HomeStreet's (HMST) CEO Mark Mason on Q2 2016 Results - Earnings Call Transcript

| About: HomeStreet, Inc. (HMST)

HomeStreet, Inc. (NASDAQ:HMST)

Q2 2016 Earnings Conference Call

July 26, 2016 01:00 PM ET

Executives

Mark Mason - President and Chief Executive Officer

Melba Bartels - Chief Financial Officer

Analysts

Paul Miller - FBR Capital Markets

Jeff Rulis - D. A. Davidson

Jacque Chimera - KBW

Tim O'Brien - Sandler O'Neill & Partners

Jordan Hymowitz - Philadelphia Financial

Bill Dezellem - Tieton Capital Management

Operator

Good afternoon and welcome to the HomeStreet Inc. Second Quarter 2016 Earnings Conference Call. All participants will be in a 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, President and CEO. Please go ahead.

Mark Mason

Hello and thank you for joining us for our second quarter 2016 earnings call. Before we begin, I'd like to remind you that our earnings release was furnished yesterday 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 2015, 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 website. 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, we announced the acquisition of certain assets, deposits in two branches from the Bank of Oswego located at the Lake Oswego Oregon and the Fluid [ph] suburb in Portland Oregon. We expect to clear approximately $40 million of loans, $50 million of deposits and two branch locations. These branches will increase our retail branch count in the Portland Oregon metro area to five. We expect to close this acquisition next month and we look forward to welcoming our new customers and employees.

We are excited by the growth opportunities in Portland as a result of the area’s strong employment and population growth. Additionally, we announced the acquisition of two branches located in Granada Hills in Burbank, California, from Boston Private Bank and Trust. The branch has held approximately $110 million in deposits and this transaction is expected to close in the fourth quarter of this year. These branches are each located in their offices of our Affinity partner, Kaiser Permanente. It will increase the number of our retail branches in Southern California to 12.

During the quarter we opened two commercial small business lending offices in Carlsbad in Santa Ana, California. We also opened three single family home loan service during the quarter one in Redlands, California and two here in Washington in Oak Harbor and Billingham.

Finally on May the 20th we completed the issuance of $65 million of 6.5% Senior Notes due in 2026. The majority of the net proceeds of $63.5 million will be used to support our growth but will be contributed overtime to the bank as capital. Initially, we have invested the net proceeds of the operating in our securities portfolio pending to future growth. This net operating has also attracted a new set of institutional investors to our company, we welcome their confidence in us.

Before Melba reviews our financial results, I’d like to share some highlights from the quarter. Total assets grew $524 million or 10% in the quarter to $5.9 billion. Net income for the quarter excluding merger related items increased 129% to $22.4 million from $9.8 million in the prior quarter.

Return on average tangible equity excluding merger related items was 17.3% in the quarter. Diluted earnings per share excluding merger related items increased 120% from $0.41 per share on the first quarter to $0.90 per share in the second quarter. Tangible book value per share increased from $20.37 at March 31 to $21.38 at June 30.

Net income for the commercial and consumer banking segment excluding merger-related items totaled $7.7 million reflecting increases in non-interest income from the seasonal increases in commercial real estate and SBA loan sales and net interest income due to growth in our loan portfolio.

Loans held for investment increased $175 million or 5% during the quarter to $3.7 billion. New portfolio loan commitments during the quarter totaled $669 million a record level for the company. The ratio of non-performing assets to total assets ended the quarter at 0.45% a slight increase from the first quarter’s level of 0.43% that’s still reflecting excellent loan quality.

Our second quarter mortgage banking segment net income increased to $14.7 million from $4.9 in the first quarter reflecting an increase in interest rate lock and forward sale commitments and increase in our corporate and our composite margin and an increase in our servicing income. Our mortgage origination volume and profit margins in the quarter benefitted from the historically low rate environment.

Closed loan volume in our single-family mortgage banking segment totaled $2.3 billion in the second quarter compared with $1.6 billion in the third quarter. Interest rate lock and forward sales commitments of $2.4 billion in the second quarter increased from $1.8 billion in the first quarter. I would also like to take a quick moment to mention the recent performance of our joint venture with various owners of Windermere real estate company franchisees, Windermere Mortgage Services or WMS.

