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 Annual Report on Form 10-K for the year ended December 31, 2023 ("2023Annual Report on Form 10-K"). FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”). Generally, forward-looking statements include the words “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “should,” “will,” and “would” and similar expressions (or the negative of these terms). Forward-looking statements in this Form 10-Q also include statements regarding the expected timing to close the proposed merger of HomeStreet into FirstSun Capital Bancorp (“FirstSun”) and HomeStreet Bank into Sunflower Bank, N.A., a subsidiary of FirstSun (collectively, the “Merger”) and expectations regarding dividend payments in 2024. Such statements involve inherent risks, uncertainties and other factors, many of which are difficult to predict and are generally beyond control of HomeStreet Inc. (the "Company"). Forward-looking statements are based on the Company’s expectations at the time such statements are made and speak only as of the date made, they are not guarantees of future performance. The Company does not assume any obligation or undertake to update any forward-looking statements after the date of this report as a result of new information, future events or developments, except as required by federal securities or other applicable laws, although the Company may do so from time to time. The Company does not endorse any projections regarding future performance that may be made by third parties. For all forward-looking statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Reform Act. We caution readers that actual results may differ materially from those expressed in or implied by the Company’s forward-looking statements. Rather, more important factors could affect the Company’s future results, including but not limited to the following:(1) our ability to successfully consummate the proposed Merger with FirstSun; (2) the ability of HomeStreet to obtain the necessary approval by shareholders with respect to the Merger; (3) the ability of HomeStreet and FirstSun to obtain required regulatory and governmental approvals of the Merger when expected or at all (and the risk that such approvals may result in the imposition of conditions that could adversely affect the combined company or the expected benefits of the Merger); (4) the failure to satisfy the closing conditions in the definitive Agreement and Plan of Merger (the “Merger Agreement”), dated as of January 16, 2024, as amended on April 30, 2024, by and between HomeStreet and FirstSun, or any unexpected delay in closing the Merger; (5) the ability to achieve expected cost savings, synergies and other financial benefits from the Merger within the expected time frames and costs or difficulties relating to integration matters being greater than expected; (6) the diversion of management time from core banking functions due to Merger-related issues; (7) potential difficulty in maintaining relationships with customers, associates or business partners as a result of the announced Merger; (8) the ability of FirstSun to consummate their investment agreements to obtain the necessary capital to support the Merger; (9) the occurrence of any event, change or circumstance that could give rise to the right of one or both parties to terminate the Merger Agreement; (10) the outcome of any legal proceedings that have been or may be instituted against FirstSun or HomeStreet; (11) changes in the U.S. and global economies, including business disruptions, reductions in employment, inflationary pressures and an increase in business failures, specifically among our customers; (12) changes in the interest rate environment may reduce interest margins; (13) changes in deposit flows, loan demand or real estate values may adversely affect the business of our primary subsidiary, HomeStreet Bank (the “Bank”), through which substantially all of our operations are carried out; (14) there may be increases in competitive pressure among financial institutions or from non-financial institutions; (15) our ability to attract and retain key members of our senior management team; (16) the timing and occurrence or non-occurrence of events may be subject to circumstances beyond our control; (17) our ability to control operating costs and expenses; (18) our credit quality and the effect of credit quality on our credit losses expense and allowance for credit losses; (19) the adequacy of our allowance for credit losses; (20) changes in accounting