Mechanics Bancorp Class A Stock

Good morning, ladies and gentlemen, and welcome to the Mechanics Bancorp Second Quarter 2026 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the call over to Nathan Duda, Chief Financial Officer of Mechanics. Please go ahead.

Thank you, operator, and good morning, everyone. We appreciate you joining our earnings conference call. With me here today are C.J. Johnson, our President and CEO; and Carl Webb, our Executive Chairman. The related earnings press release and earnings presentation are available on the News and Events section of our Investor Relations website.

Before we begin, I'd like to remind everyone that any forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those anticipated future results. Please see our safe harbor statements in our earnings press release and in our earnings presentation. All comments expressed or implied made during today's call are subject to those safe harbor statements. Any forward-looking statements made during this call are made only as of today's date, and we do not undertake any duty to update such forward-looking statements, except as required by law.

Additionally, during today's call, we may discuss certain non-GAAP financial measures, which we believe are useful in evaluating our performance. A reconciliation of these non-GAAP financial measures to the most comparable GAAP financial measures can also be found in our earnings release and in the earnings presentation.

C.J., let me hand it over to you.

Thank you, Nathan, and good morning. We appreciate everyone joining our call and for your interest in Mechanics Bancorp. I'll start today by summarizing the highlights of our second quarter performance. I'll also provide another strategic update on the bank before handing things off to Nathan to review our financials in more detail. Carl, Nathan and I will then open up the call for your questions.

With that, let's turn to Slide 4. We had a nice second quarter, reporting $57.7 million in net income. On a fully diluted basis, we earned $0.25 per share, and our tangible book value per share increased to $7.56. This quarter, we paid a large dividend of $0.70 per share, with the major driver being the successful closure of our DUS business line sale to Fifth Third in early May. Q2 did have a few noncore items, which I'll walk you through quickly.

We had 3 onetime noninterest income adjustments, including a $1.8 million MSR valuation gain, a final true-up of $900,000 related to the DUS sale and a $600,000 loss on a sale of an old branch property that's been closed for a while. We also incurred $5.9 million of merger expenses, primarily severance as we finished up our HomeStreet integration and had a significant amount of headcount reduction as a result. We also had a negative provision of $2.8 million, which we backed out of our core results.

When you adjust for these items, we earned $59 million of core net income for the quarter, representing a core ROAA of 1.1% and a core ROATCE of 14.7%. Our total assets are now $21.2 billion with total gross loans of $13.6 billion, total deposits of $18.1 billion and tangible shareholders' equity of $1.75 billion. Our deposits decreased $153 million this quarter with $199 million of the decline from high-cost CD balances and with the pace of CD decline down substantially from Q1.

Non-maturity balances grew $46 million, but we did see some mix shift into money market accounts from noninterest-bearing accounts. We expect CDs to continue declining modestly in the third quarter. But overall, we think total deposits should begin to grow from here on out. Notably, intangibles decreased $107 million in Q2, driven by the DUS business line sale. Our capital ratios remain robust with a 14.4% CET1 ratio and an 8.7% Tier 1 leverage ratio. Net charge-offs for the quarter were minimal again with only 0.6 basis points or $220,000 of non-auto net charge-offs. Also, our runoff auto loans continue to perform in line with expectations with net charge-offs continue to drop each quarter as the auto portfolio seasons.

Our ACL dropped 1 basis point to 1.12% of loans, driven by the modest negative provision I mentioned a bit ago. Our allowance remains a very robust 2.57x our total nonperforming assets as of 6/30. Our cost of deposits was 1.25% in the second quarter, down 3 bps from Q1, but our spot cost of deposits at 6/30 was back to 1.28%, primarily due to mix shift and stiff deposit competition. Our NIM was 3.62% for the quarter, up 1 basis point, and our CRE concentration ratio dropped to 342% from 348% in Q1 and is only 97% if you exclude lower-risk multifamily loans.

Turning to Slide 5. I'd like to provide you with an update on some of the key strategic initiatives happening at the bank. We have now substantially completed our HomeStreet integration, and it's good to get back to business as usual. By any measure, the merger with HomeStreet was a financial and strategic success, but it certainly was a heavy lift operationally, and I want to once again thank our dedicated employees for a job well done.

As I mentioned previously, we had $5.9 million of onetime merger charges in the quarter, which was mostly severance as our FTE went from 1,890 to 1,756 Q-over-Q. A lot of that expense reduction benefit will show up in our Q3 NIE figures. We remain on track to deliver on our budgeted cost synergies from the merger and reiterate our prior guidance of achieving an annual run rate noninterest expense, excluding CDI of approximately $430 million by the fourth quarter of this year.

Strong earnings, deleveraging of the balance sheet post merger and the successful DUS business line sale generated substantial capital in the first half of 2026 with $255 million or $1.10 per Class A share in dividends paid to investors so far this year. That on its own implies a dividend yield of roughly 7% year-to-date. In addition, we continue to have approximately $100 million of excess capital above our 8.25% Tier 1 leverage ratio target at 6/30. We expect to pay a $56 million dividend or $0.25 per Class A share in Q3 and then another larger $75 million to $100 million dividend in Q4, subject to Board and regulatory approval.

We can also efficiently use our excess capital generated by a smaller, less risky balance sheet to enhance future earnings and expect to execute a modest restructuring of our remaining low-yielding AFS securities in Q3. The highlights of our planned restructuring include selling approximately $310 million of 1.78% yielding AFS securities and reinvesting in MBS at current market rates close to 5.5%, which will result in a $25 million after-tax loss that will be earned back in 4 to 5 years.

The AFS restructuring will improve our near-term NIM, but we expect that benefit to be somewhat offset over time by increased deposit pricing pressure and auto runoff. Our modeling assumptions continue to assume a flat forward curve with no short-term rate hikes or cuts. We will also evaluate a sale of the remaining auto loans in the coming quarters. And if we decide to sell, it will be at a modest loss. We also could decide to continue servicing the auto loans out through maturity. We continue to expect a 17% to 18% ROATCE and a 1.3% to 1.4% ROAA in 2027 and beyond.

Let's flip to Slide 6, which shows an overview of Mechanics Bancorp today. We have $21.2 billion in assets with 166 branches and great deposit market share across the West Coast with a branch map spanning from Mexico to Canada and out to Hawaii. Our key stats compare very favorably to all publicly traded banks, $10 billion to $100 billion in assets. But the ones I'd like to focus on the most are our risk-weighted assets to total assets of 58%, which ranks second and a new one this quarter, our expected 2027 dividend yield of approximately 7%, which assumes cash dividends next year of $250 million. Our 7% expected dividend yield ranks first by a wide margin despite taking very little risk with either our funding base or our earning assets.

Stopping briefly on Slide 7. We continue to be the fourth largest West Coast and California bank by deposits when measuring community banks with less than $250 billion in assets. Our unique franchise has been built over many years and without a doubt, has tremendous scarcity value.

It's been a few quarters since we included Slide 8, but I wanted to refresh new investors on our market share breakdown in many highly attractive West Coast MSAs, including top 10 ranks in San Francisco, Seattle and all across the Central Coast of California.

California is an economically vibrant state that has the fifth largest GDP in the world if it was its own country. And Seattle is one of the fastest-growing large cities in the United States. We really like our market positioning post merger and are looking forward to focusing on core deposit growth now that the integration is behind us.

Slide 9 is a detailed look at the evolution of our unique deposit base, which we believe is one of the most attractive on the West Coast. Our average deposit size is only $43,000 per account with an average relationship tenure of 19 years. We also have a highly diversified customer base with 49% consumer accounts, 43% business accounts and 8% public funds with no broker deposits. Our focus is on profitably growing core relationships.

