Mechanics Bancorp 10-Q

ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes presented elsewhere in this report and in HomeStreet, Inc.'s 2021 Annual Report on Form 10-K. FORWARD-LOOKING STATEMENTS Statements contained in this Quarterly Report on Form 10-Q that are not historical facts or that discuss our expectations, beliefs or views regarding our future operations or future financial performance, or financial or other trends in our business or in the markets in which we operate, anticipated completion of loan forbearances with respect to customer loans, our future plans and the credit exposure of certain loan products and other components of our business that could be impacted by the COVID-19 pandemic, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Many forward-looking statements can be identified as using words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plan," "potential," "should," "will" and "would" and similar expressions (or the negative of these terms). Such statements involve inherent risks and uncertainties, many of which are difficult to predict and are generally beyond the control of the Company and are subject to risks and uncertainties, including, but not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2021 and the risks and uncertainties discussed below and elsewhere in this Quarterly Report on Form 10-Q that could cause actual results to differ significantly from those projected. In addition, many of the risks and uncertainties are, and will be, exacerbated by the COVID-19 pandemic and any worsening of the global, national, regional and local business and economic environment as a result. Although we believe that expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We undertake no obligation, and expressly disclaim any such obligation to update; or clarify any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to reflect changed assumptions, the occurrence of anticipated or unanticipated events, new information or changes to future results over time or otherwise, except as required by law. Readers are cautioned not to place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. Except as otherwise noted, references to "we," "our," "us" or "the Company" refer to HomeStreet, Inc. and its subsidiaries that are consolidated for financial reporting purposes. Statements of knowledge, intention or belief reflect those characteristics of our executive management team based on current facts and circumstances. You may review a copy of this Quarterly Report on Form 10-Q, including exhibits and any schedule filed therewith on the Securities and Exchange Commission's website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants, such as HomeStreet, Inc., that file electronically with the Securities and Exchange Commission. Copies of our Securities Exchange Act reports also are available from our investor relations website, http://ir.homestreet.com. Information contained in or linked from our websites is not incorporated into and does not constitute a part of this report. Critical Accounting Estimates We have identified two estimates as being critical because they require management to make particularly difficult, subjective, and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for credit losses (“ACL”) and the valuation of single family mortgage servicing rights (“MSRs"). The ACL is calculated based on quantitative and qualitative factors to estimate credit losses over the life of the loan. The inputs used to determine quantitative factors include estimates based on historical experience of probability of default and losses given default. Inputs used to determine qualitative factors include changes in current portfolio characteristics and operating environments such as current and forecasted unemployment rates, capitalization rates used to value properties securing loans, rental rates and single family pricing indexes. Qualitative factors may also include adjustments to address matters not contemplated by the model and to assumptions used to determine qualitative factors. Although we believe that our methodology for determining an appropriate level for the ACL adequately addresses the various components that could potentially result in credit losses, the processes and their elements include features that may be susceptible to significant change. Any unfavorable 40 differences between the actual outcome of credit-related events and our estimates could require an additional provision for credit losses. For example, if the projected unemployment rate was downgraded one grade, the amount of the ACL on March 31, 2022 would increase by approximately $6 million. This sensitivity analysis is hypothetical and has been provided only to indicate the potential impact that changes in assumptions may have on the ACL estimate. The valuation of MSRs is based on various assumptions which are set forth in Note 7– Mortgage Banking Operations of the financial statements. Note 7 also provides sensitivity analysis based on the assumptions used. The sensitivity analyses are hypothetical and have been provided to indicate the potential impact that changes in assumptions may have on the estimate of the value of MSRs. 41 Summary Financial Data Quarter Ended (in thousands, except per share data and FTE data) March 31, 2022 December 31, 2021 March 31, 2021 Select Income Statement data: Net interest income $ 54,546 $ 57,084 $ 54,517 Provision for credit losses (9,000) (6,000) — Noninterest income 15,558 28,620 38,833 Noninterest expense 54,473 53,971 56,608 Net income: Before income taxes 24,631 37,733 36,742 Total 19,951 29,432 29,663 Net income per share - diluted 1.01 1.43 1.35 Select Performance Ratios: Return on average equity - annualized 11.6 % 16.1 % 16.4 % Return on average tangible equity - annualized (1) 12.2 % 17.0 % 17.3 % Return on average assets - annualized 1.10 % 1.59 % 1.65 % Efficiency ratio (1) 77.0 % 62.2 % 60.0 % Net interest margin 3.27 % 3.34 % 3.29 % Other data Full time equivalent employees 962 970 1,013 (1) Return on average tangible equity and the efficiency ratio are non-GAAP financial measures. For a reconciliation of return on average tangible equity to the nearest comparable GAAP financial measure, see “Non-GAAP Financial Measures” elsewhere in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. 