We owned 50% of WMS and it offers single family home loans through 41 Windermere real estate offices in Washington and Oregon. During the quarter, WMS earned net income of $2.4 million; the results this quarter represent a quarterly return on equity of 60% or approximately 240% annualized. As 50% owner we will receive a $1.2 million distribution this quarter in addition to the mortgage volume that the joint venture sells to HomeStreet.

The President of WMS Erica does a great job for us there. The cost of the recently implemented trade requirements continue to adversely affect our results during the quarter. While our processing times for loans have normalized we expect processing times to lengthen on refinances due to the recent drop in rates coupled with the seasonal increase originations. We continue to carry additional support staff to facilitate compliance with tread. This condition will moderate as the loan origination system becomes fully compliant with the new r requirements over the remainder of this year.

I’d now like to turn it over to Melba who will share some additional details on our financial results for the quarter.

Melba Bartels

Thank you, Mark, good morning everyone. I'd like to first talk about our consolidated results and then provide detail on each of our segments. Second quarter net income was $21.7 million or $0.87 per diluted share, compared with $6.4 million or $0.27 per diluted share for the prior quarter. The increase in net income from the prior quarter was primarily due to a $24.4 million increase in the net gain on mortgage bond origination and sales.

Excluding after-tax merger-related items core net income for the second quarter was $22.4 million or $0.90 per diluted share compared to $9.8 million or $0.41 per diluted share in the first quarter. Merger related expenses totaled $1 billion for the quarter primarily due to the residual expenses related to the Orange County Business bank acquisition completed in the first quarter.

Net income for the first half of 2016 was $28.2 million or $1.15 per diluted share compared to $22.7 million or $1.14 per diluted share for the first half of 2015. The increased period over period was primarily due to $16.2 million higher in net interest income. Average loans held for investment grew by 35.2% from the year ago period from $2.6 billion to $3.5 billion.

Excluding after tax merger related items core net income for the first half of 2016 was $32.2 million or $1.32 per diluted share compared to $26.1 million or $1.32 per diluted share for the first half of 2015. Included in non-core items in the first half of 2016 was $6.2 million or merger related expenses compared with $15.4 million or merger-related expenses and the $6.5 million bargain purchase gain for the first half of 2015.

Net interest margin was $44.5 million in the second quarter compared to $40.7 million in the first quarter. This increase was primarily due to higher interest income from gross to average interest earning assets, primarily $277.9 million or 8.2% increase in average loans held for investments.

Our net interest margin was 3.48%, a decrease of 7 basis points from the first quarter half, primarily due to an increase in the cost of interest bearing liabilities. The impact of a senior notes issued in May contributed 4 basis points of the quarterly decline. Average interest earning assets increased by a larger amount than average interest bearing liabilities increasing the impact of non-interest bearing sources to 15 basis points in the second quarter from 12 basis points in the first.

Non-interest income increased $30.8 million or 42.9% from the first quarter due primarily to higher net gain on loan origination sale activities as well as an increase in mortgage servicing income. Net gain on mortgage loan origination and sale activities increased $21.6 million from the prior quarter and mortgage servicing income increased $4.6 million.

Non-interest expense was $111 million in the second quarter compared to $101.4 million in the first quarter. Excluding merger-related expenses, non-interest expense was $110 million compared to $96.2 million in the first quarter, an increase of $13.9 million. The increase in core expenses was primarily due to higher commissions paid as a result of the 43.8% increase in single family close loan volumes.

At March 31, the bank’s Tier 1 leverage ratio was 10.28% and total risk based capital was 14/3%. The consolidated company’s Tier 1 leverage ratio was 9.88% and total risk based capital ratio was 12.2%.

I’d now like to share some key points from our commercial consumer banking segment results. The commercial consumer banking segment net income was $7.1 million in the quarter compared to $1.5 million in the prior quarter. Excluding after tax net merger related items, the segments recognized core net income of $7.7 million in the second quarter compared to $4.9 million in the first quarter.

Growth in core net income was driven by its growth operating efficiencies as revenue growth outpaced expense growth.

Net interest income increased from $38.4 million in the second quarter from $35.6 million in the first primarily due to the increase in loans held for investment and investment securities. Segment non-interest income increased from $4.6 million in the first quarter -- segment non-interest income increased from $4.6 million in the first quarter to $8.2 million in the second quarter due to higher net gain on loans of sale -- sale of loans primarily from the seasonal increase in Fannie Mae DUS originations as well from higher SBA loan originations and sales. Typically the first quarter of the year and the seasonal loan for DUS and SBA loans originated for sale.