The top right chart shows this as prior to our merger with HomeStreet, we grew core deposits over $600 million since the third quarter of 2019, despite closing 32 branches after our acquisition of Rabobank's California franchise. After merging with HomeStreet, we deliberately let noncore hot CDs leave the bank as we prioritize capital efficiency and look to minimize risk. The 2 charts on the bottom left and the bottom right highlight the strong relative position of our deposit base versus the broader U.S. banking industry.

Slide 10 looks back over the past decade on the exceptional credit quality of our commercial loan portfolio. Since 2016, we've had no losses on construction or multifamily loans and only a few minor charge-offs on acquired commercial loans from both Rabobank and HomeStreet. Our credit team has a tremendous amount of experience managing through economic cycles, and we fully expect to continue our strong credit performance in the coming years.

I've reworked Slide 11 a bit, but this really is key to our investment thesis. The strength of our deposits and the efficiency with which we run our bank from both an expense and a capital management standpoint, allow us to post great returns despite having one of the lowest risk mix of assets in the country. In turn, our strong financial performance allows us to pay a market-leading dividend yield of approximately 7%. The point I will continue to emphasize is that we will pay these significant dividends despite a very conservative balance sheet and credit profile relative to our banking peers. Over time, we hope to earn a premium earnings multiple given the superior risk-adjusted returns and the lower risk cash flows we generate for our investors.

To wrap up my section, let's turn to Slide 12, which summarizes the investment highlights of Mechanics Bancorp. First and foremost, we have fantastic market share across the West Coast with a branch footprint and customer mix that's nearly impossible to replicate. We are also very profitable due to our top-notch deposits and simple, efficient business model despite taking relatively little risk.

We are a core funded bank with an exceptional track record of credit outperformance, and we're also very well capitalized with a liquid balance sheet. We are prudent with our capital, and we'll continue to pay out substantial dividends with a market-leading dividend yield. There's also a complete alignment between our public and private investors as Ford Financial Fund owns 74% of the company. Finally, we have an experienced management team with strong operating and M&A track records.

With that, let me turn the call over to Nathan to dig into more detail on our second quarter results. We've also added a few new pages this quarter, which I think you will find helpful. Nathan?

Thank you, C.J. Starting on Slide 14. For the second quarter, net interest income declined $1.9 million or 1% to $177.2 million compared to the linked quarter. Average interest-earning assets declined approximately $468 million during the quarter, driven primarily by lower loan balances. Our net interest margin increased 1 basis point to 3.62%, driven by lower funding costs as the total cost of deposits declined to 1.25% from 1.28% in the first quarter. The improvement was primarily attributable to the continued runoff and repricing of higher cost legacy HomeStreet certificates of deposits, which declined approximately $199 million during the quarter.

Second quarter interest income included $13.2 million of discount accretion on loans acquired in the HomeStreet transaction compared to $12.7 million in the first quarter. As of June 30, 2026, we had approximately $136 million of remaining discount on those acquired loans. Lastly, earning asset mix remained relatively stable during the quarter with a modest reduction in cash balances, partially offset by additional investment securities purchases.

Turning to Slide 15. This slide highlights one of the most important drivers of our future earnings growth. As we've discussed previously, the Legacy Mechanics balance sheet contains approximately $4.8 billion of lower-yielding assets with a weighted average yield of 3.12%, comprised primarily of multifamily loans, single-family residential loans and held-to-maturity securities.

Over time, these assets will mature, pay down or otherwise reprice and can be reinvested at current market rates. More than half of this portfolio or approximately $2.8 billion is expected to turn over within the next 5 years. If reinvested at current market rates, that represents approximately 260 basis points of potential yield pickup relative to the existing portfolio.

Importantly, this opportunity is already embedded within our balance sheet and does not require balance sheet growth or a change in our conservative risk profile. As these assets continue to reprice over time, we expect them to provide a meaningful tailwind to future net interest income and margin expansion.

Turning to Slide 16. We put together this illustrative example of the potential impact of short-term rate changes by comparing our variable assets to our rate-sensitive deposits, which include our time deposits and estimating the NII impact of those rate changes. As you can see, we expect a meaningful reduction in NII for any rate hikes in the short term and would benefit from any rate cuts. I would note that the actual impact of rate hikes will diminish over time as more of the bank's fixed rate loans amortize, mature or pay off and the bank reinvests those proceeds at market rates.

Turning to Slide 17. Noninterest income increased $2.8 million or 13% to $23.8 million as compared to the first quarter. The increase was primarily driven by approximately $2.2 million of nonrecurring income items, which are highlighted on the slide. Excluding these items, underlying noninterest income increased modestly from the prior quarter as trust fees increased approximately $0.4 million and bank card royalty income increased approximately $0.5 million, partially offset by a $0.3 million decline in loan servicing income.

Turning to Slide 18. Noninterest expense decreased $6 million or 4.6% to $124.5 million compared to $130.4 million in the first quarter. Merger-related expenses totaled $5.9 million during the quarter compared to $4.8 million in the prior quarter and were primarily comprised of severance costs associated with the final phase of our HomeStreet integration.

Excluding these merger-related expenses, noninterest expense declined $7.1 million from the linked quarter, driven primarily by lower salaries and employee benefits expense, reflecting headcount reductions and the realization of core conversion synergies following the successful HomeStreet conversion.

As a result, our efficiency ratio improved to 58.4% compared to 61.6% in the first quarter. Excluding CDI amortization, annualized core noninterest expense was approximately $445 million during the quarter, and we remain on track to achieve our previously communicated run rate noninterest expense target of approximately $430 million by the fourth quarter of 2026.

Turning to Slide 19. Loan interest income declined $3 million or 1.7% to $178.2 million compared to the first quarter. Loan yields declined 3 basis points to 5.22%, driven primarily by modestly lower contractual yields and changes in portfolio mix as residential and consumer balances grew as a percentage of the portfolio. Multifamily and single-family residential yields declined 8 and 11 basis points, respectively, reflecting lower discount accretion and modest pressure on contractual yields.

During the quarter, C&I yields increased due primarily to approximately $1 million of discount accretion recognized on a small subset of loans. The CRE concentration ratio improved to 342% at quarter end from 348% at March 31. During the quarter, we originated approximately $756 million of loan commitments, predominantly in construction, single-family residential and other consumer categories and sold approximately $32 million of loans, primarily multifamily DUS and single-family residential loans.

Turning to Slide 20. Our commercial real estate portfolio remains well diversified and continues to reflect our long-standing focus on lower-risk multifamily lending. Multifamily represents approximately 71% of the total CRE portfolio with an average loan size of $4 million, an average LTV of 56% and an average debt coverage ratio of 1.55x. The remainder of the CRE portfolio is broadly distributed across retail, office, industrial, hotel and mixed-use categories, each with relatively modest exposure and conservative credit characteristics. At quarter end, our CRE concentration ratio was 342% or 96%, excluding multifamily loans.

We continue to make progress reducing higher-risk segments inherited through the HomeStreet merger. Legacy HomeStreet syndicated loan balances declined from approximately $142 million at September 30, 2025, to approximately $69 million at June 30, 2026. In addition, construction and owner-occupied CRE balances continued to decline during the quarter, reflecting our disciplined approach to balance sheet risk management. Importantly, we continue to have no exposure to nondepository financial institutions. Technology-related exposure represents less than 1% of our C&I portfolio and office exposure remains modest at approximately 8% of total CRE with conservative average LTVs and debt coverage ratios.

Turning to Slide 21. You can see both Legacy Mechanics' strong historical asset quality trends and the impact of the HomeStreet merger. Mechanics has consistently maintained excellent credit quality with minimal non-auto charge-offs and a low level of nonperforming assets. As shown on the slide, the majority of our historical charge-offs have been auto related, and that portfolio continues to perform better than our original expectations as it runs off. Non-auto net charge-offs were just 1 basis point annualized during the second quarter.