42 As of (in thousands, except share and per share data) March 31, 2022 December 31, 2021 Selected Balance Sheet Data Loans held for sale $ 59,150 $ 176,131 Loans held for investment, net 5,826,546 5,495,726 ACL 37,944 47,123 Investment securities 1,083,640 1,006,691 Total assets 7,510,894 7,204,091 Deposits 6,270,535 6,146,509 Borrowings 273,000 41,000 Long-term debt 224,137 126,026 Total shareholders' equity 601,231 715,339 Other data: Book value per share $ 32.15 $ 35.61 Tangible book value per share (1) $ 30.47 $ 34.04 Total equity to total assets 8.0 % 9.9 % Tangible common equity to tangible assets (1) 7.6 % 9.5 % Shares outstanding at period end 18,700,536 20,085,336 Loans to deposit ratio 94.5 % 93.0 % Credit Quality: ACL to total loans (2) 0.66 % 0.88 % ACL to nonaccrual loans 320.3 % 386.2 % Nonaccrual loans to total loans 0.20 % 0.22 % Nonperforming assets to total assets 0.17 % 0.18 % Nonperforming assets $ 12,581 $ 12,936 Regulatory Capital Ratios: Bank Tier 1 leverage ratio 10.30 % 10.11 % Total risk-based capital 13.23 % 13.77 % Company Tier 1 leverage ratio 8.99 % 9.94 % Total risk-based capital 12.65 % 12.66 % (1) Tangible book value per share and tangible common equity to tangible assets are non-GAAP financial measures. For a reconciliation to the nearest comparable GAAP financial measure, see “Non-GAAP Financial Measures” elsewhere in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. (2) This ratio excludes balances insured by the FHA or guaranteed by the VA or SBA. 43 Current Developments On January 19, 2022, we completed a $100 million subordinated notes offering due in 2032 (the “Notes”). Interest on the Notes initially will accrue at a rate equal to 3.5% per annum from and including the date of original issuance to, but excluding, January 30, 2027, payable semiannually in arrears. From and including January 30, 2027, to, but excluding, the maturity date or the date of earlier redemption, the Notes will bear interest equal to the three-month term SOFR plus 215 basis points, payable quarterly in arrears. Net proceeds were $98 million, after deducting underwriting discounts and offering expenses. We used a significant portion of the net proceeds from the Notes offering to repurchase shares of our common stock through open market purchases and we plan to use the remainder of the net proceeds for working capital and other general corporate purposes, including support for growth of our assets. As part of our capital management strategy, during the first three months of 2022, we repurchased a total of 1,471,485 shares of our common stock at an average price of $50.97 per share. As part of our business strategy, we are focusing on growing our loan portfolio and leveraging our existing operating expense infrastructure. Increases in our loan portfolio will have the effect of increasing our level of net interest income in future periods, a more stable source of revenues as compared to gain on loan origination and sale activities. As part of this strategy, we did not sell any multifamily portfolio loans in the first quarter of 2022. 44 Management's Overview of the First Quarter 2022 Financial Performance First Quarter of 2022 Compared to the Fourth Quarter of 2021 General: Our net income and income before taxes were $20.0 million and $24.6 million, respectively, in the first quarter of 2022, as compared to $29.4 million and $37.7 million, respectively, in the fourth quarter of 2021. The $13.1 million decrease in income before taxes was due to lower net interest income, lower noninterest income and higher noninterest expenses, partially offset by a higher recovery of our allowance for credit losses. Income Taxes: Our effective tax rate was 19.0% in the first quarter of 2022 as compared to 22.0% in fourth quarter of 2021 and a statutory rate of 23.4%. Our effective tax rate was lower than our statutory rate due to the benefits of tax advantaged investments. Additionally, our effective tax rate in the first quarter of 2022 was lower than the fourth quarter of 2021 due to reductions in taxes on income related to excess tax benefits resulting from the vesting of stock awards during the first quarter. 45 Net Interest Income: The following tables set forth, for the periods indicated, information regarding (i) the total dollar amount of interest income from interest-earning assets and the resultant average yields on those assets; (ii) the total dollar amount of interest expense and the average rate of interest on our interest-bearing liabilities; (iii) net interest income; (iv) net interest rate spread; and (v) net yield on interest-earning assets: Quarter Ended March 31, 2022 December 31, 2021 (in thousands) Average Balance Interest Average Yield/Cost Average Balance Interest Average Yield/Cost Assets: Interest-earning assets: Loans (1) $ 5,691,316 $ 53,135 3.74 % $ 5,767,597 $ 55,587 3.79 % Investment securities (1) 1,028,971 6,671 2.59 % 990,273 6,178 2.50 % FHLB Stock, Fed Funds and other 65,918 108 0.65 % 82,447 97 0.46 % Total interest-earning assets 6,786,205 59,914 