Segment non-interest expense was $34.1 million, a decrease of $2.5 million from the first quarter. Included in non-interest expense for the first and second quarters of 2016 were merger related expenses of $1 million and $5.2 million respectively.

Excluding merger related expenses from both periods, the $1.6 million increase in expense is primarily due to the Orange County Business acquisition impacting the entire quarter as well as the investment in lending offices opened during the quarter and higher expenses to support our growth.

We recorded a $1.1 million provision for credit losses in the second quarter of 2016 compared to our provision of $1.4 million reported in the first quarter of 2016 reflecting the continued growth and balances of loans held for investment offset somewhat by 478,000 of recoveries during the quarter.

The portfolio of loans held for investment growth increased 5% or $175 million to $3.7 billion in the second quarter. New loan commitments totaled $669.1 million and originations totaled $439.9 million during the quarter.

Credit quality remained strong with non-performing assets at 0.45% of total assets at June 30th, and non-accrual loans at 0.42% of total loans. Non-performing assets were $26.4 million at quarter end compared to non-performing assets of $23.3 million at March 31st. This increase was primarily due to an increase in single family other real estate owned. We continued to enjoy positive charge-off experience with net recoveries of $478,000 in the quarter.

Deposit balances were $4.2 million at June 30th, up from $3.8 billion on March 31st. Transaction accounts increased 8% during the quarter of which non-interest bearing accounts increased 12%. Additionally, certificates of deposit increased $237 million to support the strong asset growth of the company. Transaction accounts grew by 7.96% during the quarter. Notably, our de novo branches stores opened since the beginning of 2012 grew deposits by 41.9% during the quarter.

I’d now like to share some key points from our mortgage banking business segment results. Net income for the mortgage banking segment was $14.7 million in the second quarter compared to net income of $4.9 million in the first. The $9.8 million increase in net income from the first quarter was primarily due to higher net gain on single family mortgage loan origination and sale activities due to higher interest rate lock and forward sale commitments during the quarter.

Net gain on single family mortgage loan origination sale activities in the second quarter was $81 million compared to $59.5 million in the prior quarter. Segment ROTE was 69.5% for the quarter.

Single family mortgage interest rate lock and forward sale commitments totaled $2.4 million in the second quarter, an increase of $558 million or 30.9% from $1.8 billion in the first quarter. The gain on sale composite margin increased to 347 basis points in the second quarter from 336 basis points in the first quarter.

Single family mortgage close loans totaled $2.3 billion in the quarter, an increase of $688.5 million or 43.8% from $1.6 billion in the first quarter. The volume of interest rate lock and forward sale commitments was higher than closed loans designated for sale by 4.4% this quarter, which positively affects reported earnings as a majority of the mortgage revenue is recognized an interest rate lock while the majority of origination cost including commissions are recognized upon closing.

If rate lock and forward sale commitments during the first quarter would have equaled close loan volume, it would have resulted in approximately $1.9 million lower net income for the segment, similarly a closed loan volume has been the same as interest rate lock and forward sale commitment net income would have been approximately $800,000 lower as a result of higher variable cost.

Mortgage banking segment non-interest expense of $76.9 million increased $12.2 million or 18.9% from the first quarter. This increase was primarily due to higher permissions and incentives due to increased close loan volumes. TRID is still having an adverse impact on our expenses for the segment with a higher percentage of segment FTE and operations relative to sales compared to the second quarter of 2015.

Overall, we grew mortgage personnel by 3.5% in the quarter. Closed loans increased in the quarter to 5.3 loans per loan officer compared to 4 loans per loan officer in the first quarter. Single family mortgage servicing income was $12 million in the quarter, a $4.6 million decrease from the prior quarter. This decrease was primarily the result of $4.7 million decrease in risk management results during the quarter.

Single family mortgage servicing fees collected in the second quarter increased by $442,000 primarily due to higher average balances in our loan service or other portfolio. The portfolio of single family loan service for others was $17.1 billion at June 30th compared to $16 billion at March 31st.

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 today. First, I would like to remind everyone that we’re fortunate to operate in some of the most attractive market areas in the United States today. Strategically, we are focused on the major markets in the Western United States, which today enjoy lower employment 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 6.8% this year over last year, and to decline by 20% in 2017. The forecast that declined from 2016 to 2017 is driven by a 51% decline in refinancing volume, however, our focus is always been on the purchase market. The Mortgage Bankers Association forecasts that purchased mortgage origination are projected to increase 8% in the third quarter and 3% in 2017.