At June 30, nonperforming assets represented 0.28% of total assets compared to 0.25% at March 31. The increase was primarily driven by a modest increase in nonperforming loans, including certain single-family, home equity and multifamily relationships, partially offset by the sale of foreclosed assets during the quarter. Our allowance for credit losses totaled 1.12% of total loans at quarter end compared to 1.13% in the prior quarter.

During the second quarter, we recorded a $2.8 million reversal of provision expense, primarily reflecting the elimination of qualitative factor adjustments established in the first quarter and a reduction in the reserves for unfunded commitments. Our ACL remains robust at approximately 2.6x nonperforming assets.

Turning to Slide 22. Securities interest income was essentially unchanged at $53.1 million during the second quarter compared to the linked quarter. Securities yields also remained stable at 3.97% during the quarter. The securities portfolio increased approximately $156 million at quarter end, primarily driven by additional purchases of agency mortgage-backed securities. Securities available for sale increased approximately $186 million, while held-to-maturity securities declined modestly due to normal paydowns. Overall, the portfolio continues to provide stable earnings and liquidity, while maintaining a conservative risk profile.

Turning to Slide 23. Total deposits declined $153 million during the quarter, driven by a $199 million reduction in the higher cost time deposits, partially offset by growth in nonmaturity deposits. This contributed to a $1.8 million or 3% decline in the deposit interest expense compared to the prior quarter.

Total cost of deposits improved to 1.25%, down 3 basis points from the first quarter, driven primarily by the continued runoff of higher cost Legacy HomeStreet time deposits. The average cost of our time deposits was down to 2.45% for the second quarter. I would note that the spot cost of deposits at June 30 was 1.28%, which reflects some competitive pressures that we are seeing in our markets. Lastly, noninterest-bearing deposits represented 35% of total deposits at quarter end.

Turning to capital and liquidity on Slide 25. We remain very well capitalized with a 14.4% CET1 ratio and an 8.7% Tier 1 leverage ratio at June 30. Available liquidity totaled approximately $15.9 billion at quarter end. Book value per share was $12.15 at quarter end, while tangible book value per share increased to $7.56.

During the second quarter, we paid dividends totaling $0.70 per Class A share, bringing year-to-date dividends to $1.10 per share. As C.J. discussed earlier, our strong capital position continues to support significant capital returns to shareholders. Subject to Board and regulatory approval, we currently expect to pay a dividend of approximately $0.25 per Class A share in the third quarter, followed by an approximately $75 million to $100 million dividend in the fourth quarter.

That concludes our prepared remarks. We will now open the line for questions.

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

I wanted to start on the deposit trends that you saw in the quarter. And as you highlighted, there was a little bit of mix shift and the spot cost is, I think, a little bit higher than where we were average. So I was just interested to know -- or just interested in your thoughts on how you think that mix shift trends over the back half of the year? And it sounds like there could be a little more pressure on the deposit cost front over the back half of the year.

Yes, I'll start, and I'll see if Carl and Nathan want to add anything. It's a good question.

Obviously, in the second quarter when we saw kind of rates back up, I think we've seen -- and we've priced up a bit on some of our CDs and some of our money markets as we've seen rate competition increase in the market. And so -- and we also had, at the end of March, a lower spot rate. April is tax season. And so there's some -- a little bit of noise there in the cost. As a data point in the month of June, our deposit costs rose 0.08 basis points, so slightly less than 1 basis point. So we saw a bit of pickup really in May. The deposit costs slowed down in June.

We do expect, Woody, that mix shift will continue through the rest of the year. We are seeing some continued mix shift into money market. Our CDs will continue to decline a bit. So we expect deposit costs to increase modestly through the rest of the year. Overall, very encouraged by just general pipelines and kind of the refocus that we have on growing the core business. Obviously, it's very competitive out there, but -- and we've got -- our deposit base is very low cost to begin with. So it's -- when we have these elevated rates and a lot of competition in our markets, it creates a bit of pressure. But overall, we still feel very solid about our deposit base.

I don't know, Nathan or Carl, do you want to add anything to that?

Yes. I'll just note that we've seen a consistent pickup in our CD renewal rate in the second quarter. Obviously, you run off the acquisition on purpose, it was relatively low. But in the second quarter, we saw that pick up to historical levels and our renewal rate overall in the entire CD portfolio is still relatively low, as noted by our cost of CDs being lower than our money market accounts at the end of the second quarter. So we feel that's a positive trend. But yes, there's certainly been additional pressures in the second quarter with elevated rates.

Yes. I'd now say we kind of have all deposits are core, right? Our CD costs are very solid, core client relationships. There's still some pressure. There's a lot of competition there. But we -- I think we most -- we've basically gotten through what we wanted to do, which was manage out high rate seekers, noncore relationships. You've actually seen our tenure -- average tenure in our stat that we share go from 17 years to 19 years, and that's also a function of some of these rate seeking CDs moving on, and that also creates a lot of excess capital for us.

Yes. That's really helpful color. And then maybe just as my follow-up on the loans or on the asset side, and I appreciate Slide 15. It's super helpful color that you provide, and it's pretty interesting to see the rate on multifamily loans is only 30 basis points higher than new securities. So given a pretty tight spread there, how does that impact your thoughts on where you see asset growth as you get some of these cash flows from both the bond and the loan side?

Yes, that's a good question. I think Carl and I and Nathan, we talk about it. There's not a lot of incremental spread between where we're seeing commercial real estate, multifamily relative to where we can reinvest in like duration securities. And so we -- and so we put a lot of effort to try to be prudent about where we're lending, who we're lending to. We want to lend to core client relationships. A lot of the multifamily relationships we've had go back decades. And so it's an allocation.

And I think you'll continue to see us manage our commercial real estate down modestly, and we'll eventually get below that 300% level. We made good progress on that, and it will continue. But yes, as some of that CRE, low-yielding CRE rolls off, the reinvestment rate in the securities is pretty competitive, and it's also a lot lower risk. And that's a trade that we've been willing to make. And I think we'll continue to see some of that.

[Operator Instructions] Our next question comes from the line of Tim Mitchell with Raymond James.

This is Tim on for David. I want to follow up kind of on Woody's question there and just talk about the outlook for the margin. All the details you gave on Slide 15, it's great. You have a lot of tailwinds just from back book repricing, you have the bond restructure, some continued runoff of the CD book. We also noted some potential pressure kind of on the deposit cost side, just given the competitive backdrop. So could you just like overall help us kind of unpack some of the puts and takes for the margin and where you think the core margin can shake out over the next few quarters?

Sure. I'm happy to go first. There's a couple of moving pieces. We did want to add these 2 new slides to try to give investors additional insights and detail into kind of our near-term -- short-term sensitivity to changes in Fed funds up or down. We are modestly liability sensitive, as you can see on Page 16, where we have a greater amount of rate-sensitive deposits than we do floating rate assets. And so rates down near term is good for us, rates up near term would be a modest drag. I try to provide more information there, and we'll see how that develops in the coming quarters.

Long run, we feel very positive that there will be margin expansion given the repricing we have on a lot of these very low-yielding $4.8 billion at 3.12% that are cash flowing. Those cash flows will pick up. And there's a lot of margin enhancement that comes from that over the long run.

So it's -- I think you'll -- and then we also -- on top of that, we plan to execute an AFS restructure that we've sold the remaining $310 million low-yielding securities we had in the AFS portfolio. We already had that out of our tangible equity. We expect a 4- to 5-year earn back. That will be a modest bump to margin near term and into next year. And you bring up again a good point that we do -- but we do expect deposit costs to increase modestly from here on out. So that will offset it somewhat. We expect modest NIM improvement in a flat rate environment. If we get rate hikes, that would cut into it.