principles, policies or guidelines may cause our financial condition to be perceived or interpreted differently; (21) legislative or regulatory changes that may adversely affect our business or financial condition, including, without limitation, changes in corporate and/or individual income tax laws and policies, changes in privacy laws, and changes in regulatory capital or other rules, and the availability of resources to address or respond to such changes; (22) general economic conditions, either nationally or locally in some or all areas in which we conduct business, or conditions in the securities markets or banking industry, may be less favorable than what we currently anticipate; (23) challenges our customers may face in meeting current underwriting standards may adversely impact all or a substantial portion of the value of our rate-lock loan activity we recognize; (24) technological changes may be more difficult or expensive than what we anticipate; (25) a failure in or breach of our operational or security systems or information technology infrastructure, or those of our third-party providers and vendors, including due to cyber-attacks; (26) success or consummation of new business initiatives may be more difficult or expensive than what we anticipate; (27) our ability to grow efficiently both organically and through acquisitions and to manage our growth and integration costs; (28) staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; (29) litigation, investigations or other matters before regulatory agencies, whether currently existing or commencing in the future, may delay the occurrence or non- occurrence of events longer than what we anticipate; and (30) our ability to obtain regulatory approvals or non-objection to take various capital actions, including the payment of dividends by us or the Bank, or repurchases of our common stock. A discussion of the factors, risks and uncertainties that could affect our financial results, business goals and operational and financial objectives discussed in our 2023 annual report on Form 10-K or in our releases, public statements and/or filings with the Securities and Exchange Commission (“SEC”) is also contained in the “Risk Factors” section of our 2023 Annual Report on Form 10-K. We strongly recommend readers review those disclosures in conjunction with the discussions herein. All future written and oral forward-looking statements attributable to the Company or any person acting on its behalf are expressly qualified in their entirety by the cautionary statements contained or referred to above. New risks and uncertainties arise from time to time, and factors that the Company currently deems immaterial may become material, and it is impossible for the Company to predict these events or how they may affect the Company. 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 loss 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 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 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 for all periods, the amount of the ACL at March 31, 2024 would increase by approximately $8 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 6– Mortgage Banking Operations of the financial statements. Note 6 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 fair value of MSRs. 41 Summary Financial Data Quarter Ended (in thousands, except per share data and FTE data) March 31, 2024 December 31, 2023 March 31, 2023 Select Income Statement data: Net interest income $ 32,151 $ 34,989 $ 49,376 Provision for credit losses — 445 593 Noninterest income 9,454 10,956 10,190 Noninterest expense 52,164 49,511 52,491 Income (loss) before income taxes (10,559) (4,011) 6,482 Net income (loss) (7,497) (3,419) 5,058 Net income (loss) per fully diluted share (0.40) (0.18) 0.27 Core net income (loss): (1) Total (5,469) (2,249) 5,058 Core net income (loss) per fully diluted share (0.29) (0.12) 0.27 Select Performance Ratios: Return on average equity - annualized (5.6) % (2.6) % 3.5 % Return on average tangible equity - annualized (1) (3.8) % (1.3) % 4.1 % Return on average assets - annualized Net income (loss) (0.32) % (0.15) % 0.22 % Core (1) (0.23) % (0.10) % 0.22 % Efficiency ratio (1) 118.0 % 105.9 % 87.2 % Net interest margin 1.44 % 1.59 % 2.23 % Other data Full time equivalent employees 858 875 920 (1) Core net income (loss), core net income (loss) per fully diluted share, return on average tangible equity, core return on average assets and the efficiency ratio are non-GAAP financial