3.54 % 6,840,317 61,862 3.57 % Noninterest-earning assets 577,384 516,640 Total assets $ 7,363,589 $ 7,356,957 Liabilities and shareholders' equity: Interest-bearing deposits: (2) Demand deposits $ 525,608 $ 143 0.11 % $ 538,468 $ 183 0.14 % Money market and savings 3,101,607 1,121 0.15 % 3,120,212 1,111 0.14 % Certificates of deposit 886,416 1,020 0.47 % 932,559 1,187 0.51 % Total 4,513,631 2,284 0.21 % 4,591,239 2,481 0.21 % Borrowings: Borrowings 64,557 91 0.56 % 25,711 48 0.73 % Long-term debt 204,553 2,107 4.12 % 125,995 1,356 4.29 % Total interest-bearing liabilities 4,782,741 4,482 0.38 % 4,742,945 3,885 0.33 % Noninterest-bearing liabilities: Demand deposits (2) 1,744,202 1,728,558 Other liabilities 138,048 159,440 Total liabilities 6,664,991 6,630,943 Shareholders' equity 698,598 726,014 Total liabilities and shareholders' equity $ 7,363,589 $ 7,356,957 Net interest income $ 55,432 $ 57,977 Net interest rate spread 3.16 % 3.24 % Net interest margin 3.27 % 3.34 % (1) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $0.9 million for tboth quarters ended March 31, 2022 and December 31, 2021. The estimated federal statutory tax rate was 21% for the periods presented. (2) Cost of all deposits, including noninterest-bearing demand deposits was 0.15% and 0.16% for the quarter ended March 31, 2022 and December 31, 2021, respectively. Net interest income was $2.5 million lower in the first quarter of 2022 as compared to the fourth quarter of 2021 primarily due to lower average loan balances, a $0.7 million increase in interest expense related to the $100 million subordinated notes offering completed in January 2022 and a $0.6 million decrease in income from Paycheck Protection Program loans. The lower average loan balances were primarily due to the sale of $244 million of multifamily loans in November of 2021 which was partially offset by the increase in loan balances during the first quarter. Provision for Credit Losses: As a result of the continued favorable performance of our loan portfolio, a stable low level of nonperforming assets and an improved outlook of the estimated impact of COVID-19 on our loan portfolio, we recorded a $9 million recovery of our allowance for credit losses in the first quarter of 2022, as compared to a $6 million recovery of our allowance for credit losses in the fourth quarter of 2021. 46 Noninterest Income consisted of the following: Quarter Ended (in thousands) March 31, 2022 December 31, 2021 Noninterest income Gain on loan origination and sale activities (1) Single family $ 6,169 $ 10,578 CRE, multifamily and SBA 2,105 9,501 Loan servicing income 3,304 2,540 Deposit fees 2,075 2,156 Other 1,905 3,845 Total noninterest income $ 15,558 $ 28,620 (1) May include loans originated as held for investment. Loan servicing income, a component of noninterest income, consisted of the following: Quarter Ended (in thousands) March 31, 2022 December 31, 2021 Single family servicing income, net Servicing fees and other $ 3,871 $ 3,870 Changes - amortization (1) (3,425) (4,216) Net 446 (346) Risk management, single family MSRs: Changes in fair value due to assumptions (2) 10,303 193 Net gain (loss) from economic hedging (10,183) (378) Subtotal 120 (185) Single Family servicing income (loss) 566 (531) Commercial loan servicing income: Servicing fees and other 4,450 5,417 Amortization of capitalized MSRs (1,712) (2,346) Total 2,738 3,071 Total loan servicing income $ 3,304 $ 2,540 (1) Represents changes due to collection/realization of expected cash flows and curtailments. (2) Principally reflects changes in model assumptions, including prepayment speed assumptions, which are primarily affected by changes in mortgage interest rates. The decrease in noninterest income in the first quarter of 2022 as compared to the fourth quarter of 2021 was due to a $11.8 million decrease in gain on loan origination and sale activities and a $1.9 million decrease in other income which were partially offset by a $0.8 million increase in loan servicing income. The decrease in gain on loan origination and sale activities was due to a $4.4 million decrease in single family gain on loan origination and sale activities and a $7.4 million decrease in commercial real estate (“CRE”) and commercial gain on loan origination and sale activities. The decrease in single family gain on loan origination and sale activities was due to a decrease in rate lock volume and margins as a result of the effects of increasing interest rates. The decrease in CRE and commercial gain on loan origination and sale activities was primarily due to an 84% decrease in the volume of loans sold. The decrease in other income was due to a $1.0 million decrease in revenues from investments in community development entities and $0.6 million gain on sale of other real estate owned realized in the fourth quarter. 