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HomeStreet (NASDAQ:HMST)
Q3 2020 Earnings Call
Oct 27, 2020, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good day, and welcome to HomeStreet's third-quarter 2020 earnings conference call. [Operator instructions] 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 ahead, sir.

Mark Mason -- Chairman, President, and Chief Executive Officer

Hello, and thank you for joining us for our third-quarter earnings call.Before we begin, I'd like to remind you that our detailed earnings release and an accompanying investor presentation were filed with 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 of this call 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, including yesterday's earnings release, the investor deck, and the risk factors disclosed in our other public filings.

Additionally, reconciliations to non-GAAP measures referred to on our call today can be found in our earnings release available on our website. Joining me today is our chief financial officer, John Michel. John will briefly discuss our financial results, and then I'd like to give an update on our results of operations, credit performance, and outlook going forward. John?

John Michel -- Chief Financial Officer

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 some pre-provision core income before taxes of $18.9 million, 22 -- $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 is only partially offset by decreases in our yields on interest-earning assets. And at the end of the third quarter, our cost of deposits was the 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 nonperforming assets, no provision for credit losses was recorded in our third quarter compared to $6.5 million in the second quarter.

Our ratio of nonperforming assets to the total assets remained low at 30 basis points while our ratio of total loans delinquent overall 30 days to total loans decreased by -- to 76 basis points at September 30th from 94 basis points at June 30th. In the third quarter, 25 commercial and CRE loans with $66 million of a balance were branded 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 now 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, noncore items included $2.4 million of impairments related to ongoing restructuring of our facilities and operations, including the closing of an office in Northern California. The decrease in noninterest 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 also 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 prepayments. As origination volumes and our profitability of single-family loan sales were consistent with the prior quarter, the increase in gain on loan sales was due to a higher volume of commercial real estate loans sold in the third quarter. The increase in this year's noninterest 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.

Mark Mason -- Chairman, President, and Chief Executive Officer

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 now 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 also 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 deferred by these historically low interest rates. As our capacity normalizes in the industry, mortgage interest rates should be decreased, in line with its 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 our new servicing values. This phenomena is not expected to continue, and we anticipate these valuation changes to recover over time. This decline in 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 the 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 nonperforming asset levels remained low. We continue to work with some borrowers, who are now more significantly negatively impacted by the pandemic.

So, 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 are 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 release, almost all of our commercial customers for whom we have provided forbearances have now reopened their businesses, and they have responded to us that they do not currently foresee the need for additional forbearance. We are 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 distressed 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 the 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 the $20 million at September 30.

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 worse, 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 concluded 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 cost 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 and early October, buying stock at an attractive average price of $27.05 per share. In all, we have repurchased 20% of the outstanding share repurchase program in the second quarter of last year. Yes, you heard that right, 2-0, 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 on October 1, we reorganized our Fannie Mae DUS business to move the origination, sale and servicing of mortgages on multifamily properties to the bank from a separate subsidiary of our HomeStreet. This separate subsidiary will continue to service the existing portfolio of DUS loans until such time as that portfolio runs off, or we are able to contribute the subsidiary to the bank, subject to and in compliance with regulatory requirements. By using the bank's capital, we will be able to offer larger loans to our clients with higher profitability to us.

As said previously, our large loan recourse and servicing revenue were reduced. This relationship with Fannie Mae has existed at HomeStreet since 1988. And we are 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 6, 2020, and payable on November 23, 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, our 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 some 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. And we believe that notwithstanding our higher current 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 to the volumes of 1.5% core return on average assets, 16.4% core return on average tangible common equity, an efficiency ratio of 59.9%, $1.23 core earnings per share and tangible book value per share of $30.15 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 the demand. That's why we are so pleased to achieve -- 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 the efficient return of excess capital to shareholders, improved deposit funding composition and cost, and as always, a consistently strong credit culture.

So, 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 the future earnings prospects are still yet to be adequately reflected in our current share price. With that, this concludes our prepared comments today. We thank you for your attention.

John and I will be happy to answer any questions you have at this time.

Questions & Answers:


Operator

[Operator instructions]And the first question will be from Jeff Rulis with D.A. Davidson. Please go ahead.

Jeff Rulis -- D.A. Davidson -- Analyst

Thanks. Good morning.

Mark Mason -- Chairman, President, and Chief Executive Officer

Good morning.

John Michel -- Chief Financial Officer

Good morning.

