Good day and welcome to the HomeStreet, Inc. First Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mark Mason, Chairman and CEO. Please go ahead.

Hello and thank you for joining us for our first quarter 2020 earnings call. Before I begin, I'd like to remind you that our detailed earnings release and accompanying investor presentation was furnished yesterday afternoon to the SEC on Form 8-K and is available on our website at ir.homestreet.com, under the News and Events link. In addition, a recording and a transcript will be available at the same address following our call. Please note that in the course of our call today, we may make certain predictive statements that reflect our current views and expectations about the company's performance and financial results. These are likely forward-looking statements that are made subject to the Safe Harbor statements included in yesterday's earnings release, the investor deck and the risk factors disclosed in other public filings. Additionally, reconciliations to non-GAAP measures referred to on our call today can be found in our earnings release available on our website. Joining me today is our Chief Financial Officer, Mark Ruh. Mark will briefly discuss our financial results and then I'd like to give an update on our response to the current COVID-19 pandemic, the results of operations and review our progress in executing our business strategy. Mark?

Thank you, Mark. Good morning, everyone, and thank you again for joining us. Our consolidated net income for the first quarter of '20 was $7.1 million or $0.30 per diluted share, compared to net income from continuing operations of $13.1 million or $0.54 per diluted share for the fourth quarter of '19. Note that we are comparing current period consolidated net income to prior period net income from continuing operations, as HomeStreet terminated discontinued operations accounting treatment effective January 1, 2020. Core net income for the first quarter of '20 was $8.1 million or $0.34 per diluted share compared with core net income from continuing operations for the fourth quarter of '19 of $14.9 million or $0.61 per diluted share. Our core pre-provision income before taxes was $24.1 million for the quarter. Excluded from core net income, in the first quarter, was approximately $1 million of restructuring-related expenses net of tax. A decrease in net income compared - our decrease in net income compared to the prior quarter was primarily due to a $14 million allowance for credit loss provision estimated under the new CECL methodology to be discussed later in the presentation. While net interest income decreased in the first quarter of '20 due to decreases in both the rate and volume on our loans held for investment, our net interest margin increased by 6 basis points due to significantly lower interest expense. While our loan rates declined during the quarter, approximately 29% of our variable rate loan portfolio was at contractual interest rate floors at quarter-end, which mitigated the impact of the general decline in interest rates on our net interest margin. Deposit balances were $5.3 billion at March 31, decreasing 1.6% from December 31. This decrease in deposit was primarily driven by a decrease in certain high…

Thank you, Mark. As you know, beginning in February, our markets have been significantly impacted by the coronavirus pandemic. Stay-at-home orders in all states, where we do business, have contributed to significant business disruption and created substantial increases in unemployment. Our customers and our company will be adversely affected by the crisis in ways we are still trying to quantify. Nevertheless, we feel strongly that HomeStreet is well positioned to navigate this crisis successfully. We have a strong capital base with consolidated Tier 1 at-risk-based capital ratios of 10.15% and 13.5%, and bank Tier 1 at-risk-based capital ratios of 10.06% and 13.9% respectively. Additionally, we have substantially increased our allowance for credit losses in anticipation of potential credit losses that may occur as a result of the crisis. Beyond our strong capital base and increased allowance for credit losses, our current earnings provide meaningful additional capacity to absorb future credit losses. Additionally, today we have ample on-balance sheet liquidity and access to more from our contingent sources. Today, our available borrowing capacity from the Federal Reserve and the Federal Home Loan Bank, including existing lines and additional unpledged collateral is $3.7 billion. During the crisis, we expect some deterioration of our loan portfolio credit quality, with certain commercial loans most at risk. Our loan portfolio has, by design, limited concentrations by product type, industry, and geography, in order to limit our risk of exposure to any one part of the market. To mitigate additional risk to our portfolio, we have among other things, suspended lending to borrowers who're operating in the most adversely affected industries, suspended most new commercial lending, commercial construction lending and certain mortgage products. We've tightened our commercial real estate underwriting standards and increased our margins. As a result of our history and portfolio composition, most of…

[Operator Instructions] Our first question will come from Jeff Rulis with D.A. Davidson.

Just a question on the provision, trying to get a sense for the thought behind that and timing. Clearly, as we progressed over the last month, there's been a pretty volatile view of the macro economy. And so just, as that's posted for the first quarter, was that more a 3/31 read or something kind of mid or late April on economy and how you adjust for CECL provision in the first quarter?