measures. measures. For a reconciliation of these measures to the nearest comparable GAAP financial measure or the computation of the 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, 2024 December 31, 2023 Selected Balance Sheet Data Loans held for sale $ 21,102 $ 19,637 Loans held for investment, net 7,405,052 7,382,404 ACL 39,677 40,500 Investment securities 1,191,108 1,278,268 Total assets 9,455,182 9,392,450 Deposits 6,491,102 6,763,378 Borrowings 2,094,000 1,745,000 Long-term debt 224,857 224,766 Total shareholders' equity 527,333 538,387 Other data: Book value per share $ 27.96 $ 28.62 Tangible book value per share (1) $ 27.49 $ 28.11 Total equity to total assets 5.6 % 5.7 % Tangible common equity to tangible assets (1) 5.5 % 5.6 % Shares outstanding at end of period 18,857,566 18,810,055 Loans to deposit ratio (Bank) 114.3 % 109.4 % Credit Quality: ACL to total loans (2) 0.54 % 0.55 % ACL to nonaccrual loans 80.2 % 103.9 % Nonaccrual loans to total loans 0.66 % 0.53 % Nonperforming assets to total assets 0.56 % 0.45 % Nonperforming assets $ 52,584 $ 42,643 Regulatory Capital Ratios: Bank Tier 1 leverage 8.34 % 8.50 % Total risk-based capital 13.34 % 13.49 % Common equity Tier 1 capital 12.67 % 12.79 % Company Tier 1 leverage 6.90 % 7.04 % Total risk-based capital 12.70 % 12.84 % Common equity Tier 1 capital 9.55 % 9.66 % (1) Tangible book value per share and tangible common equity to tangible assets are non-GAAP financial measures. For a reconciliation of this measure 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 Proposed Merger Transaction On January 16, 2024, the Company entered into a definitive merger agreement (as amended on April 30, 2024, the “merger agreement”) with FirstSun, the holding company of Sunflower Bank and Dynamis Subsidiary, Inc., whereby, under the merger agreement, the Company and the Bank will merge with and into FirstSun and Sunflower Bank, respectively. The agreement was amended on April 30, 2024, and subject to the terms and conditions of the merger agreement, the companies will combine in an all-stock transaction in which HomeStreet shareholders will receive 0.3867 of a share of FirstSun common stock for each share of HomeStreet common stock. The parties to the Merger expect to complete the Merger in late 2024, subject to the satisfaction of closing conditions, including receipt of customary required regulatory approvals, the approval of the merger agreement by HomeStreet shareholders and satisfaction or waiver of other closing conditions. Economic and Market Conditions Our financial results have been adversely impacted by the historically significant increase in short-term interest rates by the Federal Reserve during 2022 and 2023. This dramatic increase in rates resulted in significant reductions in loan demand, particularly in single family mortgage. Accordingly, our gain on loan sales activities declined significantly and are expected to remain at low levels in 2024. Additionally, our interest sensitive deposits declined as customers moved funds to higher yielding products both at our Bank and at other financial institutions and brokerage firms. We have taken a number of steps to reduce the pressure on our funding base, including: (i) significantly reducing our level of loan originations; and (ii) introducing promotional priced deposit products which allow us to attract and retain deposits without repricing our existing interest-bearing deposit base. Inflationary pressures have adversely impacted our operations by increasing our costs, primarily compensation costs which we expect to be higher in 2024. Due to the impacts of the significant increases in short term rates by the Federal Reserve in 2023, and as a result of our actions taken to address the impact of these increases, we expect the balance of our loans held for investment to stay relatively stable during 2024 and our net interest margin to be lower in 2024 as compared to 2023. Management's Overview of the First Quarter 2024 Financial Performance First Quarter of 2024 Compared to the Fourth Quarter of 2023 General: Our net loss and loss before income taxes were $(7.5) million and $(10.6) million, respectively, in the first quarter of 2024, as compared to $(3.4) million and $(4.0) million, respectively, in the fourth quarter of 2023. The $6.5 million increase in loss before income taxes was due to lower net interest income, lower noninterest income and an increase in noninterest expense which was partially offset by a lower provision for credit losses. Income Taxes: The income tax benefit realized in the first quarter of 2024 resulted in an effective tax rate of 29.0% as compared to an effective tax rate of 14.8% in the fourth quarter of 2023. Our effective tax rate in the first quarter of 2024 was higher than our statutory rate of 24.6% due to the impact of tax advantaged investments which creates a higher benefit due to our loss. Our effective tax rate of 14.8% in the fourth quarter of 2023 was significantly impacted by the goodwill impairment charge taken in 2023, a portion of which was not deductible for tax purposes, the effect of which was partially offset by benefits of tax advantaged investments. 