HMST (2020 - Q3)

Good day and welcome to HomeStreet Third Quarter 2020 Earnings Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mark Mason, Chairman, President, and CEO. Please go sir. Mark Mas

Hello and thank you for joining us for our second quarter 2020 earnings call. Before we begin, I'd like to remind you that our detailed earnings release and an accompanying investor presentation was filed this morning to the SEC on Form 8-K and are available on our website at ir.HomeStreet.com under the News & Events link. In addition, a recording and a transcript will be available at the same address following our call. Please note that during our call today, we may make certain predictive statements that reflect our current views and expectations about the company's performance and financial results. These are likely forward-looking statements that are made subject to the Safe Harbor statements included in yesterday's earnings release, the investor deck, and the risk factors disclosed in our other public filings. Additionally, reconciliations to non-GAAP measures referred on our call today can be found in our earnings release available on our website. Joining me today is our new Chief Financial Officer, John Michel. John will briefly discuss our financial results, and then I'd like to given an update on our results of operations, credit performance, and outlook going forward. John?

Thank you, Mark. Good morning everyone and thank you for joining us. In the third quarter, our net income was $26 million or $1.15 per share with core income of $28 million or $1.23 per share, and pre-provision core income before income taxes of $36 million. This compares to net income, core income, and pre-provision core income before taxes of $18.9 million, $20.2 million, and $32 million respectively in the second quarter. Net interest income was higher in the third quarter when compared to the second quarter due to an increase in interest-earning assets and an increase in our net interest margin of 3.20%. This increase in our net interest margin was due to decreased funding costs, which was only partially offset by decreases in our yields on interest-earning assets. At the end of the third quarter, our cost of deposits was 36 basis points. As a result of the favorable performance of our loan portfolio, including decreases of loans in forbearance and a stable low level of non-performing assets, no provision for credit losses was recorded in the third quarter compared to $6.5 million in the second quarter. Our ratio of non-performing assets to total assets remained low at 30 basis points, while our ratio of total loans delinquent over 30 days to total loans decreased to 76 basis points at September 30 from 94 basis points at June 30. In the third quarter, 25 commercial and CRE loans with $66 million over balance were granted a second forbearance. These second forbearances were to borrowers whose businesses continued to be impacted by the effects of the pandemic. One relationship accounted for 18 of the loans and $52 million of the balances. As of September 30, 2020, excluding the loans approved for a second forbearance, 97% of the commercial and industrial loans granted forbearance prior to the third quarter have completed their forbearance period and have resumed payments. As such, the remaining balance of commercial and CRE forbearances outstanding at the quarter end relate primarily to new and second forbearances granted in the quarter. During the third quarter, non-core items included $2.4 million of impairments related to the ongoing restructuring of our facilities and operations, including the closing of an office in Northern California. The decrease in non-interest income for the third quarter was due to a $4 million decrease in loan servicing income, which was partially offset by a $3 million increase in gain on sales of loans. The decrease in loan servicing income was due primarily to unfavorable risk management results on mortgage servicing rights resulting from valuation reductions related to market expectations of an extended period of higher pre payments. As origination volumes and profitability of single-family loans sales were consistent with the prior quarter, the increasing gain on loan sales was due to a higher volume of commercial real estate loans sold in the third quarter. The increase in non-interest expense in the third quarter was due to higher occupancy costs related to our previously mentioned restructuring charges. I will now turn the call over to Mark.

