Mechanics Bank (MCHB) Q3 2026 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Mechanics Bancorp Third Quarter 2026 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the call over to Nathan Duda, Chief Financial Officer of Mechanics. Please go ahead.

Thank you, operator, and good morning, everyone. We appreciate you joining our earnings conference call. With me here today are CJ Johnson, our President and CEO; and Carl Webb, our Executive Chairman. The related earnings press release and earnings presentation are available on the News and Events section of our Investor Relations website. Before we begin, I'd like to remind everyone that any forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those anticipated future results. Please see our safe harbor statements in our earnings press release and in our earnings presentation. All comments expressed or implied made during today's call are subject to those safe harbor statements. Any forward-looking statements made during this call are made only as of today's date, and we do not undertake any duty to update such forward-looking statements, except as required by law. Additionally, during today's call, we may discuss certain non-GAAP financial measures, which we believe are useful in evaluating our performance. A reconciliation of these non-GAAP financial measures to the most comparable GAAP financial measures can also be found in our earnings release and in the earnings presentation. CJ, let me hand it over to you.

Thank you, Nathan, and good morning. We appreciate everyone joining our call and for your interest in Mechanics Bancorp. I'll start things off by hitting the highlights of our third quarter performance. I'll also provide an update on the bank's strategy as we close out 2026 before handing things off to Nathan to review our financials in more detail. Carl, Nathan and I will then open up the call for your questions. With that, let's turn to Slide 4. We had a noisy but productive third quarter, reporting $46 million in net income. On a fully diluted basis, our earnings per share was $0.20, and our tangible book value per share ended the quarter at $7.05 with $0.25 per share of dividends paid to investors. The third quarter was a very busy one and included an AFS securities restructure and the sale of nearly all our remaining runoff auto loans. We also had a negative provision for a combination of reasons, along with several nonrecurring gains. I'll get into more detail on this on the next page. After adjusting for these various onetime items, we earned $60.6 million of core net income in Q3 for a core ROAA of 1.14% and a core ROTCE of 15.1%. Our total assets are now $20.9 billion with total net loans of $12.9 billion, total deposits of $18 billion and tangible common equity of $1.63 billion. As I mentioned last quarter, we wrapped up our HomeStreet integration in Q2 and a lot of that benefit showed up in Q3 as our noninterest expense declined over $10 million on a linked-quarter basis. This helped lower our core efficiency ratio to 54.4% from 56% in Q2. Overall, we significantly exceeded our cost savings budget for the merger, which is good to see hit the bottom line. The big news during the quarter was, of course, the shock up in long-term interest rates with the yield on the 10-year treasury rising over 80 basis points. As a result, our AOCI decreased $112 million despite the AFS restructure. Relatedly, our cost of deposits increased 8 basis points in the third quarter, driven partly by the continued mix shift into money market funds from noninterest-bearing accounts as well as higher CD pricing. Beginning in the second quarter, we increased CD pricing to more competitive market rates to stem the runoff we had deliberately planned post the HomeStreet merger. That repricing had a more significant impact on our third quarter cost of deposits given that most of our CDs have a maturity of less than seven months. Overall, our deposits decreased $70 million this quarter with $66 million of the decline in time deposits. Our pace of CD runoff slowed again in Q3, and we expect CD balances to be relatively flat moving forward given our more competitive pricing. Our NIM decreased 7 basis points this quarter, with most of the compression due to the increase in our cost of deposits, although there was some noise given the AFS restructure and auto loan sale that Nathan will discuss later. We also had elevated dividend income in the second quarter, which contributed 3 basis points to the Q3 drop in NIM. An important point to note is that while deposit cost pressures clearly increased earlier in the year as interest rates rose sharply, we got very little benefit from our floating rate earning assets repricing that will show up in the fourth quarter as most of the floating rates reset with a bit of a lag. As expected, we had another clean credit quarter with only 4 basis points of non-auto net charge-offs. Our ACL is now 1.03% of loans and totaled $134 million. Our NPAs were flat again for the quarter and remained at 0.28% of total assets. Our CET1 ratio continued to move higher to a very robust 14.7% with the increase aided by the reduction in risk-weighted assets from our auto loan sale. Let's turn to Slide 5, where I'll update you on the bank's strategy and forward outlook. We had a lot going on in the third quarter with several major initiatives accomplished. First, at the end of July, we sold $308 million of AFS