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 ("2023 Annual 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 discussions by FirstSun and the Company relating to the pursuit of an alternative regulatory structure for the proposed merger of HomeStreet into FirstSun Capital Bancorp (“FirstSun”) and HomeStreet Bank into Sunflower Bank, N.A. ("Sunflower Bank") a subsidiary of FirstSun (collectively, the “Merger”), discussions relating to terms on which HomeStreet and FirstSun would terminate the merger agreement if no alternative structure is feasible, the expected impact of decreases in interest rates 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 and 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 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); (3) 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; (4) 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; (5) the diversion of management time from core banking functions due to Merger-related issues; (6) potential difficulty in maintaining relationships with customers, associates or business partners as a result of the announced Merger; (7) the ability of FirstSun to consummate its investment agreements to obtain the necessary capital to support the Merger; (8) 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; (9) the outcome of any legal proceedings that have been or may be instituted against FirstSun or HomeStreet; (10) 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; (11) changes in the interest rate environment; (12) 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; (13) there may be increases in competitive pressure among financial institutions or from non-financial institutions; (14) our ability to attract and retain key members of our senior management team; (15) the timing and occurrence or non-occurrence of events may be subject to circumstances beyond our control; (16) our ability to control operating costs and expenses; (17) our credit quality and the effect of credit quality on our credit losses expense and allowance for credit losses; (18) the adequacy of our allowance for credit losses; (19) changes in accounting principles, policies or guidelines may cause our financial condition to be perceived or interpreted differently; (20) 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; (21) 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; (22) 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; (23) technological changes may be more difficult or expensive than what we anticipate; (24) 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; (25) success or consummation of new business initiatives may be more difficult or expensive than what we anticipate; (26) our ability to grow efficiently both organically and through acquisitions and to manage our growth and integration costs; (27) staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; (28) 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 (29) 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 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2024 (the "First Quarter 2024 Report on Form 10-Q"). 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 September 30, 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. 45 Summary Financial Data Quarter Ended Nine Months Ended September 30, (in thousands, except per share data and FTE data) September 30, 2024 June 30, 2024 2024 2023 Select Income Statement data: Net interest income $ 28,619 $ 29,701 $ 90,471 $ 131,764 Provision for credit losses — — — (886) Noninterest income 11,058 13,227 33,739 30,965 Noninterest expense 49,166 50,931 152,261 192,361 Income (loss) before income taxes (9,489) (8,003) (28,051) (28,746) Net income (loss) (7,282) (6,238) (21,017) (24,089) Net income (loss) per fully diluted share (0.39) (0.33) (1.11) (1.28) Core net income (loss): (1) Total (5,999) (4,341) (15,809) 10,533 Core net income (loss) per fully diluted share (0.32) (0.23) (0.84) 0.56 Select Performance Ratios: Return on average equity - annualized (5.4) % (4.8) % (5.3) % (5.7) % Return on average tangible equity - annualized (1) (4.2) % (3.0) % (3.7) % 3.1 % Return on average assets - annualized Net income (loss) (0.32) % (0.27) % (0.30) % (0.34) % Core (1) (0.26) % (0.19) % (0.23) % 0.15 % Efficiency ratio (1) 118.7 % 111.9 % 116.1 % 92.7 % Net interest margin 1.33 % 1.37 % 1.38 % 1.96 % Other data Full time equivalent employees 819 840 839 910 (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. 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. 