Despite the increase in short-term interest rates by the Federal Reserve in December, long-term interest rates have fallen along with mortgage rates and continue near historic lows. The 10-year treasury yield fell to a record low 1.3% recently following the Brexit vote and remains low, hovering around 1.5% to 1.6%. This should keep interest in refinancing strong and support housing affordability. Nationally purchases are expected to comprise 59% of mortgage loan volume this year.

Housing starts for this year are expected to be at 10% over 2015 levels and home sales for new and existing are expected to increase 6% during the same period. During the second quarter, purchases comprised 54% of originations nationally and 55% of originations in the Pacific Northwest.

HomeStreet continues to perform at levels above the national and regional averages with purchases accounting for 69% of our closed loans and 65% of our interest rate lock and forward sale commitments in the quarter.

Home price increases in the Washington, Oregon and California based on FHFA data accelerated across the board in the latest quarter, with year-over-year rates ranging from 8.2% in California to 11.4% 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 4.7% from a year earlier.

Seattle gained 10.7% over the last 12 months. Portland gained 12.3%, San Francisco gained 7.7%, and Los Angeles was up 5.9%. The rate of job growth in Washington, Oregon, California averaged more than 3% last quarter, 58% higher than U.S. growth rate of 1.9%.

The average unemployment rate in the same three states averaged 5.4% last quarter slightly more than the national average of 4.9%. This difference appears to be due to new job seekers migrate into our faster growing western states. People are again moving to where the jobs are.

Looking forward over the remaining two quarters in 2016 in our mortgage banking segment, we currently anticipate single-family mortgage loan lock and forward sale commitment volume of $2.4 billion in the third quarter and $1.7 billion in the fourth quarter of this year.

We anticipate mortgage loans held for sale closing volumes of $2.6 billion and $2.0 billion in the third and fourth quarter of this year respectively. As Melba stated the seasonality is expected to produce greater variation in reported results due to the timing of recognition related revenues and expenses and the expected imbalance between locks and closing. This imbalance is expected negatively impacted the quarters where closing exceed locks and vice versa.

Additionally, we expect our mortgage composite profit margin to come back down to a range of between 320 and 330 basis points over that period and range between 315 and 325 basis points during 2017.As the increase refinancing activity wanes our composite margin loss will fall.

We expect the increased TRID-related cost we experienced in the first and second quarter to continue through the next several quarters until we complete the installations of new loan origination system in the first quarter of 2017.

Looking to 2017, we anticipate single-family mortgage loan lock and forward sale commitments and loan closing volume of $9.1 billion. These volumes will be subject to the typical seasonality we experienced, the highest production coming in the second and third quarters of the year offset by the lowest production in the first and fourth quarters of the year.

Volume will also to be highly depended on the housing market in which we do business. Local economic conditions, affected employment growth and wages as well as prevailing interest rates.

In our commercial and consumer banking segment over the remaining two quarters of this year, we expect to continue net loan portfolio growth of approximately 4% to 6% quarterly and also remain within that range during 2017.

Reflecting the further flattening of the yield curve since last quarter, we now expect our consolidated net interest margin to trend down further to 3.30% to 3.35% by the fourth quarter and remain in this range of 3.30% to 3.35% during 2017 absent changes in market rates, and low prepayment fees.

Reflecting the seasonal peak of origination in sale activity as we believe that non-interest expense growth in the second quarter represented a peak for the year. Therefore consistent with our full year guidance on average of 3% growth per quarter for the full year, we do not expect our non-interest expense to meaningfully increase for the remainder of the year.

In fact, we expect non-interest expense to decline somewhat in the fourth quarter of this year. During 2017, our non-interest expenses are expected to again grow on average approximately 3% per quarter, reflecting our plan continued investment in 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 our investments in growth in both of our segments.

This concludes our prepared comments. We appreciate you joining our call today and your patience during our presentation. Melba and I would be happy to answer any questions you have at this time.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session [Operator Instructions]. Our first question comes from Paul Miller with FBR Capital Markets. Please go ahead.