securities yielding 1.78% at a $32.3 million pretax loss and reinvested the net proceeds in mortgage-backed securities yielding 5.5%. This was a strategic use of capital to enhance future earnings, and we are fortunate to have excellent capital ratios that allow us the continued flexibility to consider actions such as this. Next, in mid-September, we sold nearly all runoff auto loans at a price close to par, resulting in the successful acceleration of the exit of this noncore business line. This is something we have been considering for some time, and we were very happy to see such strong execution. The transaction improved our CET1 ratio by reducing risk-weighted assets, and we expect it to modestly enhance earnings moving forward as lower loan servicing expense should more than offset lost NIM. We expect noninterest expense to decline again next quarter, mostly as a result of the auto exit and now forecast approximately $420 million in annualized core NIE, excluding CDI amortization in Q4. I'll quickly mention that we had $15.2 million of provision release this quarter with $3.2 million related to the sale of our one-off auto loans. The other $12 million of negative provision was primarily due to lower expected loss rates on multifamily and CRE loans. We recorded a $5.1 million gain on other equity investments, which is from our modest ownership stake in Inclined, which Nathan will discuss in more depth later. We also closed out our purchase accounting from the HomeStreet merger with an additional $2.9 million in bargain purchase gain, which was tax related. We only had $600,000 of merger-related expenses in Q3, which was good to see as we continue to move past the noise of the HomeStreet deal. Core net income grew to $60.6 million from $59 million quarter-over-quarter as expense efficiencies more than offset modest NIM compression. Deposit pressures, however, will persist in this challenging interest rate environment, and we expect a relatively flat near-term NIM as we plan to absorb three additional Fed funds rate increases over the next 12 months. We remain liability sensitive on the short end of the curve, although that gap has narrowed with our recent growth in floating rate assets, most notably incline loans. Longer term, we have significant repricing opportunity embedded in our balance sheet with $4.7 billion of legacy low-yielding earning assets that will cash flow over time and be reinvested at much higher market rates, which should provide a meaningful tailwind to our NIM. We continue to have substantial excess capital and expect to pay a $100 million dividend or $0.43 per Class A share in Q4, subject to Board and regulatory approval. This should bring our total dividends paid to shareholders in 2026 to $400 million or $1.78 per Class A share, representing a 2026 dividend yield in excess of 11%. However, the interest rate environment, especially the expected rise in short-term rates has caused us to modestly reduce our forward guidance to a 17% ROTCE and 1.2% ROAA in 2027, although we do remain confident in an 18% plus ROTCE over the long run. Importantly, we expect a 2027 dividend yield to investors of approximately 8%. I'll touch quickly on Slide 6, which shows an overview of mechanics. We are just under $21 billion in assets with 166 branches and the fourth best deposit market share across California and the West Coast with a branch map that stretches from Canada to Mexico and all the way out to Hawaii. Mechanics is a high-performing bank despite taking very little risk. On the left-hand side of this page, we compare mechanics to all publicly traded banks, $10 billion to $100 billion in assets, which, including us, has 81 banks in the peer group. As you can see, we rank very favorably across all these KPIs. Going to Slide 7, which I think best illustrates our investment thesis. The strength of our deposits and the efficiency with which we expect to run our bank from both an expense and a capital management standpoint, allows us to deliver high-quality earnings at a market-leading 8% dividend yield. We expect to pay these significant dividends despite a very conservative balance sheet, which is carefully underwritten, highly liquid and core funded relative to our banking peers. We believe high-quality, low-risk earnings that are efficiently paid as dividends to investors will command a premium multiple over time, especially during periods of market stress. To wrap up my section, let's turn to Slide 8. This slide hits our investment highlights and starts with our fantastic market share across the West Coast with a branch footprint that's nearly impossible to replicate. We have very strong profitability, thanks to our great deposits and efficient business model despite taking very little credit risk. We are core funded with no wholesale borrowings or broker deposits and are highly capitalized with a very liquid balance sheet. We are prudent with our capital and expect to continue to pay a market-leading dividend to investors. There's also a firm alignment between our public and private investors as Ford Financial Fund owns 74% of the company. Finally, we have an experienced management team who I'm lucky to work with every day with a strong operating and M&A track record. With that, let me turn the call over to Nathan to provide more details on our third quarter results. We've also added a new page on our consumer lending efforts, which he will go through. Nathan?

