Banc of California, Inc (NYSE:BANC)
Q3 2016 Earnings Conference Call
October 19, 2016 10:00 AM EST
Tim Sedabres - Investor Relations
John Grosvenor - General Counsel
Steven Sugarman - President and Chief Executive Officer
Fran Turner - Chief Strategy Officer
Jim McKinney - Chief Financial Officer
Hugh Boyle - EVP, Chief Credit Officer & Chief Risk Officer
Ebrahim Poonawala - BofA Merrill Lynch
Jared Shaw - Wells Fargo
Bob Ramsey - FBR
David Eads - UBS
Andrew Liesch - Sandler O'Neill
Gary Tenner - D.A. Davidson
Jackie Boland - KBW
Thank you, and good morning everyone. Thank you for joining us for today’s third quarter 2016 earnings conference call. Joining me on the call today to discuss third quarter results are Banc of California’s Chairman and Chief Executive Officer, Steven Sugarman; Chief Strategy Officer and Co-Principal Financial Officer, Franc Turner; Chief Risk Officer, Hugh Boyle; Chief Financial Officer, Jim McKinney; and General Counsel, John Grosvenor.
Today’s conference call is being recorded a copy of the reporting will be available later on the Company’s Investor Relations Web site. We have furnished the presentation that management will reference on today’s call, and that presentation is also available on our Web site under the Investor Relations section.
Before I turn it over to John, I want to remind everyone that as always, certain elements of this presentation are forward-looking and are based on our best view of the world and our businesses as we see them today. Those elements can change as the world changes. Please interpret them in that way. The forward-looking statements are outlined on slide one of today’s presentation, which apply to our comments today.
And now, I’ll turn it over to our General Counsel, John Grosvenor.
Thank you, Tim. Good morning, ladies and gentlemen. I want to take the opportunity to make certain introductory remarks before turning the call over to Steve and the other members of management who will be speaking today. As you are aware, the schedule for this morning’s call was accelerated in order to allow us the opportunity to assure investors with the announcement of our favorable quarterly financial results and also to time respond to the allegations made in yesterday’s Slide Post in Seeking Alpha.
Let me provide a little background. As discussed in our press release yesterday management first advice the Board of Directors in 2015 regarding the facts then known pertaining to the circumstances associated with Jason Galanis’ indictment, including certain claims attributed to Galanis that he was affiliated in some manner with the Company, or members of the Company’s Board of Directors, or management.
In response, the Board of Directors determine to retain outside counsel to independently investigate the matters raised and report any information that might indicate the possible existence of any potential impropriety. The results of that investigation, which is continued over the course of more than a year, fail to disclose any ownership interest by Galanis in the Company or the Bank, and affirmatively confirmed that he exercised no direct or indirect control over the Company or the Bank or any entity owned or affiliated with Steven Sugarman or any other member of the Board of Directors. The investigation also failed to disclose any past or present lending relationship between Galanis and the Bank. And in fact, the inquiry disclose instances in which attempts by Galanis to establish a business relationship with the Company, presumably and further in so the fraudulent schemes for which he subsequently plead guilty or unsuccessful. In that regard, the Company shared information developed in the course of its own investigation in cooperation with the government’s prosecution of Galanis and others. That cooperation is evidenced by among other matters paragraphs 40 and 41 contained in the affidavit submitted by the FBI special agent in-charge of the government’s investigations as resided in the letter of Company counsel. As has been made clear, at least by reputable news organizations, none of the Company or the Bank, or any member of the Board of Directors or management, has been the subject of the government’s prosecution of Galanis.
Finally, in response to the allegations contained in the Seeking Alpha post and at the direction of the distant to some members of the Board, Company counsel has made written demand, the copy of which is included in our filing this morning for the immediate removal and a written retraction of the article.
In addition, the Company has been advised by its counsel that demonstrably of ridges nature of the defamatory statements constitutes actionable liable per se, and the Company intent to vigorously pursue all of its legal remedies. As a result, from the advice of counsel and in order to preserve our rates, we are not going to discuss any further specifics about Galanis during today’s call, while our formal demands for removal and the retraction of the article are pending. We will provide periodic public updates and further information as additional developments occur.
The cooperation is appreciated, and with those formalities concluded. I would like to now introduce Steven Sugarman to commence this morning’s discussion. Steven?
Thank you, John. Banc of California’s financial performance in the third quarter of 2016 reflects this franchise executing on its consistent focused plan. With fully diluted earnings per share of $0.59, Banc of California is clearly winning market share and demonstrating the power and scalability of the strategy. Californians clearly have the significant appetite for a bank that reflects California’s spirit of innovation and its way of doing business.
We aspired to continue to bring fresh thinking to banking to ensure our business reflects the dynamic communities we serve. We seek to exhibit innovation, passion and corporate responsibility in everything we do. And during bank franchises can take years to build, but our results are demonstrating remarkable progress.
In the three years since I became CEO, our assets have nearly tripled. But more importantly, our net income has grown from nearly zero to a run rate of over $140 million today. For the third quarter, we generated a 1.3% return on assets and a 20% return on tangible common equity. Meaning that for the full year, we have now generated a return on assets of over 1.1% and return to our common equity holders of nearly 17%.
While it is tempting to be content with the momentum we are enjoying and the results our talented team is producing. I believe our third quarter will be remembered less for our strong financial performance, but rather more for the important structural and strategic decision we made that we believe will reduce the Bank’s risk profile and increase its long-term return profile for shareholders for years to come.
First, we initiated and made meaningful progress pruning risk from our loan portfolio. We were able to meaningfully reduce our non-performing assets, delinquent loans and non-accrual TDR portfolio through a combination of active asset management and loan sales. Through these dispositions and strong market conditions, we were also pleased to reconfirm that our marks and allowances were appropriate and allowed us to exit without impairment.
Second, we began the process of exiting our seasoned residential loan portfolio. In the third quarter, we sold approximately $100 million of seasoned loans, which included a meaningful weighting of delinquencies. We executed this trade at a significant profit and recaptured capital. During the fourth quarter, we expect to make significantly more progress reducing our remaining position. We continue to believe that there remains additional capital that will be unlocked through these sales and that will reduce the overall credit risk in our portfolio.
Third, we entered into an exclusive agreement with one of California’s leading solar companies to provide tax advantaged capital for the installation of residential solar in primarily low to moderate income communities in California. We are proud that this initiative received accolades from White House. But we are even more proud that we have created a solution that will help increase the affordability of housing in lower income communities throughout our golden state.
Importantly, this transaction, alongside other tax planning strategies we’re implementing, could have an impact on our expected tax rate, bringing it down to approximately 25% in 2017. This structurally changes the overall profitability of our business, and does so in a way that is consistent with our mission, our values, and our conservative risk appetite while furthering our ability to serve our community as well. We believe this investment will be a powerful example of ways to pursue the double bottom line for other banks and corporations for years to come.
Fourth, we continue to materially increase Banc of California’s liquidity profile and improve its interest rate risk metrics by reducing FHLB borrowings and other short term funding sources in favor of core and term deposits. Our deposits grew by $1.1 billion during the quarter. Fifth, we entered into a flow agreement for our agency mortgage servicing rates. We believe this agreement will reduce our MSR exposure meaningfully going forward, reducing our volatility and compliance risks, while in fact increasing the profitability of our business.