Well, the first quarter provision is based upon the March - substantially on the March Moody's Economic Forecast. If you look at our deck on Page 22, we describe the key drivers of the provision, which is substantially almost exclusively the economic forecast by Moody's, as of the end of March, their pandemic forecast. In our model, we also compare the results using the Moderate Recession forecast. And then later, after we close the books, we took April's pandemic forecast, which is much more severe than March's, and took a look at what impact that would have had as of March, and we came up with substantially the same numbers, right. So, that is driving the reserving to-date. It's important to know what's not driving it is loan migration and probable expected losses, which ultimately is the real answer, right? How much of our sensitive or risk pools will ultimately migrate to loss, and what will that imply about total losses. At this point, it's really unclear. The regulatory guidance to all of this has been not to downgrade and not to migrate these loans. Absent the virus, we would have been reversing $2.3 million of provision, based upon performance in loan balances. So, a $14 million provision this quarter, frankly is $16.3 million delta from where we read.

Appreciate the detail. It's a pretty fluid environment. Just - that's helpful to know your positioning on how you establish the provision this quarter and how it might trend going forward. Maybe switching gears on - it's kind of an expense backdrop but trying to get the head count. I guess, reductions separate from any COVID-related impact, just trying to get a sense, I think you're down 75 full-time employees year-to-date or through the quarter. Is there much more to go there, or is that largely right-sized? And then if you could kind of dovetail that into the core expenses, understanding your guidance is to continue to decrease that. But kind of where are we at on the headcount figure?

We have a number below the current headcount number that is a current target. It's a little fluid because we're having to add some personnel, primarily in the single-family mortgage area because of the, I mean, substantial increase in volume. That of course will last until this refinancing wave abates, right? So, the numbers you see on FTE over the next couple of quarters are going to be a little volatile because of that. Having said that, we're nearing the end of the FTE reductions from an efficiency standpoint. Yes, we will end up, on a stabilized basis, a little below this. I would give you a number today, but it's kind of fluid because of: one, single-family; and two, some other business changes. But the substantial changes have occurred. We would love to get into the mid-900s, maybe just as sort of a target downstream someday, but that's going to require some system changes and clearly a change in the mortgage business. The greater amount of dollar cost changes over the next year and a half, let's say, will be coming from, first, technology, and to a lesser extent from real estate. We've been frustrated as we've talked about on prior calls by the inability to get our primary technology providers to restructure and renegotiate these contracts early. There has been some recent discussion that suggests perhaps in 2021, we will be able to get a restructuring of our core service provider agreement. I'm not relying on that yet, because we're so far from that being a reality. I can't count on that, but most recent discussion suggests that instead of waiting to 2022, we may be able to get some meaningful help in that agreement in 2021, and perhaps with some of the lesser agreements as well. So, I'm holding out hope that we will be able to pull some of those changes into '21. And the real estate environment, unfortunately, has gotten worse, right. If you think about subleasing an office space in this environment, it's clear to me that those savings are going to get pushed out a little bit, right. There are companies that will fail, who will create greater vacancy and pricing cost is probably going to get readjusted. So, that part of the savings may make it delayed or not happen, at least in our timeframe.

Our next question comes from Steve Moss with B. Riley FBR.

Want to start with just on the mortgage banking side. Just wondering, if there was any hedging impact on gain on sale income this quarter and what were total mortgage originations for the quarter here?