Thank you, John. HomeStreet again delivered solid results despite the continuing challenges of the pandemic nationally within our markets. Our net interest margin increased as a result of decreasing funding costs, and we benefited from continuing high loan volume and profitability in our single-family mortgage banking business. In addition, due to our cost control efforts and increasing revenues, we are realizing meaningful improvement in our efficiency ratio. With the Federal Reserve indicating that interest rates will remain low for the foreseeable future, our net interest margin should continue to expand as deposits reprice down, though we do not expect it to continue at the rate we experienced earlier this year. Mortgage volumes should remain robust for the foreseeable future as the low interest rate environment has not completely been priced into mortgage interest rates due to the industry's inability to absorb the massive amount of volumes spurred by these historically low interest rates. As capacity normalizes in the industry, mortgage interest rates should decrease, in line with this historical spread over long-term Treasury rates. We expect that this transition will reduce the very strong gain on sale margins we are currently enjoying, but maintain strong volumes for an extended period of time. The transition will reduce the very strong gain on sale margins, but it's important to note that in the third quarter, our mortgage servicing income declined $4 million from the prior quarter due to the impact of higher prepayment speed assumptions on new servicing values. This phenomenon is not expected to continue, and we anticipate these valuation changes to recover over time. This decline of servicing income offset somewhat the cyclical impact of higher mortgage origination revenue on our results this quarter. Despite the higher-than-expected mortgage loan volume, we have continued to maintain discipline on the expense side. To aid in processing the surge in volume, we are instituting more scalable technology solutions, which we believe will result in greater efficiencies when volumes return to more normalized levels. Our results for the third quarter are a testament to our consistent, in our view conservative approach to credit risk management. We experienced significant decreases in our commercial and commercial real estate loans in forbearance, and our non-performing asset levels remained low. We continue to work with our borrowers who are more significantly negatively impacted by the pandemic, and as a result in the quarter we granted additional forbearances to a few relationships. As John mentioned earlier, one of these relationships accounts for 18 of the loans and $52 million of the balances of additional forbearance. This company operates restaurants, hotels, and event centers in the Pacific Northwest. We have provided the company forbearances and additional credit availability, and the owners have raised capital and provided additional real estate collateral. We're optimistic this company will weather the pandemic given the success to date of their reopening strategy. Many of their locations are exceeding 80% of pre-pandemic revenues. As mentioned in our earnings released, almost all of our commercial customers for whom we have provided forbearances have reopened their businesses, and they have responded to us that they do not currently foresee the need for additional forbearance. We're confident in the credit quality of our loan portfolio as it is primarily secured by high quality real estate in some of the strongest and previously fastest growing economies in the nation. And these loans were underwritten distress levels generally more severe than the current conditions in our markets. As a result, our loan portfolio is performing well despite the challenges of the pandemic. While the CARES Act relief payments on SBA loans has ended, our delinquency and forbearance experience with SBA loans has been excellent. Also, the unguaranteed portion of SBA loans in our portfolio is less than $20 million at September 30th. Of course, there still exists significant uncertainty as to the ultimate impact of the pandemic on our loan portfolio. However, given our strong credit performance to-date in the pandemic, and unless things materially take a turn for the worst, we do not currently foresee a need to make additional provisions for loan losses at this time. Our investor deck filed with the SEC contains data on our underwriting standards and portfolio composition. We have again included a few slides further disaggregating the information and providing additional detail on the parts of our portfolio most at risk today. As a follow-up to prior discussions, reduced costs from revised technology contracts in 2021 are expected to allow us to reduce our information technology costs by somewhere between 3% and 5%. And due to our strong results, we were able to complete our previously announced $25 million repurchase authorization during the third quarter in early October, buying stock at an attractive average price of $27.5 per share. In all we have repurchased 20% of our outstanding share in the second quarter of last year. Yes, you heard that right to 20% in just six quarters. Going forward, we plan to consider additional stock repurchases early next year, subject to our financial condition and future outlook at the time and corporate governance and regulatory requirements. Beginning of October 1st, we reorganized our Fannie Mae, the U.S. business to move the origination sale and servicing of mortgages on multifamily properties to the bank from a separate subsidiary of HomeStreet. That separate subsidiary will continue to service the existing portfolio DLS loans until such time as that portfolio runs off or we are able to contribute the subsidiary to the bank, subject to an in compliance with regulatory requirements. By using the bank's capital, we will be able to offer larger loans for our clients with higher profitability to us as previously our large loan recourse and servicing revenue or reduced. This relationship with Fannie Mae has existed at HomeStreet since 1988, and we're one of only 23 authorized DUS lenders in the United States today. Reflecting our very strong third quarter results, the Board of Directors declared a $0.15 per share common stock dividend to shareholders of record on November 6th, 2020 and payable on November 23rd, 2020. Given our strong performance, the Board of Directors anticipates discussing an increase in our dividend in the first quarter of next year. Of course, future declarations of the current or higher levels of dividends are subject to condition and future outlook at the time, as well as corporate governance and regulatory requirements. As we look forward we anticipate completing the final pieces of our profitability and efficiency improvement initiative and transitioning our strategic focus to growth and maintaining capital to support growth and returning excess capital to our shareholders through repurchases and dividends. We believe that notwithstanding our higher current cycle, cyclical mortgage banking profitability, we have transitioned the company to a more consistent and durable level of core profitability and efficiency consistent with peers pre pandemic performance. As I close my remarks today, I admit it's difficult for me to overstate the progress we have made in improving our profitability and efficiency and the resulting substantial increase in the value of our company, especially over the course of the last two years, since we made the decision to reorganize the company, and in turn accelerate our development as a commercial bank. The third quarter numbers speak volumes; 1.5% core return on average assets, 16.4% core return on average tangible common equity, and efficiency ratio of 59.9%, $1.23 cent core earnings per share, and tangible book value per share of $30.15 at September at September 30, which represents over 12% growth from a year ago, even as we have paid cumulative common dividends per share of $0.45 this year, and absorbed a $0.73 per share reduction as a result of COVID-related provisions. And while the exceptional single-family mortgage lending environment continues into this quarter, we know that it will normalize at some point in the future as industry capacity catches up with demand. That's why we are so pleased to have achieved such remarkable results with many components of our strategic plan, including greater cost containment and overall expense efficiency, prudent capital management with efficient return of excess capital to shareholders, improved deposit funding composition and cost, and as always, a consistently strong credit culture. For those shareholders listening today, who have remained committed to a HomeStreet investment over this process, we hope you are enjoying the fruits of our labor as much as we are today. And for new and prospective shareholders, we welcome you aboard as we continue to believe our successful, recent reorganization, as well as our future earnings prospects are still yet to be adequately reflected in our current share price. With that, this concludes our prepared comments today. Thank you for your attention. John and I would be happy to answer any questions you have at this time.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question will be from Jeff Rulis with D.A. Davidson. Please go ahead.