44 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 interest margin: Quarter Ended March 31, 2024 December 31, 2023 (in thousands) Average Balance Interest Average Yield/Cost Average Balance Interest Average Yield/Cost Assets: Interest-earning assets: Loans (1) $ 7,460,650 $ 86,427 4.60 % $ 7,465,375 $ 87,193 4.60 % Investment securities (1) 1,239,093 11,627 3.75 % 1,278,344 12,591 3.94 % FHLB Stock, Fed Funds and other 388,462 5,571 5.76 % 179,619 2,603 5.72 % Total interest-earning assets 9,088,205 103,625 4.54 % 8,923,338 102,387 4.52 % Noninterest-earning assets 413,984 428,528 Total assets $ 9,502,189 $ 9,351,866 Liabilities and shareholders' equity: Interest-bearing deposits: (2) Demand deposits $ 324,210 $ 170 0.21 % $ 341,697 $ 185 0.22 % Money market and savings 1,840,023 7,380 1.60 % 1,981,308 7,797 1.55 % Certificates of deposit 3,068,404 35,057 4.60 % 2,864,237 31,335 4.34 % Total 5,232,637 42,607 3.27 % 5,187,242 39,317 3.00 % Borrowings: Borrowings 2,074,527 24,676 4.73 % 1,975,536 23,845 4.74 % Long-term debt 224,812 3,107 5.51 % 224,722 3,128 5.52 % Total interest-bearing liabilities 7,531,976 70,390 3.74 % 7,387,500 66,290 3.55 % Noninterest-bearing liabilities: Demand deposits (2) 1,319,309 1,343,043 Other liabilities 113,277 107,565 Total liabilities 8,964,562 8,838,108 Shareholders' equity 537,627 513,758 Total liabilities and shareholders' equity $ 9,502,189 $ 9,351,866 Net interest income $ 33,235 $ 36,097 Net interest rate spread 0.80 % 0.98 % Net interest margin 1.44 % 1.59 % (1) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $1.1 million for both quarters ended March 31, 2024 and December 31, 2023. The estimated federal statutory tax rate was 21% for the periods presented. (2) Cost of all deposits, including noninterest-bearing demand deposits was 2.61% and 2.39% for the quarters ended March 31, 2024 and December 31, 2023, respectively. Our net interest income in the first quarter of 2024 was $2.8 million lower than the fourth quarter of 2023 due to a decrease in our net interest margin from 1.59% to 1.44%. The decrease in our net interest margin was due to a 19 basis point increase in the cost of interest-bearing liabilities which was due primarily to a 22 basis point increase in the cost of deposits. The increase in the rates paid on deposits was due to the migration of noninterest-bearing and lower cost interest-bearing accounts to higher cost certificates of deposit and money market accounts. Provision for Credit Losses: There was no provision for credit losses recognized during the first quarter of 2024 as compared to a $0.4 million provision in the fourth quarter of 2023. These low levels of provisions for credit losses reflect the stable balance of our loan portfolio, a minimal level of identified credit issues in our loan portfolio and the lack of significant expected credit issues arising in future periods. 45 Noninterest Income consisted of the following: Quarter Ended (in thousands) March 31, 2024 December 31, 2023 Noninterest income Gain on loan origination and sale activities (1) Single family $ 1,986 $ 1,844 CRE, multifamily and SBA 320 264 Loan servicing income 3,032 3,258 Deposit fees 2,241 2,331 Other 1,875 3,259 Total noninterest income $ 9,454 $ 10,956 (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, 2024 December 31, 2023 Single family servicing income, net Servicing fees and other $ 3,839 $ 3,880 Changes - amortization (1) (1,428) (1,504) Net 2,411 2,376 Risk management, single family MSRs: Changes in fair value due to assumptions (2) 618 (1,380) Net gain (loss) from economic hedging (3) (1,110) 1,089 Subtotal (492) (291) Single Family servicing income 1,919 2,085 Commercial loan servicing income: Servicing fees and other 2,515 2,588 Amortization of capitalized MSRs (1,402) (1,415) Total 1,113 1,173 Total loan servicing income $ 3,032 $ 3,258 (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. (3) The interest income from US Treasury notes securities used for hedging purposes, which is included in interest income on the consolidated income statements, was $0.3 million for both the quarters ended March 31, 2024 and December 31, 2023. Noninterest income in the first quarter of 2024 decreased from the fourth quarter of 2023 primarily due to higher levels of income realized in the fourth quarter of 2023 from our investments in small business investment companies. Noninterest Expense consisted of the following: Quarter Ended (in thousands) March 31, 2024 December 31, 2023 Noninterest expense Compensation and benefits $ 28,011 $ 27,033 Information services 7,342 7,694 Occupancy 5,434 5,407 General, administrative and other 11,377 9,377 Total noninterest expense $ 52,164 $ 49,511 46 The increase in noninterest expenses in the first quarter of 2024, as compared to the fourth quarter of 2023 was primarily due to seasonally higher compensation costs and a $1.1 million increase in merger related expenses. First Quarter of 2024 Compared to First Quarter of 2023 General: Our net income (loss) and income (loss) before income taxes were $(7.5) million and $(10.6) million, respectively, in the first quarter of 2024, as compared to $5.1 million and $6.5 million, respectively, in the first quarter of 2023. Our core net income (loss) and core income (loss) before income taxes in the first quarter of 2024, which excludes the impact of merger related expenses, was $(5.5) million and $(8.0) million, as compared to $5.1 million and $6.5 million, respectively, in the first quarter of 2023. The $14.4 million decrease in core income before taxes was primarily due to lower net interest income, partially offset by a lower provision for credit losses. Income Taxes: The income tax benefit realized in the first quarter of 2024 resulted in an effective tax rate of 29.0% which was higher than our statutory rate of 24.6% due to the impact of tax advantaged investments which creates a higher benefit to our loss. Our effective tax rate in the first quarter of 2023 of 22.0% was lower than the statutory rate due to the benefits of tax advantaged investments. 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 interest margin: Quarter Ended March 31, 2024 2023 (in thousands) Average Balance Interest Average Yield/Cost Average Balance Interest Average Yield/Cost Assets: Interest-earning assets: Loans (1) $ 7,460,650 $ 86,427 4.60 % $ 7,471,456 $ 82,790 4.44 % Investment securities (1) 1,239,093 11,627 3.75 % 1,452,137 13,733 3.78 % FHLB Stock, Fed Funds and other 388,462 5,571 5.76 % 126,891 1,750 5.59 % Total interest-earning assets 9,088,205 103,625 4.54 % 9,050,484 98,273 4.35 % Noninterest-earning assets 413,984 480,221 Total assets $ 9,502,189 $ 9,530,705 Interest-bearing liabilities: Interest-bearing deposits: (2) Demand deposits $ 324,210 $ 170 0.21 % $ 430,268 $ 299 0.28 % Money market and savings 1,840,023 7,380 1.60 % 2,555,512 7,353 1.16 % Certificates of deposit 3,068,404 35,057 4.60 % 2,715,921 21,718 3.24 % Total 5,232,637 42,607 3.27 % 5,701,701 29,370 2.09 % Borrowings: Borrowings 2,074,527 24,676 4.73 % 1,342,347 15,340 4.57 % Long-term debt 224,812 3,107 5.51 % 224,435 2,965 5.28 % Total interest-bearing liabilities 7,531,976 70,390 3.74 % 7,268,483 47,675 2.64 % Noninterest-bearing liabilities: Demand deposits (2) 1,319,309 1,511,437 Other liabilities 113,277 172,252 Total liabilities 8,964,562 8,952,172 Shareholders' equity 537,627 578,533 Total liabilities and shareholders' equity $ 9,502,189 $ 9,530,705 Net interest income $ 33,235 $ 50,598 Net interest spread 0.80 % 1.71 % Net interest margin 1.44 % 2.23 % (1) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $1.1 million and $1.2 million for the quarters ended March 31, 2024 and 2023, respectively. The estimated federal statutory tax rate was 21% for the periods presented. (2) Cost of deposits including noninterest-bearing deposits, was 2.61% and 1.65% for the quarters ended March 31, 2024 and 2023, respectively. 