47 Noninterest Expense consisted of the following: Quarter Ended (in thousands) March 31, 2022 December 31, 2021 Noninterest expense Compensation and benefits $ 32,031 $ 30,627 Information services 7,062 7,278 Occupancy 6,365 5,662 General, administrative and other 9,015 10,404 Total noninterest expense $ 54,473 $ 53,971 The $0.5 million increase in noninterest expense in the first quarter of 2022 as compared to the fourth quarter of 2021 was primarily due to higher compensation and benefits and occupancy costs, partially offset by lower general, administrative and other costs. The higher level of compensation and benefit costs reflect a $1.0 million reversal of previously accrued medical benefits related to the positive experience in our self-insured medical program in the fourth quarter. Occupancy costs increased due to common area maintenance rent increases and accelerated depreciation in the first quarter of 2022. Legal costs, which are included in general, administrative and other costs, were $1.4 million lower in the first quarter of 2022 as compared to the fourth quarter of 2021 due to higher nonrecurring costs expended on litigation activities and legal matters in the fourth quarter. First Quarter of 2022 Compared to First Quarter of 2021 General: Our net income and income before taxes were $20.0 million and $24.6 million, respectively, in the first quarter of 2022, as compared to $29.7 million and $36.7 million, respectively, in the first quarter of 2021. The $12.1 million decrease in income before taxes was due to lower noninterest income, partially offset by a recovery of our allowance for credit losses in 2022 and lower noninterest expense. Income Taxes: Our effective tax rate during first quarter of 2022 was 19.0% as compared to 19.3% in the first quarter of 2021 and a statutory rate of 23.4%. Our effective tax rate for both periods was lower than our statutory rate due to the benefits of tax advantaged investments and reductions in taxes on income related to excess tax benefits resulting from the exercise and vesting of stock awards during the quarter. Net Interest Income: The following tables set forth, for the periods indicated, information regarding (i) the total dollar amount of interest income from interest-earning assets and the resultant average yields on those assets; (ii) the total dollar amount of interest expense and the average rate of interest on our interest-bearing liabilities; (iii) net interest income; (iv) net interest rate spread; and (v) net yield on interest-earning assets: 48 Quarter Ended March 31, 2022 2021 (in thousands) Average Balance Interest Average Yield/Cost Average Balance Interest Average Yield/Cost Assets: Interest-earning assets: Loans (1) $ 5,691,316 $ 53,135 3.74 % $ 5,605,868 $ 53,755 3.85 % Investment securities (1) 1,028,971 6,671 2.59 % 1,065,423 6,591 2.47 % FHLB Stock, Fed Funds and other 65,918 108 0.65 % 68,044 172 1.01 % Total interest-earning assets 6,786,205 59,914 3.54 % 6,739,335 60,518 3.60 % Noninterest-earning assets 577,384 571,073 Total assets $ 7,363,589 $ 7,310,408 Interest-bearing liabilities: Interest-bearing deposits: (2) Demand deposits $ 525,608 $ 143 0.11 % $ 493,831 $ 169 0.14 % Money market and savings 3,101,607 1,121 0.15 % 2,915,005 1,228 0.17 % Certificates of deposit 886,416 1,020 0.47 % 1,180,290 2,253 0.77 % Total 4,513,631 2,284 0.21 % 4,589,126 3,650 0.32 % Borrowings: Borrowings 64,557 91 0.56 % 203,621 161 0.32 % Long-term debt 204,553 2,107 4.12 % 125,854 1,363 4.33 % Total interest-bearing liabilities 4,782,741 4,482 0.38 % 4,918,601 5,174 0.42 % Noninterest-bearing liabilities: Demand deposits (2) 1,744,202 1,433,765 Other liabilities 138,048 226,323 Total liabilities 6,664,991 6,578,689 Shareholders' equity 698,598 731,719 Total liabilities and shareholders' equity $ 7,363,589 $ 7,310,408 Net interest income $ 55,432 $ 55,344 Net interest spread 3.16 % 3.18 % Net interest margin 3.27 % 3.29 % (1) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $0.9 million and $0.8 million for the quarters ended March 31, 2022 and 2021, respectively. The estimated federal statutory tax rate was 21% for the periods presented. (2) Cost of deposits including noninterest-bearing deposits, was 0.15% and 0.25% for the quarters ended March 31, 2022 and 2021, respectively. Net interest income was stable in the first quarter of 2022 as compared to the first quarter of 2021 as increases in the average balance of loans was offset by a decrease in the net interest margin. Our net interest margin decreased slightly from 3.29% in the first quarter of 2021 compared to 3.27% in the first quarter of 2022 as a six basis point decrease in our yield on interest earning assets was offset by a four basis point decrease in the rate on interest-bearing liabilities. The decrease in yield on interest earning assets was primarily due to the prepayment and paydown of higher yielding loans and investments in our portfolios during 2021. Our cost of interest-bearing liabilities decreased due to decreases in market interest rates during 2021 which was partially offset by the impact of the $100 million subordinated notes offering completed in January 2022. The increase in the average balance of loans reflects the increases in our loans held for investment that occurred in 2021 and in the first quarter of 2022. Provision for Credit Losses: As a result of the favorable performance of our loan portfolio, a stable low level of nonperforming assets and an improved outlook of the estimated impact of COVID-19 on our loan portfolio, we recorded a $9 million recovery of our allowance for credit losses in the first quarter of 2022. We recorded no provision for credit losses in the first quarter of 2021. 49 Noninterest Income consisted of the following: Quarter Ended March 31, (in thousands) 2022 2021 Noninterest income Gain on loan origination and sale activities (1) Single family $ 6,169 $ 26,187 Commercial 2,105 7,272 Loan servicing income 3,304 748 Deposit fees 2,075 1,824 Other 1,905 2,802 Total noninterest income $ 15,558 $ 38,833 (1) May include loans originated as held for investment. Loan servicing income, a component of noninterest income, consisted of the following: Quarter Ended March 31, (in thousands) 2022 2021 Single family servicing income, net Servicing fees and other $ 3,871 $ 3,935 Changes - amortization (1) (3,425) (5,693) Net 446 (1,758) Risk management, single family MSRs: Changes in fair value due to assumptions (2) 10,303 11,463 Net gain (loss) from economic hedging (10,183) (12,591) Subtotal 120 (1,128) Single Family servicing income (loss) 566 (2,886) Commercial loan servicing income: Servicing fees and other 4,450 4,978 Amortization of capitalized MSRs (1,712) (1,344) Total 2,738 3,634 Total loan servicing income $ 3,304 $ 748 (1) Represents changes due to collection/realization of expected cash flows and curtailments. (2) Principally reflects changes in model assumptions, including prepayment speed assumptions, which are primarily affected by changes in mortgage interest rates. 