Mechanics Bank Q3 FY2022 earnings call

• Loan portfolio grew by $454 million (7%) in Q3 and $1.7 billion (31%) year-to-date, driven by strong origination levels and low prepayments in multifamily loans.
• Efforts to replace wholesale funding with promotional deposit products; total deposits increased 10% in Q3, and plan to replace wholesale borrowings within next 2 quarters.
• Entered agreement to purchase 3 retail deposit branches in Southern California with ~$490 million deposits, expected to improve net interest margin by ~25 basis points.
• Credit quality of loan portfolio remains strong with low delinquencies and nonperforming assets.
• Single-family mortgage banking facing challenges due to low volume and high rates, but remaining business performed well with minimal losses.
• Noninterest expenses decreased to below $50 million in Q3 due to efficiency efforts, with expectations of operating leverage improvement in 2023.
• AOCI balance declined, but strategy to restructure portfolio to reduce duration and buy shorter-duration securities to mitigate impact.

In the third quarter of 2022, HomeStreet Bank's net income was $20.4 million or $1.08 per share, compared to $17.7 million or $0.94 per share in the second quarter. Net interest income increased by $3 million due to a 13% rise in interest-earning assets, but net interest margin decreased from 3.27% to 3%. Noninterest income was consistent with the second quarter, with a $4.3 million gain on sale of Eastern Washington branches offset by lower single-family gain on loan origination and sales activities and loan servicing income. Noninterest expenses decreased by $0.7 million, primarily due to reduced headcount from branch sales, but offset by higher marketing costs and FDIC fees.

• Anticipate modest loan portfolio growth in Q4 due to economic uncertainty and higher interest rates.
• Plan to replace wholesale funding with promotional deposits, aiming to reduce wholesale funding costs and improve net interest margin.
• Expect net interest margin to trough in Q4 2022 and recover sequentially in 2023, with full-year 2023 net interest margin exceeding 2022 level upon closing of branch acquisition.
• Target return on average assets in 110 basis point range and return on average tangible common equity in high teens range for second half of 2023, with higher targets for 2024 and beyond.

• Impact of volatile interest rate environment on net interest margin and net interest income.
• Dependence on wholesale funding with rising costs and need to replace with deposits.
• Challenges in single-family mortgage banking and DUS loan production due to low volume and high rates.
• Potential credit risks from economic recession or credit cycle, though portfolio is well-diversified and conservatively underwritten.

Q: Jeff Rulis asked about margin in September month average relative to quarterly average and branch acquisition appetite.

A: John Michel mentioned quarterly numbers are provided, and Mark Mason clarified margin compression in Q4 expected to be similar to Q3, with branch acquisition expected to improve margin by 25 basis points and appetite for similar transactions to improve funding.

Q: Matthew Clark asked about decline in loan servicing revenue.

A: John Michel said decline due to hedging difficulties and portfolio decay, with volatility in the line item. Mark Mason added it's accounted for on an as-received basis causing volatility.

Q: Tim Coffey asked about promotional CDs, borrowings terms, and DUS sales.

A: Mark Mason said promotional CD rates were unchanged until recently, borrowings are mostly overnight, and DUS sales expected to recover modestly in second half of 2023 at earliest