We continue to look for opportunities to prune our portfolio and insure that we enable the strong profitability and growth we are seeing today from our core businesses to drive our future. While our credit metrics are among the best in the industry, we believe we can strengthen them even further in the months to come. It is the power of our origination platform that continues to generate high quality relationship based loans in our core markets that is enabling us to aggressively manage our portfolio credit risk without compromising growth or profitability.
We expect to continue our focus of reducing the long-term risk profile of the Bank during the fourth quarter. Given the recent capital markets volatility in our stock, we will focus on building capital, strengthening our deposit franchise, and ensuring we are prepared to serve our clients well, come what may. We are prepared to finish the year with assets between $10.5 billion and $11.5 billion. This reduced growth profile will allow us to efficiently deploy capital into loans while opportunistically unlocking capital through the sale of securities and other assets with embedded gains that can reduce total consolidated assets. Given today’s valuation of our Company, we believe this strategy will allow us to continue to deliver on our mission to be California’s bank, while enabling us to create shareholder value through stock repurchases.
To the extent our enterprise value stabilizes and returns to higher levels, we would deploy the capital back into the overall growth of our franchise.
We finished the third quarter having generated earnings per share of $1.40 for the first nine months of the year, or an average of approximately $0.46 per share per quarter on a fully diluted basis. We are confident that we will remain at or above this pace for the remainder of the year. Therefore, today, we’re revising our guidance up from $1.60 per share to finish 2016 at or above $1.85 per share for the full year. This represents a 15% increase to our existing guidance for 2016 and over a 45% increase to our initial guidance of $1.26 for 2016, which we provided this time last year.
Our current stock dividend payout ratio is falling below 25%, which represents the bottom of our target range. In the coming weeks, the Board will actively consider whether to increase the dividend, pay a special dividend or convert the dividend into a greater stock repurchase strategy, or pursue a combination of these strategies. Yesterday, the Board approved an initial authorization for management to initiate a stock repurchase program. It is gratifying to see market demand for our banking solutions growth as our brand and awareness grows throughout California.
During the third quarter, this demand resulted in deposit growth of $1.1 billion. We have a lot of work left to do, but we are excited by our results during the quarter and remain optimistic about the fourth quarter.
With that, I now turn it over to Fran to discuss our performance in a little more detail.
Thank you, Steve. Turning to Slide 2, our third quarter results demonstrate consistent growth in our recurring core businesses. The third quarter was highlighted by record earnings and earnings per share, as well as 1.3% return on assets and 20% return on tangible common equity and an efficiency ratio of 62%. Since just the year ago, our total assets grown by nearly $4 billion or 55%, while our quarterly net income increased by $21 million or 147%.
Importantly, our net income is outpacing asset growth by almost 3 times, which is attributable to our strategic business model and efficiencies of scale. The strong financial performance continues to be driven by another quarter of record deposit growth of $1.1 billion, strong organic loan growth and a concerted effort to manage our balance sheet to ensure strong and stable asset quality.
Slide three highlights our consistent and improving financial performance over the past five quarters. The third quarter marked the 10th consecutive quarter of earnings which we see the consensus balance expectations. We continue to see accelerating profitability alongside consistent and increasing predictable financial returns. Our returns are exceeding our targets of 1% plus ROAA and 15% ROTCE. And the combination of these strong returns coupled with the solid growth which we’ve seen drives considerable value creation for shareholders. With the scalability, the marginal economics associated with our continued organic growth are very strong and have the most attractive investment opportunities for us today.
Earnings per share for the third quarter was $0.59 per diluted share, up from $0.43 during the second quarter, and year-to-date, our earnings per share totaled $1.40, which annualizes to $1.87 per share.
Net income totaled $35.9 million for the quarter, an increase of 35% from the previous quarter, and an increase of 147% from a year ago. Driven by strong earnings growth, we meaningfully exceeded both targets for ROAA and ROATCE, which came in at 1.3% and 20% respectively for the quarter.
Slide 4 recaps the strong upward trend of growing recurring net interest income, which increased 57% from a year ago and increased by $6 million from last quarter. For the third quarter, earnings by segment were balanced as expected as the commercial banking segment continues to drive the preponderance of our earnings, producing over 80% of our business segment earnings.
The commercial banking segment generated $42.9 million segment income before taxes, up 70% or $25.3 million from a year ago. The mortgage banking segment performed strongly in the third quarter as production volumes were strong. And unlike the prior two quarters, the segment was not negatively affected by large valuation adjustments on the mortgage servicing rights portfolio.
As Steve mentioned earlier, as part of our overall interest rate risk and balance sheet management strategies, we have signed flow agreements during the third quarter for the sale of newly originated MSRs in order to reduce the volatility associated with growing the MSR portfolio. This is another step we are taking to strengthen the balance sheet while focusing on our core business and reducing the volatility driven by changing rate environments, and ensuring consistent and predictable earnings.
Turning to slide 5, we continue to target a 40% marginal efficiency ratio as we continue to grow. Our consolidated efficiency ratio continued to improve during the quarter, declining to 62%, down from 68% last quarter and down from 75% for the full-year 2015. On a segment level basis, the efficiency ratio for the commercial banking segment was 57% for the quarter, while the efficiency ratio for the mortgage banking segment was 84% for the third quarter.
We are driving down the consolidated efficiency ratio by continuing to invest in and grow the commercial banking segment. Scaling our commercial banking businesses will drive the consolidated ratio lower over time.
We are also investing in and implementing technology solutions in order to drive down the cost of manual processes and to improve costs through automated functions. For example, we are implementing various finance and accounting reporting systems in order to produce more automated reports and self service style reporting options in order to reduce the overall time and effort spent reporting and analyzing data and trends.
Although salaries and benefits increased by $7 million compared to the prior quarter, salaries increased by just $2.4 million from the prior quarter and the uptick in this line item was primarily driven by higher commissions and bonuses tied to production and higher profitability.
One important area that we have seen attractive returns on our investment is in our marketing and community partnership expenses. These include CRA contributions, marketing activities, sports partnerships and other partnerships. We target spending up to 1 basis point of assets value per month on this collection of investments and will continue to target this level of investment for the foreseeable future.
We believe these investments are key to our deposit and loan growth, our recruiting, business development and pricing strategies. The elevated ROI that we believe these investments are generating supports our belief that we are demonstrating that what is good for California is good for our shareholders.
The commercial banking segment showed continued improvement in productivity and efficiency as noninterest expense to total asset declined to 2.1% from 2.6% during the quarter. Assets per FTE also continued to increase in the third quarter to $6.4 million per FTE.
Slide 6 summarizes a few of our third-quarter actions, which improved the overall liquidity and credit profile of our business while reducing risk and supporting stronger core business fundamentals on top of our record profitability. In the third quarter, we have made significant progress in reducing our credit risk profile by reducing nonperforming assets and delinquencies by over 25% during the quarter. This has resulted in a 37% increase to ALLL to NPL coverage ratio, which now stands at 114%.
We also initiated a series of tax planning strategies during the quarter, including a solar investment partnership focused around CRA benefits and affordable housing in LMI communities. The tax efficient and principal protected structure of this transaction improves the recurring profitability of our franchise through a lower forecasted tax rate that will likely be in place for up to five years.
We expect our tax rate from this and other tax planning strategies could fall from 40% to just under 25% beginning in 2017. This innovative and first of its kind program focused on LMI communities was recently recognized by the White House and is directly aligned with our community development program objectives.
In addition to being part and parcel to our CRA activities, the transaction targets after tax returns in excess of 15%. For the third quarter, this investment produced $5.5 million of net benefit to earnings through tax savings.