46 As of (in thousands, except share and per share data) September 30, 2024 December 31, 2023 Selected Balance Sheet Data Loans held for sale $ 38,863 $ 19,637 Loans held for investment, net 7,294,603 7,382,404 ACL 38,651 40,500 Investment securities 1,158,035 1,278,268 Total assets 9,201,285 9,392,450 Deposits 6,435,404 6,763,378 Borrowings 1,896,000 1,745,000 Long-term debt 225,039 224,766 Total shareholders' equity 538,315 538,387 Other data: Book value per share $ 28.55 $ 28.62 Tangible book value per share (1) $ 28.13 $ 28.11 Total equity to total assets 5.9 % 5.7 % Tangible common equity to tangible assets (1) 5.8 % 5.6 % Shares outstanding at end of period 18,857,565 18,810,055 Loans to deposit ratio (Bank) 113.5 % 109.4 % Credit Quality: ACL to total loans (2) 0.53 % 0.55 % ACL to nonaccrual loans 95.9 % 103.9 % Nonaccrual loans to total loans 0.55 % 0.53 % Nonperforming assets to total assets 0.47 % 0.45 % Nonperforming assets $ 43,320 $ 42,643 Regulatory Capital Ratios: Bank Tier 1 leverage 8.59 % 8.50 % Total risk-based capital 13.41 % 13.49 % Common equity Tier 1 capital 12.75 % 12.79 % Company Tier 1 leverage 7.04 % 7.04 % Total risk-based capital 12.70 % 12.84 % Common equity Tier 1 capital 9.50 % 9.66 % (1) Tangible book value per share and tangible common equity to tangible assets are non-GAAP financial measures. For a reconciliation of these measures 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. 47 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 the Company and the Bank will merge with and into FirstSun and Sunflower Bank, respectively. The merger agreement was approved by HomeStreet’s shareholders at a meeting held on June 18, 2024. 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. On October 29, 2024 FirstSun and the Company announced that based on discussions with the Federal Reserve and the Texas Department of Banking, regulatory approvals necessary for the Merger to proceed have not been obtained and FirstSun and Sunflower Bank have been asked to withdraw their merger applications. FirstSun and the Company are discussing the pursuit of an alternative regulatory structure for the Merger. The parties are also discussing terms on which they would terminate the Merger agreement if no alternative structure is feasible. There can be no assurance that an alternative regulatory structure may ultimately be feasible. 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. However, with the recent decrease in short term interest rates, we expect our funding costs to decrease in the fourth quarter and beyond and our interest margin to begin to increase. Management's Overview of the Third Quarter 2024 Financial Performance Third Quarter of 2024 Compared to the Second Quarter of 2024 General: Our net loss and loss before income taxes were $(7.3) million and $(9.5) million, respectively, in the third quarter of 2024, as compared to $(6.2) million and $(8.0) million, respectively, in the second quarter of 2024. The $1.5 million increase in loss before income taxes was primarily due to lower net interest income and lower noninterest income which was partially offset by a decrease in noninterest expense. Income Taxes: The income tax benefit realized resulted in an effective tax rate of 23.3% for the third quarter of 2024 as compared to an effective tax rate of 22.1% in the second quarter of 2024. 48 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 September 30, 2024 June 30, 2024 (dollars in thousands) Average Balance Interest Average Yield/Cost Average Balance Interest Average Yield/Cost Assets: Interest-earning assets: Loans (1) $ 7,385,970 $ 87,330 4.66 % $ 7,454,945 $ 87,492 4.66 % Investment securities (1) 1,155,284 10,536 3.65 % 1,164,144 11,065 3.80 % FHLB Stock, Fed Funds and other 186,336 3,043 6.42 % 239,344 3,640 6.06 % Total interest-earning assets 8,727,590 100,909 4.56 % 8,858,433 102,197 4.59 % Noninterest-earning assets 410,701 413,698 Total assets $ 9,138,291 $ 9,272,131 Liabilities and shareholders' equity: Interest-bearing deposits: (2) Demand deposits $ 316,487 $ 250 0.31 % $ 315,942 $ 183 0.23 % Money market and savings 1,703,531 7,237 1.68 % 1,781,427 7,517 1.68 % Certificates of deposit 3,025,378 36,522 4.80 % 3,024,915 35,835 4.76 % Total 5,045,396 44,009 3.47 % 5,122,284 43,535 3.41 % Borrowings: Borrowings 1,950,109 24,105 4.85 % 2,025,415 24,786 4.85 % Long-term debt 224,994 3,104 5.48 % 224,903 3,101 5.49 % Total interest-bearing liabilities 7,220,499 71,218 3.90 % 7,372,602 71,422 3.87 % Noninterest-bearing liabilities: Demand deposits (2) 1,283,502 1,282,447 Other liabilities 102,682 94,178 