Paul Miller

Hey, Mark. Good quarter. When you're looking at just going forward and try to model this out. I know you'd not given too much guidance, but you had about 17% ROE, but you had some benefits in there, I'd say benefits this is operational benefits hedging and things like that, so as your ROEs in that. Should we'll be looking at those ROEs between 13% and 15% or you think you can exceed that 15% ROEs going forward?

Mark Mason

We had some help this quarter from higher than normal refinancing activity and in turn that produces somewhat higher composite profit margin in the mortgage segment that we don’t expect to repeat except sort of periodically when we get one of these many refinancing booms. So, you know 17% annualized ROE this quarter is a little higher than we expected at this point. We do expect again through the cycle to average it around 15%, our target, absent refinancing is little lower than that over the next couple of years.

In part because we are growing our non-mortgage business into a larger part of the returns and those businesses carry somewhat lower ROEs even fully profitable. You did note in the call today Melba mentioned that the return on tangible activity for the mortgage banking segment was 69.5% annualize this quarter. That's pretty high, but as we look out over the next couple of years something between 30% and 40% for that segment is expected and that's how we can get the consistently sort of mid teens return on equity. So we had somewhat better quarter than expected. I would expect that we could in the next couple of years operate sort of in the 11% to 15% range without material unusual refinancing activity.

Paul Miller

And then on the commercial bank you did get some decent loan growth, some of that is even hiring a lot of commercial teams over the last couple of years I believe. Where are you stand -- do you think you still need to add not just in the Portland area – not Portland, Seattle, but you’ve entered the San Bernardino market or Los Angeles market. Are you continue to hire down there? When do you think that employment level start to become stabilized?

Mark Mason

Well, we have a significant interest in California obviously and when you look at the distribution of our originations the weakest area is still C&I lending. It is the most challenging area to grow. It has the longest sales cycle of our businesses. We are a somewhat new commercial bank in many of our markets, and so we are going to be investing in personnel somewhere across all of our footprint but more significantly in California this year and next year.

And that is going to require some investment before revenue. We are about to announce the hiring of a market president in California with significant commercial banking experience to spearhead that effort and that will be a little bit of drag initially on the commercial consumer earnings. We don't expect it to keep us from hitting our efficiency targets ultimately, but we have to invest to build that business down there.

It’s been more challenging for us to acquire the quality of C&I smaller banks that we would like in California and really because of pricing given where we trade and with the concern for excess dilution we have not been able to be competitive and grow as quickly through acquisition with the better quality properties, and so we find ourselves continuing to build and that has a cost.

Paul Miller

Okay. Thanks a lot Mark.

Mark Mason

Thanks Paul.

Operator

And our next question comes from Jeff Rulis with D. A. Davidson. Please go ahead.

Jeff Rulis

Thanks. Good morning. Mark, the guidance on margins of 3.30 to 3.35 by Q4, does that include – you discussed the negative impact of the debt offerings this quarter assuming those funds are sort of redeployed into higher yielding assets. I guess is that guidance are you seeing any positive kind of offset as that is deployed or is it all baked into the consolidated guidance that you have put out there?

Melba Bartels

Jeff, this is Melba, I'll response to that. The short answer, it is all baked into the guidance. It does reflects primarily the change quarter over quarter does reflect the flattening of the yield curve further during the quarter. But debt offering in terms of loan yields, our total portfolio, our total average interest earnings, yields did decline due to the flatter yield curve and the investment in the securities however over time that will be redeployed in the higher burning loan product which will help offset through that compression.

Jeff Rulis

Okay. And then a couple of…

Melba Bartels

But it is all baked into the guidance.

Jeff Rulis

Got you. And then on maybe just on the merger-related costs of $1 million this quarter, is that anticipated to go away, you got anything coming up with the branch acquisitions? What would be the expectation for Q3?

Melba Bartels

So, we had about a $1 million this past quarter which is primarily related to the OCBB and we do expect approximately the same level for the third and fourth quarter and third quarter related to Lake Oswego and then the fourth quarter related to Boston Private and Trust branch acquisition.

Jeff Rulis

Okay. And then, Melba, on the tax rate has been pretty volatile over the last while, but any expectation to kind of finish the year at an average rate or Q3 or Q4 expectation?

Melba Bartels

Yes. Good question. During the quarter we did update our estimate -- the impact of California on our marginal rate and so you saw those impact of that in the quarter. Also the catch up of that updated estimate from the first quarter as well. But going forward in the second half our total expectation with respect to the effective rate will be right around 35%.