That's a very good question, Steve. There was. If you have been monitoring other mortgage banking results this quarter, I assume other people have talked about mortgage pipeline hedging and mortgage servicing rights hedging effectiveness during the quarter. The fixed income markets were substantially disrupted. I'm not sure that's even a strong enough description. The volatility that we experienced in the fixed income markets, particularly in early March, was greater than we've ever seen, maybe historically the largest amount of volatility. And the disconnect or the widening of normal spreads between instruments was very challenging for hedging, particularly anything related to mortgage yields. A combination of significant increase in supply of much lower rated mortgage-backed securities because of the refinancing volume, the de-levering and liquidation of investment funds, all led to a significant decline in demand for mortgage rated product, which widened spread significantly. Mortgage rates actually increased, accordingly, during that period, to levels that shocked even us. Now, they've come back down since then. All of that, created ineffectiveness, particularly in our mortgage origination pipeline hedge. We actually lost a certain amount of money on that hedge. The impact on our gain on sale for the quarter was about 60 basis points. Again, that's how significant that impact was. Our margin, our profit margin for the quarter, in the first quarter, was approximately the same as the fourth quarter. But it would have been about 60 basis points higher. So, what does that imply going forward? Mortgage profit margins are historically wide. I would repeat that statement: Historically wide today. Example, fixed rate Ginnie Mae loans, FHA/VA loans are priced at profit margins in excess of 600 basis points. Fixed rate agency, Fannie/Freddie loans, 30-year conforming, in excess of 500 basis points. So, you're going to understand what that implies to profit margins today. And thankfully, the fixed income markets have settled into reasonable approximations of prior spreads, so hedging is much more effective today. Today, we're in a positive position on our pipeline hedge. And so, everything is sort of hitting on all cylinders, that's today. We live in very volatile times and I don't want to predict the outcome for the quarter, but things are substantially better for the month of April. In March, our servicing hedge was even more volatile. And at times, it was down as much as $3 million relative to our change in the value of the asset and ended up, well, you see our risk management results for the quarter, up about $3 million. That's how wild and volatile it was. Again, I'm happy to report that those markets and spreads have settled substantially. And all of this is a consequence of the Federal Reserve stepping into the fixed income markets and providing a steady and sufficient bid. Otherwise, they would still be just as volatile as we believe, may be worse.

Okay, that's helpful. And then, I guess in terms of just thinking about production here; is that a similar level to the first quarter, as you look at your pipeline here today?

The quarter was quite strange as you would imagine, given the changing environment and changing interest rates, right? So, we produced - what was it for the quarter? Was it total locks? $565 million, right? But versus about $300 million in the fourth quarter. But - that's $565 million, $300 million or so - over $300 million was in March alone, right? And in April, our production is going to be, it looks like a little better than half of that, maybe $160 million-ish right now, but we got a few days to go. But that would imply, if it were consistent across the quarter, something less than last quarter's locks, right. And remember, we're going to now be closing this quarter, not all but most of the locks during the first quarter. And that is going to increase our expenses, right, commission expenses, for example, most significant upon closing. So, mortgage banking profitability next quarter may or may not be as good. I think profit margins will be better, as we just discussed. That might substantially offset the additional cost. We don't really know. We'll have to see where we end up.

Okay, that's helpful. If I just take a look - implied from the numbers here for April production and your gain on sale margin, you're running around, call it, $9 million to $10 million in gain on sale income for the month of April; is that about right?

Hold on one sec, let me do some math. What did you say? 9 - that's too high.

$9 million is too high? Okay.

Yes, $9 is too high. I mean, given the numbers I gave, it could be in excess of $7 million, but that's a very gross estimate, right?

Okay, that's helpful. And then in terms of shifting gears here, just on the construction portfolio here, wondering if you see - you had a pretty significant decline this quarter. I'm wondering what your expectations are for that portfolio in the next couple of quarters given the mix of probably commitments and what you expect in normal time during paydown. But then, is there any impact from the shut down here in terms of continuing to build?

There is an impact, I mean, obviously projects have slowed down, most of our constructions in Washington, and no progress has been made on it until they restarted this week, right? Which means, no draws either. But most of our commercial construction projects are nearing completion. We slowed down new construction loans many-many months ago. And most of those balances are nearing completion in commercial construction and multifamily construction. Customer home construction, that's just kind of an ongoing business. We have houses in many phases of construction. We did suspend customer construction new lending last month, and we're considering reopening it sometime soon. But there will be a low there. Homebuilding, obviously any homebuilding in the State of Washington has come ground to a halt until this week, but sales have continued. The traffic, as you would expect, is lighter than it was, but sales continue, and we feel pretty good at this point about the build out and sale of our projects. The great part about that equation is, most of these builders have pretty substantial profit margins in these projects, at least on a pro forma basis. So, if they need to decrease pricing to move these houses, they have a lot of room to do so.

Our next question comes from Matthew Clark with Piper Sandler.

Maybe just first on the guidance, I can understand pulling the ROA and ROE guidance for the outsized provisioning. But on the efficiency ratio, which doesn't incorporate that - those credit costs, I guess why wouldn't you be able to still hit those targets mid this year, mid next year? It seems like the margin is going to see some more substantial expansion here, just based on the deposit costs at the end of March. I think they were down 50 basis points. I guess what else are witnessing here that wouldn't allow you to achieve to his prior efficiency ratio goals?

We believe we can. Our - my comments - with regarding guidance really were an overarching comment, and maybe I should have been more specific on efficiency. We believe we can. We believe by a larger margin today.