Okay. That's super helpful. And then just on the size of the balance sheet overall, it's obviously kind of declined in the past couple of quarters. There are a lot of moving parts here as you continue to optimize it post merger. But if you could just kind of walk us through some of the puts and takes around when we could see the size of the balance sheet stabilize and start to grow a little bit. Obviously, loan originations were up nicely this quarter, but also understand there may be some work to be done on the auto book and maybe some of the multifamily portfolios.

Yes, sure. From a balance sheet overall size standpoint, it's going to be driven really by our deposits. And I think we have reached the bottom of our deposit decline. We expect to grow modestly, I would say, modestly grow 1%, 2%-ish moving forward on deposits. I do think there'll be some continued mix shift and a bit of pressure on costs. But that should stabilize.

And on the asset side, I think there'll be continued remixing. We are growing single-family and HELOC modestly and our partnership with Inclined on lending against the cash surrender value of whole life is growing nicely. We will continue to be prudent on commercial real estate. construction lending, C&I, where we're selectively looking at all of our relationships and making sure we feel like they're priced appropriately on a risk-adjusted basis.

I don't know, Carl, if you want to add anything to that or...

No, I think that says it well. It gets back to what we said earlier. It's very competitive out there. It's competitive for deposits and deposits to a large extent, dictate the size of the balance sheet.

And to say that some credit pricing is irrational in the market today, I believe that. We're not going to give away credit at this bank. I think we've always been very disciplined in our extension of credit. And to that comment earlier, you've got a 30 basis point spread between securities and multifamily lending.

And so I don't see us really pressing hard to grow loans that we cannot always, number one, underwrite well and price at a point that makes sense for us, and we're not necessarily going to always be able to meet the competition. So I guess that would be some of my thoughts on balance sheet size. I think we're what $21.2 billion today. So I think that's a pretty good level to look for us going forward.

Awesome. And then since they took the question cap off, I'll ask one more just on capital.

Obviously, the ratios continue to build. The HomeStreet integration is kind of moving into the rearview mirror. So just kind of curious your updated thoughts around M&A. There's been some deals in your footprint recently. Just kind of curious if you could give us an update on your attitude, what conversations are like and just your overall thoughts there.

Yes. I'll make a couple of quick comments and then C.J. and Nathan can certainly join in.

I understand the question because if you look at the past 40 years of Ford organization, we've been extremely acquisitive. We've never tried to do a transaction just to get bigger. It always has to meet the first test of making us better. We've always defined better as it relates to franchise value, namely liabilities, deposit costs.

And I think when you've got clearly top decile deposits in the deposit franchise, it makes it very difficult when you're screening for M&A opportunities, particularly in our geographic footprint, that being the West Coast. So we're just coming off an extremely successful deal. We still have digestion to do and some assimilation with HomeStreet. I tend to think that our biggest bang for our buck, our resources is to focus internally. We still have some work to do there.

Although I think our integration, our conversion, our transition of HomeStreet home to the Mechanics Bank platform is going very, very well. A lot of people get a lot of credit for that. So I don't see anything on the horizon right now because it does have to meet this deposit test. And I think that's increasingly a high bar for a potential M&A candidate to chin for it to be attractive to us. So we're not going to do anything just for the sake of getting larger, and it help us -- it has to help us on the deposit franchise side, and that's hard.

Yes. I don't really have anything to add to that.

Awesome.

[Operator Instructions] Your next question comes from the line of David Rochester with Cantor.

I just wanted to touch on the guidance, I think you had last quarter for 2027 GAAP net income in the $275 million to $300 million range. I realize it's a long way off and a lot happens between now and then, but still want to get your updated thoughts on that range, just given the results, your comments on deposit pricing and just on the loan front as well.

Sure, Dave. Yes. No problem. I'll take that. Yes, I think our guidance is very consistent with what it was last time. We want to focus on the ROATCE target. And I think when you take the 17% ROATCE for '27, it should fall right in that same net income range. And it is -- as you know, it's hard to forecast out into '27. There's moving pieces, but we have a significant amount of confidence in kind of ever-increasing ROATCE. We're about 15% today. I think that's going to be up next quarter.

And we've got some tailwinds heading into '27 on repricing and just generally being efficient. I feel very good about our expense guide. I feel very good about our credit and I feel increasingly positive about kind of deposits bottoming out and looking to grow those moving forward. So that's my thought on that.

Okay. Great. And then you just mentioned the expense guide. But it also -- I think earlier, you mentioned getting a lot of those cost saves hitting in the third quarter. Are you expecting to get pretty close to that $430 million in the third quarter and then kind of leveling out in the fourth quarter?

Yes. I mean we did -- the core conversion was completed at the end of March. There was a lot of layoffs as part of mergers that happened in this quarter. Our headcount, I think, was down 130 something in the quarter. So a lot of layoffs, a lot of that happened later in the quarter. So yes, I think you'll see a pretty substantial pickup or reduction in our noninterest expense in the third quarter, and I think some of that will even continue into the fourth quarter. So we feel pretty confident about that.

And we should also see a significant reduction in the onetime charges related to the merger. We just don't -- there'll still be a couple of things, would be some leases here or there, but we're basically through it.

Yes. Okay. And maybe one on capital. You mentioned having $100 million in excess at the end of June. How much cushion would you guys target to have at the end of 4Q after something like a cleanup dividend, which is kind of implied by that range that you gave of $75 million to $100 million, which is above our estimate and consensus at this point. Just trying to get a sense for how you think about that going forward.

Yes. So we're kind of managing to 8.25% 1 quarter in arrears, which effectively puts us at 8.5% leverage ratio, 8.6% leverage ratio. The bank is generating a lot of capital and our risk-weighted assets continue to drop. And so we're now at a 14.4% CET1. I think peers, I look at, I don't know, maybe around 11% average, 12% average, something like that.

So we have a lot of capital flexibility, and I think that creates optionality. We are going to continue to pay a lot of dividends. We feel confident in the $250 million dividend guide for next year that we mentioned. And I guess the main thing I'd say is we're probably still running with capital above peers, and that gives us some flexibility.

Yes. Okay. Just one last one on the margin. You talked a lot about this already. But just with the restructuring you mentioned and the deposit cost comments, it seems like you're looking for maybe a little bit of a bump in the third quarter. Do you stabilize at that point and then kind of grind higher? You mentioned NIM maybe increasing modestly in this kind of rate backdrop. So that would assume that these rates continue to hold. But is that kind of how you're thinking about it?

Yes. I think when we look at this quarter's results and the continued generation of capital, we have adjusted some of our assumptions around deposit growth and betas and mix shift that would be a negative to earnings.

Obviously, the AFS restructure where we -- again, we have all this capital. We can use it sometimes to add earnings moving forward. I think that basically offsets it. And so that's why we think our guidance is relatively consistent with last quarter due to those competing factors.

We do think over the long run, our margin should increase. In the short run, it's going to be pretty dependent on what the Fed does in hikes. Either way, it's not going to be a huge needle mover to our NIM, which should be -- remain pretty strong.

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

Thank you, operator, and to all who joined us today. As we close out the quarter, we believe Mechanics Bancorp is exceptionally well positioned. The HomeStreet integration is substantially complete. Expenses continue to trend favorably. Credit quality remains strong, and we maintain capital levels that are among the strongest in our peer group.

We also believe the earnings power of the franchise continues to improve. We have meaningful embedded asset repricing opportunities, significant flexibility to optimize our balance sheet and the ability to deploy excess capital in ways that enhance shareholder value.

Perhaps most importantly, we continue to offer shareholders a unique combination of low-risk earnings, a strong and granular deposit franchise, substantial excess capital and what we believe is one of the most attractive dividend yields in the banking industry. We are proud of the progress we made since closing the HomeStreet acquisition, confident in the opportunities ahead and focused on delivering attractive long-term returns for our shareholders.