Total liabilities 8,606,683 8,749,227 Shareholders' equity 531,608 522,904 Total liabilities and shareholders' equity $ 9,138,291 $ 9,272,131 Net interest income $ 29,691 $ 30,775 Net interest rate spread 0.66 % 0.72 % Net interest margin 1.33 % 1.37 % (1) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $1.1 million for both quarters ended September 30, 2024 and June 30, 2024. The estimated federal statutory tax rate was 21% for the periods presented. (2) Cost of all deposits, including noninterest-bearing demand deposits was 2.76% and 2.73% for the quarters ended September 30, 2024 and June 30, 2024, respectively. Our net interest income in the third quarter of 2024 was $1.1 million lower than the second quarter of 2024 due to a decrease in our net interest margin from 1.37% to 1.33% and a decrease in interest earning assets. The decrease in the net interest margin was due to a 3 basis point decrease in the yield on interest earning assets and a 3 basis point increase in the rates paid on interest-bearing liabilities. Yields on interest-earning assets decreased due to lower yields on investment securities. The increase in the rates paid on our interest-bearing liabilities was due to higher deposit costs due to a greater proportion of higher cost certificates of deposit. Provision for Credit Losses: There was no provision for credit losses recognized during either the third or second quarter of 2024. This reflects 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. 49 Noninterest Income consisted of the following: Quarter Ended (in thousands) September 30, 2024 June 30, 2024 Noninterest income Gain on loan origination and sale activities (1) Single family $ 2,779 $ 2,718 CRE, multifamily and SBA (19) 318 Loan servicing income 3,058 3,410 Deposit fees 2,222 2,209 Other 3,018 4,572 Total noninterest income $ 11,058 $ 13,227 (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) September 30, 2024 June 30, 2024 Single family servicing income, net Servicing fees and other $ 3,776 $ 3,751 Changes - amortization (1) (1,669) (1,713) Net 2,107 2,038 Risk management, single family MSRs: Changes in fair value due to assumptions (2) (1,963) 529 Net gain (loss) from economic hedging (3) 1,418 (509) Subtotal (545) 20 Single Family servicing income 1,562 2,058 Commercial loan servicing income: Servicing fees and other 2,919 2,811 Amortization of capitalized MSRs (1,423) (1,459) Total 1,496 1,352 Total loan servicing income $ 3,058 $ 3,410 (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 September 30, 2024 and June 30, 2024. Noninterest income in the third quarter of 2024 decreased from the second quarter of 2024 primarily due to more income realized in the second quarter of 2024 from our investments in small business investment companies. Noninterest Expense consisted of the following: Quarter Ended (in thousands) September 30, 2024 June 30, 2024 Noninterest expense Compensation and benefits $ 26,760 $ 27,616 Information services 7,742 7,580 Occupancy 4,974 5,130 General, administrative and other 9,690 10,605 Total noninterest expense $ 49,166 $ 50,931 50 The 3.5% decrease in noninterest expenses in the third quarter of 2024, as compared to the second quarter of 2024, reflects the Company's emphasis on reducing operating expenses where possible. Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023 General: Our net income (loss) and income (loss) before income taxes were $(21.0) million and $(28.1) million, respectively, in the nine months ended September 30, 2024, as compared to $(24.1) million and $(28.7) million, respectively, in the nine months ended September 30, 2023. Our core net income (loss) and core income (loss) before income taxes in the nine months ended September 30, 2024, which excludes the impact of merger related expenses and goodwill impairment charges, was $(15.8) million and $(21.4) million, as compared to $10.5 million and $11.1 million, respectively, in the nine months ended September 30, 2023 (1) .The $32.5 million decrease in core income before taxes was primarily due to lower net interest income, partially offset by an increase in noninterest income and a decrease in noninterest expenses. Income Taxes: The income tax benefit realized in the nine months ended September 30, 2024 resulted in an effective tax rate of 25.1% as compared to an effective tax rate of 16.2% for the nine months ended September 30, 2023. Our effective tax rate in the nine months ended September 30, 2023 was significantly impacted by the goodwill impairment charge, a portion of which is not deductible for tax purposes. (1) Core net income (loss) and core income (loss) before income taxes are non-GAAP financial measures. For a discussion of these measures and a reconciliation to the most comparable GAAP measure, please see “Non-GAAP Financial Measures” at the end of this Item 2. 