We finished the quarter with approximately $25 million in outstanding exposure to these energy investments. While the program is innovative, we expect that our credit exposure will be modest and we do not anticipate our outstanding exposure will reach more than 1% of assets at any point in time. Ensuring appropriate liquidity continues to be an ongoing focal point and we have increased our liquidity by $1 billion during the third quarter. We have increased liquidity and contingent liquidity by approximately $4 billion over the past year.
As deposit growth continues to be at record levels, we simultaneously have reduced our reliance on borrowings by reducing FHLB borrowings by $425 million over the prior two quarters. This takes our FHLB borrowings to total assets to just 7%, down from 12% and funds more of our assets with core deposit funding. Again, we also signed flow agreements for our newly originated agency mortgage servicing rights in order to better manage the potential volatility caused by these assets due to interest rates.
Shifting to slide 7, our deposits grew by a record $1.1 billion during the quarter. This continued deposit growth totaling $3.7 billion over the past four quarters and growing at 67% from a year ago has a allowed us to reduce borrowings in particular and specifically lowering FHLB by $160 million during the third quarter alone.
Shifting to slide 8, this slide highlights our robust loan originations. In the third quarter, the commercial banking segment produced $1.1 billion of loan originations. This represents an increase of 51% compared to the prior year period while our mortgage banking originations accelerated to $1.5 billion driven by a strong production quarter.
We currently are on track to exceed our 2016 target of $8 billion in total loan originations for the year as year-to-date loan originations currently stand at $7.1 billion and year-to-date commercial banking segment originations total $3.2 billion.
Slide 9 breaks out our commercial banking segment loan growth, including C&I, CRE and multi-family, along with residential. Collectively, commercial banking segment loan growth was driven by C&I lending. C&I drove 70% of our overall loan growth with residential and CRE making up the remainder.
We elected to sell approximately $280 million of jumbo loans; $10 million of lease loans; $70 million of multi-family and other delinquent loans; as well as a $100 million pool of our seasoned SFR mortgage loans, which comprised some of the higher delinquency loans during the quarter. Even after these combined, non-agency commercial banking segment loan sales of $467 million, our net HFI loan growth was still $333 million.
With that, I will now turn it over to Hugh Boyle, our Chief Risk Officer, to discuss our credit and asset quality.
Thank you, Fran; and good morning, everyone. Asset quality at Banc of California remains strong and stable. Slide 10 in our investor presentation recaps the continuing actions we took to derisk and strengthen the balance sheets and the resulting improvement in asset quality metrics.
During the third quarter, we completed a series of actions aligned with our conservative credit risk appetite and active portfolio management strategy to ensure that Banc of California's asset quality remained and remains strong and stable. With the strong external capital markets environment and the internal determination that our special assets team could be more effectively allocated, we took the opportunity to selectively prune the portfolio through the completion of three loan sale transactions.
Two of these transactions include exclusively nonperforming loans. The third transaction represented the sale of a portion of our seasoned and acquired residential mortgage loans. These actions reduced our nonperforming and delinquent loan balances and alongside active credit management, we were able to reduce nonperforming assets to total assets by 29% from the prior quarter and by 48% from a year ago.
The total delinquent loans to gross loans ratio improved by 26% compared to the prior quarter with a reduction of $29 million in reported delinquencies. These reductions in classified assets came not through charge offs or provisioning, but through the positive resolution of the credits themselves.
It is important to note that all three loan sale transactions were completed at prices above our book value and represented a net gain on sale to the bank, inclusive of third party commissions and transfer costs. This reflects our conservative internal marks and disciplined market approach.
During the quarter, we experienced net recoveries on loan resolutions, meaning that recoveries outpaced charge offs. This provides us comfort that our confidence in our credit quality and credit risk is supported by the market and actual trades.
We expect to continue to actively reduce classified assets and proactively manage loan concentrations during the fourth quarter given the strong market appetite for our loans and the reputation for strong and transparent credit performance that our loans have earned in the market.
Turning to slide 11, all credit and asset quality metrics improved from the second quarter. On a percentage basis, nonperforming assets to total assets declined to just 32 basis points, the lowest level experienced since our recapitalization in 2010.
Year-over-year, our nonperforming assets to total assets ratio has improved by 30 basis points or 48%. Nonperforming loans to total gross loans also improved to 54 basis points in the quarter, down from 72 basis points in the second quarter and down from 96 basis points from the prior year.
OREO balances declined from the prior quarter and were de minimis at just $275,000 at quarter-end. Recoveries exceeded charge-offs for the quarter resulting in a net recovery of $158,000. Importantly, these reductions were due to improving credit quality as we experienced lower gross charge offs during the period at a rate of roughly 70% of our average quarterly charge offs for the last five quarters.
The bank's allowance for loan and lease losses, or ALLL, increased by $2.8 million for the quarter to end at $40.2 million. Net loan growth was the key driver of provisions and the increased level of reserves. With the improvement in our asset quality during the quarter, the ratio of ALLL to nonperforming loans improved from 83.3% last quarter to 114.2% this quarter. The ratio of ALLL to originated loans and leases declined slightly quarter-over-quarter to end at 0.79%, or 79 basis points, reflecting the improvement in our asset quality and the relatively benign macroeconomic environment. When both the ALLL and fair value discounts are combined relative to total HFI loans, the bank has a 1.92% coverage ratio at quarter end.
Lastly, I would like to spend a minute discussing our views of the current credit environment. We are cognizant that the banking system is at or just coming off a cyclical low point for credit losses and that credit losses are beginning to impact other banks. Our entire management team is focused on attempting to proactively identify key areas of risk and opportunistically reduce the potential for such losses to impact Banc of California.
To date, we feel very good about our portfolio. Our comfort is not based on trust, rather it is based on the seriousness in which we take credits and the threat we understand credit poses to a growth oriented bank. Last year, we took notice of the elevated level of commercial real estate, or CRE concentrations, that our regulators began warning banks about and we proactively sold down our CRE exposure to ensure we reduced concentration risk and tail risk in that portfolio. We have also worked to ensure that our lending terms enable us to increase the liquidity of our portfolio in the event that changing market conditions require active portfolio management to change our overall exposure profile.
While we know that the above actions will not overt losses entirely throughout an economic cycle, we will continue to work vigilantly to ensure that our credit quality remains strong within the overall industry.
On the last earnings call, our CEO, Steven Sugarman, discussed seeking opportunities to prune our portfolio and focus our energies on scalable businesses, consistent with our mission and vision as California's bank. This approach has resulted in the sales we reported during the third quarter and we hope to continue to extend and execute a similar strategy into the fourth quarter.
While these risk-reduction initiatives may be premature relative to our current position in the economic cycle and hence may incrementally reduce our overall loan growth, we strongly believe that these actions will improve the quality of our credit risk profile through the cycle. Banc of California has the right tone in its leadership to risk being ahead of the curve on credit and risk mitigation. I believe that this is an example of the benefits of a strong risk appetite framework, supported by investments in risk systems, expertise and analytics and coupled with the right culture to listen to and include risk and credit professionals in the strategic planning process.
Now I will pass it over to our CFO and Co-Principal Financial Officer, Jim McKinney, to address capital and liquidity.
Thank you, Hugh. Slide 12 highlights our strong capital ratios at the end of the quarter as they continue to exceed both current and fully phased in Basel III requirements. During the third quarter, we did not execute any transactions on our filed ATM program as we continue to view the program as contingent capital that supports the business and strengthens our stress testing program.
