Mechanics Bancorp Class A Common Stock 2026 Q3 Earnings Call

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 things off by hitting the highlights of our third quarter performance. I'll also provide an update on the bank's strategy as we close out 2026 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 noisy but productive third quarter, reporting $46 million in net income. On a fully diluted basis, our earnings per share was $0.20, and our tangible book value per share ended the quarter at $7.05, with $0.25 per share of dividends paid to investors.

The third quarter was a very busy one and included an AFS securities restructure and the sale of nearly all our remaining runoff auto loans. We also had a negative provision for a combination of reasons, along with several non-recurring gains. I'll get into more detail on this on the next page. After adjusting for these various one-time items, we earned $60.6 million of core net income in Q3 for a core ROAA of 1.14% and a core ROATCE of 15.1%. Our total assets are now $20.9 billion, with total net loans of $12.9 billion, total deposits of $18 billion, and tangible common equity of $1.63 billion. As I mentioned last quarter, we wrapped up our HomeStreet integration in Q2, and a lot of that benefit showed up in Q3 as our non-interest expense declined over $10 million on a linked-quarter basis.

This helped lower our core efficiency ratio to 54.4% from 56% in Q2. Overall, we significantly exceeded our cost savings budget for the merger, which is good to see hit the bottom line. The big news during the quarter was, of course, the shock up in long-term interest rates with the yield on the 10-year Treasury rising over 80 basis points. As a result, our AOCI decreased $112 million despite the AFS restructure. Relatedly, our cost of deposits increased eight basis points in the third quarter, driven partly by the continued mix shift in the money market funds from non-interest-bearing accounts, as well as higher CD pricing. Beginning in the second quarter, we increased CD pricing to more competitive market rates to stem the runoff we had deliberately planned post the HomeStreet merger.

That repricing had a more significant impact on our third quarter cost of deposits, given that most of our CDs have a maturity of less than seven months. Overall, our deposits decreased $70 million this quarter, with $66 million of the decline in time deposits. Our pace of CD runoffs slowed again in Q3, and we expect CD balances to be relatively flat moving forward given our more competitive pricing. Our NIM decreased seven basis points this quarter with most of the compression due to the increase in our cost of deposits, although there was some noise given the AFS restructure and auto loan sale that Nathan will discuss later. We also had elevated dividend income in the second quarter, which contributed three basis points to the Q3 drop in NIM.

An important point to note is that while deposit cost pressures clearly increased earlier in the year as interest rates rose sharply, we got very little benefit from our floating rate earning assets repricing. That will show up in the fourth quarter as most of the floating rates reset with a bit of a lag. As expected, we had another clean credit quarter with only four basis points of non-auto net charge-offs. Our ACL is now 1.03% of loans and totals $134 million. Our NPAs were flat again for the quarter and remained at 0.28% of total assets. Our CET1 ratio continued to move higher to a very robust 14.7%, with the increase aided by the reduction in risk-weighted assets from our auto loan sale. Let's turn to slide 5, where I'll update you on the bank's strategy and forward outlook.

We had a lot going on in the third quarter with several major initiatives accomplished. First, at the end of July, we sold $308 million of AFS securities yielding 1.78% at a $32.3 million pre-tax loss and reinvested the net proceeds in mortgage-backed securities yielding 5.5%. This was a strategic use of capital to enhance future earnings, and we are fortunate to have excellent capital ratios that allow us the continued flexibility to consider actions such as this. Next, in mid-September, we sold nearly all our runoff auto loans that are priced close to par, resulting in the successful acceleration of the exit of this non-core business line. This is something we had been considering for some time, and we were very happy to see such strong execution.

The transaction improved our CET1 ratio by reducing risk-weighted assets, and we expect it to modestly enhance earnings moving forward as lower loan servicing expense should more than offset lost NIM. We expect non-interest expense to decline again next quarter, mostly as a result of the auto exit, and now forecast approximately $420 million in annualized core NIE, excluding CDI amortization in Q4. I'll quickly mention that we had $15.2 million of provision release this quarter, with $3.2 million related to the sale of our runoff auto loans. The other $12 million of negative provision was primarily due to lower expected loss rates on multifamily and CRE loans. We recorded a $5.1 million gain on other equity investments, which is from our modest ownership stake in Incline, which Nathan will discuss in more depth later.

We also closed out our purchase accounting from the HomeStreet merger with an additional $2.9 million in bargain purchase gain, which was tax-related. We only had $600,000 of merger-related expenses in Q3, which was good to see as we continue to move past the noise of the HomeStreet deal. Core net income grew to $60.6 million from $59 million quarter-over-quarter as expense efficiencies more than offset modest NIM compression. Deposit pressures, however, will persist in this challenging interest rate environment, and we expect a relatively flat near-term NIM as we plan to absorb three additional fed funds rate increases over the next 12 months. We remain liability sensitive on the short end of the curve, although that gap has narrowed with our recent growth in floating rate assets, most notably Incline loans.

Longer term, we have significant repricing opportunity embedded in our balance sheet with $4.7 billion of legacy low-yielding earning assets that will cash flow over time and be reinvested at much higher market rates, which should provide a meaningful tailwind to our NIM. We continue to have substantial excess capital and expect to pay a $100 million dividend or $0.43 per Class A share in Q4, subject to board and regulatory approval. This should bring our total dividends paid to shareholders in 2026 to $400 million or $1.78 per Class A share, representing a 2026 dividend yield in excess of 11%. However, the interest rate environment, especially the expected rise in short-term rates, has caused us to modestly reduce our forward guidance to a 17% ROATCE and 1.2% ROAA in 2027. Although we do remain confident in an 18% plus ROATCE over the long run.

Importantly, we expect a 2027 dividend yield to investors of approximately 8%. I'll touch quickly on slide 6, which shows an overview of Mechanics. We are just under $21 billion in assets with 166 branches and the fourth best deposit market share across California and the West Coast, with a branch map that stretches from Canada to Mexico and all the way out to Hawaii. Mechanics is a high-performing bank, despite taking very little risk. On the left-hand side of this page, we compare Mechanics to all publicly traded banks, $10 billion to $100 billion in assets, which including us, has 81 banks in the peer group. As you can see, we rank very favorably across all these KPIs. Going to slide 7, which I think best illustrates our investment thesis.