51 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: Nine Months Ended September 30, 2024 2023 (dollars in thousands) Average Balance Interest Average Yield/Cost Average Balance Interest Average Yield/Cost Assets: Interest-earning assets: Loans (1) $ 7,433,680 $ 261,248 4.64 % $ 7,477,454 $ 254,959 4.51 % Investment securities (1) 1,186,061 33,228 3.74 % 1,417,438 40,755 3.83 % FHLB Stock, Fed Funds and other 271,070 12,254 6.00 % 160,833 6,270 5.19 % Total interest-earning assets 8,890,811 306,730 4.56 % 9,055,725 301,984 4.42 % Noninterest-earning assets 412,787 452,976 Total assets $ 9,303,598 $ 9,508,701 Interest-bearing liabilities: Interest-bearing deposits: (2) Demand deposits $ 318,871 $ 604 0.25 % $ 399,962 $ 732 0.24 % Money market and savings 1,774,733 22,133 1.65 % 2,320,958 23,077 1.32 % Certificates of deposit 3,039,514 107,414 4.72 % 2,736,363 74,794 3.65 % Total 5,133,118 130,151 3.38 % 5,457,283 98,603 2.41 % Borrowings: Borrowings 2,016,440 73,567 4.81 % 1,677,276 59,016 4.69 % Long-term debt 224,904 9,312 5.49 % 224,525 9,081 5.37 % Total interest-bearing liabilities 7,374,462 213,030 3.84 % 7,359,084 166,700 3.02 % Noninterest-bearing liabilities: Demand deposits (2) 1,295,044 1,459,506 Other liabilities 103,376 124,911 Total liabilities 8,772,882 8,943,501 Shareholders' equity 530,716 565,200 Total liabilities and shareholders' equity $ 9,303,598 $ 9,508,701 Net interest income $ 93,700 $ 135,284 Net interest spread 0.73 % 1.40 % Net interest margin 1.38 % 1.96 % (1) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $3.2 million and $3.5 million for the nine months ended September 30, 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 2.70% and 1.90% for the nine months ended September 30, 2024 and 2023, respectively. Net interest income in the nine months ended September 30, 2024 decreased $41.3 million as compared to the nine months ended September 30, 2023 due primarily to a decrease in our net interest margin. Our net interest margin decreased from 1.96% in the nine months ended September 30, 2023 to 1.38% in the nine months ended September 30, 2024 due to a 82 basis point increase in the rates paid on interest-bearing liabilities which was partially offset by a 14 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 nine months ended September 30, 2024 as compared to a $0.9 million recovery in the nine months ended September 30, 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. 52 Noninterest Income consisted of the following: Nine Months Ended September 30, (in thousands) 2024 2023 Noninterest income Gain on loan origination and sale activities (1) Single family $ 7,483 $ 6,656 CRE, multifamily and SBA 619 582 Loan servicing income 9,500 9,390 Deposit fees 6,672 7,817 Other 9,465 6,520 Total noninterest income $ 33,739 $ 30,965 (1) May include loans originated as held for investment. Noninterest income in the nine months ended September 30, 2024 increased from the nine months ended September 30, 2023 primarily due to higher levels of income realized from our investments in small business investment companies, an increase in single family gain on loan origination and sales activities which were partially offset by lower deposit fees. Loan servicing income, a component of noninterest income, consisted of the following: Nine Months Ended September 30, (in thousands) 2024 2023 Single family servicing income, net Servicing fees and other $ 11,366 $ 11,643 Changes - amortization (1) (4,810) (4,874) Net 6,556 6,769 Risk management, single family MSRs: Changes in fair value due to assumptions (2) (816) 1,794 Net gain (loss) from economic hedging (3) (201) (2,833) Subtotal (1,017) (1,039) Single Family servicing income 5,539 5,730 Commercial loan servicing income: Servicing fees and other 8,245 8,023 Amortization of capitalized MSRs (4,284) (4,363) Total 3,961 3,660 Total loan servicing income $ 9,500 $ 9,390 (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 $0.9 million and $1.1 million for the nine months ended September 30, 2024 and 2023, respectively. 