50 The decrease in noninterest income for the first quarter of 2022 as compared to the first quarter of 2021 was due to decreases in gain on loan origination and sale activities, which was partially offset by higher loan servicing income. The $25.2 million decrease in gain on loan origination and sale activities was due to a $20.0 million decrease in single family gain on loan origination and sale activities and a $5.2 million decrease in CRE and commercial gain on loan origination and sale activities. The decrease in single family gain on loan origination and sale activities was due to a decrease in rate lock volume and margins as a result of the effects of increasing interest rates. The decrease in CRE and commercial gain on loan origination and sale activities was primarily due to a 81% decrease in the volume of loans sold. The $2.6 million increase in loan servicing income was primarily due to lower levels of prepayments and improved risk management results. Noninterest Expense consisted of the following: Quarter Ended March 31, (in thousands) 2022 2021 Noninterest expense Compensation and benefits $ 32,031 $ 35,835 Information services 7,062 6,784 Occupancy 6,365 6,492 General, administrative and other 9,015 7,497 Total noninterest expense $ 54,473 $ 56,608 The $2.1 million decrease in noninterest expense in the first quarter of 2022 as compared to the first quarter of 2021 was due to lower compensation and benefit costs, partially offset by an increase in general, administrative and other expenses. The $3.8 million decrease in compensation and benefits expense is primarily due to reduced commission expense on lower loan origination volumes in our single family mortgage operations. The increase in general, administrative and other costs was due to charges related to nonrecurring costs expended on litigation activities and legal matters in the first quarter of 2022. 51 Financial Condition During the first quarter of 2022, total assets increased $307 million due primarily to a $331 million increase in loans held for investment and a $77 million increase in investment securities which were partially offset by a decrease of $117 million in loans held for sale. Loans held for investment increased due to $747 million of originations, which were partially offset by prepayments and scheduled payments of $419 million. Total liabilities increased $421 million due to increases in deposits, borrowings and long-term debt. The $124 million increase in deposits was due to higher levels of business deposits and wholesale deposits. The increase in borrowings was due to an increased need for wholesale borrowings to fund loan growth. Long-term debt increased due to our $100 million subordinated debt offering in completed in January 2022. 52 Credit Risk Management As of March 31, 2022, our ratio of nonperforming assets to total assets remained low at 0.17% while our ratio of total loans delinquent over 30 days to total loans was 0.42%. The Company recorded a $9 million recovery of our allowance for credit losses for the quarter ended March 31, 2022. As a result of the COVID-19 pandemic, the Company has approved forbearances for some of its borrowers. The status of these forbearances as of March 31, 2022 is as follows: Forbearances Approved (2)(3) Total Expired Outstanding (in thousands) Number of loans Amount Number of loans Amount Number of loans Amount Loan type: Commercial and CRE: Commercial business 92 $ 46,026 92 $ 46,026 — $ — CRE owner occupied 25 65,210 25 65,210 — — CRE nonowner occupied 13 56,233 12 42,194 1 14,039 Total 130 $ 167,469 129 $ 153,430 1 $ 14,039 Single family and consumer (1) Single family 9 $ 5,036 HELOCs and consumer 4 487 Total 13 $ 5,523 (1) Does not include any single family loans that are guaranteed by Ginnie Mae. (2) Does not include construction loans that were modified as a result of COVID-19 related construction delays to extend the construction or lease-up periods. Each of these loans continued to make monthly payments under the existing or modified payment terms. At March 31, 2022, only one of these loans with a $1 million balance is still operating under the terms of their modification. (3) There were no forbearances initiated in the first quarter of 2022. The forbearances approved for commercial and industrial loans and CRE nonowner occupied loans were generally for a period of three months while the forbearances for single family, HELOCs and consumer loans were generally for a period of three to six months. As of March 31, 2022, excluding the loans with forbearances still in place, 99% of the commercial and CRE loans approved for a forbearance have completed their forbearance period and have resumed payments. The forbearance periods for the majority of single family and consumer loans granted forbearance that were not complete as of March 31, 2022 are scheduled to be completed in the second quarter of 2022. 