Thanks for your time today. We look forward to speaking with you next quarter.

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

Good morning, ladies and gentlemen, and welcome to the Mechanics Bancorp First Quarter 2026 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would like now to turn the call over to Nathan Duda, Chief Financial Officer of Mechanics. Please go ahead.

Thank you, operator, and good morning, everyone. We appreciate you joining our earnings conference call. With me here today are C.J. Johnson, our President and CEO; and Carl Webb, our Executive Chair. The related earnings press release and earnings presentation are available on the News and Events section of our Investor Relations website.

Before we begin, I'd like to remind everyone that any forward-looking statements are subject to those risks, uncertainties and other factors that could cause actual results to differ materially from those anticipated future results. Please see our safe harbor statements in our earnings press release and in our earnings presentation. All comments expressed or implied made during today's call are subject to those safe harbor statements.

Any forward-looking statements made during this call are made only as of today's date, and we do not undertake any duty to update such forward-looking statements, except as required by law.

Additionally, during today's call, we may discuss certain non-GAAP financial measures, which we believe are useful in evaluating our performance. A reconciliation of these non-GAAP financial measures to the most comparable GAAP financial measure can also be found in our earnings release and in the earnings presentation.

C.J., let me hand it over to you.

Thank you, Nathan, and good morning. We appreciate everyone joining our call and for your interest in Mechanics Bancorp. I'll kick things off today and we'll summarize the highlights of our first quarter performance. I'll also provide another strategic update on the bank before handing things off to Nathan to review our financials in more detail. Carl, Nathan and I will then open up the call for your questions.

With that, let's turn to Slide 4. We had a productive first quarter, reporting $44.1 million in net income. On a fully diluted basis, our earnings per share was $0.19, and our tangible book value per share ended the quarter at $7.53 with $0.40 per share of dividends paid to investors in Q1. As anticipated, this was another noisy quarter, so I'll walk you through some of the major items.

First, we recorded a $6.5 million provision entirely related to qualitative CECL factors tied to geopolitical uncertainty stemming from the Iran war. Importantly, this was not driven by any specific credit deterioration within our loan portfolios. Asset quality metrics remained strong, and I'm pleased to report that we had 0 basis points of net charge-offs when you exclude our auto net charge-offs. Our runoff auto portfolio, by the way, is also performing well as it winds down. This provision was a conservative response to the heightened global risk of the Iran war and its potential impact on the U.S. economy, particularly given higher oil prices.

Second, we incurred just under $5 million of merger-related expenses as we continue to work through the final phases of our HomeStreet integration. These costs were in line with our expectations and are nearing completion.

The third noncore item was a $1.7 million tax provision related to the remeasurement of our deferred tax assets due to a lower anticipated effective tax rate moving forward for the company. For forecasting purposes, we expect our effective tax rate to be approximately 26.5% in 2026, but this could still move around a bit. When you adjust for the noncore items, it adds up to $53.8 million of core net income for the quarter, representing a core ROAA of 1% and a core ROATCE of 13%.

The first quarter is always the seasonally weakest for us for both noninterest expenses and core deposits. On the deposit front, our seasonality primarily stems from our $860 million of food and ag deposit customers who see large inflows in December and outflows in January. This quarter, $137 million of our nonmaturity deposit decrease was from these customers, which is normal course activity. Otherwise, core deposits were roughly flat.

Importantly, we did see a $640 million reduction in CD balances during the quarter. This was deliberate as we continue to hold the line on CD pricing and let hotter money from legacy HomeStreet customers leave the bank. When we modeled the merger over a year ago, we expected $1 billion in CD runoff by the end of the second quarter of 2026. However, runoff has been greater than anticipated, and we now expect $1.4 billion cumulative reduction in CDs with overall Mechanics CD balances expected to stabilize at a $2.0 billion run rate. This implies an additional reduction in CDs of just under $150 million in Q2.

Notably, the vast majority of CDs leaving the bank were from single account households and our core deposit retention through the merger has been very strong. Also, nearly all of our CDs have repriced once at our lower rates and have maturities of 7 months or less. While this elevated time deposit runoff has a negative impact on earnings, it's higher risk, low ROE noncore money that's better to not have in our bank. Getting a bit smaller also generates excess capital, which provides strategic flexibility.

Staying on the topic of risk reduction, legacy HomeStreet construction loans also decreased nearly $100 million during the quarter, as we made the strategic decision to let certain business go that we felt wasn't priced appropriately relative to the credit exposure we were taking as a bank. In general, competition for loans and deposits remains quite stiff. And we are okay getting a bit smaller in the near term to minimize risk to the company and position ourselves for long-term success.

Our total assets are now $21.4 billion with total gross loans of $13.9 billion, total deposits of $18.2 billion and tangible shareholders' equity of $1.7 billion. We remain 100% core funded with no broker deposits or FHLB borrowings at 3/31, and I'm pleased that we paid off $65 million of high-cost senior debt in March that was acquired from legacy HomeStreet.

Primarily because of the Iran war provision, our ACL grew 5 basis points this quarter to 1.13% of loans and now totals $157 million. Our allowance is also a very robust 2.95x our total nonperforming assets as of 3/31 with NPAs generally flat for the quarter. Our capital ratios remain healthy with a 13.9% CET1 ratio and an 8.7% Tier 1 leverage ratio. Our cost of deposits was 1.28% in the first quarter, down 15 bps from Q4, and our spot cost of deposits at 3/31 was 1.21%. Our NIM was 3.61% for the quarter, up 11 bps sequentially, and our CRE concentration ratio was 348%.

Turning to Slide 5. I'd like to provide you with an update on some of the key strategic initiatives happening at the bank. I'm very happy to report that we successfully converted all legacy HomeStreet customers onto our core banking platform the final week of March. This major milestone was achieved, thanks to a tremendous amount of planning and hard work from all our employees. We will substantially complete our merger integration during the second quarter and expect to realize significant additional expense synergies moving forward as we will not be paying 2 core providers, other redundant contracts will be terminated and final headcount reductions occur.

We remain on track to deliver on our budgeted cost synergies from the merger and reiterate our prior guidance of achieving an annual run rate noninterest expense, excluding CDI of approximately $430 million by the fourth quarter of this year. The $130 million sale of our DUS business line to Fifth Third has taken a bit longer than expected, but we have a high degree of confidence that it will close in the second quarter. Given the pending DUS sale, our first quarter earnings and our modestly smaller balance sheet, we will have significant excess capital, and we expect to pay approximately $0.70 per share in dividends in Q2, subject to regulatory and Board approval.

The merger integration is almost behind us after a very full year of work and the build-outs of our wealth, commercial banking and treasury sales teams are substantially complete. It will be nice to move past integration work and focus entirely on growing each of our core business lines with a technology road map for the bank that is increasingly focused on leveraging AI tools to improve enterprise productivity. As for the big picture, we expect a relatively flat NIM for the next 2 to 3 quarters as auto loan runoff remains a drag and our deposit costs stop declining given we no longer expect any Fed rate cuts, and our CD repricing moderates.

Our NIM should begin expanding again in early 2027 as the impact of auto fades, driven by legacy Mechanics Bank earning asset repricing, which will continue to occur over the next 5 years and will provide a tailwind to earnings growth. We now expect to deliver a 17% to 18% ROATCE and a 1.3% to 1.4% ROAA in 2027 and beyond with a projected GAAP net income range of $275 million to $300 million for 2027. Our earnings guidance has been reduced primarily due to removing 2 Fed rate cuts from our projections, as well as from a modestly smaller balance sheet due to the lower CD balances. We also expect outstanding construction loans to decline to roughly $300 million over the rest of the year versus $500 million previously.