Jeff Rulis -- D.A. Davidson -- Analyst

A couple of questions on the expense side and kind of a near-term, long-term -- kind of two parts. So maybe for John. I just want to understand what you said at 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?

John Michel -- Chief Financial Officer

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 managed, which is basically commissions on productions of especially single family loans. You see the noncore 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.

Mark Mason -- Chairman, President, and Chief Executive Officer

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 of 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 discount that back a little, that's probably around where it's at [Inaudible]

Jeff Rulis -- D.A. Davidson -- Analyst

That's really helpful. Yes. Thank you. And I guess to that end, the -- those contract negotiations, I thought it was maybe some kind of toward 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?

Mark Mason -- Chairman, President, and Chief Executive Officer

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 stepdown at that point, that's more meaningful.

John Michel -- Chief Financial Officer

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

Mark Mason -- Chairman, President, and Chief Executive Officer

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.

Jeff Rulis -- D.A. Davidson -- Analyst

OK. No, that's -- all that's good info. Maybe, Mark, just on the buyback then. You mentioned maybe taking it through the end of the year and the 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?

Mark Mason -- Chairman, President, and Chief Executive Officer

Yes. The -- 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.

Jeff Rulis -- D.A. Davidson -- Analyst

Great. Thanks. And one quick last one. Yes, loan runoff or net loan runoff, pull out the crystal ball, but just trying to think about when you think that begins to ebb or we trough on the runoff and where that may firm up if we -- I mean probably rate driven, but your expectations for when we could see net growth resume?

Mark Mason -- Chairman, President, and Chief Executive Officer

Well, 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 in commercial real estate, but still high.

John Michel -- Chief Financial Officer

So a couple of factors going in there. 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 in going forward into next year, we have the PPP loans being forgiven, so it's kind of going to be 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.

Jeff Rulis -- D.A. Davidson -- Analyst

OK. Thank you.

Operator

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

Steve Moss -- B. Riley FBR, Inc. -- Analyst

Good morning.

Mark Mason -- Chairman, President, and Chief Executive Officer

Good morning.

Steve Moss -- B. Riley FBR, Inc. -- Analyst

Let's start in just on loan yields and the margin. Just kind of curious what you're seeing for new money yields these days? I you can just start there.

Mark Mason -- Chairman, President, and Chief Executive Officer

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 the significant rates on new activity.

Steve Moss -- B. Riley FBR, Inc. -- Analyst

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

Mark Mason -- Chairman, President, and Chief Executive Officer

[Inaudible] comment, isn't?

John Michel -- Chief Financial Officer

Yes. In the deposit comment, we -- our cost of 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, etc., tends to be less than that also at the current time.

Steve Moss -- B. Riley FBR, Inc. -- Analyst

OK. Thank you very much. That was helpful.

Operator

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

Jackie Bohlen -- KBW -- Analyst

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?

Mark Mason -- Chairman, President, and Chief Executive Officer

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 of our deposit increases could really be characterized as conservatism or cash hoarding. So it kind of remains to be 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 '22 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 of 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 a 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 commercial real estate volumes, but also meaningfully increased origination of multifamily loans, both Fannie Mae DUS loans, which I discussed earlier 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.

Jackie Bohlen -- KBW -- Analyst

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 U.S.

product, outside of the potential to -- or 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?

Mark Mason -- Chairman, President, and Chief Executive Officer

I think what you'll see is we're planning on meaningful increase in loan volume. Let me 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 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 has operated today.

John Michel -- Chief Financial Officer

And the other thing with the -- I'm sorry, go ahead.

Jackie Bohlen -- KBW -- Analyst

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

Mark Mason -- Chairman, President, and Chief Executive Officer

There is capital efficiency. We probably should touch on that. Today, we have to carry 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 be upstreamed 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. The biggest synergy here, frankly, is capital. 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.

Jackie Bohlen -- KBW -- Analyst

OK. I'm sorry, John, you were going to add something to that or did Mark cover it?

John Michel -- Chief Financial Officer

[Inaudible] to say the other advantage we have by going on and 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.

Mark Mason -- Chairman, President, and Chief Executive Officer

Yes. Just to explain that a little further, at our previous size, that is to say, the 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 in the bank fairly substantially [Audio gap] hopefully. And when I say full profitability or loan above the low $20 million may have had their profitability cut in half previously from a [Audio gap] stand point to the full profitability. And so, we're expecting that to have a noticeable impact on Fannie Mae DUS revenue next year.