53 Management considers the current level of the ACL to be appropriate to cover estimated lifetime losses within our LHFI portfolio. The following table presents the ACL by product type: At March 31, 2022 At December 31, 2021 (in thousands) Amount Rate (1) Amount Rate (1) CRE Non-owner occupied CRE $ 2,294 0.33 % $ 7,509 1.06 % Multifamily 8,427 0.31 % 5,854 0.24 % Construction/land development Multifamily construction 456 1.24 % 507 1.34 % CRE construction 184 1.02 % 150 1.06 % Single family construction 7,735 2.42 % 6,411 2.16 % Single family construction to permanent 990 0.64 % 1,055 0.71 % Total 20,086 0.51 % 21,486 0.59 % Commercial and industrial loans Owner occupied CRE 3,536 0.76 % 5,006 1.10 % Commercial business 6,910 1.83 % 12,273 3.39 % Total 10,446 1.24 % 17,279 2.11 % Consumer loans Single family 3,762 0.58 % 4,394 0.68 % Home equity and other 3,650 1.24 % 3,964 1.31 % Total 7,412 0.78 % 8,358 0.88 % Total ACL $ 37,944 0.66 % $ 47,123 0.88 % (1) The ACL rate is calculated excluding balances related to loans that are insured by the FHA or guaranteed by the VA or SBA. Liquidity and Sources of Funds Liquidity risk management is primarily intended to ensure we are able to maintain sources of cash to adequately fund operations and meet our obligations, including demands from depositors, draws on lines of credit and paying any creditors, on a timely and cost-effective basis, in various market conditions. Our liquidity profile is influenced by changes in market conditions, the composition of the balance sheet and risk tolerance levels. The Company has established liquidity guidelines and operating plans that detail the sources and uses of cash and liquidity. The Company's primary sources of liquidity include deposits, loan payments and investment securities payments, both principal and interest, borrowings, and proceeds from the sale of loans and investment securities. Borrowings include advances from the FHLB, federal funds purchased and borrowing from other financial institutions. Additionally, the Company may sell stock or issue long-term debt to raise funds. While scheduled principal repayments on loans and investment securities are a relatively predictable source of funds, deposit inflows and outflows and prepayments of loans and investment securities are greatly influenced by interest rates, economic conditions and competition. The Company’s contractual cash flow obligations include the maturity of certificates of deposit, short-term and long-term borrowings, interest on certificates of deposit and borrowings, operating leases and fees for information technology related services and professional services. Obligations for certificates of deposit and short-term borrowings are typically satisfied through the renewal of these instruments or the generation of new deposits or use of available short-term borrowings. Interest payments and obligations related to leases and services are typically met by cash generated from our operations. The Company has $64 million of Senior Notes which mature in 2026 which it expects to pay off from available cash or from the issuance of new debt. At March 31, 2022 and December 31, 2021, the Bank had available borrowing capacity of $1.8 billion and $1.8 billion, respectively, from the FHLB, and $308 million and $274 million, respectively, from the FRBSF and $1.0 billion and $1.0 billion under borrowing lines established with other financial institutions. 54 Cash Flows For the quarter ended March 31, 2022, cash and cash equivalents increased by $9 million compared to an increase of $11 million during the quarter ended March 31, 2021. As excess liquidity can reduce the Company’s earnings and returns, the Company manages its cash positions to minimize the level of excess liquidity and does not attempt to maximize the level of cash and cash equivalents. The following discussion highlights the major activities and transactions that affected our cash flows during these periods. Cash flows from operating activities The Company's operating assets and liabilities are used to support our lending activities, including the origination and sale of mortgage loans. For the quarter ended March 31, 2022, net cash of $124 million was provided by operating activities, primarily from cash proceeds from the sale of loans exceeding cash used to fund LHFS. For the quarter ended March 31, 2021, net cash of $2 million was used in operating activities, primarily from cash used to fund LHFS production exceeding cash proceeds from the sale of loans. We believe that cash flows from operations, available cash balances and our ability to generate cash through short-term debt borrowings are sufficient to fund our operating liquidity needs. We are currently not aware of any trends or demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in our liquidity increasing or decreasing in any material way that will impact our capital needs during or beyond the next 12 months. Cash flows from investing activities The Company's investing activities primarily include AFS investment securities and loans originated as held for investment. For the quarter ended March 31, 2022, net cash of $464 million was used in investing activities primarily from the origination of LHFI net of principal repayments and the purchase of AFS investment securities. For the quarter ended March 31, 2021, net cash of $28 million was used in investing activities for the origination of LHFI and the purchase of AFS investment securities, which were partially offset by principal payments and the proceeds from the sale of loans originated as LHFI and AFS investment securities. Cash flows from financing activities The Company's financing activities are primarily related to deposits and net proceeds from borrowings. For the quarter ended March 31, 2022, net cash of $349 million was provided by financing activities, primarily due to growth in deposits and an increase in short-term borrowings and proceeds from the issuance of