Let's move to Slide 6, which shows an overview of Mechanics Bancorp today. Again, we have $21.4 billion in assets with 166 branches and very competitive deposit market share. We are the fourth largest community bank in both California and on the West Coast with a branch map that's nearly impossible to replicate. We fully expect Mechanics to be a high-performing bank despite taking very little risk with our earning asset strategy.

On the left-hand side of the page, we compare Mechanics to all publicly traded banks, $10 billion to $100 billion in assets, which, including us, now has 77 banks in the comparative group. As you can see, our cost of deposits for the first quarter was 1.28% versus the median of 77 banks of 1.76%, giving us a rank of #10. And I expect our cost of deposits to continue to drop in the second quarter before flattening the remainder of the year.

Next, our noninterest-bearing deposit mix is 36%, which is third out of 77%, up one spot from a quarter ago and the greatest store of value for our company. Our CET1 ratio of 13.9% ranks 19th and our risk-weighted assets to total assets is just 59% versus the group median at 76%, which is the second lowest out of our 77 competitor banks nationwide. Despite this low risk profile, our expected 2027 ROATCE of 17% ranks 8 out of the 77 banks, which would be exceptional.

Finally, our 2027 efficiency ratio is now projected to be approximately 50%, which ranks 22nd out of 77 despite our operating in higher cost markets and with the majority of our deposits comprised of small balance consumer accounts.

Slide 7 is key to our investment thesis and another way of visualizing some of the important statistics from Page 6. The strength of our deposits and the efficiency with which we run our bank, both from an expense and a capital management standpoint, will allow us to post very strong returns despite having nearly the lowest risk mix of assets in the country.

These charts provide a great visual in my opinion, especially the risk-weighted assets to total assets comparison. In fact, we expect our risk-weighted assets as a percentage of total assets to continue to come down over time as our auto loans run off and our CRE concentration ratio is managed below 300%. While we will pay substantial dividends in the first half of 2026, we expect moving forward that our dividend payout ratio will be closer to 80% of net income as we retain some capital to support core growth and preserve strategic optionality.

To wrap up my section, let's turn to Slide 8. This slide summarizes our investment highlights. First and foremost, we have very strong market share across the West Coast with a branch footprint that's nearly impossible to replicate. We also expect to have very strong profitability due to our top-notch deposits and efficient business model despite taking very little credit risk. We are 100% core funded with no wholesale borrowings or broker deposits and are highly capitalized with a very liquid balance sheet with 70% loan-to-deposit ratio forecast for 2027. We are efficient with our capital and plan to pay out substantial dividends, which would imply a very attractive yield at today's share price. There's also firm alignment between our public and private investors as Ford Financial Fund owns 74% of the company. Finally, we have an experienced management team with a strong operating and M&A track record.

Overall, the future prospects for Mechanics are quite bright, and I'm looking forward to finishing the job with the HomeStreet integration and moving on to the next chapter of growth for our great company.

With that, let me turn the call over to Nathan to dig into more detail on our first quarter results. Nathan?

Thank you, C.J. Starting on Slide 10. For the first quarter, net interest income declined $3.9 million or 2.2% to $179 million compared to $183 million in the fourth quarter of 2025. Our net interest margin expanded 11 basis points to 3.61%, driven primarily from the reduction in deposit costs from the $640 million runoff of higher cost legacy HomeStreet CDs.

First quarter interest income included $12.7 million of discount accretion on loans acquired in the HomeStreet transaction, and we have approximately $150 million of remaining discount on those loans as of March 31, 2026. Lastly, the earning asset mix shifted modestly during the quarter, reflecting lower cash balances as CDs continue to roll off.

Turning to Slide 11. Noninterest income declined $57.5 million or 73% to $21 million compared to $78.5 million in the linked quarter. As a reminder, the fourth quarter included a $55.1 million bargain purchase gain related to the write-up of the DUS intangible assets acquired in the HomeStreet merger. Excluding that item, underlying noninterest income declined $2.4 million quarter-over-quarter, primarily driven by lower trust fees, lower gain on sale of loans and reduced BOLI income.

Turning to Slide 12. Noninterest expense increased $0.9 million or 0.7% to $130.4 million compared to $129.5 million in the fourth quarter. Merger-related expenses totaled $4.8 million, up modestly from $3.5 million last quarter and were primarily comprised of professional services and severance costs. Excluding these onetime merger expenses, noninterest expense declined $0.4 million versus the linked quarter. The efficiency ratio increased to 61.6% compared to 46.7% in Q4, reflecting the absence of the prior quarter bargain purchase gain rather than any deterioration in underlying operating efficiency.

Turning to Slide 13. Loan interest income declined $12.9 million or 6.7% to $181.2 million and loan yields declined 9 basis points to 5.25%, driven by slightly lower contractual yields and reduced discount accretion. Multifamily and single-family residential yields declined modestly by 6 and 3 basis points, respectively. The CRE concentration ratio increased to 348% at quarter end. During the quarter, we originated $546 million of loan commitments, predominantly in SFR and other consumer categories and sold $54 million of loans, primarily DUS multifamily and residential real estate.

Turning to Slide 14. Our commercial real estate portfolio remains well diversified and continues to reflect our long-standing focus on lower-risk multifamily lending. Multifamily represents approximately 70% of the total CRE portfolio with an average loan size of $3.8 million, an average LTV of 56% and an average debt coverage ratio of 1.55x. The remainder of the CRE portfolio is broadly distributed across retail, office, industrial, hotel and mixed-use categories, each with modest exposure and conservative credit characteristics. At the end of the first quarter, our CRE concentration was 348%, which would be 101% when excluding our multifamily portfolio.

We also continue to manage down the higher risk segment of the legacy HomeStreet portfolio. During the last 6 months, we made progress reducing our HomeStreet syndicated loan exposure with balances declining from approximately $142 million at September 30, 2025, to about $58 million at March 31, 2026. During the first quarter, we sold roughly $9 million of unpaid principal balance or $18 million of commitments of legacy HomeStreet C&I syndications at par, and we ended the quarter with no exposure to nondepository financial institutions.

Turning to Slide 15. You can see both legacy Mechanics asset quality trends and the impact of the HomeStreet merger. Mechanics has historically maintained excellent credit quality with minimal non-auto charge-offs and a very low level of nonperforming assets. As shown on the slide, the majority of our historical charge-offs were auto related. And as mentioned earlier, that portfolio is in runoff and continues to outperform expectations. As a reminder, the increase in the non-auto charge-offs in the fourth quarter of 2025 was due to a charge-off of a legacy HomeStreet acquired loan that has specific reserves established and the actual charge-off was slightly lower than the original anticipated loss.

At March 31, nonperforming assets represented 0.25% of total assets, modestly higher from 0.23% in the fourth quarter. The increase reflects the impact of lower loan balances in total and a slight increase in the non-auto nonperforming assets of $2 million. Loan loss reserves to loans held for investment were 1.13% at quarter end compared to 1.08% in the prior quarter. The increase in the allowance reflects the incorporation of qualitative factor adjustments, including a $6.35 million pretax provision driven by the heightened economic uncertainty related to geopolitical developments.

Turning to Slide 16. Securities interest income increased $3.5 million or 7% to $53.1 million from $49.5 million in the fourth quarter. The increase was driven by higher yields on the portfolio, which increased by 11 basis points to 3.97% as compared to the fourth quarter. The increase in the portfolio's yield was due to the full quarter impact of the $650 million of securities purchased in the fourth quarter of 2025 at accretive yields to the portfolio. The overall securities portfolio decreased by $83 million in the first quarter due to paydowns and a $33 million reduction in fair value due to higher interest rates.

