Mechanics Bank Q4 FY2024 earnings call

• In the fourth quarter, the company completed the sale of $990 million of multifamily loans, which improved liquidity, reduced commercial real estate concentrations, and lowered the loan-to-deposit ratio. - Net interest margin expanded in the fourth quarter due to decreases in funding costs. - Noninterest expenses were lower in the fourth quarter, with reductions in compensation benefits through FTE decreases. - There were increases in nonperforming assets and delinquent loans partially due to the multifamily loan sale and a syndicated commercial loan downgrade. - The company had significant exposure in commercial real estate in Southern California affected by wildfires, but all relevant properties had full insurance coverage. - Tangible book value per share decreased due to the loss on loan sale, tax impacts, and interest rate effects on securities portfolio.

In the fourth quarter of 2024, HomeStreet Bank had a net loss of $123.3 million or $6.54 per share. On a core basis (excluding loss on sale of multifamily loans, deferred tax asset valuation allowance, and merger-related expenses), the net loss was $5.1 million or $0.27 per share. Net interest income in the fourth quarter was $1 million higher than the third quarter, with net interest margin increasing from 1.33% to 1.38%. Noninterest income decreased primarily due to the $88.8 million loss on the sale of $990 million of multifamily loans. Noninterest expenses were $5.2 million lower in the fourth quarter, with decreases in compensation benefits and general, administrative and other expenses partially offset by an increase in occupancy expenses. The ratio of nonperforming assets to total assets was 71 basis points and total loans delinquent over 30 days including nonaccrual loans to total loans was 106 basis points as of December 31, 2024.

• The company anticipates returning to profitability in the first half of the year and generating continuous earnings growth through loan repricing, borrowings reduction, interest rate reductions, and effective noninterest expense management. - Assumes continued strong credit in the absence of adverse economic changes.

• Economic changes could adversely impact the expectations of returning to profitability. - Syndicated commercial loan participation has potential credit risks. - Section 382 tax code limitations on utilization of deferred tax assets in case of change of control. - Interest rate environment impacts fair value and creates challenges. - Competition in deposit rates from other banks.

Q: Hi, thanks for taking my questions. I wanted to start with on the NIM. It should see a pretty meaningful pickup next quarter with the loan sale factored in. When you think of the NIM trajectory, is there a breakeven level in the NIM that you're targeting to achieve in the first half of the year that gets you back to the return in profitability?

A: We don't have a targeted number specifically, but we do expect as we -- as Mark said, you could see what the change in difference between 3.30% and 4.65% were on the loans that we sold and the debt that we did retire. We -- the expectations going forward is that obviously, as with any kind of security or loan, it's going to take a couple of years to fully recover the value, but it does impact the -- positive impact on earnings immediately in the first quarter and going forward. Plus we have the impact of loan repricing, first quarter and moving forward.

Q: Yeah. So the expectation is that you don't need additional rate cuts from here to hit profitability in the first half of the year?

A: That's correct.

Q: Got it. So you completed the loan sale, which was great to see and as you're thinking about the return to profitability and growing from there, are there any other strategic initiatives or actions that need to take place in the near term?

A: No. It's a pretty simple strategy. Now, having said that, we are doing what we can to accelerate the process of returning to profitability and then thereafter improving it. Things like working proactively with our commercial real estate borrowers who have upcoming repricing to hopefully rewrite those loans either to sell or to improve their yields until you get very close to repricing dates, as you would expect, most borrowers are ready to preemptively restructure their debt. But given the current posture of the Federal Reserve on slowing rate decreases, we are getting more attention from the borrowers earlier than we have previously.

Q: Thanks. Good morning, everyone. Just starting around the NIM. Do you have a spot rate on deposits after you paid down the brokered CDs here in January? Just trying to get a sense for where we stand here in January?

A: Yeah, as of December 31, our spot rate of all our deposits was 2.65%. Excluding our broker deposits, it's 2.39%. Going forward, we did pay off some of the broker deposits in -- already in the first quarter, and we intend to pay them off over the next few months and going forward. So we'll get down to that -- closer to that 2.39% pretty quickly.