the subordinated notes, partially offset by repurchases of and dividends paid on our common stock. For the quarter ended March 31, 2021, net cash of $41 million was provided by financing activities, primarily due to growth in deposits, which was partially offset by net repayment of short-term borrowings, repurchases of and dividends paid on our common stock. Off-Balance Sheet Arrangements In the normal course of business, we are a party to financial instruments that carry off-balance sheet risk. These financial instruments (which include commitments to originate loans and commitments to purchase loans) include potential credit risk in excess of the amount recognized in the accompanying consolidated financial statements. These transactions are designed to (1) meet the financial needs of our customers, (2) manage our credit, market or liquidity risks, (3) diversify our funding sources and/or (4) optimize capital. These commitments include the following: (in thousands) At March 31, 2022 At December 31, 2021 Unused consumer portfolio lines $ 433,656 $ 405,992 Commercial portfolio lines (1) 807,658 820,131 Commitments to fund loans 99,648 90,852 Total $ 1,340,962 $ 1,316,975 (1) Within the commercial portfolio, undistributed construction loan proceeds, where the Company has an obligation to advance funds for construction progress payments, were $554 million and $584 million at March 31, 2022 and December 31, 2021, respectively. 55 Capital Resources and Dividend Policy The capital rules applicable to United States based bank holding companies and federally insured depository institutions (“Capital Rules”) require the Company (on a consolidated basis) and the Bank (on a stand-alone basis) to meet specific capital adequacy requirements that, for the most part, involve quantitative measures, primarily in terms of the ratios of their capital to their assets, liabilities, and certain off-balance sheet items, calculated under regulatory accounting practices. In addition, prompt corrective action regulations place a federally insured depository institution, such as the Bank, into one of five capital categories on the basis of its capital ratios: (i) well capitalized; (ii) adequately capitalized; (iii) undercapitalized; (iv) significantly undercapitalized; or (v) critically undercapitalized. A depository institution’s primary federal regulatory agency may determine that, based on certain qualitative assessments, the depository institution should be assigned to a lower capital category than the one indicated by its capital ratios. At each successive lower capital category, a depository institution is subject to greater operating restrictions and increased regulatory supervision by its federal bank regulatory agency. The following table sets forth the capital and capital ratios of HomeStreet Inc. (on a consolidated basis) and HomeStreet Bank as compared to the respective regulatory requirements applicable to them: At March 31, 2022 Actual For Minimum Capital Adequacy Purposes To Be Categorized As "Well Capitalized" (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio HomeStreet, Inc. Tier 1 leverage capital (to average assets) $ 661,438 8.99 % $ 294,206 4.0 % NA NA Common equity Tier 1 capital (to risk-weighted assets) 601,438 9.48 % 285,432 4.5 % NA NA Tier 1 risk-based capital (to risk-weighted assets) 661,438 10.43 % 380,576 6.0 % NA NA Total risk-based capital (to risk-weighted assets) 802,274 12.65 % 507,434 8.0 % NA NA HomeStreet Bank Tier 1 leverage capital (to average assets) $ 744,371 10.30 % $ 289,021 4.0 % $ 361,276 5.0 % Common equity Tier 1 capital (to risk-weighted assets) 744,371 12.52 % 267,492 4.5 % 386,378 6.5 % Tier 1 risk-based capital (to risk-weighted assets) 744,371 12.52 % 356,657 6.0 % 475,542 8.0 % Total risk-based capital (to risk-weighted assets) 786,711 13.23 % 475,542 8.0 % 594,428 10.0 % At December 31, 2021 Actual For Minimum Capital Adequacy Purposes To Be Categorized As "Well Capitalized" (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio HomeStreet, Inc. Tier 1 leverage capital (to average assets) $ 723,232 9.94 % $ 291,098 4.0 % NA NA Common equity Tier 1 capital (to risk-weighted assets) 663,232 10.84 % 275,281 4.5 % NA NA Tier 1 risk-based capital (to risk-weighted assets) 723,232 11.82 % 367,041 6.0 % NA NA Total risk-based capital (to risk-weighted assets) 774,695 12.66 % 489,388 8.0 % NA NA HomeStreet Bank Tier 1 leverage capital (to average assets) $ 727,753 10.11 % $ 287,990 4.0 % $ 359,988 5.0 % Common equity Tier 1 capital (to risk-weighted assets) 727,753 12.87 % 254,442 4.5 % 367,527 6.5 % Tier 1 risk-based capital (to risk-weighted assets) 727,753 12.87 % 339,256 6.0 % 452,341 8.0 % Total risk-based capital (to risk-weighted assets) 778,723 13.77 % 452,341 8.0 % 565,426 10.0 % 56 As of each of the dates set forth in the above table, the Company exceeded the minimum required capital ratios applicable to it and the Bank’s capital ratios exceeded the minimums necessary to qualify as a well-capitalized depository institution under the prompt corrective action regulations. In addition to the minimum capital ratios, both HomeStreet Inc. and HomeStreet Bank are required to maintain a capital conservation buffer consisting of additional Common Equity Tier 1 Capital of more than 2.5% above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses. The required ratios for capital adequacy set forth in the above table do not include the Capital Rules’ additional capital conservation buffer, though each of the Company and Bank maintained capital ratios necessary to satisfy the capital conservation buffer requirements as of the dates indicated. At March 31, 2022, capital conservation