UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________ 
FORM 10-Q
________________________________ 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 20132014
Commission file number: 001-35424
________________________________ 
HOMESTREET, INC.
(Exact name of registrant as specified in its charter)
________________________________ 
Washington 91-0186600
(State or other jurisdiction of incorporation) (IRS Employer Identification No.)
601 Union Street, Suite 2000
Seattle, Washington 98101
(Address of principal executive offices)
(Zip Code)
(206) 623-3050
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
 
Large Accelerated Filer ¨oAccelerated Filer x
      
Non-accelerated Filer ¨oSmaller Reporting Company ¨o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨o  No  x
The number of outstanding shares of the registrant's common stock as of October 31, 20132014 was 14,425,224.14,856,611.
 



PART I – FINANCIAL INFORMATION 
  
ITEM 1FINANCIAL STATEMENTS 
  
Consolidated Statements of Financial Condition (Unaudited) at September 30, 2013,2014 and December 31, 20122013
4
  
Interim Consolidated Statements of Operations (Unaudited) for the Three and Nine Months Ended September 30, 20132014 and 20122013
5
  
Interim Consolidated Statements of Comprehensive Income (Unaudited) for the Three and Nine Months Ended September 30, 20132014 and 20122013
6
  
Interim Consolidated Statements of Shareholders’ Equity (Unaudited) for the Nine Months Ended September 30, 20132014 and 20122013
7
  
Interim Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 20132014 and 20122013
8
  
Notes to Interim Consolidated Financial Statements (Unaudited)
 
  
Note 1 – Summary of Significant Accounting Policies
10
  
Note 2 – Significant Risks and UncertaintiesInvestment Securities
1012
  
Note 3 – Investment Securities Available for SaleLoans and Credit Quality
1115
  
Note 4 – Loans and Credit Quality
14
Note 5 – Deposits
26
Note 6 – Derivatives and Hedging Activities
27
Note 7 – Mortgage Banking Operations
30
  
Note 85 – Derivatives and Hedging Activities
32
Note 6 – Mortgage Banking Operations
34
Note 7 – Commitments, Guarantees, and Contingencies
3538
Note 8 – Fair Value Measurement
40
  
Note 9 – Fair Value MeasurementEarnings Per Share
3648
  
Note 10 – Earnings Per ShareShare-based Compensation Plans
45
  
Note 11 – Business Segments
4550
  
Note 12 – Subsequent Events
4752
  
ITEM 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
  
Forward-Looking Statements
4853
  
Summary Financial Data
5055
  
Management’s Overview of Financial Performance
5358
  
Critical Accounting Policies and Estimates
5561
  
Results of Operations
5662
  
Review of Financial Condition
6370
  
Business Segments
6673
  
Off-Balance Sheet Arrangements
7278
  
Enterprise Risk Management
7278
  
Credit Risk Management
7279
  
Liquidity and Capital Management
7884
  
Accounting Developments
8187

2


   
ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
8288
   
ITEM 4
CONTROLS AND PROCEDURES
8288
   
PART II – OTHER INFORMATION
 
   
ITEM 1
LEGAL PROCEEDINGS
8390
   
ITEM 1A
RISK FACTORS
8390
   
ITEM 6
EXHIBITS
96105
  
SIGNATURES
97106

Unless we state otherwise or the content otherwise requires, references in this Form 10-Q to “HomeStreet,” “we,” “our,” “us” or the “Company” refer collectively to HomeStreet, Inc., a Washington corporation, HomeStreet Bank (“Bank”), HomeStreet Capital Corporation and other direct and indirect subsidiaries of HomeStreet, Inc.

3


PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

HOMESTREET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)
 
(in thousands, except share data)September 30,
2013		 December 31,
2012		 September 30,
2014		 December 31,
2013
       
ASSETS       
Cash and cash equivalents (including interest-bearing instruments of $21,747 and $12,414)$37,906
 $25,285
Investment securities available for sale573,591
 416,329
Loans held for sale (includes $385,110 and $607,578 carried at fair value)385,110
 620,799
Loans held for investment (net of allowance for loan losses of $24,694 and $27,561)1,510,169
 1,308,974
Mortgage servicing rights (includes $136,897 and $87,396 carried at fair value)146,300
 95,493
Cash and cash equivalents (including interest-bearing instruments of $16,044 and $9,436) $34,687
 $33,908
Investment securities (includes $432,096 and $481,683 carried at fair value) 449,948
 498,816
Loans held for sale (includes $614,876 and $279,385 carried at fair value) 698,111
 279,941
Loans held for investment (net of allowance for loan losses of $21,847 and $23,908) 1,964,762
 1,871,813
Mortgage servicing rights (includes $115,477 and $153,128 carried at fair value) 124,593
 162,463
Other real estate owned12,266
 23,941
 10,478
 12,911
Federal Home Loan Bank stock, at cost35,370
 36,367
 34,271
 35,288
Premises and equipment, net24,684
 15,232
 44,476
 36,612
Accounts receivable and other assets128,927
 88,810
Goodwill 11,945
 12,063
Other assets 101,385
 122,239
Total assets$2,854,323
 $2,631,230
 $3,474,656
 $3,066,054
LIABILITIES AND SHAREHOLDERS’ EQUITY       
Liabilities:       
Deposits$2,098,076
 $1,976,835
 $2,425,458
 $2,210,821
Federal Home Loan Bank advances338,690
 259,090
 598,590
 446,590
Securities sold under agreements to repurchase 14,225
 —
Accounts payable and other liabilities87,492
 69,686
 79,958
 77,906
Long-term debt61,857
 61,857
 61,857
 64,811
Total liabilities2,586,115
 2,367,468
 3,180,088
 2,800,128
Shareholders’ equity:       
Preferred stock, no par value, authorized 10,000 shares, issued and outstanding, 0 shares and 0 shares—
 —
 —
 —
Common stock, no par value, authorized 160,000,000, issued and outstanding, 14,422,354 shares and 14,382,638 shares511
 511
Common stock, no par value, authorized 160,000,000, issued and outstanding, 14,852,971 shares and 14,799,991 shares 511
 511
Additional paid-in capital91,415
 90,189
 96,650
 94,474
Retained earnings185,379
 163,872
 197,945
 182,935
Accumulated other comprehensive income (loss)(9,097) 9,190
Accumulated other comprehensive income (538) (11,994)
Total shareholders' equity268,208
 263,762
 294,568
 265,926
Total liabilities and shareholders' equity$2,854,323
 $2,631,230
 $3,474,656
 $3,066,054

See accompanying notes to interim consolidated financial statements (unaudited).

