well. So, just something to keep in mind.

[Russell Gunther:]

I appreciate that and I thank you for clarifying. And then my last question, you guys may have mentioned it, I just missed it, I was just wondering if you had offhand the number of loan officers. You mentioned loans closed per officer, but do you have an absolute amount at the end of the year?

[Mark K. Mason:]

464 exactly.

[Russell Gunther:]

I appreciate that.

[Mark K. Mason:]

I had a little assistance here.

[Russell Gunther:]

I can imagine. Thanks again.

[Operator:]

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

[Tim O'Brien:]

Here's a TRID question, between lock and funding, is that where the TRID bottleneck hits or does it hit pre-lock?

[Mark K. Mason:]

It impacts both sets of disclosures. So remember the old disclosures, within a short period of time after making an application as defined, three days, it was required that you receive a set of disclosures. Those initial disclosures, the [indiscernible] disclosures have changed into what's called a loan estimate or an LE. That loan estimate format has changed pretty substantially and it is still due within three days from when an application is deemed to have been made. The format of that disclosure is far superior to what previously existed. So as much as we complain about the challenges we've had in implementing these disclosures, I would say these are much better for the consumer, and once all the [things] [ph] get worked out of this process, we will have an improved process. But early on, we had changes in the format of that disclosure. Included in that disclosure are estimates of how the loan will close and not just estimates of the costs of loan itself, which is what the old disclosures contained, but estimates of the cash flows and cost or other cash that's going to move around in the transaction, let's say in a purchase transaction. Before closing, we must provide a closing disclosure which reiterates everything in the original loan estimate but corrects or amends anything that might have changed from the original estimates and of course in many transactions things change, [indiscernible] sales transactions, and completes the disclosure of all of the cash flows associated with the loan and/or the real estate transactions in this case, things that we never had previously been required to disclose as a lender. If you think of closing escrow statement on a home purchase, cash flows like a home or required home repairs, the commissions due each side of the real estate representatives, the things just unassociated with the loan itself are now included in the reconciliation of total cash flows related to the loan. Thinking through this you can see there are sources of this information that are outside of our control that we have to get from escrow or other parties associated with the loan and purchase transaction, and these new pieces of information are now being integrated into the disclosures, they have to be accurate, if they are not accurate, we eat the difference, so we have risk not only in the cost of making loans but if there are inaccuracies that are material and uncorrected, there's now the potential for price line of action by borrowers. And so we really don't know how this is going to play out long term. I think the industry is doing its best to implement a poorly designed rollout by the [FPV] [ph] and accordingly we are all playing catch-up. All of our software vendors have done sounds like a uniformly poor job at integrating these disclosures accurately, and so all of us have a fair number of manual workarounds and corrections to ensure that the disclosures we put out are consistent with the language of the standard. And all of that is moving along. We have caught that some pretty poor inefficiencies early on. It was taking us about 2.5x normal to fund a loan. We're down to about 1.5x. That's not total cost, that's just the funding process. That's still not great but it's a lot better than where we started and we expect to fully claw back these efficiencies at some point but not until our software is [indiscernible] compliant. I hope that helps, Tim.

[Tim O'Brien:]

It does. So kind of suffice it to say what you are saying is TRID impacts both – it lengthens the time it takes to lock plus the time it takes to fund?

[Mark K. Mason:]

The customer is still locking on the same sort of schedule. It takes more effort to produce the disclosures associated with making an application and closing a loan.

[Tim O'Brien:]

And the 2.5x normal to fund a loan from lock to funding that you described that TRID has caused and that's down to 1.5x the timeline, that's from lock to fund, that's what you measure, right, or is it receipt of application to fund?

[Mark K. Mason:]

It's the receipt of application to fund, but that's really just speaking to the funds in process. Of all the processes we have, the process of taking an application by the loan officer themselves, we have a processing activity with some of the [indiscernible] processor who collects documentation, sets up the underwriting and then once it goes through underwriting, there's a funding process where all of the requirements or conditions to closing are collected, verified and then the loan is funded. And so it's that funding process where everything comes together at the end which is going to lengthen so substantially.

[Tim O'Brien:]

Thanks for answering my question, Mark. Good luck this year, you guys.

[Operator:]

[Operator Instructions] The next question comes from Jordan Hymowitz of Philadelphia Financial. Please go ahead.

[Jordan Hymowitz:]

Congratulations. Mark, could you describe that in earlier release that it's the locks and fundings were equal this quarter, there would have been 8 million more in net income?

[Mark K. Mason:]

Yes, if locks were equal to fundings, yes, 8.7 million pre-tax.

[Jordan Hymowitz:]

Okay. So if I annualize that number, it's obviously a weak quarter, that's 35 million. 40% tax rate is 21 million. That's about $1 per share. Is it unreasonable to think that next year if the market were somewhere [indiscernible], you can make $1 per share funding what happens just in your mortgage business?

[Mark K. Mason:]

Sure, I mean we did it this year. This year the mortgage segment made [indiscernible] – it's in the release, right? Hold on. We haven't shown a quarterly trend but…

[Melba A. Bartels:]

It's just over 23 million.

[Mark K. Mason:]

Just over 23 million, we have 22 million shares outstanding. That's $1 a share.

[Jordan Hymowitz:]

So if you look at it in a different way, you made $0.39 this quarter with nothing from mortgage, correct?