Turning to Slide 17. Total deposits declined $782 million during the quarter, driven by a $640 million reduction in higher cost time deposits and $232 million reduction in noninterest-bearing demand and $137 million of seasonal non-maturity deposit outflows, partially offset by money market growth. This mix shift and balance reduction contributed to a $10.7 million or 15% decline in the deposit interest expense compared to the prior quarter. The total cost of deposits improved to 1.28%, down 15 basis points from the prior quarter, driven primarily by the continued runoff of the higher cost legacy HomeStreet time deposits. Spot cost of deposits at March 31 was 1.21%, reflecting ongoing repricing benefits. Noninterest-bearing deposits represented 36% of total deposits, continuing to support our low-cost funding profile.

Turning to capital and liquidity on Slide 19. We remain very well capitalized with a 13.9% CET1 ratio and an 8.7% Tier 1 leverage ratio at March 31. Available liquidity totaled approximately $16.3 billion. Book value per share at quarter end was $12.61 and tangible book value per share was $7.53. During the first quarter, we paid a $0.40 per share dividend on our Class A common stock.

As C.J. discussed earlier, we expect the $130 million sale of our Fannie Mae Delegated Underwriting and Servicing or DUS business to Fifth Third to be approved and closed shortly. Pro forma for that transaction, we expect to have approximately $165 million of excess capital, which we intend to return to shareholders through a special dividend of approximately $0.70 per share in the second quarter, subject to regulatory and Board approval.

That concludes our prepared remarks. Operator, please open the line for questions.

[Operator Instructions] Your first question comes from Woody Lay with KBW.

I wanted to start on the net interest margin. And just based off the spot rate of deposits you gave, I'm a little surprised margin would be flat or relatively flat next quarter. Could you kind of just walk through the puts and takes to that, to the flat margin over the next couple of quarters and kind of the glide path we need to see in order to hit the $275 million to $300 million of net income in 2027?

Woody, I'll take that. I'll start with and maybe let Nathan comment as well. I think, yes, the spot cost of deposits is down, and that will provide a bit of a tailwind. But the -- I think we expect our deposit cost to be kind of not quite at 1.21%, probably a little higher than that for the quarter overall as we really are through most of our CD repricing. We also have kind of a bit of a day count issue with the first quarter in February and how we do some of our yields, the 3.61%, especially in February, which is a short month, is a bit elevated. So that gets some of it. I do think we now -- again, we're very liability sensitive.

We're going to add a bit more disclosure around that in our next investor deck in the second quarter, but we do have -- of our $18 billion of deposits, $10 billion is at basically 1 basis point, noninterest-bearing or very low cost. But we do have $7 billion that's at 2.85% today. And so it's bit of a bifurcated deposit base. And so not getting the rate cuts, having a flat forward curve is a bit of a negative for us, clearly. And we do have about $3 billion -- basically just about $4 billion of floating rate assets. So there's a $3 billion gap between our rate-sensitive liabilities and our floating rate assets, and we've been working to narrow that gap. It has come down, it will continue to come down. But that's putting some of the pressure on the margin during the year, especially as we still have $600 million or so of auto loans at a 6.5% yield. Those are running off to 0. That's putting pressure on the margin.

The offset is we've outsourced the expense for that. And as those loans run off, our NIE continues to proportionately run off with that as well. We have $12 million right now that we're paying. And so as those balances run down, the $12 million also comes down. So the offset to the margin impact is going to show up in noninterest expense. Nathan, do you want to add anything to that?

Yes, I think you covered most of it. A couple of other items I would add is you gave updated guidance on the construction land balances, which is one of our highest-yielding assets. So there's an impact there. In addition, we have seen interest-bearing transaction costs tick up. Part of that is some of the CD runoff from HomeStreet. Strategically, we've been pushing some of that into interest-bearing transaction. And so we expect that to tick up during the second quarter, along with everything else that you discussed already.

Got it. And then maybe just with some of the moving pieces, is there kind of a margin range you expect in 2027 in order to achieve the NII run rate you expect?

Yes, I'd say probably 3.7%, 3.8% in '27 would be my estimate. Obviously, that's -- it's still a ways down the road and things can change. So I hesitate to give too much there. But what I do know is we're 100% core funded and our deposit costs should be pretty stable, especially when we -- if we can grow core deposits, which we think we can do. I think our deposit costs should remain pretty stable once we get through the second quarter. And we have, I'd say, at least $5 billion of low-yielding legacy Mechanics assets that are hangover from the COVID era, that will continue to amortize, prepay, cash flow reprice. We're going to add some disclosure around that as well in the second quarter, but that's going to be a tailwind. And that's going to come. That's happening. And so that will push our margin higher every year for the next 5 years.

And so this run rate, this would eventually be a bank that's north of a 4% NIM. And there's levers we can pull to accelerate that. We are going to be continuing to generate excess capital as we're a little smaller. And we've got low-yielding loans, low-yielding securities. We may consider a restructure on some of that. It would be small. The other thing we're going to do eventually, Woody, is we're eventually going to sell these auto loans. And so that will be -- I don't know when that will be, but it's going to be back half of this year, early next year. We're still going to try to determine the ideal timing of it, and that will be -- we may take a modest loss when that occurs, but it will be a pickup to earnings for sure, so -- because that's still -- that's losing us money at the moment as we continue our runoff. So there's a lot of levers we can pull. And the underlying earnings power of this bank is very strong, thanks to our great deposits. And we haven't embedded any of that kind of stuff in our guidance.

Yes. No, that's really helpful. Maybe just shifting over to the balance sheet real quick. As you noted, some of the deposit runoff is coming a little bit more than expected. And I think you said there's another $150 million of planned CDs from HomeStreet that's coming off next quarter. Once we kind of get through that tranche, how are you thinking about the size of the balance sheet? Should it remain pretty stable at those levels? Or just given the sale of the auto -- potential sale of the auto portfolio, could we see some additional shrinkage in the back half of the year?

No, I think once we get through any remaining CD reductions in the second quarter -- and again, the first quarter is also the seasonal low for deposits with us. Every quarter, that's the case. Every first quarter, that's the case. So we expect core deposit growth, not -- we've always -- we think we should grow 2%, 3%, 4% a year in line with our economies and we've got a ton of focus at the bank on growing core deposits. And so the noncore stuff is basically all out.

If we sell auto loans, we'll get the proceeds and reinvest somewhere else. So the assets won't -- that won't change the size of the balance sheet. So I view this as very close to the low and we should be growing. We're budgeting to grow. We think we've got momentum there on deposit pipelines and stuff like that. So I would not expect much, if any, more balance sheet shrinkage, maybe a bit in the second quarter, but that should be the within the year.

Got it. And then maybe just last for me. You all noted in your opening remarks, 80% payout ratio in '27 that provides some capital to be strategic with. And as you noted, you could look at restructures, but I was also just interested in your thoughts on additional M&A from here, especially once we get past the official core conversion?

Carl, do you want to take that one?

I think that you have to look at our past to somewhat predict our future. We've always been extremely acquisitive. We're always looking at situational opportunities. Obviously, the opportunities have to be within our footprint. We're not looking to really expand our West Coast footprint, and we don't want to do an M&A transaction simply to get bigger. It has to make us better. And I think the overlay to that is making us better with an M&A transaction, it's harder and harder and harder.

You heard the 1.28% deposit cost for the quarter and the 1.21% spot rate. We protect these deposits judiciously. And I'm not talking about our time deposits, and the story there is we've run those down intentionally. But it really gets harder and harder to move the needle. And I'm not saying that we have to buy another bank or acquire another opportunity that has a like deposit cost, but we think the value of a bank -- the franchise value of a bank is demonstrated predominantly by its liability structure and its deposit cost.