4


HOMESTREET, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands, except share data)2013 2012 2013 20122014 2013 2014 2013
              
Interest income:              
Loans$19,425
 $18,512
 $54,920
 $52,344
$25,763
 $19,425
 $71,865
 $54,920
Investment securities available for sale3,895
 2,517
 9,552
 7,205
Investment securities2,565
 3,895
 8,199
 9,552
Other28
 24
 82
 216
150
 28
 449
 82
23,348
 21,053
 64,554
 59,765
28,478
 23,348
 80,513
 64,554
Interest expense:              
Deposits2,222
 3,908
 8,078
 12,985
2,364
 2,222
 7,080
 8,078
Federal Home Loan Bank advances434
 297
 1,113
 1,506
509
 434
 1,366
 1,113
Securities sold under agreements to repurchase—
 19
 11
 69
6
 —
 7
 11
Long-term debt274
 305
 2,274
 1,041
271
 274
 851
 2,274
Other6
 4
 16
 13
20
 6
 42
 16
2,936
 4,533
 11,492
 15,614
3,170
 2,936
 9,346
 11,492
Net interest income20,412
 16,520
 53,062
 44,151
25,308
 20,412
 71,167
 53,062
(Reversal of) provision for credit losses(1,500) 5,500
 900
 7,500
Provision (reversal of provision) for credit losses—
 (1,500) (1,500) 900
Net interest income after provision for credit losses21,912
 11,020
 52,162
 36,651
25,308
 21,912
 72,667
 52,162
Noninterest income:              
Net gain on mortgage loan origination and sale activities33,491
 65,336
 139,870
 141,683
37,642
 33,491
 104,946
 139,870
Mortgage servicing income4,011
 506
 9,265
 15,470
6,155
 4,011
 24,284
 9,265
(Loss) income from Windermere Mortgage Services Series LLC(550) 1,188
 1,063
 3,748
Loss on debt extinguishment—
 —
 —
 (939)
(Loss) income from WMS Series LLC(122) (550) (69) 1,063
Gain (loss) on debt extinguishment2
 —
 (573) —
Depositor and other retail banking fees791
 756
 2,273
 2,262
944
 791
 2,676
 2,273
Insurance commissions242
 192
 612
 551
(Loss) gain on sale of investment securities available for sale (includes unrealized gains (losses) reclassified from accumulated other comprehensive income of $(184) and $397 for the three months ended September 30, 2013 and 2012, and $6 and $1,349 for the nine months ended September 30, 2013 and 2012, respectively)(184) 397
 6
 1,349
Insurance agency commissions256
 242
 892
 612
Gain (loss) on sale of investment securities available for sale (includes unrealized gain (loss) reclassified from accumulated other comprehensive income of $480 and $(184) for the three months ended September 30, 2014 and 2013, and $1,173 and $6 for the nine months ended September 30, 2014 and 2013, respectively)480
 (184) 1,173
 6
Other373
 716
 1,584
 1,965
456
 373
 841
 1,584
38,174
 69,091
 154,673
 166,089
45,813
 38,174
 134,170
 154,673
Noninterest expense:              
Salaries and related costs39,689
 31,573
 113,330
 81,148
42,604
 39,689
 118,681
 113,330
General and administrative9,234
 7,148
 30,434
 19,304
10,326
 9,234
 31,593
 30,434
Legal844
 312
 2,054
 1,471
630
 844
 1,571
 2,054
Consulting884
 1,069
 2,343
 1,746
628
 884
 2,182
 2,343
Federal Deposit Insurance Corporation assessments227
 794
 937
 2,751
682
 227
 1,874
 937
Occupancy3,484
 2,279
 9,667
 6,160
4,935
 3,484
 14,042
 9,667
Information services3,552
 2,411
 10,122
 6,128
4,220
 3,552
 13,597
 10,122
Net cost of operation and sale of other real estate owned202
 348
 1,740
 8,917
133
 202
 (320) 1,740
58,116
 45,934
 170,627
 127,625
64,158
 58,116
 183,220
 170,627
Income before income taxes1,970
 34,177
 36,208
 75,115
6,963
 1,970
 23,617
 36,208
Income tax expense (includes reclassification adjustments of $(64) and $139 for the three months ended September 30, 2013 and 2012, and $2 and $472 for the nine months ended September 30, 2013 and 2012, respectively)308
 12,186
 11,538
 14,487
Income tax expense (includes reclassification adjustments of $168 and $(64) for the three months ended September 30, 2014 and 2013, and $411 and $2 for the nine months ended September 30, 2014 and 2013, respectively)1,988
 308
 6,979
 11,538
NET INCOME$1,662
 $21,991
 $24,670
 $60,628
$4,975
 $1,662
 $16,638
 $24,670
Basic income per share$0.12
 $1.53
 $1.72
 $4.68
$0.34
 $0.12
 $1.12
 $1.72
Diluted income per share$0.11
 $1.50
 $1.67
 $4.52
$0.33
 $0.11
 $1.11
 $1.67
Basic weighted average number of shares outstanding14,388,559
 14,335,950
 14,374,943
 12,960,212
14,805,780
 14,388,559
 14,797,019
 14,374,943
Diluted weighted average number of shares outstanding14,790,671
 14,699,032
 14,793,427
 13,414,475
14,968,238
 14,790,671
 14,957,034
 14,793,427
See accompanying notes to interim consolidated financial statements (unaudited).

5


HOMESTREET, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Net income$1,662
 $21,991
 $24,670
 $60,628
$4,975
 $1,662
 $16,638
 $24,670
Other comprehensive income (loss), net of tax:              
Unrealized (loss) gain on securities:       
Unrealized holding (loss) gain arising during the period (net of tax (benefit) expense of $(362) and $1,564 for the three months ended September 30, 2013 and 2012 and $(9,845) and $3,135 for the nine months ended September 30, 2013 and 2012, respectively)(673) 3,525
 (18,283) 6,107
Reclassification adjustment included in net income (net of tax (benefit) expense of $(64) and $139 for the three months ended September 30, 2013 and 2012, and $2 and $472 for the nine months ended September 30, 2013 and 2012, respectively)120
 (258) (4) (877)
Unrealized gain (loss) on investment securities available for sale:       
Unrealized holding gain (loss) arising during the period, net of tax expense (benefit) of $501 and $(362) for the three months ended September 30, 2014 and 2013, and $6,579 and $(9,845) for the nine months ended September 30, 2014 and 2013, respectively930
 (673) 12,218
 (18,283)
Reclassification adjustment for net gains included in net income, net of tax expense (benefit) of $168 and $(64) for the three months ended September 30, 2014 and 2013, and $411 and $2 for the nine months ended September 30, 2014 and 2013, respectively(312) 120
 (762) (4)
Other comprehensive income (loss)(553) 3,267
 (18,287) 5,230
618
 (553) 11,456
 (18,287)
Comprehensive income$1,109
 $25,258
 $6,383
 $65,858
Comprehensive income (loss)$5,593
 $1,109
 $28,094
 $6,383

See accompanying notes to interim consolidated financial statements (unaudited).

