Mechanics Bank Q4 FY2022 earnings call

• Impact of interest rates: Significant increase in short-term interest rates adversely affected the business, with net interest margin decreasing due to higher costs of interest-bearing liabilities partially offset by higher yields on interest-earning assets.
• Deposit outflows: Interest-sensitive deposits declined as customers moved funds to higher-yielding products. Attractive rates on treasury securities and non-bank money market funds created competition.
• Loan volume: Cyclical downturn in commercial real estate and single family mortgage loan volume, with fourth quarter at historically low levels.
• Mitigation steps: Reduced loan originations, introduced promotional deposit products, entered into $1 billion of fixed rate federal home loan bank advances, reduced staffing levels, and reduced controllable expenses.
• Loan portfolio: Grew by $209 million in Q4 2022, with $1.9 billion growth year to date; limiting growth in 2023 due to loan prepayments and uncertainty.
• Allowance for credit losses: $3.8 million provision recorded in Q4 2022 due to portfolio growth and qualitative collateral factor increase related to home price projections.
• Credit quality: Remained strong with low non-performing assets ratio.
• Branch acquisition: Acquiring three retail deposit branches from Union Bank in Southern California with ~$450 million deposits and $22 million loans, expecting closing this quarter.
• Mortgage industry: Single family mortgage industry in difficult stage, expecting recovery from low levels in 2023.
• Accumulated other comprehensive income: Negative $100 million balance, not a permanent impairment.
• Financial targets: Deferred near-term financial performance targets due to interest rate and economic volatilities.

In the fourth quarter of 2022, HomeStreet Bank's net income was $8.5 million or $0.45 per share, compared to $20.4 million or $1.08 per share in the third quarter of 2022. For the full year 2022, net income was $67 million or $3.49 per share. The annualized return on average tangible equity in the fourth quarter of 2022 was 6.4%, with a return on average assets of 36 basis points and an efficiency ratio of 76.2%. For the full year 2022, the return on average tangible equity was 11.5%, return on average assets was 79 basis points, and the efficiency ratio was 72.4%. Net interest income in the fourth quarter of 2022 was $7.3 million lower than the third quarter due to a net interest margin decrease from 3% to 2.53%.

• Revenue pressure: Current pressure on revenues expected to be greatest in Q1 2023 then ease assuming short-term rates stabilize and acquisition completes.
• Loan growth: Anticipate modest increase in loan portfolio in 2023.
• Funding: Replacing wholesale funding with promotional deposit products, aiming to eliminate broker deposits.
• Branch acquisition: Expecting closing of Southern California branch acquisition this quarter.
• Financial targets: Deferred near-term financial performance targets, will return to guidance when volatilities subside.

• Impact of interest rate increases: Adverse impact on net interest margin and funding base.
• Deposit outflows: Customers moving funds to higher-yielding products, creating competition.
• Cyclical downturn: In commercial real estate and mortgage loans, affecting loan volume.
• Acquired deposits: Potential runoff in acquired deposits due to rates and alternative investments.
• Uncertainty: In interest rate and economic environments, making near-term guidance difficult.

Q: Around the margin outlook for the upcoming quarter, specifically asking about average margin in December and end-of-year deposit rates.

A: Don't separately disclose margin by month, but Q4 margin was lower due to December Fed move and November decline; ending deposit costs can be found in investor presentation.

Q: On the Union Bank transaction, regarding attrition and cost increase assumptions.

A: Hard to estimate runoff, but history with acquisitions shows minimal runoff; expecting minimal runoff as customers can transfer to higher rate products and better basic check-in products.

Q: Use of deposits from Union Bank transaction and update on FHLB advances.

A: Will use deposits to pay down broker deposits.

Q: Incremental loan growth and funding plans.

A: Plan to eliminate borrowings by growing promotional deposits and organically growing customers, with longer term goal to eliminate broker deposits.

Q: Follow-up on branch purchase NIM impact, staffing levels, and asset threshold.

A: Branch purchase still expected to have day one NIM benefit; staffing levels reduced by ~6% throughout the year; not expecting to cross $10 billion asset threshold soon due to slow growth expectations