Thanks. Good morning.

Good morning.

Good morning.

Couple of questions on the expense side and kind of a near-term, long-term -- kind of two parts. So, maybe for John, just want to understand what you said the core expense kind of baseline is if we back out some of those facility impairments. Where do you get comfort on? What that level is understanding we've got a pretty high variable cost with the mortgage?

Yes, from the perspective of looking at our expenses going forward, we think we’ve reached a pretty stable environment other than the item you mentioned, which is basically commissions on productions of especially single-family loans. You see the non-core items and then Mark mentioned, we expect some decreases in our information services costs going forward. But we have a pretty stable base expectation of expenses going forward, obviously with normal expenses such as raises next year and the volumes of activities of our loan operations.

So Jeff, I think if you consider, we have identified some IT savings from contract renegotiation, we've converted several systems to lower cost systems over the last year, particularly in the Treasury area, we've reduced headcount with a little more to go. And yet offsetting that, of course, is inflation. But I think the levels today have sort of normalized non extra mortgage expenses when we look out past the inflated mortgage volume period, say a year to two years from now, that number is probably in the $53 million to $54 million a quarter range giving effect to inflation to that point. So, if you just count that back a little bit, it's probably around -- where it's at -- that's really helpful.

Yes, thank you. And I guess to that end, the -- those contract negotiations, I thought that was maybe some towards the end of the year, early next year. Is that correct? I mean you've captured quite a bit of it, but there's still a few upcoming?

Yes, so a more significant piece that relates to our core services contract with FIS should start in January of next year. And so, you should see a step down at that point that's more meaningful.

Yes. And also want to mention that those savings help offset, obviously, everywhere, continuing to invest in IT resources and making sure that we're staying current from security perspective, from a client service perspective. So, these savings have allowed us not only to have a reduction, but also to offset the cost that we're doing in terms of continuing to invest in the company.

Right. That's why that forward number that I cited is somewhat higher than it might have been a year or so ago -- two years ago.

Okay, that's -- all that's good info. Maybe, Mark just on the on the buyback then, you mentioned maybe taking it through the end of the year and then revisiting, maybe the buyback, is that in line with kind of your comments on the Board looking at the dividend announcement. So, you might pause here through Q4 to look at those items, is that what I'm hearing that you might buy back from here is probably quiet through the end of the year?

Yes. The -- and it's not that we don't think we have some excess capital today or that we're going to create some this quarter. I think our pause really is in respect to the regulatory environment and the current concerns about a spike in the pandemic potentially impacts -- we don't foresee the impacts, but I think environmentally our regulators are cautious. And while they've supported us to this point, even last quarter, approving a further buyback, I think we want to respect their caution and revisit that subject in the first quarter. But our internal plan suggests that the activity you saw this year given all the caveats could be repeated next year.