Jackie Bohlen -- KBW -- Analyst

OK. Great. Thank you for all the additional color. I appreciate that.

Mark Mason -- Chairman, President, and Chief Executive Officer

Thanks, Jackie.

Operator

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

Matthew Clark -- Piper Sandler -- Analyst

Hey. Good morning, everyone.

Mark Mason -- Chairman, President, and Chief Executive Officer

Hey, Matt.

John Michel -- Chief Financial Officer

Good morning, Matthew.

Matthew Clark -- Piper Sandler -- Analyst

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

Mark Mason -- Chairman, President, and Chief Executive Officer

First quarter next year [Inaudible] going forward.

Matthew Clark -- Piper Sandler -- Analyst

OK. You broke up a little bit. OK. And then just on the overall expense outlook, that $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?

Mark Mason -- Chairman, President, and Chief Executive Officer

Yes, that's net of a lot of stuff going in both directions, right? Savings, some additional digital investment, inflation, right, contract escalators and things like that.

John Michel -- Chief Financial Officer

And a return to normal volume.

Mark Mason -- Chairman, President, and Chief Executive Officer

I'm sorry. In a footnote, and a return to normalized volumes in the mortgage business.

Matthew Clark -- Piper Sandler -- Analyst

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?

Mark Mason -- Chairman, President, and Chief Executive Officer

Absolutely, right. I mean balance sheet will grow, expenses should fall due to mortgage volume and some other improvements obviously. [Audio gap] And 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 higher [Inaudible] expense to revenue relationship.

But of course, that business has a very, very high-return on equity on our relationship. And -- but you have to live with the impact on efficiency ratios.

Matthew Clark -- Piper Sandler -- Analyst

OK. And then just on the upcoming multifamily sale in 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 onetime decision?

Mark Mason -- Chairman, President, and Chief Executive Officer

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 liquidity alternative for the company.

It helps us manage our loan-to-deposit ratio [Inaudible]. 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 [Inaudible] should be consistent with other similar quarters to last year.

Matthew Clark -- Piper Sandler -- Analyst

OK. 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 does the zero provision consider that Moody's model incrementally deteriorating if we -- some parts of the country gets locked up again?

Mark Mason -- Chairman, President, and Chief Executive Officer

We use the Moody's base forecast scenario in our assumptions. Again, we compare that to a more severe scenario, and it doesn't change the outlook for us. Obviously, we're getting to the point like all of our other peers, where the analysis is very cuspy, right, where the current period impact is more severe than we think the following year impact, right, as 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 and 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. And so 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 maybe -- may not be needed in the future, and will either have to be reversed or 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 real uncertainty.

Matthew Clark -- Piper Sandler -- Analyst

Thank you.

Operator

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

Tim Coffey -- Janney Montgomery Scott -- Analyst

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?

Mark Mason -- Chairman, President, and Chief Executive Officer

Oh, gosh. A lot. I mean, more than we'll likely do. It's -- that's an interesting question, right, because 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 we're still -- you have some realistic limits as to how large our total risk assets we would allow to get, and that plays into that answer. But there's a fair amount of room, particularly when you consider that these assets are all 50% risk weighted, right? And so I don't really have a calculation for you other than to say, it is not going to restrict our activity.

Tim Coffey -- Janney Montgomery Scott -- Analyst

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

Mark Mason -- Chairman, President, and Chief Executive Officer

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

Tim Coffey -- Janney Montgomery Scott -- Analyst

OK. OK. And then just on the -- you mentioned a couple of times the digital investments that you're thinking about making. Can you maybe provide more detail on what your plans are?

Mark Mason -- Chairman, President, and Chief Executive Officer

Sure. I mean, these aren't earthshaking additions, right? Digital mobile experiences of customers continue to improve. And much of these -- of this functionality is table stakes today. If you have a meaningful consumer deposit business, which we do now, so we have to continue to make incremental investments and adding functionality to stay at least reasonably close, all right, and to the large national banks.

And we have some of those improvements scheduled over our next couple of years.

Tim Coffey -- Janney Montgomery Scott -- Analyst

OK. Any related client onboarding, either loans or deposits?