Thank you, CJ. Starting on Slide 10. For the third quarter, net interest income declined $2.3 million or 1.3% to $174.9 million compared to the linked quarter. Average interest-earning assets declined approximately $133 million during the quarter, driven primarily by lower average loan balances. Our net interest margin decreased 7 basis points to 3.55%, driven primarily by higher deposit costs. Our total cost of deposits increased to 1.33% from 1.25% in the second quarter, reflecting higher average deposit rates and a shift in deposit mix. This pressure was partially offset by higher investment securities income from the partial quarter benefit from our securities portfolio restructuring completed in July. There was also some noise in the reported margin this quarter from the timing of the sale of our auto loan portfolio in September. With both the securities restructuring and the auto loan sale occurring during the quarter, the third quarter results did not reflect a full quarter impact from either action. Third quarter interest income included $11.4 million of discount accretion on loans acquired in the HomeStreet transaction. As of September 30, 2026, we had approximately $125 million of remaining discount on those acquired loans. Lastly, earning asset mix remained relatively stable during the quarter as investment securities increased modestly as a percentage of average earning assets following the sales of auto loans. Turning to Slide 11. This slide provides some additional detail on what we continue to view as one of the most important drivers of our future earnings growth. We have approximately $4.7 billion of lower-yielding legacy assets with a weighted average roll-off yield of 3.25%, comprised of multifamily loans, single-family residential loans and held-to-maturity securities. As these assets mature, pay down or reset, we have an opportunity to reinvest or reprice them at significantly higher current market rates. As shown on the slide, approximately $2.6 billion or 56% of the portfolio is expected to cash flow through 2030. Based on the replacement yields illustrated on the slide and assuming a static rate environment, this repricing opportunity could ultimately generate approximately $154 million of incremental annual pretax income or approximately $113 million after tax. Importantly, this earnings opportunity is already embedded within our existing balance sheet and does not require balance sheet growth or a change in our conservative risk profile. As these assets continue to reprice over time, we expect this embedded opportunity to provide a meaningful tailwind to net interest income and margin. Turning to Slide 12. This illustrative analysis shows the potential impact of changes in short-term interest rates by comparing our floating rate assets with our rate-sensitive deposits. At September 30, we had approximately $3.9 billion of floating rate assets compared with $8.5 billion of rate-sensitive deposits, resulting in a gap of approximately $4.6 billion. As shown on the slide, we currently estimate that a 25 basis point increase in short-term rates would reduce annualized net interest income by approximately $5.2 million, while a 25 basis point reduction would provide a similar benefit. Our deposit beta was approximately 30% during the last Fed hiking cycle, and we expect it to be modestly higher this time around. Importantly, we expect this rate sensitivity to diminish over time as more of our fixed rate assets mature, pay down or reset and are reinvested at current market rates. Turning to Slide 13. Noninterest income decreased $37.2 million to a net loss of $13.4 million compared to $23.8 million in the second quarter. The third quarter included $34.6 million of net nonrecurring losses, primarily reflecting the $32.3 million loss associated with the AFS securities restructuring and the $10.3 million loss on sale of auto loans. These losses were partially offset by a $5.1 million gain on other equity investments and a $2.9 million bargain purchase gain adjustment related to the HomeStreet acquisition. Excluding these noncore items, noninterest income was relatively stable at $21.2 million compared to $21.6 million in the prior quarter. The modest decline primarily reflected lower ATM network fee and bank card royalty income, partially offset by higher bank-owned life insurance income. Turning to Slide 14. Noninterest expense decreased $10.3 million or 8.3% to $114.2 million compared to $124.5 million in the second quarter. Merger-related expenses declined to $0.6 million during the quarter from $5.9 million in the prior quarter and were primarily comprised of consulting and professional service fees. Excluding merger-related expenses, noninterest expense declined $4.9 million from the linked quarter, driven primarily by staffing and core conversion synergies realized during the quarter. As a result, our core efficiency ratio improved to 54.4% compared to 56% in the second quarter. Excluding CDI amortization, annualized core noninterest expense was approximately $427 million during the quarter. We expect continued expense improvement in the fourth quarter and now anticipate a $420 million core annualized run rate in Q4. Turning to Slide 15. Loan interest income declined $2.8 million or 1.6% to $175.4 million compared to the second quarter. Loan yields declined 4 basis points to 5.18%, driven primarily by slightly lower purchase discount accretion. Multifamily yields declined 12 basis points, reflecting lower discount accretion, lower contractual yields and lower prepayment and late fees. This was partially offset by a 10 basis point increase in single-family residential yields driven by higher discount accretion and contractual yields. C&I yields also declined due to lower discount accretion. Total loans declined approximately $561 million during the quarter, driven primarily by the sale of the auto portfolio and normal loan repayments, partially offset by new originations and advances. Our CRE concentration ratio improved modestly to 340% at quarter end from 342% at June 30. During the quarter, we originated approximately $568 million of loan commitments, predominantly in single-family residential and life insurance cash surrender value-backed loans. We also sold $417 million of auto loans and approximately $13 million of single-family residential loans during the quarter. Turning to Slide 16. Our commercial lending