Okay. And then just on the securities yields, I think they were down 38 basis points. Can you give us a sense if there was anything unusual there, premium AM quarter-to-quarter or new purchases, or just repricing, just want to get a sense for where that 2.14% yield might go?

Well, up. I mean, again, an excellent question. Our accounting standard for mortgage-backed securities is the retrospective method. I have different names for it, but that's the official one. It literally requires us to re-calculate from the date we purchase the security through the current date and then forward as if we had perfect knowledge. And so, when you have spikes in prepayment speeds, that imply a different forward balance. You must recalculate a level yield for the birth to grave ownership of that security. And so, when rates fall like they did, and of course that implies a faster run off, you have to write down the yield you have recognized life-to-date. And that was about $1 million of net interest income, a $1 million in our securities portfolio. And we expect the yield to recover. Not to the yield it was before, of course, because the life yield came down slightly. But you can expect a meaningful recovery in yield in net interest income from the securities portfolio next quarter.

Great. And then just last one from me, on the - on Slide 23, the forbearance request, and the amount you've granted, can you give us an overall sense for how large those portfolios are, the dentists, the restaurant, bars, entertainment, transportation, so forth? I know some of this can quickly recover, like the dentists, but - and then maybe kind of within the real estate industry and investor CRE that's asked for request, what specific industries those are? Just to get a better handle on the overall exposure that's getting some increased scrutiny these days.

Sure. We added Page 18 in our deck, which breaks down the C&I portfolio by these groups. And you can see that healthcare, which includes dentists, it's mostly dentists, frankly, is 22% of the $662 million C&I component that excludes owner-occupied real estate, right? The $211 million includes owner-occupied real estate. So, there's a little bit of a correlation there. But I think in total, we have approximately $180 million roughly of healthcare, including owner-occupied real estate. May not be quite that high, I could have Gerhard get back to you on that. But the $86 million of that component, obviously is not 100% or near 100%, which means that we have a lot of dental practices that have sufficient liquidity to - they think to get through the shutdown order. When we republish this again, we will probably add the total portfolio here to give you some proportionality. That's a fair criticism of this slide.

Okay. And then just thinking about hotels as another example, is that - that's on CRE portfolio breakdown. I don't recall seeing it, but -

If you look on the detailed slide of permanent CRE in other, there's a footnote. So, the other category includes loan secured by schools, $81 million, and hotels $36 million. Of that $36 million, the largest loan I believe is $27 million, I think a single loan, which is a large well-known flag hotel in Bellevue, and - yes, $26.7 million. It's in the bullets under other largest dollar loan. That $26.7 million is 40% of the land value of that property. So, we're very-very well secured. Obviously, they're not operating today, right? But they are very-very strong owner and we feel very good about loss risk in that loan. And obviously the difference between that and the total hotel exposure of $36 million, we have a couple of smaller exposures. We have one participation which is relatively small, of flag franchise hotel with another one of our peer banks, and then another even smaller ones. So, relatively little exposure.

Okay. And then just last one from me. I guess, how are you modeling the PPP loans? You expect them just come and go by the end of the third quarter on most of them?

I'd love to hear your view on that. Yes, mostly, right. I think we're going to experience somewhere between 50% and say 80% forgiveness. I think that there will be some companies who can't accomplish 100% forgiveness or spend within that period, or at least subject to the 75% payroll requirement on forgiveness. I haven't seen much analysis on it yet, but we are - we have analyzed profitability assuming a forgiveness period of three months, six months, nine months, and forgiveness amounts between 50% and 75%. And I will tell you that the return on equity of those various levels of fees, right 1%, 3%, 5%, runs between 50% and over 100% and return on assets accordingly, obviously quite high, right. So, this is a program that should be highly profitable. We'll certainly be highly aggravating. It's miserably run. I can't even express to you my aggravation and true sadness for our customers and what they've been through. Aggravation for our employees and what they're going through, as we speak, maybe is a real [expletive] show of a program.

[Operator Instructions] Our next question will come from Jackie Bohlen with KBW.

Sticking with the PPP, I just want to make sure that I have those numbers right. So, you had $396 million in loans for $158 million that were approved as of 4/16. And then an additional 1,100 applications for $160 million that you're working through for round two. Do I have that right?

That's correct. That's what we decided just now on script. I will add to that that in the last 24 hours, we've only been able to enter 144 loans for $35.1 million with 20 people working 24 hours straight.

I can see why you are frustrated.

Sorry, just - just, sorry for my level of aggregation.