Additionally, we tested our advances from our holding company line of credit by drawing down $50 million during the third quarter. We have added a chart on the right side of the slide, which reviews the increasing liquidity position we have built over the past year. We have proactively undertaken a series of actions to increase contingent liquidity to strengthen the balance sheet and ensure we can serve clients consistently over time across various macroeconomic environments.
We have increased our securities portfolio to 26% of total assets, increased our FHLB borrowing capacity and expanded repo lines to $1.25 billion. Banc of California could not be better positioned and I am proud of the progress we have made in strengthening the balance sheet, liquidity and capital over the past year. As I will pass the torch along, I have no doubt that the actions we have taken and continue to pursue will ensure that Banc of California is a franchise built for the long term.
On slide 13, we are delivering market leading compound annual growth rates for asset growth, loan growth and deposit growth, all of which continue to be in excess of 55%. Meanwhile, net income has grown by over 100% annualized since 2012 from $6 million to over $140 million annualized this quarter.
In similar fashion earnings per share has grown over 45% annually since 2012. Based on the quality and quantity of the balance sheet assets and deposits added to date, their impact on predictable core spread based income and a positive business outlook, we are increasing our 2016 earnings per share public guidance to exceed $1.85 per share.
With that, before I turn it back to Steve, I would like to pause for a moment to thank Steve, the Board of Directors and the bank for the opportunity to be the Company's CFO over the last year. Steve, your vision and mission to be California's bank are inspirational, commendable and provide a thought construct on resource prioritizations and allocations that are good for shareholders. It's been an honor to work with and learn from you. You have been and continue to be a good mentor. Thank you.
Related, I have deeply enjoyed being a part of the Banc of California team and working with various members across the bank to enhance the speed and quality of the close process, improve the control environment, enrich our financial policies and create strong financial analytic and business transformation groups that will continue to enhance the bank's decision making capabilities, operating efficiency and control environment.
A few noteworthy items include the creation of a master data management strategy and roadmap; the formalization of contingent liquidity requirements; the introduction of SaaS to serve as a platform for bottom-up forecasting and DFAST automation; the rollout of SBO 2000 to minimize the bank's loan accounting and operational platforms while increasing functionality and production optionality; the implementation of Tableau to provide data visualization and to enhance the bank's control environment by separating the data and presentation layers while increasing process automation; and the strengthening of financial and regulatory reporting processes. I now turn it back to you, Steve, for closing remarks.
Thank you, Jim. On slide 14, we outline our increased guidance for 2016, as we have achieved all targeted metrics we set out to deliver against. We have increased our earnings-per-share guidance for 2016 by 25% to $1.85 per share or greater, up from $1.60 per share previously.
Our year-to-date results highlight that, for the entire year thus far, we've exceeded all of our stated targets with a return on tangible common equity of 16.8%, a return on assets of 1.1% and an efficiency ratio of 67%. Additionally, we have already achieved $1.40 earnings per share with a quarter to go for the year.
In closing, I want to thank Jim for the work and expertise he has provided to Banc of California. Jim, you and your team's ability today to accelerate this earnings release for the benefit of all of our investors and stakeholders reflects well on the quality of your work and on your professionalism. It also reflects well on your strong control environment and closing process. We wish you well in your future endeavors and appreciate the strength of your team and the fact that you leave us a very strong, capable team of finance professionals able to move the bank forward.
That concludes our formal comments today. Operator, let's open the call up for questions.
Yes, sir. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Ebrahim Poonawala of Bank of America Merrill Lynch. Please go ahead.
Good morning, guys. So I guess first question -- thanks, John, for giving an update into the investigation. I think to the extent you can, is the investigation -- what was not clear was, was the investigation complete, or is there a timeframe by which we should expect that investigation to be completed and should we, as from the outside, anticipate an update on the final findings and what sort of the takeaways from the investigation were?
Ebrahim, thanks for the question. The investigation and the review is in the hands of the disinterested directors, so the Board of Directors. Anytime to receive a comment or letter that raises questions on any matter, the Board will go through each of the items and ensure that each of them are investigated, reviewed and that there's adequate resolution. That's the case here as it is with any information that comes to the Board's attention. So the process continues. It's headed by our disinterested directors. It's something that they are committed to providing updates to the market as they have them and while there's a substantial amount of work that they've done and that they have been able to provide to the market, they will and are committed to providing additional transparency as they can.
And I'm not sure if I missed this, Steve, who specifically from the Board is heading this investigation?
Well, it's comprised of all the disinterested directors of the Board and it's also complemented by third-party independent investigators to ensure that there is a robust and complete review. And so we will leave it to them to communicate on their own behalf as I'm not directly involved in that process.
Understood. And I guess switching to -- obviously means you announced the CFO transition in the middle of the quarter. Just wanted to get a sense in terms of if the structured that's in place today, is that the final plan on that, or do you expect to have eventually someone back in the CFO seat? And if you can just talk about are you looking to hire from the inside, outside, what the process around that is?
Yes. Well, thanks for the question. Our process around succession group planning is pretty consistent across the bank where what we like to do is ensure that we have a robust process that, one doesn't rush things and two, puts people in positions to review and go through a cycle. As you can see in this close process, we've had unexpected and different situations come up, which kind of test the capabilities of the existing team and test the capabilities of the organization. And so we find it to be healthy and something that's prudent for a regulated organization to not rush into these decisions, but to take them appropriately and prudently and to evaluate them so when we make a decision, we feel that it's in the best interest of the Company.
The fact that this morning's call was able to be organized so quickly, that we were able to go through our complete and full control process, all of our committee meetings, all of our Board meetings and all of our financial controls and accelerate them and we're able to report our earnings today and do them seamlessly, I think we reflect very well on the internal team and the internal capabilities we have. And I think that that's something that we take very proud note of and ultimately, for this position, it's a role that goes through the Board, it needs to be approved by the Board and is a formal process with the Board and it's also something that we talk and work closely with our regulators on.
And so over the next couple of days and weeks, I think that you will see clarity provided to the market on this, but we have a great deal of confidence in the team we have. We've put in place a structure that we think is robust and keeps the Company in very strong stead and we have a lot of confidence in where we are today closing the books for the third quarter.
Understood. If I can sneak in one last one in terms of just rounding out on capital appetite. You obviously have the ATM out there, but you talked about potentially raising a dividend, considering a special dividend or something on those lines. Does that mean that given the growth that you see for bank, I guess let's call it the next four to six quarters, we shouldn't anticipate equity or a common equity offering in the next 15 to 18 months?
Yes, let me be clear on this. The revised guidance I gave earlier in the call is that management is prepared for asset growth to be dampened and even negative where we can create a more efficient platform, still serve our mission and our clients, but reduce asset size through the sale of some of our increased securities portfolio and other appreciated assets to unlock capital and reduce total assets as necessary so that we can go an extended period of time without any need for capital.
And at these capital market prices, we would go an extended period of time and focus economically on building shareholder value through stock repurchases in lieu of asset growth. And we are prepared to shrink assets if necessary if that's what it takes to increase shareholder value, and if our shareholder value in the capital markets returns to more stabilized levels, we will evaluate the best use of our capital. If that returns to be asset growth, we will continue upon asset growth.
One of the nice parts of our platform is we have a very healthy and robust capital markets function so we are able to manage our balance sheet without putting our clients at risk and with servicing our clients' needs. We are able to fulfill our mission without being interdependent on our balance sheet size. So we will serve our clients very well. We will manage our balance sheet very well and with the capital markets where they are today, we will run our business such that we can meet our mission and our goals independent of capital markets activities.