Right. Thanks. And one quick last one. Just loan run off or net loan run off, pull out this crystal ball, but just trying to think about when you think that begins to ebb or we trough on the run off and where that may firm up if we mean probably rate driven, but your expectations for when we could see net growth resumed?

I think, internally, we're expecting it to continue through next year in our major portfolios, right. I think commercial real estate, single-family; we were expecting -- particularly single-family, pretty significant CPRs, somewhere in the 25%, 30% range, roughly, probably a little less than commercial real estate, but still high.

So, couple of factors going in that actually looking at production, we're anticipating some a little bit higher level of multifamily loan sales in the fourth quarter of this year. And then going forward into next year, we have the PPP loans being forgiven, so it's kind of giving an offset from our growth perspective, which is a little less than $300 million. So, we expect them to pretty much be gone by the end of the year. Other than that, I think we can -- we are anticipating some stabilization and growth near the end of next year in the loan balances.

Okay. Thank you.

Next question will be from Steve Moss with B Riley FBR. Please go ahead.

Good morning.

Good morning.

You touched just on loan yields and the margin, just kind of curious what you're seeing for new money yields these days, just to start there.

Well, they're lower than we'd like, Steve. Obviously, it depends on loan types. We're still seeing construction lending in the high 4% range -- quite high 4% range, single-family mortgage portfolio and for sale mortgage rates are in the 3% to 3.25% range, multifamily perm, 3.5%, C&I a little closer to 4%. Those are, those are the significant rates on new activity.

Okay. That's helpful. And then on the funding side, Mark, I think you mentioned that funding cost continue to come down, but at a slower pace. Kind of curious you give us a flavor of where they were interest-bearing liabilities at quarter end?

Yes, in the deposit comment, our cost to deposits were 36 basis points at the end of the quarter as compared to I think it was in the 40s for the quarter itself. So, we expect to see that continue to decrease because of that. Our borrowing costs, in terms of wholesale funding broker CDs, et cetera tends to be less than that also at the current time.

Okay, thank you very much. That was helpful.

The next question is from Jackie Bohlen with KBW. Please go ahead.

Hi, good morning, everyone. I just wanted to touch on balance sheet first and thinking about liquidity management, obviously, your deposit balances have had really good growth over the last two quarters. And just wanted to see, number one, if you've had any indication from your customers as to any balance fluctuations you might expect going forward? And number two; how you're thinking about deploying any excess liquidity potentially as the PPP loans start to run off?

There's a general concern in the industry about cash hoarding and cash conservatism, investment conservatism, and how long this liquidity preference of customers will last. Obviously, we don't have a crystal ball to know that. And we don't -- we're not really sure how much our deposit increases could really be characterized as conservatism or cash hoarding. So it kind of remains we've seen how long extra liquidity is going to last. We intend to begin growing our loan portfolio again. That is of course much tougher today given the high prepayment speeds that we just discussed. So that is our investment goal. To do that, we're going to have to run harder than we have last year or this year to outgrow those prepayment speeds. We think we can accomplish it, though I think the pace of that growth will be more significant in 2022 as hopefully, prepayment speeds abate. But we're going to do our best to start growing our loan portfolio again. In terms of absolute potential for cash runoff, we don't know any specifics. I mean, we don't see absolute lumpiness in certain accounts. So it's hard to know what customers plans are at this point. And our growth has been very granular. And I really should touch on that. It hasn't been the acquisition of the number of large accounts. We've done a great job of bringing on new customers, like a lot of our peers have during this period of time. Our loan portfolio next year, just to make another point related to growth is going to benefit one from lower sales, of course, real estate loans. But also meaningfully increased origination of multifamily loans, both Fannie Mae DUS loans, which I discussed everyone on the call, a change we made in the structure of that business and the on balance sheet portfolio as well. So we're optimistic about the environment next year. The potential of our growth, we're pretty cautious about prepayment speeds.

Understood. And I know there's a lot of moving parts there. Just as a follow-up, in terms of the restructuring that you've done with the DUS product, outside of the potential -- the ability to grow larger volume loans, is there any discernible change that we would see on our end from what you've done internally?

I think what you'll see is -- we're planning on meaningful increase in loan volume, start there, and we've hired some more people to support that growth. Structurally, there's nothing to really see because it's inside the consolidation. But you'll -- if you saw inside the consolidation, you'll see a servicing portfolio of Fannie Mae DUS loans being built at the bank level, as opposed to a sister company that is operated today.