portfolio remains highly granular and well diversified across both collateral types and geography. We continue to maintain a significant focus on lower-risk multifamily lending, which represents approximately 72% of our $7.2 billion commercial real estate portfolio. Our multifamily loans have an average loan size of approximately $4 million and an average LTV of 55% and an average debt coverage ratio of 1.54x. Our retail and office exposures also remain modest and conservatively underwritten. Retail loans have an average LTV of 47% and debt coverage ratio of 1.95x, while office loans have an average LTV of 49% and debt coverage ratio of 1.7x. Office balances declined $27 million or 5% during the quarter, and we have just 7 office loans totaling $35 million in the central business districts of Los Angeles, Oakland, San Francisco and Seattle. We also continue to reduce the legacy HomeStreet syndicated loan portfolio, which has declined from approximately $142 million at September 30, 2025, to approximately $64 million at September 30, 2026. Lastly, we have no loans to non-depository financial institutions, while technology-related exposure represents less than 1% of our C&I portfolio. Turning to Slide 17. Our single-family residential and HELOC portfolios continue to reflect strong credit characteristics. Our $3.6 billion single-family residential portfolio has an average FICO score of 793 and an average LTV of 49%, while our $550 million HELOC portfolio has an average FICO score of 786. In addition, we service approximately $4.1 billion of single-family residential loans for others, which provides a stable source of revenue, particularly in an elevated interest rate environment. As we originate new single-family residential loans, we have increasingly focused on intermediate-term addressable rate mortgages to help reduce interest rate risk. Approximately 90% of our 2026 year-to-date SFR portfolio originations by dollar volume have been intermediate ARMs. Lastly, we continue to see attractive growth in our partnership with Inclined, which originates floating rate loans secured by the cash surrender value of whole life insurance policies. We ended the quarter with $837 million of these loans outstanding, up from $599 million at the end of 2025. Since the program's inception, we have experienced 0 net charge-offs and no loans over 30 days past due. The portfolio also carries nominal servicing expense and given its floating rate structure, helps reduce interest rate risk and balance the duration of our overall loan portfolio. Turning to Slide 18. Our asset quality remained strong during the quarter. Non-auto net charge-offs were approximately 4 basis points annualized and nonperforming assets remained stable at 0.28% of total assets. Total delinquent loans declined to $67.5 million or 0.52% of total loans from $95.4 million or 0.70% at June 30. The decrease in delinquencies was primarily attributable to the auto portfolio sale and 2 matured commercial real estate loans that were extended and brought current during the quarter. During the third quarter, we recorded $15.2 million reversal of provision for credit losses compared to a $2.8 million reversal in the second quarter. The third quarter reversal was primarily driven by lower expected losses on multifamily and CRE investor loans, corresponding reductions in qualitative factors and the sale of the auto portfolio. Our allowance for credit losses totaled $133.6 million or 1.03% of total loans held for investment at quarter end compared to $152.6 million or 1.12% at June 30. The allowance remains approximately 2.24x total nonperforming assets. Turning to Slide 19. Securities interest income increased $5.4 million or 10.2% to $58.5 million compared to the second quarter as the average portfolio yield increased 24 basis points to 4.21%. During the quarter, we completed a $308 million restructuring of our available-for-sale securities portfolio, reinvesting the proceeds from lower-yielding securities into higher-yielding mortgage-backed securities. The transaction resulted in a $32.3 million pretax loss with an estimated earn-back period of 4 to 5 years. The restructuring contributed to the improvement in portfolio yields during the quarter despite only a partial quarter benefit. Turning to Slide 20. Total deposits declined $70 million during the quarter to approximately $18 billion. The total cost of deposits increased 8 basis points to 1.33% compared to 1.25% in the second quarter. The increase in deposit costs reflected higher average rates and a shift in deposit mix. Non-maturity deposits declined modestly during the quarter, while the mix continued to shift toward higher-yielding money market accounts. Importantly, our deposit franchise remains a significant strength with noninterest-bearing deposits representing approximately 35% of total deposits at quarter end. Turning to Slide 21. This slide provides some additional detail on the composition and granularity of our deposit franchise. Our deposits remain well diversified across consumer, business and public customers with an average account balance of approximately 44,000 and a median balance of approximately 3,400. The relationship weighted average age of these accounts is approximately 19 years, reflecting the long-standing nature of our customer relationships. We believe this granularity and relationship tenure are important strengths of our core deposit franchise. Turning to capital and liquidity on Slide 22. We remain very well capitalized with a 14.7% Tier 1 risk-based capital ratio, a 17% total risk-based capital ratio and an 8.7% Tier 1 leverage ratio at September 30. Each of our capital ratios remains above the applicable regulatory requirements and our internal policy limits. Regulatory capital ratios for the third quarter remain preliminary. Available liquidity totaled approximately $15.8 billion at quarter end compared with $15.9 billion at June 30. This included approximately $15 billion of available borrowing capacity, $400 million of excess reserves at the Federal Reserve and $400 million of other unencumbered securities. During the third quarter, we also paid dividends of $0.25 per share of Class A common stock and $2.50 per share of Class B common stock, reflecting our continued commitment to return capital to shareholders. That concludes our prepared remarks. We will now open the line for questions. Operator?