One of the things that I would just like to add to that is I think that a lot of the investments that we've made in analytics and data and in particular our DFAST consistent stress testing over the last 24 to 48 hours have really reflected to myself, my management team and my risk team just the important role they play for the bank and how fortunate we are to have been on the leading edge for a bank our size to have made these investments.
One of the things you see in DFAST stress testing is looking at how you manage your balance sheet to preserve capital in times of stress. We look at the last 24 hours as a time of stress, not stress for our business, not stress in a real sense of serving our customers, but capital market stress. And when you look at capital market stress, you need to look at the overlays you can put on your balance sheet and how you can manage capital so you don't impact clients and you don't impact employees and you don't impact business.
And what's terrific is, over the last year, we've managed our business thinking about these situation and thinking about our DFAST stress test and the build of our securities portfolio provides us a 26% cushion as of the end of the third quarter, which is flexible, that can come down and come up as necessary to measure with liquidity. And that's one of the big benefits of having the expanded securities portfolio. We cited that when we talked about building the portfolio. Today, we are able to put that in practice.
Similarly, how we've structured the liability side with some of our FHLB deposits and some of our non-core funding, that's also very flexible, but we can bring that down in conjunction with securities and without comprising the core value of our franchise or any of the ability of any of our business units to serve our relationships, we can bring down our capital, which brings up our TCE and brings up our capital to total assets and manage through discrete periods like this when the capital markets go through periods that maybe delinked, delinked from earnings and fundamentals.
So we aren't thrilled about volatility in the capital markets, but we recognize that that's a fact of life and we recognize that we need to be prepared and that we need to manage our business with data analytics, stress testing and contingency planning. That's where we are and that's what we will do.
Understood. Thanks for taking my questions.
And our next question comes from Timur Braziler from Wells Fargo. Please go ahead.
Good morning. It's actually Jared for Timur here. Just following up on the question about the independent investigation, or the Board investigation. I guess, to what extent, if any, are the regulators involved in this process and are they, what are the required discussions you are having with them regarding this whole situation?
Look, we don't engage in public discussions about regulatory discussions. What I can tell you is that we have really been proud since my time as CEO of our regulatory relationships. I've mentioned publicly that my greatest upside surprise as CEO has been the quality of the relationship with the regulators, the quality of their advice and the open and transparent nature of our communications.
I reiterate those thoughts today. I think that we are really blessed with strong and knowledgeable regulators. And with that, I will just leave it at we are regulated by numerous regulators. We talk with them regularly. They are on site regularly. We are highly transparent and communicative, but we don't get into the details of our conversations.
Okay. Thanks for that color. And then also following up on the capital discussion that you just had too, realizing that you are focused more on those risk-adjusted and regulatory capital ratios, but at what point, I guess, will TCE become more of a focus for you below the peer group here in terms of the actual TCE ratio? Are you comfortable with that at this level, or as part of the whole discussion around capital options and asset size, will you be looking to try to grow the TCE ratio specifically?
We have no concerns on capital or TCE ratios within our capital stack as we are currently situated. Within our strategy, if we were to actually believe that TCE would simply grow, our earnings potential is so strong and we have the ability to unlock earnings that that's not a driver within this discussion. In fact, as you transition to more of a DFAST model, what we look at is capital risk where we believe much higher than peers when you think about capital risk. When you look at the actions we took in the third quarter and what we are discussing taking in the fourth quarter with the reduction of classified, delinquent and NPA assets and the reduction of at-risk loans and assets, that really impacts our capital at risk and brings it down. And so the proactive credit decisions we are making are really meaningful to the capital decisions and also the stated guidance on the ability to manage the business without the total asset growth, if necessary, takes any capital ratios off the table for the near term or really as long as -- for the medium term or long term as long as that situation persists.
The last thing I would just mention is, with the scale we've achieved as a franchise, as we look out over the next several quarters asset, growth is not necessary for us to achieve our guidance for earnings growth and EPS growth. So when we think about investing our capital into either asset growth or share repurchases, when our stock is trading at a discount to tangible book value and we are making so much money, one of those things and one of the primary things evaluate that against is which drives higher EPS growth and drives higher fundamental returns to our investors. So what we are not talking about today is sacrificing the trajectory of our EPS in total returns. What we are talking about is actually a pretty interesting opportunity where you can drive the returns in a much lower risk manner with much lower operational risk and other risks just because of opportunities the market is availing to the Company.
Thanks. And then my final question is just looking at the change in the securities portfolio and the growth there, can you give us a little color on what you are buying in the quarter in terms of duration and yield and was it still heavily on the CLO side, or are you looking more at the liquidity side in terms of your purchases this quarter?
Yes, it's a good question. Our securities portfolio in terms of the interest rate duration has come in significantly. One of the things we've done is favored those securities with three month resets on yield. That's a big tailwind for us. As you may have noticed, LIBOR has ticked up over the last 30 to 60 days, in particular 60 day LIBOR. As you look at the impact of that on our portfolio, there is meaningful interest upside that you will see over the fourth quarter on over $1 billion of securities that reset quarterly and are linked to 60 day LIBOR. Within the quarter, you have seen the shorter duration. Yields have also compressed so the yields within the securities portfolio on similar asset classes have compressed a bit and part of our mix of assets have reduced some of our NIM because of the increased weight of securities across our asset base.
I think as you look forward you also asked about CLOs as you look forward, I think that our position in CLOs is about the size that we had been targeting and that we are comfortable with. There's been a meaningful inflow of capital into that space. On a fair market value basis, there's a meaningful appreciation and mark to market embedded gain in that portfolio. So that's one of those portfolios that is relevant to the discussion when I gave guidance earlier that we have securities that may be available for us to consider evaluating should it make sense for us to scale back our assets to unlock capital or reduce assets. So there's now meaningful gains from that portfolio that could really be attractive should we choose to unlock them, at least as of the end of the third quarter.
Great. Thanks for the color.
And our next question comes from Bob Ramsey of FBR. Please go ahead.
Hey, good morning. I guess I'm still trying to reconcile the focus on building capital with the talk about dividend increases, special dividends and buybacks. Is it fair to think that any sort of uses out of capital in that way that capital ratios would still be flat or up as you guys bring down total assets and of course of internal capital generation, but is that the right way to think about it such that all regulatory capital ratios would be flat to up in any scenario?
That would be a fair way to think of it, or at least up compared to our internal targeted ranges. So if we set a base target that is Board approved if you look at this quarter, we generated $35 million, I believe of net income. That means that if we grow by less than $400 million, it becomes accretive to our capital ratios. That's the highest level. That's a rough estimate because there's other things that go into that calculation, but just as a rough estimate, if we are not growing by several hundred million dollars, our capital ratios are going up.
In addition to that, if the balance sheet on exposure actually comes down a little bit, for every $100 million we bring it down, that probably frees up a little bit north of $10 million. So there's significant ability to increase capital and capital without decreasing capital ratios that's embedded in our balance sheet and that's what I was trying to refer to when you think about the DFAST scenarios of how you can fluctuate the size of your balance sheet to manage your capital and your capital ratios and why we are pretty proud of the liquidity on our balance sheet that's in an in the money position.
When you look at the size of our securities position and the size of some of our short-term funding, that may not add that much to our mission in core enterprise value. We've got a lot of flexibility to navigate our asset size if the Board were to elect to redeploy capital away from asset growth and into share buybacks.