53 Noninterest Expense consisted of the following: Nine Months Ended September 30, (in thousands) 2024 2023 Noninterest expense Compensation and benefits $ 82,387 $ 84,031 Information services 22,664 22,207 Occupancy 15,538 16,834 General, administrative and other 31,672 29,432 Goodwill impairment charge — 39,857 Total noninterest expense $ 152,261 $ 192,361 The $40.1 million decrease in noninterest expenses in the nine months ended September 30, 2024 as compared to the nine months ended September 30, 2023 was primarily due to a $39.9 million goodwill impairment in the nine months ended September 30, 2023, lower compensation and benefit costs and lower occupancy costs, which were partially offset by $6.7 million of merger related expenses recognized in 2024. The decrease in compensation and benefit costs was primarily due to lower staffing levels, which was partially offset by wage increases given in the nine months ended September 30, 2024. FTEs decreased from 910 in the nine months ended September 30, 2023 to 839 in the nine months ended September 30, 2024. 54 Financial Condition During the nine months ended September 30, 2024, our total assets decreased $191 million due primarily to a $120 million decrease in investment securities as we are not purchasing new investment securities to replace principal paydowns in our portfolio. During the nine months ended September 30, 2024, total liabilities decreased $191 million due to a $328 million decrease in deposits, partially offset by an increase in borrowings. The decrease in deposits was primarily due to a $477 million decrease in brokered certificates of deposit which was partially offset by increases in non-brokered deposits. The $151 million of additional borrowings were used to replace maturing brokered deposits. Credit Risk Management During the third quarter of 2024, our ratios of nonperforming assets to total assets and total loans delinquent over 30 days, including nonaccrual loans remained at low levels. As of September 30, 2024, our ratio of nonperforming assets to total assets was 0.47% compared to 0.42% at June 30, 2024 while our ratio of total loans delinquent over 30 days, including nonaccrual loans, to total loans was 0.69% compared to 0.66% at June 30, 2024. 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 September 30, 2024 At December 31, 2023 (dollars in thousands) Amount Rate (1) Amount Rate (1) CRE Non-owner occupied CRE $ 1,812 0.31 % $ 2,610 0.41 % Multifamily 15,760 0.40 % 13,093 0.33 % Construction/land development Multifamily construction 1,389 0.88 % 3,983 2.37 % CRE construction 82 0.85 % 189 1.02 % Single family construction 7,187 2.29 % 7,365 2.69 % Single family construction to permanent 255 0.47 % 672 0.64 % Total 26,485 0.52 % 27,912 0.54 % Commercial and industrial loans Owner occupied CRE 639 0.18 % 899 0.23 % Commercial business 4,472 1.30 % 2,950 0.83 % Total 5,111 0.72 % 3,849 0.52 % Consumer loans Single family 3,804 0.36 % 5,287 0.51 % Home equity and other 3,251 0.80 % 3,452 0.90 % Total 7,055 0.49 % 8,739 0.61 % Total ACL $ 38,651 0.53 % $ 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 55 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 September 30, 2024 and December 31, 2023, the Bank had available borrowing capacity of $1.6 billion and $2.1 billion, respectively, from the FHLB, and $874 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 nine months ended September 30, 2024, cash and cash equivalents decreased by $10 million compared to an increase of $154 million during the nine months ended September 30, 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 nine months ended September 30, 2024, net cash of $47 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 trading securities. For the nine months ended September 30, 2023, net cash of $1.5 million was used in operating activities, as cash generated from earnings was offset by cash used to fund LHFS in excess of proceeds from the sale of loans and increases in other assets. Cash flows from investing activities The Company's investing activities primarily include AFS investment securities and loans originated as held for investment. For the nine months ended September 30, 2024, net cash of $215 million was provided by investing activities primarily from principal repayments on AFS securities and by LHFI principal repayments, net of originations, partially offset by net FHLB stock purchases. For the nine months ended September 30, 2023, net cash of $392 million was provided by investing activities primarily from net cash acquired from an acquisition, principal repayments on AFS securities, partially offset by 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 nine months ended September 30, 2024, net cash of $178 million was used in financing activities, primarily due to a decrease in deposits, partially offset by an increase in borrowings. For the nine months ended September 30, 2023, net cash of $237 million was used in financing activities, primarily due to decreases in deposits and dividends paid on our common stock, partially offset by an increase in borrowings. 