6


HOMESTREET, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited)
 
(in thousands, except share data)
Number
of shares
 
Common
stock
 
Additional
paid-in
capital
 
Retained
earnings
 
Accumulated
other
comprehensive
income (loss)
 Total
Number
of shares
 
Common
stock
 
Additional
paid-in
capital
 
Retained
earnings
 
Accumulated
other
comprehensive
income (loss)
 Total
                      
Balance, January 1, 20125,403,498
 $511
 $31
 $81,746
 $4,119
 $86,407
Net income—
 —
 —
 60,628
 —
 60,628
Share-based compensation—
 —
 2,415
 —
 —
 2,415
Common stock issued8,951,474
 —
 86,818
 —
 —
 86,818
Other comprehensive income—
 —
 —
 —
 5,230
 5,230
Balance, September 30, 201214,354,972
 $511
 $89,264
 $142,374
 $9,349
 $241,498
           
Balance, January 1, 201314,382,638
 $511
 $90,189
 $163,872
 $9,190
 $263,762
14,382,638
 $511
 $90,189
 $163,872
 $9,190
 $263,762
Net income—
 —
 —
 24,670
 —
 24,670
—
 —
 —
 24,670
 —
 24,670
Dividends declared—
 —
 —
 (3,163) —
 (3,163)
Share-based compensation—
 —
 1,098
 —
 —
 1,098
Dividends ($0.11 per share)—
 —
 —
 (3,163) —
 (3,163)
Share-based compensation expense—
 —
 1,098
 —
 —
 1,098
Common stock issued39,716
 —
 128
 —
 —
 128
39,716
 —
 128
 —
 —
 128
Other comprehensive loss—
 —
 —
 —
 (18,287) (18,287)—
 —
 —
 —
 (18,287) (18,287)
Balance, September 30, 201314,422,354
 $511
 $91,415
 $185,379
 $(9,097) $268,208
14,422,354
 $511
 $91,415
 $185,379
 $(9,097) $268,208
           
Balance, January 1, 201414,799,991
 $511
 $94,474
 $182,935
 $(11,994) $265,926
Net income—
 —
 —
 16,638
 —
 16,638
Dividends ($0.11 per share)—
 —
 —
 (1,628) —
 (1,628)
Share-based compensation expense—
 —
 1,867
 —
 —
 1,867
Common stock issued52,980
 —
 309
 —
 —
 309
Other comprehensive income—
 —
 —
 —
 11,456
 11,456
Balance, September 30, 201414,852,971
 $511
 $96,650
 $197,945
 $(538) $294,568

See accompanying notes to interim consolidated financial statements (unaudited).

7


HOMESTREET, INC. AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended September 30,Nine Months Ended September 30,
(in thousands)2013 20122014 2013
      
CASH FLOWS FROM OPERATING ACTIVITIES:      
Net income$24,670
 $60,628
$16,638
 $24,670
Adjustments to reconcile net income to net cash used in operating activities:   
Amortization/accretion of discount/premium on loans held for investment, net of additions56
 (919)
Amortization/accretion of discount/premium on investment securities5,629
 3,877
Amortization of intangibles22
 77
Amortization of mortgage servicing rights1,347
 1,551
Provision for credit losses900
 7,500
Adjustments to reconcile net income to net cash provided by (used in) operating activities:   
Depreciation, amortization and accretion13,293
 10,285
(Reversal of) provision for credit losses(1,500) 900
Provision for losses on other real estate owned547
 10,955
73
 547
Depreciation on premises and equipment3,231
 1,864
Fair value adjustment of loans held for sale15,602
 (26,975)(11,320) 15,602
Fair value adjustment of foreclosed loans transferred to other real estate owned(218) (489)
Origination of mortgage servicing rights(53,627) (33,606)(32,726) (53,627)
Change in fair value of mortgage servicing rights1,493
 27,889
26,075
 1,493
Net gain on sale of investment securities(6) (1,349)(1,173) (6)
Net gain on sale of other real estate owned(526) (2,764)
Net deferred income tax expense (benefit)18,650
 (11,494)
Net gain on sale of loans originated as held for investment(4,586) —
Net fair value adjustment and gain on sale of other real estate owned(714) (744)
Loss on early retirement of long-term debt573
 —
Net deferred income tax (benefit) expense(13,502) 18,650
Share-based compensation expense932
 2,415
1,100
 932
Origination of loans held for sale(4,151,302) (3,433,925)(2,840,050) (4,151,302)
Proceeds from sale of loans held for sale4,425,792
 3,075,401
Proceeds from sale of loans originated as held for sale2,459,748
 4,425,792
Cash used by changes in operating assets and liabilities:      
Increase in accounts receivable and other assets(36,680) (55,462)
Increase in accounts payable and other liabilities1,704
 38,691
Net cash provided by (used in) operating activities258,216
 (336,135)
Decrease (increase) in other assets25,486
 (36,680)
Increase (decrease) in accounts payable and other liabilities9,959
 4,867
Net cash (used in) provided by operating activities(352,626) 261,379
      
CASH FLOWS FROM INVESTING ACTIVITIES:      
Purchase of investment securities(286,741) (260,566)(45,179) (286,741)
Proceeds from sale of investment securities54,166
 159,174
75,599
 54,166
Principal repayments and maturities of investment securities41,556
 28,150
32,040
 41,556
Proceeds from sale of other real estate owned17,396
 47,392
6,019
 17,396
Proceeds from sale of loans originated as held for investment271,409
 —
Proceeds from sale of mortgage servicing rights39,004
 —
Mortgage servicing rights purchased from others(20) (65)(8) (20)
Capital expenditures related to other real estate owned(22) (4,643)—
 (22)
Origination of loans held for investment and principal repayments, net(261,379) (62)(389,196) (261,379)
Property and equipment purchased(12,683) (8,355)
Purchase of property and equipment(13,904) (12,683)
Net cash used in investing activities(447,727) (38,975)(24,216) (447,727)

8


Nine Months Ended September 30,Nine Months Ended September 30,
(in thousands)2013 20122014 2013
      
CASH FLOWS FROM FINANCING ACTIVITIES:      
Increase (decrease) in deposits, net$121,241
 $(27,941)
Increase in deposits, net$214,637
 $121,241
Proceeds from Federal Home Loan Bank advances4,477,102
 4,975,490
4,619,927
 4,477,102
Repayment of Federal Home Loan Bank advances(4,397,502) (4,901,811)(4,467,927) (4,397,502)
Proceeds from securities sold under agreements to repurchase159,790
 393,500
58,308
 159,790
Repayment of securities sold under agreements to repurchase(159,790) (393,500)(44,083) (159,790)
Proceeds from Federal Home Loan Bank stock repurchase997
 330
1,017
 997
Repayment of long-term debt(3,527) —
Dividends paid(1,628) (3,163)
Proceeds from stock issuance, net128
 87,791
130
 128
Excess tax benefits related to the exercise of stock options166
 —
767
 166
Net cash provided by financing activities202,132
 133,859
377,621
 198,969
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS12,621
 (241,251)779
 12,621
CASH AND CASH EQUIVALENTS:      
Beginning of year25,285
 263,302
33,908
 25,285
End of period$37,906
 $22,051
$34,687
 $37,906
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:      
Cash paid during the period for:      
Interest$24,969
 $16,642
$10,785
 $24,969
Federal and state income taxes6,796
 11,746
Federal and state income taxes (paid), net of refunds10,642
 6,796
Non-cash activities:      
Loans held for investment foreclosed and transferred to other real estate owned10,831
 37,305
3,647
 10,831
Loans transferred from held for investment to held for sale54,403
 9,966
310,455
 54,403
Ginnie Mae loans recorded with the right to repurchase, net$3,775
 $3,330
Loans transferred from held for sale to held for investment17,095
 —
Ginnie Mae loans recognized with the right to repurchase, net$649
 $3,775

See accompanying notes to interim consolidated financial statements (unaudited).