Mark Mason -- Chairman, President, and Chief Executive Officer

Yes. Part -- actually part of that is onboarding mobile functionality that has to do with onboarding, right, mobile, but also in the mortgage area, the things I referred to later as permanently increasing our efficiency. We are headed very soon to be 100% digital application through fulfillment. And today, our disclosures -- well, above 90%, I believe, are e-disclosures.

And we're headed to the implementation in the near-term about -- of the e-fulfillment, that is e-signing and e-notarization, which is ultimately the holy grail to a full digital fulfillment of the mortgage. And beyond that, on the front end, we are building a channel for our business to allow consumers to make applications directly. And the digital experience, which is becoming the digital preference of mortgage customers, really given the success of Quicken, Rocket Mortgage and others, we're having to make investments there. But also there's infrastructure investments.

So, our commercial real estate business sorely needs a front-end origination system. It is very manual at this point. And so, when you are originating the levels of commercial real estate we are, we have to also create some more efficiencies in that business. So sort of across the board, some of it's internal infrastructure, which is just getting cheaper amazingly.

And also, we need -- we have a significant need to be safe. So we're investing in cybersecurity as well.

Tim Coffey -- Janney Montgomery Scott -- Analyst

OK. And in terms of the mortgage application process, how much of that is digital? Is it all of it?

Mark Mason -- Chairman, President, and Chief Executive Officer

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 just 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.

Tim Coffey -- Janney Montgomery Scott -- Analyst

Thank you. All right. Well, I appreciate it. Those are all my questions.

Thanks.

Mark Mason -- Chairman, President, and Chief Executive Officer

Thanks, Tim.

Operator

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

David Chiaverini -- Wedbush Securities -- Analyst

Hi. Thanks. A couple of questions. The first one on loan growth.

I want to make sure I get 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?

Mark Mason -- Chairman, President, and Chief Executive Officer

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 hundred million. How many hundred million remains to be seen.

David Chiaverini -- Wedbush Securities -- Analyst

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 just curious as to what your views are on the mortgage banking line over the next few quarters.

Mark Mason -- Chairman, President, and Chief Executive Officer

Well, we expect volume to continue to be unseasonably strong, right? I mean typically, here in the fourth quarter and first quarter next year, our revenue will 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 that they are, and we expect mortgage refinancing to hold those levels meaningfully higher than what they would otherwise be. What does that mean in real numbers? So I also 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 the internal forecast.

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 now 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 some scenarios where volume and profit margins remain high as well as decline. 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, I guess, outstripping our capacity, you will have mortgage rates remain higher than they otherwise naturally would, which translates to higher mortgage profit margins and steady volume. So, 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 then ultimately, volume and profit margins fall to some normalized level. The challenge 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 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 of servicing are valuing servicing at the annual prepayment rates or CPRs, far in excess of what they think could be sustained over the period of expectation. So now to put that in perspective, you noticed that our servicing income was down meaningfully this year, sorry, 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 of newly originated mortgage servicing of 30% to 40%. And to put that in perspective, typically, that is a 10% to 11% number. We think that, that is practically impossible and that you have 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 also recover. And when it recovers, we're likely to recover value, which means more revenue, but until people begin to understand the length of the depth of this refinancing period, you're going to have that overreaction in valuation. And I know that was a lot for an answer, sorry about that.

David Chiaverini -- Wedbush Securities -- Analyst

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

Mark Mason -- Chairman, President, and Chief Executive Officer

Well, my treasurer is sitting here in the room with me clapping silently. No, we have not. Though, I would tell you, economically, the returns should be substantial, which makes you wonder about the depth of that market today. Because if you could truly -- if you truly can trade servicing at these levels, and you can -- for some people who have to sell their servicing as opposed to us, there's a huge opportunity in 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 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.

David Chiaverini -- Wedbush Securities -- Analyst

Great. Thanks very much.

Operator

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.

Mark Mason -- Chairman, President, and Chief Executive Officer

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

Operator

[Operator signoff]

Duration: 54 minutes

Call participants:

Mark Mason -- Chairman, President, and Chief Executive Officer

John Michel -- Chief Financial Officer

Jeff Rulis -- D.A. Davidson -- Analyst

Steve Moss -- B. Riley FBR, Inc. -- Analyst

Jackie Bohlen -- KBW -- Analyst

Matthew Clark -- Piper Sandler -- Analyst

Tim Coffey -- Janney Montgomery Scott -- Analyst

David Chiaverini -- Wedbush Securities -- Analyst

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