56 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 September 30, 2024 At December 31, 2023 Unused consumer portfolio lines $ 608,237 $ 586,904 Commercial portfolio lines (1) 580,285 648,609 Commitments to fund loans 13,219 38,426 Total $ 1,201,741 $ 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 $340 million and $403 million at September 30, 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 September 30, 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) $ 655,581 7.04 % $ 372,240 4.0 % NA NA Common equity Tier 1 capital (to risk-weighted assets) 595,581 9.50 % 282,051 4.5 % NA NA Tier 1 risk-based capital (to risk-weighted assets) 655,581 10.46 % 376,068 6.0 % NA NA Total risk-based capital (to risk-weighted assets) 795,820 12.70 % 501,425 8.0 % NA NA HomeStreet Bank Tier 1 leverage capital (to average assets) $ 798,532 8.59 % $ 372,004 4.0 % $ 465,005 5.0 % Common equity Tier 1 capital (to risk-weighted assets) 798,532 12.75 % 281,917 4.5 % 407,213 6.5 % Tier 1 risk-based capital (to risk-weighted assets) 798,532 12.75 % 375,889 6.0 % 501,185 8.0 % Total risk-based capital (to risk-weighted assets) 840,277 13.41 % 501,185 8.0 % 626,482 10.0 % 57 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 September 30, 2024, capital conservation buffers for the Company and the Bank were 4.46% and 5.41%, 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 September 30, 2024. 58 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 net 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. 59 Reconciliations of non-GAAP results of operations to the nearest comparable GAAP measures: For the Quarter Ended Nine Months Ended September 30, (in thousands, except ratio, rate and share data) September 30, 2024 June 30, 2024 2024 2023 Core net income (loss) Net income (loss) $ (7,282) $ (6,238) $ (21,017) $ (24,089) Adjustments (tax effected) Merger related expenses 1,283 1,897 5,208 — Goodwill impairment — — — 34,622 Total $ (5,999) $ (4,341) $ (15,809) $ 10,533 Core net income (loss) per fully diluted share Fully diluted shares 18,857,565 18,857,566 18,857,335 18,774,593 Computed amount $ (0.32) $ (0.23) $ (0.84) $ 0.56 Return on average tangible equity (annualized) Average shareholders' equity $ 531,608 $ 522,904 $ 530,716 $ 565,200 Less: Average goodwill and other intangibles (8,176) (8,794) (8,789) (30,934) Average tangible equity $ 523,432 $ 514,110 $ 521,927 $ 534,266 Core net income (loss) (per above) $ (5,999) $ (4,341) $ (15,809) $ 10,533 Adjustments (tax effected) Amortization on core deposit intangibles 488 487 1,463 1,687 Tangible income (loss) applicable to shareholders $ (5,511) $ (3,854) $ (14,346) $ 12,220 Ratio (4.2) % (3.0) % (3.7) % 3.1 % Efficiency ratio Noninterest expense Total $ 49,166 $ 50,931 $ 152,261 $ 192,361 Adjustments: Merger related expenses (1,645) (2,432) (6,677) — Goodwill impairment — — — (39,857) State of Washington taxes (438) (463) (1,353) (1,653) Adjusted total $ 47,083 $ 48,036 $ 144,231 $ 150,851 Total revenues Net interest income $ 28,619 $ 29,701 $ 90,471 $ 131,764 Noninterest income 11,058 13,227 33,739 30,965 Total $ 39,677 $ 42,928 $ 124,210 $ 162,729 Ratio 118.7 % 111.9 % 116.1 % 92.7 % Return on Average assets (annualized) - Core Average Assets $ 9,138,291 $ 9,272,131 $ 9,303,598 $ 9,508,701 Core net income (loss) - per above (5,999) (4,341) (15,809) 10,533 Ratio (0.26) % (0.19) % (0.23) % 0.15 % Effective tax rate used in computations above (1) 22.0 % 22.0 % 22.0 % 22.0 % (1) Effective tax rate indicated is used for all adjustment except the goodwill impairment charge as a portion of this charge was not deductible for tax purposes. Instead, a computed effective rate of 13.1% was used for the goodwill impairment charge. 60 As of (in thousands, except ratio, rate and share data) September 30, 2024 December 31, 2023 Tangible book value per share Shareholders' equity $ 538,315 $ 538,387 Less: Intangible assets (7,766) (9,641) Tangible shareholder's equity $ 530,549 $ 528,746 Common shares outstanding 18,857,565 18,810,055 Computed amount $ 28.13 $ 28.11 Tangible common equity to tangible assets Tangible shareholder's equity (per above) $ 530,549 $ 528,746 Tangible assets Total assets $ 9,201,285 $ 9,392,450 Less: Intangible assets (7,766) (9,641) Net $ 9,193,519 $ 9,382,809 Ratio 5.8 % 5.6 % 61