9


HomeStreet, Inc. and Subsidiaries
Notes to Interim Consolidated Financial Statements (Unaudited)

NOTE 1–SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

HomeStreet, Inc. and its wholly owned subsidiaries (the “Company”) is a diversified financial services company serving customers primarily in the Pacific Northwest, California and Hawaii. The Company is principally engaged in real estate lending, including mortgage banking activities, and commercial and consumer banking. The consolidated financial statements include the accounts of HomeStreet, Inc. and its wholly owned subsidiaries, HomeStreet Capital Corporation and HomeStreet Bank (the “Bank”), and the Bank’s subsidiaries, HomeStreet/WMS, Inc., HomeStreet Reinsurance, Ltd., Continental Escrow Company, Union Street Holdings LLC, YNB Real Estate LLC, BSBC Properties LLC, HS Cascadia Holdings LLC and Lacey Gateway LLC. HomeStreet Bank was formed in 1986 and is a state-chartered savings bank.

The Company’s accounting and financial reporting policies conform to accounting principles generally accepted in the United States of America (U.S. GAAP). Inter-company balances and transactions have been eliminated in consolidation. In preparing the consolidated financial statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and revenues and expenses during the reporting periods and related disclosures. Although these estimates contemplate current conditions and how they are expected to change in the future, it is reasonably possible that actual conditions could be worse than anticipated in those estimates, which could materially affect the Company’s results of operations and financial condition. Management has made significant estimates in several areas, and actual results could differ materially from those estimates. Certain amounts in the financial statements from prior periods have been reclassified to conform to the current financial statement presentation.

The information furnished in theseThese unaudited interim financial statements reflectsreflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim financial statements do not necessarily indicate the results that may be expected for the full year. The interim financial information should be read in conjunction with the Company’sour Annual Report on Form 10-K for the year ended December 31, 20122013, filed with the Securities and Exchange Commission (“20122013 Annual Report on Form 10-K”).

Shares outstanding and per share information presented in this Form 10-Q have been adjusted to reflect the 2-for-1 forward stock splits effective on November 5, 2012 and on March 6, 2012.

NOTE 2–SIGNIFICANT RISKS AND UNCERTAINTIES:

Regulatory Agreements

Homestreet, Inc. received notification from the Federal Reserve Bank of San Francisco that the Cease and Desist Order, dated May 18, 2009 issued by the Office of Thrift Supervision, had been terminated effective March 26, 2013.Purchase Accounting Adjustments

On November 1, 2013, the Company completed its acquisition of Fortune Bank and YNB Financial Services Corp. ("YNB"), the parent of Yakima National Bank. The assets acquired and liabilities assumed in the acquisitions were accounted for under the acquisition method of accounting. The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the acquisition date. On December 27, 2012,6, 2013, the Company acquired two retail deposit branches and some related assets from AmericanWest Bank, had been notifieda Washington state-chartered bank. During the second quarter of 2014, the Company completed a more detailed fair value analysis of premises and equipment assumed in the acquisition of YNB and determined that adjustments to the acquisition-date fair value were required. The Company also determined that adjustments were required to the provisional estimates for core deposit intangibles that were assumed in all three acquisitions. As a result of these adjustments, core deposit intangibles increased by $1.1 million, premises and equipment decreased by $740 thousand, and deferred tax liabilities increased by $280 thousand, resulting in a net decrease to goodwill of $118 thousand. These immaterial measurement period adjustments and corrections of accounting errors were made in the second quarter of 2014 as they were not material to the prior periods.

Recent Accounting Developments

In January 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-01, Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects. The ASU applies to all reporting entities that invest in qualified affordable housing projects through limited liability entities that are flow through entities for tax purposes. The amendments in this ASU eliminate the effective yield election and permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received, and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). Those not electing the proportional amortization method would account for the investment using the equity method or cost method. The amendments in this ASU should be applied retrospectively to all periods presented and are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014, although early adoption is permitted. The Company elected to adopt this new accounting guidance as of January 1, 2014. It is being

10


adopted prospectively, as the retrospective adjustments were not material. The Company's income tax expense for the nine months ended September 30, 2014 includes discrete tax benefit items of $406 thousand related to the recognition of the cumulative effect for prior years of adoption of this new accounting guidance. 

In January 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon foreclosure. The ASU clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the Federal Deposit Insurance Corporation (“FDIC”)creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2014 and can be applied with a modified retrospective transition method or prospectively. The adoption of ASU 2014-04 is not expected to have a material impact on the Company's consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU clarifies the principles for recognizing revenue from contracts with customers. The new accounting guidance, which does not apply to financial instruments, is effective on a retrospective basis beginning on January 1, 2017. The adoption of ASU 2014-09 is not expected to have a material impact on the Company's consolidated financial statements.

In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing (Topic 860): Repurchase-to Maturity Transactions, Repurchase Financings, and Disclosures. The ASU applies to all entities that enter into repurchase-to-maturity transactions or repurchase financings. The amendments in this ASU require that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements. In addition, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty (a repurchase financing), which will result in secured borrowing accounting for the repurchase agreement. The amendments require an entity to disclose information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements, in which the transferor retains substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. In addition the amendments require disclosure of the types of collateral pledged in repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions and the Washington State Departmenttenor of Financial Institutions (“WDFI”) thatthose transactions. The amendments in this ASU are effective for public business entities for the Bank had taken appropriate corrective actions to address the memorandumfirst interim or annual period beginning after December 15, 2014. Early adoption is not permitted. The application of understanding ("MOU") in place since March 26, 2012, and consequently the Bank's MOU was terminated effective December 27, 2012. The Bank is no longer considered a “troubled institution” and is considered “well-capitalized” within the meaningthis guidance may require enhanced disclosures of the FDIC's prompt corrective action rules.Company's repurchase agreements, but will have no impact on the Company's consolidated financial statements.


In August 2014, the FASB issued ASU 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. The ASU clarifies the classification of certain foreclosed mortgage loans held by creditors that are either fully or partially guaranteed under government programs. The ASU requires that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. The separate other receivable should be measured based on the amount of the loan balance expected to be recovered from the guarantor. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2014 and can be applied with a modified retrospective transition method or prospectively. The adoption of ASU 2014-14 is not expected to have a material impact on the Company's consolidated financial statements.


1011


NOTE 3–2–INVESTMENT SECURITIES AVAILABLE FOR SALE:SECURITIES:

The following tables settable sets forth certain information regarding the amortized cost and fair values of our investment securities available for sale.
 