And the other thing….

And are there…

I'm sorry, go ahead.

I was just going to ask if there's any expense efficiencies with that change?

There's capital efficiency, we probably should touch on that. Today, we have to carry a certain amount of liquidity and capital in HomeStreet Capital, which is a subsidiary of the holding company to satisfy the requirements of running the $1.6 billion servicing portfolio we run today. As that portfolio runs off, that capital will the upstream to the holding company and available for dividends, buybacks or investment in the bank for growth. We are not -- we need no additional capital to grow our Fannie Mae DUS business. It is -- the biggest synergy here, frankly, is capital will add a little bit of corporate governance and accounting and all that. Our Fannie Mae DUS business will essentially ride free from a capital standpoint on our existing bank capital and liquidity as well.

Okay. And sorry, John, you were going to add something to that or did Mark covered it?

Just to say the other advantage we have [technical difficulty] we can do more profitable, larger loans in terms of originating the DUS loans. And so I think that will help us from our volume perspective and our profitability perspective.

Yeah, just to explain that a little further, at our previous size, that is to say that HomeStreet Capital subsidiary size, we were limited in the size of the loans we could do at full profitability. Given the capital in that subsidiary, loans above a certain size in the low $20 million range, we could do, but Fannie would reduce our servicing fee and in turn reduce our recourse obligation accordingly. That will not be true in the bank. And we have increased our maximum loan size and the bank [technical difficulty] may have had their profitability cut in half, previously, from stone point to the full profitability. So we're expecting that to have a noticeable impact on Fannie Mae DUS revenue next year.

Okay, great. Thank you for all the additional color appreciate it.

Thanks.

The next question is from Matthew Clark with Piper Sandler. Please go ahead.

Hey, good morning. Hello.

Good morning.

Hey, Matt.

Maybe just on the expenses, that 3% to 5% savings on the tech side, is that just for the upcoming fourth quarter or in other additional savings that we should expect beyond that?

This quarter next year [technical difficulty] going forward.

Okay. You broke up a little bit. Okay. And then just on the overall expense outlook, at $53 million to $54 million I think you may have mentioned it, but that's net of any additional savings and any additional reinvestment. Is that correct?

Yeah. There's not a lot of stuff going both directions, right savings, some additional digital investment, inflation, right contract escalators and things like that.

Okay. And a return to normalized volume?

And a footnote and return to normalize volumes in the mortgage business.

Got it. And then on the expense to average asset ratio that's been kind of hovering around 3%. Should we expect that ratio to decline as we get into next year and beyond as mortgage normalizes as well or no?

Absolutely, right. I mean, balance sheet will grow. Expenses should fall due to mortgage volume and some other improvements [technical difficulty] but remember, because we have -- we still have a mortgage business, our absolute level of expenses to assets will be higher than some peers as a consequence of the mortgage origination business, which has a high expense to revenue relationship, but of course, that business has a very, very high return on equity, our relationship and which you have to live with the impact on efficiency ratios.

Okay. And then just on the upcoming multi-family sale on the fourth quarter, how much in loans do you plan to sell? And can you update us on your strategy there? Is that a deliberate strategy to reduce that concentration over time? Or is this just kind of a one-time decision?

If you look at the past several years, we have consistently sold a certain level of our originations. We did that early on to manage concentration that's becoming less important to us. And so you'll see us next year and going forward, reduce somewhat the level of sales at least planned at this point. We've done it, in part to establish a liquidity alternative for the company. It helps us manage our loan to deposit ratio. And so we find it useful to do. But as we go forward, we find it less attractive to sell loans, given the relationship of premiums to the net interest spread these loans generate. And so, I think going forward, you'll see somewhat lower levels of sales. Our sales expert should be consistent with other similar quarters to last year.

Okay. And then last one for me just on the provision expectations, to be zero again, can you just give us a sense for the underlying assumptions there with the Moody's model is that, are you assuming 100% baseline? Are you assuming some contribution from the adverse scenarios and into this zero provision consider that Moody's model incrementally deteriorating if we -- some part of the country gets locked up again?