buffers for the Company and the Bank were 4.43% and 5.23%, respectively. The Company paid a quarterly cash dividend of $0.35 per common share in the first quarter of 2022. It is our current intention to continue to pay quarterly dividends, and on April 28, 2022 we declared another cash dividend of $0.35 per common share payable on May 24, 2022 to shareholders of record as of the close of business on May 10, 2022. The amount and declaration of future cash dividends are subject to approval by our Board of Directors and certain regulatory restrictions. We had no material commitments for capital expenditures as of March 31, 2022. However, we intend to take advantage of opportunities that may arise in the future to grow our businesses, which may include opening additional offices or acquiring complementary businesses that we believe will provide us with attractive risk-adjusted returns. As a result, we may seek to obtain additional borrowings and to sell additional shares of our common stock to raise funds which we might need for these purposes. There is no assurance, however, that, if required, we will succeed in obtaining additional borrowings or selling additional shares of our common stock on terms that are acceptable to us, if at all, as this will depend on market conditions and other factors outside of our control, as well as our future results of operations. 57 Non-GAAP Financial Measures To supplement our unaudited condensed consolidated financial statements presented in accordance with GAAP, we use certain non-GAAP measures of financial performance. In this Quarterly Report on Form 10-Q, we use the following non-GAAP measures: (i) tangible common equity and tangible assets as we believe this information is consistent with the treatment by bank regulatory agencies, which excluded intangible assets from the calculation of capital ratios; and (ii) an efficiency ratio which is the ratio of noninterest expenses to the sum of net interest income and noninterest income, excluding certain items of income or expense and excluding taxes incurred and payable to the state of Washington as such taxes are not classified as income taxes and we believe including them in noninterest expenses impacts the comparability of our results to those companies whose operations are in states where assessed taxes on business are classified as income taxes. These supplemental performance measures may vary from, and may not be comparable to, similarly titled measures provided by other companies in our industry. Non-GAAP financial measures are not in accordance with, or an alternative for, GAAP. Generally, a non-GAAP financial measure is a numerical measure of a company’s performance that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with GAAP. A non-GAAP financial measure may also be a financial metric that is not required by GAAP or other applicable requirements. We believe that these non-GAAP financial measures, when taken together with the corresponding GAAP financial measures, provide meaningful supplemental information regarding our performance by providing additional information used by management that is not otherwise required by GAAP or other applicable requirements. Our management uses, and believes that investors benefit from referring to, these non-GAAP financial measures in assessing our operating results and when planning, forecasting and analyzing future periods. These non-GAAP financial measures also facilitate a comparison of our performance to prior periods. We believe these measures are frequently used by securities analysts, investors and other parties in the evaluation of companies in our industry. Rather, these non-GAAP financial measures should be considered in addition to, not as a substitute for or superior to, financial measures prepared in accordance with GAAP. In the information below, we have provided reconciliations of, where applicable, the most comparable GAAP financial measures to the non-GAAP measures used in this Quarterly Report on Form 10-Q, or a reconciliation of the non-GAAP calculation of the financial measure. Reconciliations of non-GAAP results of operations to the nearest comparable GAAP measures: 58 For the quarter ended (in thousands) March 31, 2022 December 31, 2021 March 31, 2021 Return on average tangible equity (annualized) Average shareholders' equity $ 698,598 $ 726,014 $ 731,719 Less: Average goodwill and other intangibles (31,624) (31,901) (32,777) Average tangible equity $ 666,974 $ 694,113 $ 698,942 Net income $ 19,951 $ 29,432 $ 29,663 Adjustments (tax effected) Amortization on core deposit intangibles 191 229 236 Tangible income applicable to shareholders $ 20,142 $ 29,661 $ 29,899 Ratio 12.2 % 17.0 % 17.3 % Efficiency ratio Noninterest expense Total $ 54,473 $ 53,971 $ 56,608 Adjustments: State of Washington taxes (506) (664) (579) Adjusted total $ 53,967 $ 53,307 $ 56,029 Total revenues Net interest income $ 54,546 $ 57,084 $ 54,517 Noninterest income 15,558 28,620 38,833 Total $ 70,104 $ 85,704 $ 93,350 Ratio 77.0 % 62.2 % 60.0 % Effective tax rate used in computations above 22.0 % 22.0 % 19.3 % As of (in thousands, except share data) March 31, 2022 December 31, 2021 Tangible book value per share Shareholders' equity $ 601,231 $ 715,339 Less: goodwill and other intangibles (31,464) (31,709) Tangible shareholder's equity $ 569,767 $ 683,630 Common shares outstanding 18,700,536 20,085,336 Computed amount $ 30.47 $ 34.04 Tangible common equity to tangible assets Tangible shareholder's equity (per above) $ 569,767 $ 683,630 Tangible assets Total assets 7,510,894 7,204,091 Less: Goodwill and other intangibles (31,464) (31,709) Net $ 7,479,430 $ 7,172,382 Ratio 7.6 % 9.5 % 59