At September 30, 2013At September 30, 2014
(in thousands)
Amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Fair
value
Amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Fair
value

              
Mortgage-backed securities:              
Residential$147,396
 $221
 $(3,354) $144,263
$112,131
 $374
 $(1,668) $110,837
Commercial13,478
 242
 —
 13,720
13,119
 452
 —
 13,571
Municipal bonds152,481
 672
 (5,712) 147,441
120,799
 2,713
 (470) 123,042
Collateralized mortgage obligations:      
      
Residential153,460
 1,473
 (1,467) 153,466
56,359
 130
 (1,601) 54,888
Commercial17,457
 —
 (466) 16,991
16,047
 —
 (415) 15,632
Corporate debt securities75,888
 1
 (5,926) 69,963
74,166
 50
 (2,104) 72,112
U.S. Treasury securities27,744
 3
 —
 27,747
41,971
 43
 —
 42,014
$587,904
 $2,612
 $(16,925) $573,591
$434,592
 $3,762
 $(6,258) $432,096

At December 31, 2012At December 31, 2013
(in thousands)Amortized
cost		 Gross
unrealized
gains		 Gross
unrealized
losses		 Fair
value		Amortized
cost		 Gross
unrealized
gains		 Gross
unrealized
losses		 Fair
value
              
Mortgage-backed securities:              
Residential$62,847
 $223
 $(217) $62,853
$137,602
 $187
 $(3,879) $133,910
Commercial13,720
 660
 —
 14,380
13,391
 45
 (3) 13,433
Municipal bonds123,695
 5,574
 (94) 129,175
136,937
 185
 (6,272) 130,850
Collateralized mortgage obligations:      
      
Residential163,981
 6,333
 (115) 170,199
93,112
 85
 (2,870) 90,327
Commercial8,983
 60
 —
 9,043
17,333
 —
 (488) 16,845
Corporate debt securities75,542
 —
 (6,676) 68,866
U.S. Treasury securities30,670
 11
 (2) 30,679
27,478
 1
 (27) 27,452
$403,896
 $12,861
 $(428) $416,329
$501,395
 $503
 $(20,215) $481,683

Mortgage-backed securities ("MBS") and collateralized mortgage obligations ("CMO") represent securities issued by government sponsored entities ("GSEs"). Each of the MBS and CMO securities in our investment portfolio are guaranteed by Fannie Mae, Ginnie Mae or Freddie Mac. Municipal bonds are comprised of general obligation bonds (i.e., backed by the general credit of the issuer) and revenue bonds (i.e., backed by revenues from the specific project being financed) issued by various municipal corporations. As of September 30, 20132014 and December 31, 20122013, all securities held, including municipal bonds and corporate debt securities, were rated investment grade based upon external ratings where available and, where not available, based upon internal ratings which correspond to ratings as defined by Standard and Poor’s Rating Services (“S&P”) or Moody’s Investors Services (“Moody’s”). As of September 30, 20132014 and December 31, 20122013, substantially all securities held had ratings available by external ratings agencies.


12


Investment securities available for sale that were in an unrealized loss position are presented in the following tables based on the length of time the individual securities have been in an unrealized loss position.


11


At September 30, 2013At September 30, 2014
Less than 12 months 12 months or more TotalLess than 12 months 12 months or more Total
(in thousands)
Gross
unrealized
losses
 
Fair
value
 
Gross
unrealized
losses
 
Fair
value
 
Gross
unrealized
losses
 
Fair
value
Gross
unrealized
losses
 
Fair
value
 
Gross
unrealized
losses
 
Fair
value
 
Gross
unrealized
losses
 
Fair
value

                      
Residential mortgage-backed securities$(3,133) $121,234
 $(221) $7,361
 $(3,354) $128,595
Mortgage-backed securities:           
Residential$(40) $11,758
 $(1,628) $69,570
 $(1,668) $81,328
Municipal bonds(5,712) 97,091
 —
 —
 (5,712) 97,091
(13) 3,612
 (457) 29,295
 (470) 32,907
Collateralized mortgage obligations:                      
Residential(1,169) 50,895
 (298) 10,678
 (1,467) 61,573
(249) 8,802
 (1,352) 31,346
 (1,601) 40,148
Commercial(466) 16,991
 —
 —
 (466) 16,991
—
 —
 (415) 15,633
 (415) 15,633
Corporate debt securities(5,926) 69,826
 —
 —
 (5,926) 69,826
(281) 17,145
 (1,823) 45,573
 (2,104) 62,718
$(16,406) $356,037
 $(519) $18,039
 $(16,925) $374,076
$(583) $41,317
 $(5,675) $191,417
 $(6,258) $232,734

At December 31, 2012At December 31, 2013
Less than 12 months 12 months or more TotalLess than 12 months 12 months or more Total
(in thousands)Gross
unrealized
losses		 Fair
value		 Gross
unrealized
losses		 Fair
value		 Gross
unrealized
losses		 Fair
value		Gross
unrealized
losses		 Fair
value		 Gross
unrealized
losses		 Fair
value		 Gross
unrealized
losses		 Fair
value
                      
Mortgage-backed securities:                      
Residential$(217) $18,121
 $—
 $—
 $(217) $18,121
$(3,767) $98,717
 $(112) $6,728
 $(3,879) $105,445
Commercial(3) 7,661
 —
 —
 (3) 7,661
Municipal bonds(94) 4,212
 —
 —
 (94) 4,212
(5,991) 106,985
 (281) 3,490
 (6,272) 110,475
Collateralized mortgage obligations:        
 
        

 

Residential(115) 13,883
 —
 —
 (115) 13,883
(2,120) 63,738
 (750) 15,081
 (2,870) 78,819
Commercial(488) 16,845
 —
 —
 (488) 16,845
Corporate debt securities(6,676) 68,844
 —
 —
 (6,676) 68,844
U.S. Treasury securities—
 —
 (2) 10,238
 (2) 10,238
(27) 25,452
 —
 —
 (27) 25,452
$(426) $36,216
 $(2) $10,238
 $(428) $46,454
$(19,072) $388,242
 $(1,143) $25,299
 $(20,215) $413,541

The Company has evaluated securities available for sale that are in an unrealized loss position and has determined that the decline in value is temporary and is related to the change in market interest rates since purchase. The decline in value is not related to any company-issuer- or industry-specific credit event. As of September 30, 20132014 and December 31, 20122013, the present value of the cash flows expected to be collectedCompany does not expect any credit losses on all of the Companyits debt securities was greater than amortized cost of those securities. In addition, as of September 30, 20132014 and December 31, 20122013, the Company had not made a decision to sell any of its debt securities held, nor did the Company consider it more likely than not that it would be required to sell such securities before recovery of their amortized cost basis. The Company did not hold any marketable equity securities as of September 30, 20132014 and December 31, 20122013.



1213


The following tables present the fair value of investment securities available for sale by contractual maturity along with the associated contractual yield for the periods indicated below. Contractual maturities for mortgage-backed securities and collateralized mortgage obligations as presented exclude the effect of expected prepayments. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations before the underlying mortgages mature. The weighted-average yield is computed using the contractual coupon of each security weighted based on the fair value of each security and does not include adjustments to a tax equivalent basis.