Jeff Rulis

Great. Thank you.

Operator

And our next question comes from Jacque Chimera with KBW. Please go ahead.

Jacque Chimera

Hey, Mark, hey, Melba.

Mark Mason

Hi, Jacque.

Melba Bartels

Good morning.

Jacque Chimera

Question on the TRID related employees that you mentioned. Am I inferring correctly -- did you mean to imply that we could see some costs trend down there after the conversion in 1Q 2017?

Mark Mason

Yes, relatively, right. So what we anticipate is not a net reduction in personnel, but a decline and increase in personnel as we redeploy people doing what I would call TRID workaround work and QC work into normal processing and funding positions. So our efficiency should improve. We are expecting originations to grow in next year. So we would have a need for additional operations personnel, it should be redevelopment and greater efficiency.

Jacque Chimera

Okay. That makes sense. And can you give us an update on the employee growth that you expect in both the consumer commercial division and then mortgage banking division over the next maybe - in the latter half of 2016 and then 2017 as well, just in terms of headcount?

Mark Mason

Sure. It's not going to be as significant as it has been. In the mortgage banking segments we may add roughly five originators a month for the remainder of the year, which translates to sort of similar number of operations personnel. Right now give or take a couple. So not nearly as significant as in prior quarters of prior years, I'll only qualify that which the potential that we would have some opportunistic -- opportunity to bring some office of larger folks into is not currently identified today.

On the commercial and consumer banking side, we think that over the next couple of quarter the personnel will rise in the commercial consumer segment somewhere in that 5% or 6% range. We have plan next quarter two branch openings as it is example to new retail branches in California. I believe one more before the end of the year in another location, each of those as 4.5 FTE roughly.

We're going to be adding commercial banking staff not only in California, but in order as we close the acquisition of the assets liabilities of The Bank of Oswego for the Greater Portland area, and then to support our growth in both Northern and Southern California.

Melba Bartels

And then Jacque, I would just add, looking forward into next year that the expectation in terms of average FTE growth would be in line with our expectation of non-interest expense growth on the average for the quarter is up 3%.

Jacque Chimera

Okay. That's very helpful. Thank you. And then just one last quick one if you could provide an update on obviously you had really good sales with the Fannie Mae in the quarter but other commercial sales were strong as well, just an update on how those new groups -- relatively new groups are doing and what your outlook is for future growth?

Mark Mason

We had record quarter for Fannie Mae the U.S. origination in sales this quarter in part because we had a couple of pretty large loans, in fact we did our largest Fannie Mae multi-family loan in August with some $65 million for beautiful multi-use mostly a multi-family project here in Seattle and another $35 million loan. So a big piece of the quarter for Fannie Mae was made up just in two loans but we have a whole bunch of smaller loans.

We have a lot of momentum with that business and we are trying to introduce that to California. At this point we finally have a loan in prospect of Fannie Mae loan processed in California. And we think the opportunity there is of course the significant given the size of market. It has not been our traditional Fannie Mae multi-family markets. So we think the opportunity is great.

The operation in California are small balanced commercial real estate operation is above plan and volume for the year. And yields consistently are 25 to 40 basis points higher than we did in the rest of our commercial real estate business here in Pacific Northwest. We are very happy with that business. Our commercial real estate business in Pacific Northwest overall continues strong. The construction projects that we financed are all primarily on budget and on time.

And the market here continues to be very, very strong. I think in the past we talked about how we monitored the forward line of sight on concerns about market stability and pricing valuation and we continue to see an operated markets that are characterized by an imbalance of demand and supply, demand continues to grow. Job creation, and household formation continues to support high levels of construction in our markets, new project absorption continues to be well short of projected amounts.

Rents continue to rise at levels in excess of pro formas on these projects. It’s a little frightening honestly if you think about being a renter or a home buyer in these markets today, because there is not lot to choose from and it's getting increasingly expensive. Let me refer to some of the statistics I talked about earlier on home price appreciation in these markets, while the same is true for rental rates. And so all of those businesses continue to operate at levels in excess of our plan for this year and the profitability is consistent or better than planned.

So, our biggest challenge honestly with those businesses is balance sheet capacity and ability to process all of the business in front of us. The SBA business continues to be a good business. We are in the process of hiring a couple more SBA specialist originators, one in the north and one in the south. And so we look forward to increase production in that business as well.