47 Net interest income in the first quarter of 2024 decreased $17.2 million as compared to the first quarter of 2023 due primarily to a decrease in our net interest margin. Our net interest margin decreased from 2.23% in the first quarter of 2023 to 1.44% in the first quarter of 2024 due to a 110 basis point increase in the rates paid on interest-bearing liabilities which was partially offset by a 19 basis point increase in the yield on interest earning assets. Yields on interest-earning assets increased as yields on adjustable rate loans increased due to increases in the indexes on which their pricing is based. The increase in the rates paid on our interest-bearing liabilities was due to an increase in the proportion of higher cost borrowings and a decrease in the proportion of noninterest-bearing deposits to the total balance of interest-bearing liabilities and higher deposit costs and higher borrowing costs. The increases in the rates paid on deposits were due to increases in market interest rates over the prior year and the migration of noninterest-bearing and lower cost interest-bearing accounts to higher cost certificates of deposit and money market accounts. Provision for Credit Losses: There was no provision for credit losses recognized during the first quarter of 2024 as compared to a $0.6 million provision in the first quarter of 2023. These low levels of provisions for credit losses reflect the stable balance of our loan portfolio, a minimal level of identified credit issues in our loan portfolio and the lack of significant expected credit issues arising in future periods. Noninterest Income consisted of the following: Quarter Ended March 31, (in thousands) 2024 2023 Noninterest income Gain on loan origination and sale activities (1) Single family $ 1,986 $ 2,218 CRE, multifamily and SBA 320 192 Loan servicing income 3,032 3,039 Deposit fees 2,241 2,658 Other 1,875 2,083 Total noninterest income $ 9,454 $ 10,190 (1) May include loans originated as held for investment. 48 Loan servicing income, a component of noninterest income, consisted of the following: Quarter Ended March 31, (in thousands) 2024 2023 Single family servicing income, net Servicing fees and other $ 3,839 $ 3,923 Changes - amortization (1) (1,428) (1,684) Net 2,411 2,239 Risk management, single family MSRs: Changes in fair value due to assumptions (2) 618 (311) Net gain (loss) from economic hedging (3) (1,110) (81) Subtotal (492) (392) Single Family servicing income 1,919 1,847 Commercial loan servicing income: Servicing fees and other 2,515 2,746 Amortization of capitalized MSRs (1,402) (1,554) Total 1,113 1,192 Total loan servicing income $ 3,032 $ 3,039 (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. (3) The interest income from US Treasury notes securities used for hedging purposes, which is included in interest income on the consolidated income statements, was $0.3 million and $0.4 million for the quarters ended March 31, 2024 and 2023, respectively. Noninterest Expense consisted of the following: Quarter Ended March 31, (in thousands) 2024 2023 Noninterest expense Compensation and benefits $ 28,011 $ 29,253 Information services 7,342 7,145 Occupancy 5,434 5,738 General, administrative and other 11,377 10,355 Total noninterest expense $ 52,164 $ 52,491 The $0.3 million decrease in noninterest expenses in the first quarter of 2024 as compared to the first quarter of 2023 was primarily due to lower compensation and benefit costs, partially offset by higher general, administrative and other costs. The decrease in compensation and benefit costs was primarily due to lower staffing levels, which was partially offset by wage increases given in the first quarter of 2024. FTEs decreased from 920 at the quarter ended March 31, 2023 compared to 858 at the quarter ended March 31, 2024. The increase in general, administrative and other costs was primarily due to $2.6 million in merger related costs. 49 Financial Condition During the first quarter of 2024, our total assets increased $63 million due primarily to a $105 million increase in cash, partially offset by a decrease in investment securities. During the first quarter of 2024 total liabilities increased $74 million due to an increase in borrowings, partially offset by a decrease in deposits. The $272 million decrease in deposits was primarily due to a $297 million decrease in brokered certificates of deposit. The $349 million of additional borrowings were used to replace maturing brokered deposits and increase our on-balance sheet cash balances. Credit Risk Management During the first quarter of 2024, our ratios of nonperforming assets to total assets and total loans delinquent over 30 days, including nonaccrual loans, increased but remained at low levels. As of March 31, 2024, our ratio of nonperforming assets to total assets was 0.56%, while our ratio of total loans delinquent over 30 days, including nonaccrual loans, to total loans was 0.82%. 