At September 30, 2013At September 30, 2014
Within one year 
After one year
through five years
 
After five years
through ten years
 
After
ten years
 TotalWithin one year 
After one year
through five years
 
After five years
through ten years
 
After
ten years
 Total
(in thousands)
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
                                      
Mortgage-backed securities:                                      
Residential$—
 —% $—
 —% $11,310
 1.82% $132,953
 2.18% $144,263
 2.15%$—
 —% $—
 —% $7,466
 1.73% $103,371
 1.81% $110,837
 1.80%
Commercial—
 —
 —
 —
 —
 —
 13,720
 4.49
 13,720
 4.49
—
 —
 —
 —
 —
 —
 13,571
 4.63
 13,571
 4.63
Municipal bonds—
 —
 —
 —
 19,890
 3.51
 127,551
 4.41
 147,441
 4.29
—
 —
 45
 3.43
 22,642
 3.54
 100,355
 4.25
 123,042
 4.12
Collateralized mortgage obligations:                                      
Residential—
 —
 —
 —
 13,643
 2.17
 139,823
 2.65
 153,466
 2.61
—
 —
 —
 —
 —
 —
 54,887
 2.07
 54,887
 2.07
Commercial—
 —
 —
 —
 5,311
 1.85
 11,680
 1.40
 16,991
 1.54
—
 —
 —
 —
 9,692
 1.93
 5,940
 1.37
 15,632
 1.72
Corporate debt securities—
 —
 —
 —
 33,238
 3.31
 36,725
 3.75
 69,963
 3.54
—
 —
 —
 —
 40,854
 3.25
 31,259
 3.64
 72,113
 3.42
U.S. Treasury securities26,746
 0.24
 1,001
 0.18
 —
 —
 —
 —
 27,747
 0.23
2,002
 0.25
 40,012
 0.35
 —
 —
 —
 —
 42,014
 0.34
Total available for sale$26,746
 0.24% $1,001
 0.18% $83,392
 2.88% $462,452
 3.11% $573,591
 2.94%$2,002
 0.25% $40,057
 0.35% $80,654
 3.03% $309,383
 2.93% $432,096
 2.70%
 
At December 31, 2012At December 31, 2013
Within one year 
After one year
through five years
 
After five years
through ten years
 
After
ten years
 TotalWithin one year 
After one year
through five years
 
After five years
through ten years
 
After
ten years
 Total
(in thousands)
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
 
Fair
Value
 
Weighted
Average
Yield
                                      
Mortgage-backed securities:                                      
Residential$—
 —% $—
 —% $—
 —% $62,853
 2.81% $62,853
 2.81%$—
 —% $—
 —% $10,581
 1.63% $123,329
 1.82% $133,910
 1.81%
Commercial—
 —
 —
 —
 —
 —
 14,380
 4.03
 14,380
 4.03
—
 —
 —
 —
 —
 —
 13,433
 4.51
 13,433
 4.51
Municipal bonds—
 —
 —
 —
 15,673
 3.64
 113,502
 4.66
 129,175
 4.53
—
 —
 —
 —
 19,598
 3.51
 111,252
 4.29
 130,850
 4.17
Collateralized mortgage obligations:                                      
Residential—
 —
 —
 —
 —
 —
 170,199
 2.64
 170,199
 2.64
—
 —
 —
 —
 19,987
 2.31
 70,340
 2.17
 90,327
 2.20
Commercial—
 —
 —
 —
 —
 —
 9,043
 2.06
 9,043
 2.06
—
 —
 —
 —
 5,270
 1.90
 11,575
 1.42
 16,845
 1.57
Corporate debt securities—
 —
 —
 —
 32,848
 3.31
 36,018
 3.75
 68,866
 3.54
U.S. Treasury securities30,679
 0.23
 —
 —
 —
 —
 —
 —
 30,679
 0.23
1,001
 0.18
 26,451
 0.30
 —
 —
 —
 —
 27,452
 0.29
Total available for sale$30,679
 0.23% $—
 —% $15,673
 3.64% $369,977
 3.33% $416,329
 3.11%$1,001
 0.18% $26,451
 0.30% $88,284
 2.84% $365,947
 2.92% $481,683
 2.75%


1314


Sales of investment securities available for sale were as follows.
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Proceeds$1,972
 $39,635
 $52,566
 $159,174
$9,753
 $1,972
 $75,599
 $52,566
Gross gains—
 434
 322
 1,780
480
 —
 1,375
 322
Gross losses(184) (37) (316) (431)—
 (184) (201) (316)

There were $57.639.9 million and $47.3 million in investment securities pledged to secure advances from the Federal Home Loan Bank of Seattle ("FHLB") at September 30, 2013 and $51.9 million in investment securities pledged to secure advances from the FHLB at December 31, 2012. At September 30, 20132014 and December 31, 20122013, respectively. At September 30, 2014 and December 31, 2013, there were $27.149.7 million and $18.637.7 million, respectively, of securities pledged to secure derivatives in a liability position. At September 30, 2014, there were $15.0 million of securities pledged under repurchase agreements and none at December 31, 2013.

Tax-exempt interest income on securities available for sale oftotaling $1.5 million856 thousand and $1.31.5 million for the three months ended September 30, 20132014 and 20122013, respectively, and $4.2$2.6 million and $3.0$4.2 million for the nine months ended September 30, 20132014 and 20122013, respectively, was recorded in the Company's consolidated statements of operations.


NOTE 4–3–LOANS AND CREDIT QUALITY:

For a detailed discussion of loans and credit quality, including accounting policies and the methodology used to estimate the allowance for credit losses, see Note 1, Summary of Significant Accounting Policies and Note 5,6, Loans and Credit Qualityto the Company's within our 20122013 Annual Report on Form 10-K.

The Company's portfolio of loans held for investment is divided into two portfolio segments, consumer loans and commercial loans, which are the same segments used to determine the allowance for loan losses.  Within each portfolio segment, the Company monitors and assesses credit risk based on the risk characteristics of each of the following loan classes: single family and home equity loans within the consumer loan portfolio segment and commercial real estate, multifamily, construction/land development and commercial business loans within the commercial loan portfolio segment.

Loans held for investment consist of the following.following:
 
(in thousands)At September 30,
2013		 At December 31,
2012		At September 30,
2014		 At December 31,
2013
      
Consumer loans      
Single family$818,992
 $673,865
$788,232
 $904,913
Home equity129,785
 136,746
138,276
 135,650
948,777
 810,611
926,508
 1,040,563
Commercial loans      
Commercial real estate400,150
 361,879
530,335
 477,642
Multifamily42,187
 17,012
62,498
 79,216
Construction/land development79,435
 71,033
297,790
 130,465
Commercial business67,547
 79,576
173,226
 171,054
589,319
 529,500
1,063,849
 858,377
1,538,096
 1,340,111
1,990,357
 1,898,940
Net deferred loan fees and discounts(3,233) (3,576)(3,748) (3,219)
1,534,863
 1,336,535
1,986,609
 1,895,721
Allowance for loan losses(24,694) (27,561)(21,847) (23,908)
$1,510,169
 $1,308,974
$1,964,762
 $1,871,813


15


Loans in the amount of $675.2850.2 million and $469.8800.5 million at September 30, 20132014 and December 31, 20122013, respectively, were pledged to secure borrowings from the FHLB as part of our liquidity management strategy. The FHLB does not have the right to sell or re-pledge these loans.