We use the Moody's base forecast scenario in our assumptions. Again, we compare that to the more severe scenario, and it doesn't change the outlook for us. Obviously, we're getting to the point like all the other peers where the analysis very customized, right, where the current period impact is more severe than we think the following year impact, right, as we -- we get to this point of inflection from recession to recovery. And I think that's having a positive impact on everyone's, CECL based, reserving, and we're no different. Additionally, though, our calculated expected losses continue to decline, as we continue to have really fantastic experience with losses. And you continue to add additional periods of good performance. Obviously, that dilutes your expected loss calculation. We have continued to hold additional reserves that we added in the second quarter of this year against the uncertainty of future performance of loans, for which we have granted forbearances. We think that in an abundance of caution, and given the murky outlook, still, on the link, and impact of the pandemic on the economy in our business, it is appropriate for us to continue to hold reserves against that uncertainty. And I would expect to see us do that for the foreseeable future, until there's clarity. It is possible that as the pandemic continues to some ultimate end, and as we grow our balance sheet, hopefully, those reserves may be utilized to grow our business without the need for additional provisioning. As we sit here today, and if the performance of our portfolio continues, at this extremely good level, those reserves may not be needed in the future, and will either have to be reversed or are utilized for growth. We obviously prefer the latter. It's all very uncertain at this point. And that's why we hold those reserves against that uncertainty.

Thank you.

The next call -- the next question will be from Tim Coffey with Janney. Please go ahead.

Thanks. Good morning, gentlemen. Appreciate you holding this call. Mark, if we can circle back to the DUS question for a bit. Given current capital, how much production could you do?

Oh, gosh, a lot. I mean, more than likely to it. That's an interesting question right. Because it is -- it is a business that is somewhat capital light still that servicing portfolio has to be included in risk weighted assets for our risk based capital ratios, and still you have some unrealistic limits as to how large our total risk assets we would allow it to get. And that's, you know, that plays into that answer, but there's a fair amount of room, typically when you consider that these assets are all 50%, risk weighted, right? And so, I don't have a calculation for you, other than to say. It is not going to restrict our activity.

Okay. So, I mean, what kind of opportunity, I would expect that you maybe see, you know, I guess, better loan growth going right out the gate?

I think you'll see that in the next quarter.

Okay. Okay. And then this, on the -- you mentioned, sometimes the digital investments, are you thinking about making. Can you maybe provide more detail on what your plans are?

Sure. I mean, these are earth shaking additions, right? Digital mobile experiences of customers continue to improve. And much of -- of these of this functionality is table stakes today, if you have a meaningful consumer deposit business, which we do. So we have to continue to make incremental investments in adding functionality to stay at least reasonably close, right, to large national banks. And we have some of those improvements scheduled over the next couple of years.

Okay. Any of it related to client on-boarding either loans or deposits?

Yes, Part -- absolutely part of that is on-boarding, on-boarding, mobile functionality that has to do with on-boarding, right mobile. But also in the mortgage area, that thing's referred to later as permanently increasing our efficiency. We are headed very soon to 100% digital application through fulfillment. And today, our disclosures rollout 90%, I believe are the disclosures. And we're headed to the implementation in the near-term of the fulfillment that is a signing an eNotarization. Which is ultimately the Holy Grail to a full digital payment of the mortgage. Beyond that on the front end, we are building channel for a business to allow consumers to make applications directly and the digital experience, which is becoming the digital preference of mortgage customers, and given the success of Quicken Rocket Mortgage and others, we were having to make investments there. But also there's infrastructure, our commercial real estate, business sorely needs. A friend and origination system is very manual at this point. And when you are originating, you know, the levels of commercial real estate we are, we have to create some more efficiencies in that business. So sort of across the board some of its internal infrastructure, which is getting cheaper, amazingly. But also, we have a significant need to be safe. So we're invested in cybersecurity as well.

Okay. In terms of the mortgage application process, how much of that is digital? Is it all of it?

Today, nearly all of it on the front-end is digitally input to start. And I couldn't have said that a year ago. But of course, the pandemic has accelerated that substantially. Our business -- our mortgage business is still primarily a relationship based business, our fantastic mortgage originators, get their business from referrals from real estate, agents, closing agents and the like. But the experience from that point forward is becoming increasingly digital.

Okay, I appreciate those are my questions. Thanks.

Thanks, Tim.

Thanks. [Operator Instructions] And our next question will be from David Chiaverini with Wedbush Securities. Please go ahead.