Additionally, I would just note that if you look at market dynamics, the ROA that you could return on securities, or the basket of securities that we've elected to deploy into has come down over the past couple quarters as the mark-to-market value of these securities has gone up and at some point, that ROA becomes less compelling.
So we are actually at an interesting moment where the capital markets volatility by happenstance comes at a time where the return profile of those securities may justify a change of strategy in any event. And so we are not talking about much of an earnings impact and there may actually be an acceleration of earnings.
And that's the analysis we need to go through and so I provide this just as a commentary and guidance. It hasn't been an extended period of time over the last 24 hours since the volatility picked up [technical difficulty], but we have some feel and some guidance as to the path so we want to be transparent. We want to share with you what our thoughts are and I think that you will find, like with most things, that we have the quality of data and the quality of expertise here that you will find decision-making reflects the speed at which our markets move.
And so we will try and keep you up-to-date on how these decisions come out and be transparent with it, but we feel very good about our franchise and we feel very good that if events like this were to come out, you want it to come out when things are operating very well, when the sun is shining, when you are making a lot of money and when the market really values your services and you are taking market share and that's where we are today.
Okay. And when you talk about tempered growth or even possibly contraction, is it fair to assume that's all in the securities side or possibly on some portfolio sales like you guys did this quarter and are contemplating in the fourth, but that your core loan growth would be unaffected by any of this shift?
Well, one thing we are committed to is our mission and we've got great business units with great relationship-based business and we will take no action to compromise that, or to compromise our relationships with our clients, or to reduce the level of service and commitment to our clients. So that's not what I'm talking about. However, I did give some guidance earlier in the call that we are looking to reduce our seasoned loan portfolio. That's something that we started the process in the third quarter. It's a portfolio that is a purchased portfolio, so it's not direct to any relationship-based business. It's a function of historic decisions we had made. It's a portfolio that we believe to be meaningfully in the money and, at the end of the quarter, it was a portfolio that had size of $700 million to $800 million, I believe. And as we sit here today, if we are under LOI to sell a meaningful amount of that portfolio and I believe I gave some guidance on that and so there are some loans that we would also sell along the way. And so that would be an example of something that's $700 million in size that would not compromise our mission that would unlock what we believe to be meaningful capital and that provides additional flexibility.
Okay. Great. And then in thinking about the buyback authorization that you guys came out with last night, it's fair to assume they you all have engaged in active discussions with regulators and they are completely comfortable with you all buying back 10% of shares outstanding?
We have had this program approved by the Board previously, so this is not a new program and it replicates a program that we had put out a couple years ago. It's something that as we look at our stock and our position, we feel could be very attractive. It's also something that given the speed and movements within the market, we decided was very opportunistic as far as the timing yesterday. Depending on size, there's different levels of actions that would be taken, but we are very comfortable that with any plan we have that this is consistent with it, it's within our regulatory capabilities and that we would not pursue this if we thought that it would reduce our capital below our currently targeted levels or could sacrifice the safety and soundness of the bank. However, as an alternative capital deployment against growth in a more accretive way with less risk, we believe that it could be exactly the right way to go, and we believe that our policies, our regulatory regime and our governance structure is consistent with it.
Okay. I guess what I was saying is you highlighted the positive open relationship with the regulators. Is this something you've been open with them about and everyone is connected on?
I can assure you that when you 8-K things like this that you have positive and open dialogue on all items that go through an 8-K process during the course of a regulatory relationship.
Okay. Great. Last question and I will give someone else a chance. But just curious, obviously, the Company is looking at buying stock here. Is management of the same mind? Should we expect whenever a blackout period ends that you and other members of management would be stepping in with open market purchases as well?
One of the probably biggest points of dissatisfaction I've had from the management team recently is that we are a very active bank and oftentimes it's hard to find a window that opens, so we are hopeful that there is a window that opens. I don't want to speak for everyone, but I would be surprised if there wasn't meaningful interest amongst the Board and the management team to the extent we got to a window that opened for us to be able to participate in our shares.
Okay. Thank you.
And our next question comes from David Eads of UBS. Please go ahead.
Hi, hood morning. I guess maybe starting off on the investigation. The comments have mostly been around the direct ties between Jason Galanis and the bank. And I'm just curious whether the investigation and the report are going to get into some of the other allegations made of indirect ties between executives and Board members and other entities involved in the frauds that Jason Galanis was involved in.
David, this is John Grosvenor. I'm going to have to protect Steve from his own good nature. We are not going to talk about Galanis. So please go onto your next question.
All right. You gave the color around potentially keeping asset size flattish and I know there's a lot of moving pieces in moving to 2017, but if we're assuming the increased efficiency, the upside from the tax credit investments, potentially offset by flattish balance sheet and potentially lower mortgage revenues, is it reasonable to think that the earnings outlook for 2017 could be at least flat to up from the new $1.85 level for 2016?
Yes. We will be prepared to provide some updated guidance around 2017 here in the very near future. What I can tell you is that we target, as we've said before, 15% year over year EPS growth. That continues to be our target and we see nothing that's happened in the last 24 hours, the last week or the last month that would cause us to have any reason that that would not be our target. And so I believe that that target would be pretty consistent with your target for 2016 and above just about every sell side target that exists. But we will provide our preliminary guidance around 2016 in the not too distant future. I'm sorry, for 2017. My bad.
Sure, no worries. And then just on the mechanics of the tax credit, should we expect the dynamics to be similar to the third quarter, but in smaller numbers per quarter of seeing an increase in the expense line item more than offset by a reduction in the tax expense? Is that dynamic going to continue?
Yes. That's exactly right and what I would point you to in the earnings tables is, in the back, we do a reconciliation that walks you through it and we've also provided you an adjusted efficiency ratio, which is the efficiency ratio we will use to help you evaluate against our targets, and so that will walk you through in some part how that tax situation works with the solar investment. But you are exactly right; it will be the new line item around the solar expense generally offset against the tax item.
We use a discrete set of accounting for this so it can fluctuate. That being said, when you think about the size from period to period, we've tried to give guidance that this is not going to be a meaningful kind of credit exposure at any one point in time, but as these credits flow through the system and we have capacity, we will put more out. We are looking to finance tens of thousands of houses here and creating affordable housing opportunities for tens of thousands of Californians.
This business is really a lending and lease business. So while it goes through a partnership, what we are really doing is we are providing financing to low to moderate income communities and people for their houses and so it's really part of our core type of mission where we lend money to people on loans or leases and things of that nature. And what this does is, through the structure, lowers the cost of their housing and their electricity.
It lowers the cost of their electricity so it meets an affordable housing goal and the reason we are comfortable here, not just with the size of the outstanding exposure at any point in time, but it also gets you repaid with critical principle protection that's not reliant on the homeowner themselves through tax credits and tax advantaged structures. So the preponderance of our investment comes back to us just at the tax line, which provides a very high credit quality investment. It's something that will be consistent over time for multiple years with a low outstanding balance.
So we think that it has a risk appetite, risk tolerance that's in line with our risk tolerance. We think that it will structurally improve the profitability and the use of our tax line item for our investors and it will reinforce and accelerate the reputation we have for doing innovative and great things for California's low to moderate income community in line with our mission.
All right. Thanks so much.
And our next question comes from Andrew Liesch of Sandler O'Neill. Please go ahead.