Jacque Chimera

Thank you for all of the added color.

Mark Mason

Thank you.

Operator

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

Tim O'Brien

Good morning.

Mark Mason

Good morning.

Tim O'Brien

So to follow on Jacque's question about Fannie DUS lending. You talked about a couple of loans. Are those outliers kind of can you characterize how big the general, you know the average size of a loan that you underwrite there typically and what your expect – is that going to grow with your expansion of the business that franchise in Southern California? Are we going to continue to see -- could you find a bigger loan still maybe $100 million loan? How big can you go?

Mark Mason

Theoretically we can under our house limits. They get larger in California. I mean, you know the market, right. The apartment complexes in California tend to be much larger in unit size. So theoretically that may happen. I will tell you we are generally more focused on the small balance market. Fannie Mae, as you're familiar with their restrictions under the FHFA, they have a cap on large balance loan originations. But they are uncapped on small balance. And part of their mission in addition to supporting senior housing and low income housing is small balance lending.

And so, I expect our average balance on Fannie Mae loans to be much smaller than the $35 million to $60 million range. And today it's probably in the $67 million range because of the focus on smaller balances. Now, that also – while it's more expensive to process more loans, they are also more profitable which more than offsets the additional processing cost.

Tim O'Brien

And what's the typical spread on sales there these days?

Mark Mason

Well, there's a pretty big range on the larger loans, the profit margin could be in the 250 basis point range and the smaller loans it can rise to 4600 basis points. For the quarter it was roughly 370 basis points.

Tim O'Brien

Thanks for the color Mark. That's great. And then as far as the CD contracting, you guys grew CDs this quarter and it looks like average rate was up a little bit. Can you talk about the outlook there for tapping that part of the deposit world to fund your growth going forward in 2017 through the end of this year and in 2017?

Mark Mason

Well, I'll let Melba start and then I'll finish with a comment.

Melba Bartels

Yes thanks Mark, I understand. So yes, our CDs as a percent of total deposits rose to 27% in the quarter which is certainly up sequentially but it’s actually pretty consistent to where we were in the year ago quarter. We do manage our percent brokerage CDs with respect to total deposits to remain at 10% or less so we are well below that.

Mark Mason

The time deposit market is one that -- we historically used the company used to be much more concentrated in time deposits. We had -- of about 15% of deposits knowing that that will really be a low water mark. Our asset growth rate requires a significant growth rate and funding and while we have been growing deposits well and almost exclusively retail deposits that have required the use of some time deposits. And while from a cost of funds standpoint that’s not optimal, understand we use that as a way to help build our customer base in new offices and new markets.

Typically new offices need some promotional products to bring in the initial group of new customers, overtime you convert those single product customers to multiple product customers for which you hold their primary operating check in accounts. And so, it’s actually useful for us during the time where we are active opening new branches, still building branches we’ve opened in recent quarters to have a need for time deposits and to be able to run some specials to help grow the deposits in those branches faster and populate those branches with new customers. So when you think about the branches working [Indiscernible] in California but we are really an unknown name. Its’ helpful to have some specials.

Tim O'Brien

And then last question. Mark, did you guys give efficiency guidance or outlook for 2017, if so I didn’t catch the number.

Mark Mason

I don’t think we have other than our general target for the company is to reach an efficiency ratio in the mid 70% range on a consolidated basis. We expect to achieve that next year. Thinking about the opportunity for improved efficiency that primarily lies in the commercial and consumer segment. You saw the efficiency improve this quarter, it didn’t quite hit our targets we are hoping that that would end up around 69%, it’s actually 71% this quarter. We still expect that segment, the efficiency ratio of that segment to fall into the mid plus 60% range by the fourth quarter of this year and next year averaging below 65% falling to the low 60s by the end of next year.

And we can accomplish this by the operating leverage that we are producing by growing revenue at the multiple of expense growth. And so, I feel like we are very much on target. It’s a little volatile, but that opportunity to improve efficiency we think is very much intact. We think we are on track and as a matter it’s continued to execute at the growth rates that we have planned, that have been experiencing.

Tim O'Brien

Thanks for the feedback.

Mark Mason

You bet. Thanks, Jim.

Operator

And our next question comes from Jordan Hymowitz with Philadelphia Financial. Please go ahead.