[Operator Instructions] Your first question comes from the line of Wood Lay with KBW.

I wanted to start on deposit costs and specifically the time portfolio. In your opening remarks, you called out that, that portfolio is relatively short duration and there was a little bit of catch-up there. So I was just curious on maybe where new time deposits are pricing on to and how you expect or what percent of the portfolio you expect to reprice next quarter?

Wood, it's a good question, and it is something that we've been focused on. Obviously, as part of the merger, we wanted to delever HomeStreet a bit a lot really. They funded a lot of their growth with, I would describe it as noncore single account CDs. And so we really kind of kept our pricing pretty consistent with how mechanics have historically been pricing CDs, and we saw a lot of runoff. And we probably got a little bit more than we anticipated. So in the second quarter, we made a pretty conscious decision in April to start raising rates back towards market levels. Today, I described that market level as being basically 4%, 3.75% to 4%. And so that's kind of where we're at. And we've seen in the last couple of months and so far in October, retention rates that are keeping our CDs flat. And so first quarter, second quarter, third quarter, the pace of runoff has slowed. We do expect some continued catch-up in the fourth quarter and into the first quarter, but it should moderate over time. And I think we'll continue with our kind of pricing matrix to stay competitive.

And Woody, to answer your question about the volume, we have approximately $580 million up for renewal in the fourth quarter.

Got it. All right. That's helpful. And then maybe just in terms of the balance sheet and looking at the size of it, the auto sale completed was one of those final initiatives brought loans down. Do you think we're at the point where loan balances have stabilized and we can even see potential a little bit of growth from here?

Yes. I think we're at the point where I feel deposits have stabilized, especially CDs. The fourth quarter is typically a stronger seasonal quarter for us, especially with ag deposits. So we are budgeting modest growth in deposits, although it is difficult in this interest rate environment, that should keep our balance sheet stable. From a lending perspective, we've been growing consumer. We can talk about that. We expect continued growth in single-family, HELOC, inclined. We have a number of these inclined loans that are going to be -- that are actually in a promo period that flip to floating next year, that will be a tailwind. But on the commercial side, we do expect continued modest declines in CRE, multifamily. I think C&I and construction lending should be pretty stable. But the loans that are running off, Woody, especially on the commercial real estate side, for CRE, it's loans coming up for maturity typically at rates that are below market. And so as they mature and refinance or pay off, we'll get a pickup in yields, whether it's CRE or investment securities. Multifamily, same thing. We have a lot of multifamily, especially next year and in '28 that are hitting their reset dates and moving to floating. And if they pay off or run off, it's going to be from a much lower yield rolling into a higher yield, either a floating multifamily rate, a new multifamily loan or an investment security. So hopefully, that answers your question.

No, that does. I appreciate it. And then just last for me. How should we think about the payout ratio on the dividend next year? Should we still think about an 80% plus?

Yes. I mean I think last quarter, we mentioned $250 million of expected dividends for next year. I've got a high degree of confidence the number will be higher than that. I think we have -- and we showed it, I think, this past quarter, we have a lot of capital. We generate a lot of capital. We have very strong risk-based capital ratios, in particular, that gives us flexibility to continue to pay a very high dividend amount. And it will be, I think, higher than 80%. I think recently, it's been a payout ratio closer to 100%. I think, obviously, in the fourth quarter, it's going to be north of 100% with a $100 million dividend. that's going to be in excess of earnings, clearly. Moving into '27, we're still going to have -- we still budget some growth of deposits that we'll withhold capital for, but we could also use capital to think about what we consider additional loan sales in '27, maybe. The good news is we have a lot finally coming up for resets, and that will be a tailwind. But no matter what, we have a high degree of confidence we're going to pay a lot of dividends, and we've guided to an 8% dividend yield next year.