Just some questions on the expense lines. I was wondering if you could just back out the tax credit expense. Looks like on aggregate $107 million a quarter or so. Sounds like you are still looking to hire, especially with the group that you brought on the other day. I would imagine, because you are a growth company, that you are going to continue to hire and it sounds like there are some other back office investments you are going to make, but then on the flipside maybe without the growth in the balance sheet, it might be revenue or, maybe expenses grow faster than spread income. Is there opportunities to grow gain-on-sale revenue, gain-on-sale used portfolios and some of the securities faster than expense growth?
The place that we are going to see the most meaningful profitability growth and where our focus is isn't necessarily gain on sale. While that might be the case at points in time, I think our prior guidance there stands. It's really around our core spread business. We even saw in this last quarter re-pricing some of our loans to extend out the spread. Now, that doesn't come through on NIM immediately because that portion of the portfolio needs to grow in size to get the benefit. But it is important. I would also caution you, this was a record quarter in terms of net income. We made $0.59 diluted earnings per share. And so when you look at things like bonus numbers, which tend to link as a percentage of income, there is some downward trajectory if you are modeling less than $0.59 per share of earnings and so the expense numbers in large part probably appropriately reflect expectations if you are modeling $0.59 per share of earnings in some of these line items and so just keep that in mind. There is also a lot of efficiencies and investments we continue to make where some of those investments would not be as urgent or as necessary to the extent that the asset growth slowed for a couple quarters, so there is some capabilities to apply with that.
Okay. That's very helpful, and then just more then on the tax credits. So did you take a full-year benefit in this quarter so the tax rate should jump up towards 25% for the full year with some accruals in the fourth quarter? So maybe the 17.7 million of the expense in the third quarter won't be as high in the fourth quarter and going into next year. Is that the right way to look at it?
Yes, we've given you some guidance overall of where we think our tax rate will settle out for 2017. So I would stick with that guidance on the kind of 25% target. So that's not quite as high as where we are.
Just to take a second, Andrew, and come back to your prior question, I'd also want to mention, if we make the strategic decision to reduce the overall securities portfolio against the portfolio, I think that the securities yield -- the securities yield, about 2.86% less than loans, so to the extend -- I'm sorry, the securities yield 2.86% and the loans yield 4.41%. So there's a 150 basis point pickup if we decided to remix our portfolio and realize some of the securities and replace some of those with loans. So as you think about the run rate and earnings potential of the mix of our portfolio changes if we have the same base of expenses, but we remix from securities to loans in the same businesses we are in, which is something that is something that we would consider.
Okay. Then are you looking to sell the lower-yielding securities so the remix could be even better? Or just kind of curious what average yield you are looking to sell.
Well, look, we would evaluate those securities, make sure that our securities portfolio provides the right liquidity, the right duration and the right metrics for our bank. That being said, as we discussed earlier, a lot of embedded gains sit within some security classes like CLOs that have very short durations and are floating rate and the floating rate securities in the near term tend to have lower yields than fixed rate securities of similar aspects. So while the yield curve is not significantly upward floating, it is upward sloping a little bit and so the fixed rate things tend to have a higher yield than floating and some of our embedded gains are in the floating rate part of the portfolio.
And our next question comes from Gary Tenner of D.A. Davidson. Please go ahead.
Thanks. Good morning. Just a couple questions. I wonder if you could tell us what the amount of mortgages sold during the quarter was just from the mortgage segment and what the associated gain on sale in the mortgage segment was.
So just high level, the gain on sale that we experienced in the quarter was roughly 323 basis points. That's in line with where we were historically at. Last quarter, the numbers in what we provided you was 320. In terms of the funded volume that went through, that was about $1.55 billion this quarter. As you can see from the delta, that's relatively in line with where we are at and if you triangulate those things, I think you'll find that we are pretty consistent quarter over quarter from that perspective.
Okay. And then I had a question going back to the prior quarter guidance on yearend balance sheet growth, obviously, that then changed, I think it was in August or in early September and now you've changed it again given these more recent events. But what I'm curious about is that, as of June 30, I think you were around $10.2 billion in assets projected full year or yearend assets in the $10 billion to $11 billion range and then you indicated that you were already at $11 billion at the end of August. So effectively six weeks after you gave that guidance you were already at the range you thought you would be at for the full year. Can you talk about, as you model and project balance sheet growth, forgetting the current conditions in terms of contracting potentially given the recent noise, how is it that the growth over that six week period got you to where you were projecting to be at the end of the year?
So it depends what buckets the growth is coming from and we model our balance sheet not by aggregate, but by line item and there are some areas within the balance sheet that are highly liquid and opportunistically there may be the ability to add to it quickly and some areas that you do not want to add to quickly because that would increase credit risk or operational risk.
An example of an area that's relevant to your example would be agency pass through securities. If we make a decision to increase liquidity and buy agency securities and we believe in the market and with our interest rate exposure, it's the right time to buy agency securities, there is no real significant risks to doing that from a credit perspective. And so one thing that could drive doing such a thing would just be the liability side of the balance sheet. If we have meaningful success on our deposits early in the quarter and we have meaningful deposits flow in, we may complement those against things like agencies and you could see a big spike in assets early in the quarter.
To the extent that the growth though isn't coming from something like agencies and it's just coming from new originations, that's something that we would not expect ever to want to put pressure on. We tend to want to let our business units originate at their own pace. We don't pressure them quarter to quarter or by timeline. We'd like them to manage their business appropriately, but we don't want to hold them to quotas because we think that could hurt credit risk and other kind of risks to the bank.
Okay. I appreciate the explanation on that. And then last quick question. In terms of the mortgages servicing right flow agreements on the originations, are you still building the servicing portfolio, or are you selling the servicing now? Are you releasing.
Yes. Strategically, I think that we have a consensus view we would be happy for our MSR exposure to decrease and so we are happy to do that, but we want to do it strategically and thoughtfully. So we were happy to find a sound partner to sell flow new origination MSRs to. It's not 100% of our new production, so there will still continue to be some MSRs that come onto our portfolio.
To the extent that those MSRs coming onto our portfolio add to our portfolio or whether the portfolio shrinks will more be a function of pay downs of the existing portfolio and the net factor, but overall to the extent that opportunistically there are ways to reduce the volatility associated with MSRs and the exposure to MSRs, it's something that we are not opposed to and it's something that we consider. But that's kind of our thinking right now.
Okay. And just to be clear, the $2.1 million of loan servicing fees, that reflects the mortgage servicing fee income, or is the MSR income embedded on the mortgage banking line?
So the answer is a little bit of both. As far as the manufacturer of the MSRs is embedded in the mortgage banking income and then some of the MSRs that we own and service from month-to-month is embedded in the mortgage loan servicing fee income.
Yes. So just if I can add just a little bit. Again, the changes in the fair value, which I think is one of the items that you are particularly looking at, those items roll through the servicing income line that you are referring to. And so that's why you see volatility in that line item. This quarter, you didn't see a lot of volatility in terms of where the rates played out and so that's why you see a more stabilized number there as you would traditionally see for a quarter where Treasury yields play out the way that they played out this quarter.
Okay. So then presuming a lack of volatility in that line, selling more that loan servicing income line should be a little more stable to maybe slightly up over time given growth of MSRs, but not to a large degree in line with your production?
Well, I think the point is that if we were to be able to eliminate or sell the MSRs upon the flow agreement, the volatility you are seeing in our loan servicing income, which in the first and second quarter of this year created meaningful net losses, would disappear in large part.
Got you. Okay. Thank you.
And our next question comes from Jackie Boland with KBW. Please go ahead.