14

Concentrations of credit risk arise when a number of customers are engaged in similar business activities or activities in the same geographic region, or when they have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions.


Loans held for investment are primarily secured by real estate located in the states of Washington, Oregon, California, Idaho and Hawaii. Loan concentrations may exist when there are amounts loaned to borrowers engaged in similar activities or similar types of loans extended to a diverse group of borrowers that would cause them to be similarly impacted by economic or other conditions. At September 30, 2014, we had concentrations representing 10% or more of the total portfolio by state and property type for the loan classes of single family, commercial real estate and construction/land development within the state of Washington, which represented 26.2%, 22.2% and 11.8% of the total portfolio, respectively. At December 31, 2013 we had concentrations representing 10% or more of the total portfolio by state and property type for the loan classes of single family and commercial real estate within the state of Washington, which represented 42.8%37.3% and 20.8% respectively. At December 31, 2012 we had concentrations representing 10% or more of the total portfolio by state and property type for the loan classes of single family and commercial real estate within the state of Washington, which represented 40.4% and 22.5%21.2% of the total portfolio, respectively. These loans were mostly located within the metropolitan area of Puget Sound, area, particularly within King County.

Credit Quality

Management considers the level of allowance for loan losses to be appropriate to cover credit losses inherent within the loans held for investment portfolio as of September 30, 20132014. In addition to the allowance for loan losses, the Company maintains a separate allowance for losses related to unfunded loan commitments, and this amount is included in accounts payable and other liabilities on the consolidated statements of financial condition. Collectively, these allowances are referred to as the allowance for credit losses.

For further information on the policies that govern the determination of the allowance for loan losses levels, see Note 1, Summary of Significant Accounting Policies within theour 20122013 Annual Report on Form 10-K.

Activity in the allowance for credit losses was as follows.

 Three Months Ended September 30, Nine Months Ended September 30, Three Months Ended September 30, Nine Months Ended September 30,
(in thousands) 2013 2012 2013 2012 2014 2013 2014 2013
                
Allowance for credit losses (roll-forward):                
Beginning balance $27,858
 $27,125
 $27,751
 $42,800
 $22,168
 $27,858
 $24,089
 $27,751
(Reversal of) provision for credit losses (1,500) 5,500
 900
 7,500
Provision (reversal of provision) for credit losses —
 (1,500) (1,500) 900
(Charge-offs), net of recoveries (1,464) (4,998) (3,757) (22,673) (57) (1,464) (478) (3,757)
Ending balance $24,894
 $27,627
 $24,894
 $27,627
 $22,111
 $24,894
 $22,111
 $24,894
Components:                
Allowance for loan losses $24,694
 $27,461
 $24,694
 $27,461
 $21,847
 $24,694
 $21,847
 $24,694
Allowance for unfunded commitments 200
 166
 200
 166
 264
 200
 264
 200
Allowance for credit losses $24,894
 $27,627
 $24,894
 $27,627
 $22,111
 $24,894
 $22,111
 $24,894



16


Activity in the allowance for credit losses by loan portfolio and loan class was as follows.

Three Months Ended September 30, 2013Three Months Ended September 30, 2014
(in thousands)
Beginning
balance
 Charge-offs Recoveries (Reversal of)Provision 
Ending
balance
Beginning
balance
 Charge-offs Recoveries (Reversal of) Provision 
Ending
balance
                  
Consumer loans                  
Single family$13,810
 $(606) $179
 $(1,251) $12,132
$9,111
 $(226) $65
 $(72) $8,878
Home equity4,879
 (377) 273
 (139) 4,636
3,517
 (135) 94
 87
 3,563
18,689
 (983) 452
 (1,390) 16,768
12,628
 (361) 159
 15
 12,441
Commercial loans                  
Commercial real estate5,723
 (1,306) —
 51
 4,468
4,063
 —
 275
 (357) 3,981
Multifamily690
 —
 —
 80
 770
887
 —
 —
 (174) 713
Construction/land development1,185
 —
 348
 (141) 1,392
2,418
 —
 123
 146
 2,687
Commercial business1,571
 —
 25
 (100) 1,496
2,172
 (304) 51
 370
 2,289
9,169
 (1,306) 373
 (110) 8,126
9,540
 (304) 449
 (15) 9,670
Total allowance for credit losses$27,858
 $(2,289) $825
 $(1,500) $24,894
$22,168
 $(665) $608
 $—
 $22,111
 Three Months Ended September 30, 2013
(in thousands)
Beginning
balance
 Charge-offs Recoveries (Reversal of) Provision 
Ending
balance
          
Consumer loans         
Single family$13,810
 $(606) $179
 $(1,251) $12,132
Home equity4,879
 (377) 273
 (139) 4,636
 18,689
 (983) 452
 (1,390) 16,768
Commercial loans         
Commercial real estate5,723
 (1,306) —
 51
 4,468
Multifamily690
 —
 —
 80
 770
Construction/land development1,185
 —
 348
 (141) 1,392
Commercial business1,571
 —
 25
 (100) 1,496
 9,169
 (1,306) 373
 (110) 8,126
Total allowance for credit losses$27,858
 $(2,289) $825
 $(1,500) $24,894

1517




Three Months Ended September 30, 2012Nine Months Ended September 30, 2014
(in thousands)
Beginning
balance
 Charge-offs Recoveries (Reversal of)Provision 
Ending
balance
Beginning
balance
 Charge-offs Recoveries (Reversal of) Provision 
Ending
balance
                  
Consumer loans                  
Single family$12,865
 $(1,363) $22
 $2,028
 $13,552
$11,990
 $(509) $106
 $(2,709) $8,878
Home equity4,851
 (1,078) 121
 1,139
 5,033
3,987
 (694) 420
 (150) 3,563
17,716
 (2,441) 143
 3,167
 18,585
15,977
 (1,203) 526
 (2,859) 12,441
Commercial loans                  
Commercial real estate4,343
 (1,757) 130
 1,020
 3,736
4,012
 (23) 431
 (439) 3,981
Multifamily923
 —
 —
 (151) 772
942
 —
 —
 (229) 713
Construction/land development3,022
 (1,823) 193
 1,472
 2,864
1,414
 —
 185
 1,088
 2,687
Commercial business1,121
 (74) 631
 (8) 1,670
1,744
 (592) 198
 939
 2,289
9,409
 (3,654) 954
 2,333
 9,042
8,112
 (615) 814
 1,359
 9,670
Total allowance for credit losses$27,125
 $(6,095) $1,097
 $5,500
 $27,627
$24,089
 $(1,818) $1,340
 $(1,500) $22,111


 Nine Months Ended September 30, 2013
(in thousands)
Beginning
balance
 Charge-offs Recoveries (Reversal of) Provision 
Ending
balance
          