And so we have to take that into consideration. And frankly, there just aren't a lot of banks out there. We're always looking. There are a scant few opportunities that we constantly monitor. And I think something in our favor is we're trading at a pretty good multiple. So all I can say is we're keen to the opportunity set. We're always looking. I would say just being extremely transparent. There is nothing right now on the front burner, and that's simply because there is nothing more important for our bandwidth today than getting this integration right.

We've only acquired HomeStreet, which significantly increased our size and our footprint, what is it, 8 months ago. And we're now in the midst of getting our cost out and C.J. spoke to the conversion. Those are the very important things that we've got to get done and get right first, and we're getting in the later innings of doing that. And then we'll certainly see what's out there.

[Operator Instructions] Your next question is from Dave Rochester with Cantor.

Back on your comments on growth in core deposits. It sounds like you feel pretty good about doing that through the end of this year. I was curious, just given the headwinds in auto and construction, if you think you could still grow the loan book this year? And I'm just trying to triangulate into an NII trend with a stable NIM. It kind of sounds like you're still expecting NII to grow through the end of this year as well with whether it's loan growth or securities growth through the end of the year, just given that you're growing core deposits. Just wanted to get your thoughts on that?

Yes, I think from a loan growth standpoint, we expect to grow our consumer loans. We had modest growth in single-family. We expect that to pick up throughout the year. And mortgages, HELOCs, we've seen good demand and growth in those verticals, also our lending against the cash surrender value of whole life policies through our partner Inclined, that's growing pretty rapidly. We're now at, I think, $600 million plus, $670 million of drawn balances. We expect that over the course of the year to get to $1 billion drawn and really like that business from a risk-adjusted return standpoint, especially given its short duration and a good counter to that gap I talked to earlier of our floating rate-sensitive deposits versus our floating rate assets.

So the consumer should grow. We've talked before about our construction that we expect those balances to go -- to decrease around $300 million. A lot of what we've -- the homebuilder team that came over from HomeStreet does a great job. They really are a strong team. But that business is -- it was thinly priced in some areas, and we're getting it deliberately a little bit smaller. So that will be a bit of a headwind through the year. But it will -- we're derisking and not doing construction lending, which can be obviously -- goes great for a while and then it can go the other way very quickly. So I think that's prudent.

And on commercial real estate, I think we're originating loans, but the plan is still to get that below 300%. And so I'd kind of model us at -- over the next couple of years, getting both in your sense. There will be a modest decrease in outstanding multifamily CRE. C&I should be -- we deliberately sold some of the syndicated loans that HomeStreet had, that's part of the balance reduction there. We -- That should be close to a midyear and should be starting to grow again. So I don't know, Nathan, Carl, anything else you want to add to that? I...

I would add color there. Just one other comment, C.J., and that is the market, it is extremely -- and I know everyone says the same thing, and we've been monitoring earning releases and some have had loan growth -- modest loan growth. But I'd say the competitive landscape on both term and pricing is as thin and as tight as I've ever seen it. And we are -- I'd just say we're tough on credit. And I think that would be an opinion shared by probably a lot of our lenders that are out in the market today.

It is -- you're seeing some things out there that I think may trend to this thing just getting really, really competitive to the extent that it's probably not all that healthy, particularly as it relates to term, which I equate to underwriting. And then credit spreads are extremely tight. And so my way of thinking is not the time to necessarily be pressing the accelerator too hard for loan growth and the overlay of our CRE concentration. We have to be very mindful of that.

Okay, appreciate that. Are you, at this point, still expecting NII growth from the first quarter through the end of the year? Or is it more stable along with the margin?

It should be pretty stable, I would say, for a couple of quarters and start to pick up. The balance sheet, again, is going to be getting a little bit smaller in the second quarter and then should start to grow, but the growth will be modest. I'd kind of guide the stable NII and then picking up, and I think, pretty materially in '27.

And you mentioned the upside in the margin as you get into the early part of '27. Where are you seeing that roll-on, roll-off differential in the earning asset buckets you have at this point?

Yes, I mean we have, I think, a lot of lower-yielding mortgages. I think our legacy Mechanics single-family is probably a low 4s coupon. A fair amount of that is starting to prepay, amortize, coming back on the books at, call it, 6%. Multifamily, we've got $2.4 billion, or north of $2 billion of multifamily loans that yield low 4s in aggregate. That business today is closer also to 5.75% to 6%. That will -- that entire book will reprice or is all adjustable, 5%, 7%, 10%, it was mostly originated in '21 and '22. By '32, it will all have reset to market rates closer to 6%. And so there's a lot of tailwinds there. We also have an HTM portfolio that's a drag. It's $1.3 billion today, yielding 1.61% and $100 million of that amortizes a year. So slower, longer duration, but over time, will continue to be a tailwind.

So I think it's -- there's a lot of upside to the bank over time. It just -- as time passes, we'll have a natural tailwind just from that occurring. And this year will be a bit more flat though, just given the flat -- no Fed cuts and the final drag of auto. And we'll make up for some of that in our pretty substantial expense reductions that are coming here in the second quarter and third quarter.

Yes, I mean it looks like between now and the fourth quarter, you're looking at, at least a $10 million reduction on a quarterly run rate basis on expenses, right? How much of that are you expecting to get in 2Q?

Yes. We're at $474 million ex CDI annualized in the first quarter. We expect to get to $430 million by the fourth quarter. That's $44 million. So yes, over $10 million quarterly. In the second quarter, we should see, I don't know, maybe a lot. I don't know the exact number, but it's going to be a significant amount of cost reductions coming off and that will persist into the third quarter. By the fourth we'll be there.

Good. That's really good. Maybe just switching to the fee side for a minute on the Trust business. You guys were opening an office in Delaware. Sorry if I missed you mentioning it. I think it was this quarter. I was just wondering if that were up and running, if you could just remind us what that does for you guys and what other expansion you're planning in that business going forward, that would be great?

Yes. We got a little bit delayed. It's now expected to open in May. So we're almost there on the Delaware Trust business. We have some demand waiting for us to open that. That should -- that's a major step for our Wealth group. So that's exciting, but it has been delayed 1 quarter. And yes, I think overall, we -- our build-out of the team is complete. We've got a great team. Really almost everyone came over from -- at least a number of folks came over from First Republic after that. [ Failed ], right, in our backyard. And so we've been laying the groundwork. We've been very busy with the integration, with the merger, and we've picked up some private bankers and new clients from HomeStreet on the deposit side through it. And I think there's opportunity on the Trust and Wealth side to continue to grow. So I'm very much optimistic that, that business will continue to grow and be a very accretive business line for us. But it has been -- the Trust business did take longer than we thought, but we're on the finish line.

Great. Maybe just one last one on capital. You mentioned the big payout, obviously, next quarter. I think it was $165 million of excess that you're looking at. Does that get you down to your target 8.25% Tier 1 leverage? Or do you keep a little bit of extra there for what you said in terms of flexibility going forward? How are you thinking about that?

Yes. I think the way we've been managing capital is 8.25%, but 1 quarter in arrears. And so it's more effectively like 8.5% to 8.6% leverage this quarter, we're at 8.7%. To your comment, we actually are going to have excess, I think, my rough math is maybe $35 million this quarter that we're not paying out in dividends. I mean our dividend is going to be close to $160 million, $162 million this quarter, but there's still some that we're holding back, and we'll think about how best to use that. But -- And that will persist as we go into the third quarter due to the kind of a lag on leveraged assets as the bank gets a bit smaller, leverage assets kind of take a quarter to catch up fully. And so we'll have some excess capital. And the bank -- the other thing I'll point out is there's a lot of CDI amortization that doesn't show up in GAAP earnings, but it does compound in capital generation for the bank. So that's another source of kind of excess capital that we create above and beyond the actual GAAP net income. So something else to think about.

There are no further questions at this time. This concludes today's call. Thank you for attending, and you may now disconnect.