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, 2024 At December 31, 2023 (in thousands) Amount Rate (1) Amount Rate (1) CRE Non-owner occupied CRE $ 2,131 0.34 % $ 2,610 0.41 % Multifamily 18,947 0.48 % 13,093 0.33 % Construction/land development Multifamily construction 1,621 0.84 % 3,983 2.37 % CRE construction 188 1.02 % 189 1.02 % Single family construction 5,578 2.00 % 7,365 2.69 % Single family construction to permanent 435 0.51 % 672 0.64 % Total 28,900 0.56 % 27,912 0.54 % Commercial and industrial loans Owner occupied CRE 836 0.22 % 899 0.23 % Commercial business 2,646 0.69 % 2,950 0.83 % Total 3,482 0.46 % 3,849 0.52 % Consumer loans Single family 4,273 0.40 % 5,287 0.51 % Home equity and other 3,022 0.78 % 3,452 0.90 % Total 7,295 0.51 % 8,739 0.61 % Total ACL $ 39,677 0.54 % $ 40,500 0.55 % (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, borrowings from the Bank Term Funding Program and borrowings from other financial institutions. Additionally, the Company may sell stock or issue long-term debt to raise funds. While scheduled principal 50 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 $65 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, 2024 and December 31, 2023, the Bank had available borrowing capacity of $1.6 billion and $2.1 billion, respectively, from the FHLB, and $853 million and $710 million, respectively, from the FRBSF and $1.1 billion, in both periods, under borrowing lines established with other financial institutions. Cash Flows For the quarter ended March 31, 2024, cash and cash equivalents increased by $105 million compared to an increase of $304 million during the quarter ended March 31, 2023. 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, 2024, net cash of $7.8 million was used in operating activities, as cash generated from operations was offset by cash used to fund LHFS in excess of proceeds from the sale of loans and increases in other assets. For the quarter ended March 31, 2023, net cash of $52 million was used in operating activities, primarily from cash proceeds from the purchase of trading securities and cash used to fund LHFS exceeding proceeds from the sale of loans. 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, 2024, net cash of $36 million was provided by investing activities primarily from principal repayments on AFS securities, partially offset by the origination of LHFI net of principal repayments and net FHLB stock purchases. For the quarter ended March 31, 2023, net cash of $269 million was provided by investing activities primarily from net cash acquired from an acquisition partially offset by the origination of LHFI net of principal repayments and the purchase of AFS investment securities and net FHLB stock purchases. 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, 2024, net cash of $76 million was provided by financing activities, primarily due to by an increase in short-term and long-term borrowings, partially offset by decreases in deposits. For the quarter ended March 31, 2023, net cash of $87 million was provided by financing activities, primarily due to an increase in short-term and long-term borrowings partially offset by a decrease in deposits and dividends paid on our common stock. 51 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, 2024 At December 31, 2023 Unused consumer portfolio lines $ 599,576 $ 586,904 Commercial portfolio lines (1) 653,192 648,609 Commitments to fund loans 19,644 38,426 Total $ 1,272,412 $ 1,273,939 (1) Within the commercial portfolio, undistributed construction loan proceeds, where the Company has an obligation to advance funds for construction progress payments were $414 million and $403 million at March 31, 2024 and December 31, 2023, respectively. 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, 2024 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) $ 669,490 6.90 % $ 388,113 4.0 % NA NA Common equity Tier 1 capital (to risk-weighted assets) 609,490 9.55 % 287,337 4.5 % NA NA Tier 1 risk-based capital (to risk-weighted assets) 669,490 10.48 % 383,116 6.0 % NA NA Total risk-based capital (to risk-weighted assets) 810,910 12.70 % 510,822 8.0 % NA NA HomeStreet Bank Tier 1 leverage capital (to average assets) $ 808,549 8.34 % $ 387,900 4.0 % $ 484,875 5.0 % Common equity Tier 1 capital (to risk-weighted assets) 808,549 12.67 % 287,224 4.5 % 414,880 6.5 % Tier 1 risk-based capital (to risk-weighted assets) 808,549 12.67 % 382,966 6.0 % 510,621 8.0 % Total risk-based capital (to risk-weighted assets) 851,564 13.34 % 510,621 8.0 % 638,276 10.0 % 52 At December 