Jordan Hymowitz

Well hey guys, thanks for your question. I mean just because I’m not very good it sounds like maths. Now you say you are targeting 11 to 15 ROE, kind of imply like 240 to 320 in earnings over the next year or two?

Mark Mason

How many periods are you including? Are you saying per share?

Jordan Hymowitz

Yes.

Mark Mason

Or in total. You know I think that number is going to be higher than that probably if you think about next year, right. And in this year consensus as I said was $1.95 or something with our consensus.

Jordan Hymowitz

$1.95.

Mark Mason

What is it this year?

Melba Bartels

I don’t have it right at my finger tips.

Mark Mason

Maybe you know and next year 250 or something. I mean if you look at our growth rate.

Jordan Hymowitz

This year is 215...

Melba Bartels

Right. That’s right.

Mark Mason

215, okay. It will probably go up a little after this quarter because we exceeded the consensus. A 240 number given our growth rate it seems like a reasonable expectation to be able to accomplish.

Jordan Hymowitz

I guess that was my point is that if people think you are going to fall off the map next year mortgage rises basically guiding their lease by earnings next year.

Mark Mason

Well that’s not what we expect. We’ve had some nice re-financing activity in the mortgage sector but we expect to continue to grow our originations. We guided originations higher and our composite margin while we believe right now it will be slightly lower. We are expecting our mortgage earnings next year to exceed our mortgage earnings this year.

Jordan Hymowitz

Okay. And then the other thing is you called out a couple of one-time things. But instead of $14 million a little over 30 set heads of writing down the MSR. And I know some people think we're going to go to negative rates in this country. But if things are just stable, another $0.30 of earnings this quarter they won't be repeated next quarter.

Mark Mason

Well remember we hedge that away, right. And even in the corollary office of impact when our MSR goes up, we hedge that gateway as well. So the real impact of that loss in volume MSRs will be realized over some future period if prepayment speeds really do increase over that period.

And that's a pretty volatile number, because we have a strong track record of effective hedging, the increases and decreases in our MSRs are largely hedged away in terms of the impact on current earnings.

Jordan Hymowitz

I’m sorry, I completely missed the hedging. I apologize. Sorry about that.

Mark Mason

That’s okay.

Operator

And our next question comes from Bill Dezellem with Tieton Capital Management. Please go ahead.

Bill Dezellem

Thank you. That's Tieton Capital. And a couple of questions. First of all, did you complete the Orange County Business Bank cost reduction here this quarter. Is that now done?

Mark Mason

They are complete. In fact, we completed all of the cost reduction systems and personnel in mid April. And so this quarter while not completely clean of transition expenses, marginally done. And then in the third quarter complete.

Bill Dezellem

Great. Thank you, Mark. And then if the current rate lock trends were to continue incorporating any seasonality that would be appropriate, what would be the mismatch between rate locks and closings in the third quarter?

Mark Mason

Well we guided that. I'll refer you back to my comments. I'll reread them for you. But you can check the script later when it's published. So bear with me for a second. I'll find my notes.

Bill Dezellem

I apologize for missing it

Mark Mason

Go ahead, Melba.

Melba Bartels

In the third quarter so we anticipate single-family mortgage-loan lock and sales commitment volume of $2.4 billion in the third quarter. And closings of $2.6 million. So closings expected to be higher than locks in the third quarter. And then in the fourth quarter, lock volume of 1.7 billion compared to closed volume of $2 billion. So, again, closed volume higher than lock volume in the fourth quarter.

Mark Mason

And of course, that does not anticipate any unusual level of refinancing activity.

Bill Dezellem

Which it would be reasonable to expect an unreasonable level of refi activity given what rates they had post Brexit.

Mark Mason

Well, it’s so hard to tell, right. They have been coming up slightly from their lows. And I know I've always said this a lot of times on calls and in other meetings. We have a healthy regard for not knowing what is going to happen to interest rate. And I believe they can go up as easily as they can go down. I think there are a lot of conditions in the world today that create uncertainty and the flight to safety and treasuries is always just one incident away internationally and nationally.

And while we think that rates if you listen to current discussion are going to stabilize from here and maybe rise, I don't think that can be assured. And so, we create our plans based upon earnings as they are today knowing, that they could go up or down.

Bill Dezellem

All right thank you both.

Mark Mason

You bet. Thank you.

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 Mason

Again we appreciate your patience and your great question today. Look forward to talking to you next quarter.

Operator

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

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