[Mark K. Mason:]

Substantially correct, yes.

[Jordan Hymowitz:]

That's about $1.56 annualized on a run rate basis with nothing from mortgage. If you added $1 with no growth whatsoever, you are basically at 2.56 run rate. Now obviously we have some seasonality but is that a crazy number to think that you can make next year?

[Mark K. Mason:]

No, and I think it's consistent with analyst estimates if you look at the range of…

[Jordan Hymowitz:]

Yes, but arguably that might be some growth, you are in the best markets in the country, and that the acquisitions you have made haven't been fully integrated and hypothetically there could be another acquisition or something. I mean it just seems like you guys are in a pretty good space at this point.

[Mark K. Mason:]

We feel very comfortable with our growth expectations this year. We think that everything we have done in the last couple of years foundationally in the non-mortgage businesses have produced what should be consistent growth and consistent quality in the non-mortgage businesses. And the mortgage business, I know it could be exasperating because of the seasonality, the reality is in the middle of the year we make a lot of money and this is a segment that made return on equity well in excess of 20%, closer to 23%, 24% this year. If you can handle the seasonality, it's a great contribution.

[Jordan Hymowitz:]

Got it. And final question, any comments on what happened to your Seahawks?

[Mark K. Mason:]

Slow start going east, a slow start to the game unfortunately.

[Operator:]

And we have a question from Timothy Coffey of FIG Partners. Please go ahead.

[Tim Coffey:]

What kind of M&A cost are you expecting in this next quarter with the closing of Orange County?

[Mark K. Mason:]

We will have some pretty substantial costs. I think they are in the $5 million to $6 million range. We can follow up on that, but if you look at our debt, I should've brought it with me out of my office, from when we did the deal we had an estimate of one-time costs, and I think it's in that range. I'll follow-up with you but the debt that we filed, the 8-K, at the time we announced, that has an estimate in it.

[Tim Coffey:]

Okay. And when we think of the drag that TRID caused in 4Q, was it more pronounced would you say on the revenue side or on the expense side?

[Mark K. Mason:]

A little of both because we elected to portfolio some loans we previously would have sold at a gain in the quarter, and we had the drag of expenses. I don't know which was larger. I'll have to think about that. The impact on loan sales – I have to think about that, instead of giving you a [indiscernible] shot.

[Tim Coffey:]

Okay. How about like if we were thinking about from a net effect on the revenue or on the income from the mortgage operation, how much do you think TRID cost net income [indiscernible]?

[Mark K. Mason:]

It would be a guess which I hate making. Let me simply say that it is in the hundreds of thousands of dollars. It's not in the millions of dollars on the cost side. On the revenue side, I would say the same thing. So together, you might see $1 million plus impact, but we haven't tried to dimension it in that manner.

[Tim Coffey:]

Okay, no problem. I think that you had said that that lag time is starting to decline [indiscernible].

[Mark K. Mason:]

Really very bad in October and November, December was substantially better, January better yet. We are expecting some – to roll some updates for our software beginning of February, which would further improve our workflow and more coming. So really the improvement is dependent upon software at this point.

[Tim Coffey:]

Okay, understood. And then the process for evaluating prepayment speed to the MSR portfolio, is that done on an annual basis, a quarterly basis or an as-needed basis?

[Mark K. Mason:]

It's almost daily frankly because we have to manage the hedge. Formerly it's done monthly. That's when we know for the month what the total repayments have been by tranche and we tranche our servicing into 43 separate pools, each one having a different enough prepayment [curve] [ph] that we would analyze them separately. We are trying to get some real benefit. Under this quarter our [indiscernible] was down substantially from the third quarter. I think the first quarter will be down even more. That's meaningful dollars in terms of servicing revenue because it's a straight offset to what we collect. And so I think next year, this year you'll see continued increases in servicing revenue as the servicing portfolio grows but you will see a continued decrease at least in the first couple of quarters we're expecting [indiscernible]. So I think you're generally going to see a better servicing result in 2016.

[Tim Coffey:]

So even if the mortgage rates continue to stay kind of low-ish, it's not declining more, you think [indiscernible]?

[Mark K. Mason:]

Yes, that's what we're seeing right now. In answer to your earlier question, first quarter merger costs for Orange County Business Bank, $6.8 million.

[Tim Coffey:]

Okay, great, thanks. And then the expansion in FTEs and the mortgage banking unit, is that a result of kind of the environment for adding those after you've been accommodative or is it your anticipation for a slowdown in originations in 2016?

[Mark K. Mason:]

So for us our strategy has been to be opportunistic and when we are presented with an opportunity to bring on full offices of high-performing people in current markets or new markets that we admire, we'll take that opportunity. We plan for a certain number of them. We don't know where they will come from. They could be end market, they could be additions to existing offices or they might be new offices. And so as it is our plan to take these opportunities when they arise, we put it into our strategic plan for growth, even though we don't know exactly where they will be.

[Tim Coffey:]

Okay, so that's been done to maintain loan volumes?

[Mark K. Mason:]

It's been done to grow loan volumes. We're here to grow the business and to generate operating leverage in that business as well.

[Tim Coffey:]

Okay. All right, those were my questions. Thank you very much.

[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 K. Mason:]

Thank you all for your patience and listening to our prepared remarks today and for your very good questions. We look forward to talking to you next quarter. Thank you, operator.

[Operator:]

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