31, 2023 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) $ 675,440 7.04 % $ 383,696 4.0 % NA NA Common equity Tier 1 capital (to risk-weighted assets) 615,440 9.66 % 286,709 4.5 % NA NA Tier 1 risk-based capital (to risk-weighted assets) 675,440 10.60 % 382,279 6.0 % NA NA Total risk-based capital (to risk-weighted assets) 818,075 12.84 % 509,705 8.0 % NA NA HomeStreet Bank Tier 1 leverage capital (to average assets) $ 814,719 8.50 % $ 383,482 4.0 % $ 479,352 5.0 % Common equity Tier 1 capital (to risk-weighted assets) 814,719 12.79 % 286,569 4.5 % 413,933 6.5 % Tier 1 risk-based capital (to risk-weighted assets) 814,719 12.79 % 382,092 6.0 % 509,456 8.0 % Total risk-based capital (to risk-weighted assets) 858,992 13.49 % 509,456 8.0 % 636,820 10.0 % As 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 both the Company and Bank maintained capital ratios necessary to satisfy the capital conservation buffer requirements as of the dates indicated. At March 31, 2024, capital conservation buffers for the Company and the Bank were 4.48% and 5.34%, respectively. The Company did not declare a cash dividend in the quarter and currently does not plan to pay any quarterly dividends in 2024. The amount and declaration of future cash dividends are subject to approval by our Board of Directors and certain statutory requirements and regulatory restrictions. We had no material commitments for capital expenditures as of March 31, 2024. 53 Non-GAAP Financial Measures To supplement our unaudited condensed consolidated financial statements presented in accordance with GAAP, we use certain use certain non-GAAP measures of financial performance. In this 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 exclude intangible assets from the calculation of capital ratios; (ii) core income and effective tax rate on core income before taxes, which excludes goodwill impairment charges and merger related expenses and the related tax impact as we believe this measure is a better comparison to be used for projecting future results and (iii) an efficiency ratio which is the ratio of noninterest expense 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 expense 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. 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, or a calculation of the non-GAAP financial measure. 54 Reconciliations of non-GAAP results of operations to the nearest comparable GAAP measures: For the Quarter Ended (in thousands, except ratio, rate and share data) March 31, 2024 December 31, 2023 March 31, 2023 Core net income (loss) Net income (loss) $ (7,497) $ (3,419) $ 5,058 Adjustments (tax effected) Merger related expenses 2,028 1,170 — Total $ (5,469) $ (2,249) $ 5,058 Core net income (loss) per fully diluted share Fully diluted shares 18,856,870 18,807,965 18,771,899 Computed amount $ (0.29) $ (0.12) $ 0.27 Return on average tangible equity (annualized) Average shareholders' equity $ 537,627 $ 513,758 $ 578,533 Less: Average goodwill and other intangibles (9,403) (10,149) (30,969) Average tangible equity $ 528,224 $ 503,609 $ 547,564 Core net income (loss) (per above) $ (5,469) $ (2,249) $ 5,058 Adjustments (tax effected) Amortization on core deposit intangibles 488 615 459 Tangible income (loss) applicable to shareholders $ (4,981) $ (1,634) $ 5,517 Ratio (3.8) % (1.3) % 4.1 % Efficiency ratio Noninterest expense Total $ 52,164 $ 49,511 $ 52,491 Adjustments: Merger related expenses (2,600) (1,500) — State of Washington taxes (452) 659 (555) Adjusted total $ 49,112 $ 48,670 $ 51,936 Total revenues Net interest income $ 32,151 $ 34,989 $ 49,376 Noninterest income 9,454 10,956 10,190 Total $ 41,605 $ 45,945 $ 59,566 Ratio 118.0 % 105.9 % 87.2 % Return on Average assets (annualized) - Core Average Assets $ 9,502,189 $ 9,351,866 $ 9,530,705 Core net income (loss) - per above (5,469) (2,249) 5,058 Ratio (0.23) % (0.10) % 0.22 % Effective tax rate used in computations above 22.0 % 22.0 % 22.0 % 55 As of (in thousands, except ratio, rate and share data) March 31, 2024 December 31, 2023 Tangible book value per share Shareholders' equity $ 527,333 $ 538,387 Less: intangible assets (9,016) (9,641) Tangible shareholder's equity $ 518,317 $ 528,746 Common shares outstanding 18,857,566 18,810,055 Computed amount $ 27.49 $ 28.11 Tangible common equity to tangible assets Tangible shareholder's equity (per above) $ 518,317 $ 528,746 Tangible assets Total assets $ 9,455,182 $ 9,392,450 Less: intangible assets (9,016) (9,641) Net $ 9,446,166 $ 9,382,809 Ratio 5.5 % 5.6 % 56