Your next question comes from the line of David Feaster with Raymond James.

I was hoping you could maybe elaborate on some of the deposit trends that you're seeing. It sounds like if I'm hearing you that this is really more migration and mix shift with the existing clients rather than like outflows that you're having to go out and replace. I guess, is that a fair characterization? And then are you seeing that pressure continue this quarter? And at what point do you think that starts to stabilize?

Yes. I think we had our core conversion at the very end of the first quarter. I think in the second quarter, there's a lot of all the HomeStreet clients are coming on to our core. There's a lot of change, a lot of focus on deposits. And I think we were playing a little defense sometimes on pricing. And then at the same time, rates really started moving up in the second quarter, especially in the third quarter. I think if you look at our average noninterest-bearing demand balances, it was pretty consistent second quarter to third quarter. But there is some mix shift. There is opportunity for folks to earn higher yields. We're being competitive on that. We don't want to lose deposits. Our core deposits are basically flat quarter-over-quarter. But when rates are at 5% and we have 35% noninterest-bearing, it does create a bit of a challenge. That said, one thing I added was this median account size for the bank, which is I think, a strength and a lot of our accounts are smaller. And so I think we'll stay -- have a lot less beta. But we do expect continued move up in deposit costs. I'd expect a similar increase that we had in the third quarter in the fourth quarter. But we did a pretty good job last cycle of holding our beta at 30%. I think it will be a little higher this time around. But we think we should be able to manage it pretty well.

Okay. And then just help us think through how does that impact the margin, right? I mean there's a lot of puts and takes here, right? You talked about the liability sensitivity, we got rising funding costs, but you got huge back book repricing. Could you just help us think through, I mean, the margin trajectory from here and just kind of how you think that, that's going to trend?

Yes, absolutely. And I think we did have a lot of dividend income in the second quarter. And the dividend income is core, but it's a little bit lumpy. And so that was 3 basis points of the NIM moving down. We've also had auto running off, and it was running off at 6.5% yield. We took those cash flows and reinvested it at close to 6% in securities when we did that trade in mid-September. So you should see our securities yields continue to move up. And I would expect that to be closer to 4.5% in the fourth quarter. But from a margin standpoint, we also are going to get a benefit of floating rates. Floating rates are going to pick up in the fourth quarter. The rate hike happened mid-September. All those floating rate loans, which we have over $3.5 billion and securities, that will pick up in the fourth quarter to offset, we think, the deposit pressure. So our guide is to a relatively flat NIM near term. We do start getting a lot of these resets in '27, especially in '28. And so I still think long run, our NIM will move higher. But with the sharp rise in rates, basically 100 basis points, we've already had one hike. We expect three more. It's going to keep us in a relatively stable NIM for the next couple of quarters is our expectation. The good news is now that we're out of auto, that's a lot of noise out of the way, and it should be a pretty clean, we expect fourth quarter from both a margin and an expense standpoint.

Okay. And then we touched on it a bit, right? You guys have done a ton of optimization of the balance sheet through what you did this quarter and what you guys have done previously. Obviously, the multifamily book, that optimization is going to take time. It doesn't sound like there's any interest in really ripping that band it off. But how do you think about -- at this point, it sounds like it's basically just a stable balance sheet going forward and just continued remixing within it. Is that a fair characterization? And then do you have any interest in optimizing -- just reducing liability sensitivity or managing your rate sensitivity through the balance sheet?

That's a good question, David. Couple of things. First, it's been a very busy year, right? We had the core merger core conversion at the end of the first quarter. We sold the DUC business in the second quarter. We did an AFS restructure in the third quarter. We sold our auto loans. So we've had a lot going on. We have been focused on optimizing, derisking, getting the costs out. I think we've done a good job of getting the cost out. And there's been a lot happening. So that's for sure. Also, on your question about balancing interest rate risk, that's something we've been focused on really for the past year. We've been deliberately trying to -- we bought $400 million of floating rate securities last fourth quarter. We'll have some benefit from that this fourth quarter. We've been growing inclined, which is floating rate, short duration cash surrender value secured. We really like that asset. That's going to benefit us. So we have been focused on narrowing the gap of rate-sensitive liabilities and floating rate assets. I think we will continue to do that with some of our securities purchases. And we expect inclined, frankly, to continue to grow on our balance sheet next year. And we expect some of the longer duration assets, especially commercial real estate and multifamily to get smaller. So we will continue to narrow that gap. And I don't know, I've been rambling -- I missed anything in your question there that I should revisit.