Q: Okay. That's helpful. And then on the new nonperformer, the commercial participation. Can you just remind us how much you have in syndicated or participations in terms of the exposure there overall?

A: That's not a number we generally disclose. I think that it's a little south of $200 million at this point, roughly.

Q: Okay. That's fine. And then just on the DTA, and you guys mentioned the fair value of tangible book based on the rate changes. But I just want to confirm that DTA is portable. I mean, a buyer could use that, right, and put it to work. So your tangible book of $12 and change is -- could be grossed up by the DTA. Is that fair?

A: Yeah, it is. I mean it's going to be converted into net operating loss carryforwards. Now remember, there's a Section 382 the tax code that deals with limitations on annual utilization in the event of a change of control. But given what we believe the value of the company is, we think that those annual limitations are not likely to reduce the full value. And also, just to be clear, we did add back the valuation allowance in terms of computing tangible book value per share. So if you look at the schedule on the back of the earnings release and in the deck, you'll see the computation that shows that added back because the value is transferable and also realizable by us.

Q: Okay. So it's embedded in that $12.50 something?

A: Yes.

Q: Okay. Sorry about that. And then just any update on potential conversations with -- or conversations with potential buyers. Has that started yet? Has it been ongoing? Well, I guess, where do we stand on that front?

A: Well, I think I spoke to it in my prepared comments that the Board of Directors is continuously reviewing strategic alternatives. And that's what we can say at this time.

Q: Thanks, gentlemen. My first question has to do with kind of the fee income line items and servicing, the mortgage servicing. Did the loan sale have a material impact on what those values might be going forward? Or is that totally separate?

A: Remember that we sold portfolio loans. So, we weren't previously recording servicing fees, so it doesn't impact that line item. There is a potential impact of retained servicing. And I say potential because even though we retained it, there is some probability that the buyer will be securitizing some meaningful portion of those loans. And at that point, we would have to transfer the servicing or the buyer has told us they transfer servicing to a regular servicing provider of a CMBS servicer. And just to be clear, we did not recognize a mortgage servicing asset related to that because of the temporary nature.

Q: Okay. Great. That's helpful. And gain on -- what is your -- kind of fully out the phrases, so I will say that bluntly. What is your appetite for doing more originate to sale business going forward?

A: It's large. It's tempered somewhat by both ends of those transactions. One, the application activity for new loans has not yet picked up substantially, though there is some activity. I think I spoke a little bit to borrower trends. Two, most of the secondary market activity for buyers of loans has been focused on buying legacy low-rate loans and so we're not quite sure yet how significant the appetite will be for newly originated loans, but we're in discussions with several parties at this time, hopefully, to establish a flow program.

Q: Okay. And then on noninterest expenses, obviously, you're doing what you can to lower that number. Is there more that you can do in the near term?

A: Boy, we're really down to very small opportunities at this point. We never -- I mean, we never thought we would get down below 800 on FTE, which means we're probably running a little thin, and we have some positions that we were holding open in anticipation of the prior proposed merger. Having said that, we're trying to hold the line on add-backs to really critical positions. And now if volume changes, particularly in the origination areas, we'll have to add some support, but that is less costly support generally. So we think we're getting pretty close to what we can do. Unfortunately, each year, you do have inflation and compensation. And to be competitive, to retain and attract anyone we need to attract, we're going to have to, like everyone else, provide merit increases this year. We're using a budget of about 3% again, which we think is consistent with our market. So even where we're at, inflation is going to hit our comp line like everyone else. Yeah. On the other expenses, too, no big changes in our other G&A expenses per se, other than as we continue to move forward here and restructure our balance sheet, we expect our FDIC insurance fees to go down slightly. Secondly, from the occupancy cost, we are kind of going through and managing those down. As we move out of spaces, we are not going renewed because we have adopted a remote and somewhat remote environment for the company. And so those are the two areas that you may see some stability or slight decrease in expenses. Having said that, it's a tough market to sublet space.