Hi, thanks. A couple questions. The first one on loan growth, I want to make sure I get that the message right. So it sounds like originations looking out to next year will be strong, but prepays when combined with PPP runoff could curtail that growth. So if we were to fast-forward to the end of next year, is the base case for stable loan balances versus where we're at today?

No. They will be up somewhat, not nearly the amount we might have hoped with slower prepayments, but we're still expecting our loan portfolio to grow several 100 million. How many 100 million remain [technical difficulty]?

Thanks for that. And then on mortgage banking, so clearly, the mortgage banking market is booming. As we look out, volumes it sounds like will remain strong and gain on sale margins could be under a little bit of pressure. Just curious, I'm assuming that mortgage banking income will come down somewhat from this really excellent level, but curious as to what your views are on the mortgage banking line over the next few quarters?

Well, we expect volume to continue to be unseasonably strong, right? I mean, typically, gainer in the fourth quarter and first quarter next year, our revenue would be down somewhat either to declining pipeline during the holidays, or rising pipeline in the first quarter, it's still not up to the peak home buying season. However, given mortgage rates are at the levels they are, we expect mortgage refinancing to hold those levels meaningfully higher than what they would otherwise be. What does that mean in real numbers? I think that we will have production over the next couple of quarters that will fall somewhat in the fourth quarter, a little more so in the first quarter. But we're being pretty conservative, honestly, in our internal forecasts. And we're internally forecasting a little bit of a decline in volume that may not be realized. Same with mortgage profit margins that are obviously historically high right now. I think it's inevitable that mortgage profit margins fall over the next year or so. It's very hard to determine what the pace of that decline will be. There are scenarios where volume and profit margins remain high, as well as decline. And we're being conservative internally with our internal estimates of forward results. I think it has a lot to do with how quickly originators like us can satisfy demand. At this point in a refinancing period, it's all about manufacturing capacity and how much originators can handle relative to their demand. As long as demand is outstripping capacity, you will have mortgage rates remain higher than they otherwise naturally would, which translates to higher mortgage profit margins, and steady volume. At some point you start to experience burnout and profit margins fall, when they fall initially, production levels are supported and production will remain higher, with profit margins falling and ultimately volume and profit margins fall to some normalized volume. The challenges is trying to understand when and how much. And we are truly in unprecedented waters here. We have never had mortgage rates as low as they are today for an extended period of time. And we have never had the, I'll call it mathematical opportunity at substantially lower rates, because these conditions are what they are, there's a certain amount of hysteria in the mortgage asset market today, where particularly buyers servicing are valuing servicing at annual prepayment rates are CPRs far in excess of what they think could be sustained over the period of expectation. To put that in perspective, you notice that our servicing income was down meaningfully this year, outside this quarter, this past quarter. That is based upon having to reduce the value of newly originated servicing substantially to valuation levels, which anticipate lifetime CPRs of 30% to 40%. And I want to repeat that, not next year, lifetime CPRs a newly originated mortgage servicing of 30% to 40%. To put that in perspective, typically that is a 10% to 11% number. We think that that is practically impossible, and that you have a -- an anxiety and valuation dislocation between the demand from buyers of servicing to originators. But today, that is the valuation. And we think, as I mentioned earlier in my comments that's going to recover. And when it recovers, we're likely to recover value, which means more revenue. But until people begin to understand the length and the depth of this refinancing period, you're going to have that overreaction in valuation. I know that was a lot for an answer. Sorry about that.

No. That's all really helpful. And since it sounds like servicing rights are being mispriced out there, have you considered purchasing some servicing rights to take advantage of the dislocation?

Well, my treasurer is sitting here in the room with me clapping silently. No, we have not. Though, I will tell you economically, the returns should be substantial, which makes you wonder about the depth of that market today, because if you truly can trade servicing at these levels, and you can for some people who have to sell their servicing, as opposed to loss. There's a huge opportunity mortgage servicing today. The reality is when we have to price our servicing, we have to price down to these kind of numbers. And it's just not rational, but it's real, which if you look at our numbers today, it means our quarter could have been $4 million to $5 million higher than it was. I’ll repeat that $4 million to $5 million higher.

Great. Thanks very much.

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

We appreciate everybody participating this morning. Obviously, we're very excited about our business going forward. Thanks for listening today.

And thank you, sir. The conference has not concluded. Thank you for attending today's presentation. You may now disconnect.