Wait. One other item that I would just like to highlight on that question is absent fair value changes, that line item would not be a material line item by any, it would be a non-significant line item inside our financial statement. So literally something that's a few hundred thousand dollars, so not a material economic change relative, but it is a significant change relative to the risk profile that we have at the bank that we are changing with this decision.
I wanted to touch on deposits great quickly. So, as we think about, and this is assuming that there's not a meaningful upward movement in capital markets that thus causes you to grow assets again. As you are thinking about keeping the balance sheet in that range that you discussed earlier, given that you've had over $1 billion in deposits growth over the last two quarters, I understand you can bring down FHLB borrowings. But how do you intend to manage the potential for deposit inflows against the desire to not drive your assets up too much?
That would be a pretty nice problem to have, huh, Jackie?
So look, we've been very happy with the market share gains we are seeing on the deposits side. We are hopeful to be able to answer that question for you. But what I would say is in this last quarter, we had $700 million to $800 million of our deposit growth come from our core commercial banking segment. The rest were through duration, term CDs, and things that were more broker or less high-quality because we were looking to extend out some of our duration and reduce some risk in the portfolio around IRR and other things. So we have some capacity, not just on FHLB line item, but also on the types of deposits we have to improve the mix and get a higher quality deposit, which will have a good effect also on our deposit study in our IRR analysis. So to the extent that this moment in time lasts for several, several quarters, that's a good question to revisit me on sometime in the middle of next year, because our deposit portfolio will be so high-quality and so core that it will probably be a discussion around pricing. But for right now, we have adequate flexibility within our balance sheet to really optimize earnings, optimize quality of franchise value, without running into that situation.
Okay. So similar to the remix of securities into loans, the remix of deposits into more core accounts and less CDs to improve that flexibility could also benefit the NIM over the next couple of quarters?
Yes, and you've been seeing us do this over the last couple of quarters. We've just been doing it in slower motion where we are growing and remixing. You've seen that with our FHLB falling from 11% to 12% down to 7%, and so we are doing that. We are just doing it prudently and in time. But what I would be talking about is dampening the growth and doing it more quickly, and it would probably be a little bit more transparent when you looked at our financial statements, but it would not be any -- the quality of the deposits that are coming in we've been very pleased with. And we are bringing them in as quickly as we think possible, so I'm not sure that their strategy is to accelerate that. It's more just limit the other types of business that also come in.
And we talked about this on the last earnings call when I talked about pruning some of our deposits even that looked good on paper but had adverse cost structures and things like that. So we are already doing some of this. This would just be taking it a little bit further.
Okay, that's very helpful. Question on the gain on sale of loans not related to mortgage banking but the other line item. Just since you had indicated that you may do more sales of the pooled loans in next quarter, do you have more of a breakout -- you gave the breakout of how much of those loans were sold, but what the contribution of the income received from them was given that you had different types of loan sales in the quarter?
Yes I mean we've sold different types of pools and they each had different economics. But if you were to look at the contribution of the loans that Hugh Boyle spoke of that were in the seasoned loan pool and the NPL pools, that contribution was a little bit north of $5 million. It was under $6 million and over $5 million.
Okay. Thank you. And as I think about the reduction of those loan pools, please correct me if I am wrong on this, but I'm assuming that they are at a higher yield than the overall portfolio. Given that they are roughly 10% of the portfolio, how do you think about loan yields as we go forward?
Can you just repeat that? I missed the last part of that question.
So you had commented that the loan pools were roughly in the neighborhood of around $700 million, which is roughly around 10% of the loan portfolio. Because they are discounted, I'm assuming that the yield on them is higher than the overall loan portfolio. If that isn't the case, what kind of an impact would selling those loans have on your forward yield?
In fact, it is not the case. I think that when you look at credit and other things, these are sub 4% anticipated return loans. The markets price these things at a level where they are no longer above where we believe we can originate new origination, and that's why we've started this process.
Okay. Thank you, that's great. Just one last quick one, probably a question for Jim. I know we've touched on some of the solar items. As I'm looking at those four items that are on page 12, I wondered if you could just specify how each of those breakout. Obviously, I know where the expense of $17.7 million goes in, but just the other three lines items, how that impacted if it was all in taxes or if there were other areas of the income statement that those flowed into?
No, they're all in taxes. They specifically result in a contribution, as you have seen for the quarter, of about $5.5 million on an after tax basis from that. There's some other marginal expense items that are above the line, but again we don't adjust those because those are the true costs essentially associated with the origination and the servicing of those items. Again, nonmaterial, non significant, efficiency ratio sub 20% on a marginal efficiency ratio here for this.
So, Jackie, I would just say the way we are looking at this business is there's an origination component which is similar to all the lending businesses we are in, whether it's loans or leases. And all those expenses are within the line items that they are associated that are core expenses for originating a loan where you have legal, you have people, you have all these things. This is a business that we have to staff up. We have to do analytics that go through our normal credit process. It has modeling; it has a real business behind it. So our expense base for this business is throughout the balance sheet, just like any other business unit.
That being said, we've broken out here the items that are more financial in nature that just reflect how the return comes to us, which because the accounting is different than how you see the accounting on an HFI loan that comes in that just goes to that one line items, in here instead of going through the line item up on top, it comes through in part as an expense and in part as a tax benefit. I just want to make sure it's not that it's not a core part of our business; it's that the accounting treatment just pushes it through a couple different line items. But if you were to exclude the benefit, there's all sorts of costs that are just embedded in our cost structure otherwise that are still there.
Okay. And as we go forward, I would assume that given that the tax rate will be 25% in 2017, that we could back into what the associated expense line would be from that based on where the tax rate was this year. Is that a good way to think about it?
Again, we applied the discrete method of accounting, and so these, it's really important that we are going to control some of the timing and other elements of this, but we don't control other significant items similar to everyone else with solar investment. And that's specific to, again, once we've made the decision to deploy capital in this, there's a period of time that it takes for that capital to be deployed.
And then those assets have to be taken into service, right, where they go to the grid. We don't control that item either. But what we can do is once we see those items occurring where we know that we've pushed the capital out at that stage, we understand from there that there is some reasonable period of time where that credit is going to adjust. And that could be in one quarter or another quarter or throughout the year.
I don't know that we would specifically state that in any particular quarter that we are going to forecast with that kind of level of precision just because the nature isn't there, but we will have a meaningful impact relative to that, and you can see a meaningful improvement in terms of how the business is going to run on annual year-over-year basis.
Yes. So the guidance we gave is more if you think about it annually, although there could be some choppy points. What we will try and do, and just looking at the clock since we are about setting a new record, an hour and 42 minutes, what we will try to do is as we move forward I think that we are going to look to provide some additional transparency from the Board as decisions are made.
This is a time where our stakeholders probably will benefit from more timely reports on some of these decisions, given some of the volatility in the markets. So we will do that. But alongside those, we will try and put out some more granular detail or follow-up with some more granular detail on the solar.
It's something that is, it's a really good opportunity. It's going to be really meaningful for our investors. It's not going to be a big exposure in terms of credit or out-standings, but it's something we are excited about. We think it furthers a lot of our strategic objectives. And we think that structurally you will see in 2017, it will have a meaningfully accretive improvement in all your models. So with that and just looking at the time, we will let everyone get on with their day. We appreciate the interest that everyone had in readjusting their schedules and joining us this morning a day early. Hopefully, you all benefited and appreciated accelerating the transparency here, and we will look forward to talking with you again soon. So thank you.
Ladies and gentlemen, the conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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