No, I think you covered it well.

Your next question comes from the line of Dave Rochester with Cantor Fitzgerald.

Maybe just back on that question that you gave such a great answer to. You had mentioned loan sales potentially earlier in the call. And I was just wondering if you could flesh that out a little bit in terms of what you're thinking about as maybe you're talking about CRE or multifamily loan sales to sort of accelerate that? Or do something else within the portfolio? It would just be great if you could give some more details as to what you're thinking.

Yes. I think it's nothing near term. I don't think anything will happen in the fourth quarter. It's something that we think about in the sense that we have a lot of lower-yielding assets. We have that page that's $4.7 billion of low-yielding assets that could we consider selling to bring forward earnings and use a lot of our -- we have a ton of capital. We generate a lot of capital. It's a possibility. But we also feel like we're in a pretty good position. We're through the merger. We've gotten a lot of the cost out. I think we're going to continue to leverage technology, and we're really focused on leaning into technology, leaning into AI. We've got a ton of focus across the organization on growing core deposits and getting out in the market and selling our bank. And I think we've got a great bank. And so there's a lot of benefit to, I think, focusing internally and just growing the core business and continuing to be efficient. But we have a lot of tools. We can -- and we've shown that we are willing to use some capital to bring forward future earnings. And I think the future earnings power of this bank is substantial given our back book repricing.

Okay. And then you mentioned Inclined. I mean that's been a solid grower for you guys over the last few quarters and beyond that. You talked about growing that next year. I mean I think it's about 6% of your portfolio right now. What's holding you back on that? Can you accelerate that growth? Can you make new hires that can work with the incline guys maybe a bit more? It just seems like that's credit and interest rate sensitivity that you guys really like with good yields. And anything more that can be done to accentuate that part of the portfolio?

I think Inclined is just a great company. They're doing well. They're growing. We are their largest bank partner. We helped get them started, worked with them on standing up their business model and navigating the compliance traps and all that. They've got their own sales force, and they've had nice momentum adding carriers and growing. And so we expect to grow with them, and they've been growing pretty quickly. So we're budgeting growth. It will probably pick up or be close to it relative to where we are today. So it will be a continued nice, I think, growth engine for us and especially in a way that balances interest rate risk and in a way where we feel great about the credit because it's cash secured essentially. But I would expect the growth to continue, perhaps accelerate a bit as Inline grows.

Okay. Maybe just switching to fees. Can you just give an update on the trust business in Delaware and how that's progressing? And any new planned hires or any recent incentive restructuring? Just trying to get an update on that and get a sense for where those fees can go from here?

Yes. I think the trust business, we have a new head of the Delaware Trust. It has been delayed getting going, but it's open now. We're starting to see some momentum, some accounts fund up. We expect it to grow as we head into the next couple of years. But I think it's going to be modest. The trust business is a core part of what we do. We've got a great team there. But at the end of the day, it's not a huge needle mover in terms of the overall profitability of the bank, but I would expect some growth as we now it open and we're getting new business. So -- but it will be modest.

Your next question comes from the line of Andrew Terrell with Stephens.

Maybe just to start on the expense side, the $420 million run rate NIE in the fourth quarter. Can you just talk about your expectations kind of beyond that a bit? Is it fair to think we see some inflationary growth off that base, especially if you're targeting some balance sheet growth? Or do you think there's levers you can pull to offset and maintain kind of that current expense run rate? And if so, can you talk more specifically about where you're getting that?

Yes. I think in the third quarter, we were at about $427 million of kind of core NIE. I feel very confident about getting down to $420 million in the fourth quarter because we did have a lot of expense with this auto business that will go away. In terms of your question about forward, I feel very confident that all banks, all companies are going to have some merit increases and the cost of insurance is going up. And just generally, that's inflationary. We understand that. But I'm quite optimistic that we can keep our expenses flat in '27. I think we have continued ability to find ways to be efficient at our company, whether it's technology related or just generally optimizing how we run the business. So I would I would expect generally a pretty flat noninterest expense from that run rate. The first quarter is always seasonally the most expense. But I think over the course of the year, we should be pretty flat on expenses next year, if not down.