No, that's very helpful information to have. So, thank you. Where I'm getting at with my questioning is I'm just trying to think of the fee breakout between the first round and the second round. Because it - just using the numbers that you have, it sounds - seems like the average loan size was a lot higher for the first round, and I know that that $10 million loan you spoke of is part of that. So, I'm assuming there's some other larger loans with the 396 loans. And then, with the additional 1,100 application, I'm assuming they're much smaller loans, is that accurate?

That's accurate. And I think people have gotten the wrong idea, maybe politically or otherwise, about why that occurred. A couple of reasons; one, the more sophisticated borrowers were ready the minute we could take applications. We have complete packages that were tied out, made sense, fully documented. As you get into smaller loan sizes, you get much less sophisticated business owners. They often forget to provide back up, or they provide back up, it doesn't tie to the calculation of the loan. And while it seems like we're supposed to just accept any representation of the borrower, we actually have a responsibility delineated by the SBA to make just minimal reasonable sense of the application and do certain things. And what that did do is force a delay in many of these smaller applications to get reconciled. And we spent the last week and a half doing that with about 800 of these 1,100 left.

And that - I mean that all makes perfect sense. And when I think about how to apply the fees that you're receiving for that, obviously with an average loan balance for the first tranche of those over $350,000, I would assume that the fee is probably somewhere between, maybe around 2%, as it would be between 1% and 3%. And then maybe with the second round is probably somewhere between 3% and 5%, so maybe an average of around 4%, is that a reasonable way to think about it?

I think it's probably a little better than that, right. If we're averaging $330,000, $340,000 in the first group, the cut-off was $350,000, right, to go from 1% to 3% - I mean, from 5% to 3%, right. So that would imply there's a lot in that 3% to 5% bucket, because the lumpiness of some of the larger ones like a $10 million loan, I know we processed a couple of $5 million or $6 million deals, things like that. We expect it will probably be closer to 3%, maybe even a little better.

Okay. And then I would assume higher in the second round to the extent that you're able to fund some of those?

Yes, because the difference between the average and the median is much closer in the second group.

Okay, that's helpful. And then just lastly, as in the past, we've talked significant amount in terms of heat maps and how you're thinking about just the overall state of the economy and how it relates to your loan portfolio, and obviously no one expected this to happen and with the speed that it happened. When you think about reentering loan segments that you are no longer doing right now, what kind of indicators are you looking for and able to get back into those markets? I know this is a very open-ended question, and relates on a lot of factors outside of your control, but how are you thinking about potential timing?

Well, I think there are some obvious steps. One, they have to reopen their businesses. Two, we need to understand their level of activity relative to their prior profitable level of activity, and this may be the biggest hurdle, right. We may have companies who reopen - who are reopening, had a marginal loss, right. If you just look at cash flow, maybe they can make positive cash flow, but it's not fully absorbed net income, right, probably not ready to lend into that circumstance except in certain cases. And so, I think some of these industries are going to struggle for credit for a while. But one thing that I worry most about are those that will require additional capital for starting working capital, who exhausted their working capital reserves in paying final payroll and in paying suppliers to the extent they could. Well, they've got to refill that cash pipeline of those - that working capital reserve in order to restart. And I think that that's an area of the market that Congress really hasn't focused on, right. There's this restart capital. It's not enough to keep employees employed and cash flowing to consumers, but you have this restart need that I think is as yet unaddressed.

Okay. And when you think about the timing of that, my assumption is that when you gave your average growth forecast for 2020, that assumes that the segments that you have exceeded, you won't be re-entering them during that period of time, is that fair?

It is generally. I think our portfolio is going to end up different at the end of 2020 than we had expected. I can say that for certain, right. We were expecting higher levels of C&I lending than we will surely accomplish as a consequence. We may experience lower levels of homebuilding. Surely, homebuilding will not be immune from this, even in our markets. I'm not worried about credit risk, but the velocity of homebuilding will probably decline somewhat. Mortgage lending obviously will be up, and we are currently reviewing our targets on multifamily lending with an eye potentially to actually increasing our mortgage lending activity over the remainder of the year. It's an area we feel that we could operate in not just successfully but safely and something we're quite good at. So, these are the things we're thinking about right now as we think about what our earning assets are going to be for rest of the year.

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Mason for any closing remarks.

Thank you. I know this is a busy week for everyone from an earnings standpoint. We appreciate you joining us today. Appreciate you listening to our view on our market. Good luck. Look forward to talking to you next quarter.

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