Great. Really appreciate it. And then just on your Page 13 disclosure, maybe I got the page number down wrong, the repricing. If I look, the new multifamily yields listed at 6.65% this quarter. Last quarter, it was 5.80. What does that incremental 80 basis points do to your confidence about the credit performance of the multifamily assets as they come up for repricing? And do you start having to compromise on yield or repricing at a certain point? Just trying to get a sense of your comfortability for credit just given the backup in rates we've seen and some of the maybe sensitivity of these assets.

Yes. I think that's a good question, and it's something that's certainly on our mind. We do a lot of stress testing. Frankly, we've had a pretty good performance. We've had a lot of commercial real estate mature and successfully pay off this year. We've had a fair amount of multifamily do the same. Overall, our multifamily, in particular, is a very granular, low LTV, a lot of guarantor support. And so even with a pretty substantial -- a lot of these loans are going from, call it, 3.5% to 6.5% to 7%. Even with that, we still feel like the substantial majority of these loans have plenty of room. There is some pressure. Will there be some losses? I certainly expect there to be some, but most of these loans are very small, which gives us comfort. And overall, does it increase the risk? Yes. Do we think the risk is extremely manageable? Yes. I think the pickup in interest income will be substantial. I think the -- will there be some charge-offs? -- always might be some smaller ones, some here or there, but we're going to be -- we're going to really benefit from these resets. But it's on our mind. It's it causes stress when you've got higher rates and everything is a little more difficult and there'll be re-margining but we've been very happy with, especially our commercial real estate this year has paid off at a pretty healthy clip. And a lot of that's been by design as we work our CRE concentration down. But we've had very nominal charge-offs, and that includes our loans acquired in the HomeStreet deal.

Great. I appreciate your perspective. And then if I could just ask one more. Just -- it feels like a lot is evolving in kind of macro backdrop. And I'm curious like what you're hearing in terms of how the macro is unfolding for the bank, how it plays in the conversations around M&A, particularly kind of seller interest or lack thereof? And then would love to just refresh on your views on kind of how M&A will be a part of your strategy or not going forward?

I would say we've been so focused on running the bank that it hasn't -- and getting to HomeStreet that hasn't been a high priority. Any M&A where we are the buyer would be a very high bar to clear. And I think there's a lot of value to having focus because any M&A deal, no matter big or small, it takes up a lot of time and effort -- and so for us to go do M&A, it would have to be a very compelling transaction. I don't think there's very many of those out there. Obviously, could we be a seller? Yes, we could be a seller. That could be, I think, any bank, except for maybe the very big banks, that could be a consideration.

Yes. And Andrew, this is Carl. And I think we've had this conversation over the past. But we try to position the bank any day, we could be a buyer or a seller. And I think if you look at our history, it somewhat predicts our future. We are always receptive to M&A going either way. You've got these external forces out there that I think we're all aware of and somewhat sensitive to and whether you call it the Trump window or administration change, regulatory environment change, it can get much more friendly than it is today. And I think that plays both ways, whether you're a buyer or a seller. And we like the optionality of being able to go either way. I think CJ is 100% correct. We did a very accretive deal five quarters ago, coming up on five quarters ago. It takes time to mature that acquisition. I think we did the conversion integration very well. We should. It's what we've done for many, many years. So I think we have a particular skill set in M&A. And I think we have a particular skill set within M&A of really cost control. And when we say we're going to get out x million dollars, we typically exceed whatever our deal model suggests, and we certainly did that. Are there opportunities out there? Yes, but it's -- and I'm talking about from being an acquirer side of the table. They're getting few and far between because we don't want to do a deal just to get bigger. It's got to make us better. And this is a very competitive market out here for deposits, and we think deposits are our hallmark, and it's our calling card and it's our defining balance sheet items. So it's hard. But I would leave you with we're always surveilling and looking and nothing is on the front burner right now, but that could obviously always change.

There are no further questions at this time. I will now turn the call back to CJ Johnson for closing remarks.

Thank you, operator, and thanks to everyone who joined us today. As we look ahead, I think Mechanics is very well positioned. We've moved past the HomeStreet integration, substantially completed the exit of our noncore auto business and continue to realize the benefits of a more efficient operating platform. At the same time, our credit quality remains very strong. We have substantial capital flexibility, and we continue to benefit from what we believe is one of the strongest deposit franchises on the West Coast. While the current interest rate environment presents some near-term pressure, we remain very confident in the long-term earnings power of the franchise. We have meaningful embedded asset repricing opportunities, compelling risk-adjusted returns and a market-leading dividend yield. We appreciate your continued interest in mechanics and look forward to speaking with you again next quarter.

This concludes today's call. Thank you for attending. You may now disconnect.