Consumer loans         
Single family$13,388
 $(2,468) $425
 $787
 $12,132
Home equity4,648
 (1,515) 526
 977
 4,636
 18,036
 (3,983) 951
 1,764
 16,768
Commercial loans         
Commercial real estate5,312
 (1,449) —
 605
 4,468
Multifamily622
 —
 —
 148
 770
Construction/land development1,580
 (148) 699
 (739) 1,392
Commercial business2,201
 —
 173
 (878) 1,496
 9,715
 (1,597) 872
 (864) 8,126
Total allowance for credit losses$27,751
 $(5,580) $1,823
 $900
 $24,894


 Nine Months Ended September 30, 2012
(in thousands)Beginning
balance		 Charge-offs Recoveries (Reversal of)Provision Ending
balance
          
Consumer loans         
Single family$10,671
 $(3,889) $455
 $6,315
 $13,552
Home equity4,623
 (3,577) 398
 3,589
 5,033
 15,294
 (7,466) 853
 9,904
 18,585
Commercial loans         
Commercial real estate4,321
 (3,474) 258
 2,631
 3,736
Multifamily335
 —
 —
 437
 772
Construction/land development21,237
 (13,858) 835
 (5,350) 2,864
Commercial business1,613
 (538) 717
 (122) 1,670
 27,506
 (17,870) 1,810
 (2,404) 9,042
Total allowance for credit losses$42,800
 $(25,336) $2,663
 $7,500
 $27,627



1618


The following table disaggregates our allowance for credit losses and recorded investment in loans by impairment methodology.
 
At September 30, 2013At September 30, 2014
(in thousands)
Allowance:
collectively
evaluated for
impairment
 
Allowance:
individually
evaluated for
impairment
 Total 
Loans:
collectively
evaluated for
impairment
 
Loans:
individually
evaluated for
impairment
 Total
Allowance:
collectively
evaluated for
impairment
 
Allowance:
individually
evaluated for
impairment
 Total 
Loans:
collectively
evaluated for
impairment
 
Loans:
individually
evaluated for
impairment
 Total
                      
Consumer loans                      
Single family$10,676
 $1,456
 $12,132
 $745,211
 $73,781
 $818,992
$8,042
 $836
 $8,878
 $713,339
 $74,893
 $788,232
Home equity4,585
 51
 4,636
 127,226
 2,559
 129,785
3,448
 115
 3,563
 135,755
 2,521
 138,276
15,261
 1,507
 16,768
 872,437
 76,340
 948,777
11,490
 951
 12,441
 849,094
 77,414
 926,508
Commercial loans                      
Commercial real estate4,468
 —
 4,468
 372,905
 27,245
 400,150
3,859
 122
 3,981
 499,198
 31,137
 530,335
Multifamily315
 455
 770
 38,997
 3,190
 42,187
347
 366
 713
 59,396
 3,102
 62,498
Construction/land development1,081
 311
 1,392
 72,768
 6,667
 79,435
2,687
 —
 2,687
 292,097
 5,693
 297,790
Commercial business811
 685
 1,496
 66,022
 1,525
 67,547
1,092
 1,197
 2,289
 169,481
 3,745
 173,226
6,675
 1,451
 8,126
 550,692
 38,627
 589,319
7,985
 1,685
 9,670
 1,020,172
 43,677
 1,063,849
Total$21,936
 $2,958
 $24,894
 $1,423,129
 $114,967
 $1,538,096
$19,475
 $2,636
 $22,111
 $1,869,266
 $121,091
 $1,990,357
 
At December 31, 2012At December 31, 2013
(in thousands)
Allowance:
collectively
evaluated for
impairment
 
Allowance:
individually
evaluated for
impairment
 Total 
Loans:
collectively
evaluated for
impairment
 
Loans:
individually
evaluated for
impairment
 Total
Allowance:
collectively
evaluated for
impairment
 
Allowance:
individually
evaluated for
impairment
 Total 
Loans:
collectively
evaluated for
impairment
 
Loans:
individually
evaluated for
impairment
 Total
                      
Consumer loans                      
Single family$11,212
 $2,176
 $13,388
 $599,538
 $74,327
 $673,865
$10,632
 $1,358
 $11,990
 $831,730
 $73,183
 $904,913
Home equity4,611
 37
 4,648
 133,026
 3,720
 136,746
3,903
 84
 3,987
 133,006
 2,644
 135,650
15,823
 2,213
 18,036
 732,564
 78,047
 810,611
14,535
 1,442
 15,977
 964,736
 75,827
 1,040,563
Commercial loans                      
Commercial real estate3,682
 1,630
 5,312
 334,406
 27,473
 361,879
4,012
 —
 4,012
 445,766
 31,876
 477,642
Multifamily106
 516
 622
 13,791
 3,221
 17,012
515
 427
 942
 76,053
 3,163
 79,216
Construction/land development1,092
 488
 1,580
 58,129
 12,904
 71,033
1,414
 —
 1,414
 124,317
 6,148
 130,465
Commercial business680
 1,521
 2,201
 77,256
 2,320
 79,576
1,042
 702
 1,744
 168,199
 2,855
 171,054
5,560
 4,155
 9,715
 483,582
 45,918
 529,500
6,983
 1,129
 8,112
 814,335
 44,042
 858,377
Total$21,383
 $6,368
 $27,751
 $1,216,146
 $123,965
 $1,340,111
$21,518
 $2,571
 $24,089
 $1,779,071
 $119,869
 $1,898,940

Interest payments on impaired loans, applied against loan principal or recognized as interest income, of $1.2 million and $1.3 million were recorded for cash payments received during the three months ended September 30, 2013 and 2012, respectively, and $3.5 million and $4.3 million was recorded for cash payments received during the nine months ended September 30, 2013 and 2012, respectively.


1719


Impaired Loans

The following tables present impaired loans by loan portfolio segment and loan class.
 
At September 30, 2013At September 30, 2014
(in thousands)
Recorded
investment (1)
 
Unpaid
principal
balance (2)
 
Related
allowance
Recorded
investment (1)
 
Unpaid
principal
balance (2)
 
Related
allowance
          
With no related allowance recorded:          
Consumer loans          
Single family$38,138
 $41,130
 $—
$41,422
 $43,600
 $—
Home equity1,802
 1,868
 —
1,949
 1,974
 —
39,940
 42,998
 —
43,371
 45,574
 —
Commercial loans          
Commercial real estate27,245
 29,247
 —
30,344
 33,367
 —
Multifamily508
 508
 —
508
 508
 —
Construction/land development6,356
 16,061
 —
5,693
 14,824
 —
Commercial business120
 137
 —
1,854
 3,294
 —
34,229
 45,953
 —
38,399
 51,993
 —
$74,169
 $88,951
 $—
$81,770
 $97,567
 $—
With an allowance recorded:          
Consumer loans          
Single family$35,643
 $35,701
 $1,456
$33,471
 $33,530
 $836
Home equity757
 757
 51
572
 572
 115
36,400
 36,458
 1,507
34,043
 34,102
 951
Commercial loans          
Commercial real estate793
 797
 122
Multifamily2,682
 2,860
 455
2,594
 2,771
 366
Construction/land development311
 311
 311
—
 —
 —
Commercial business1,405
 1,534
 685
1,891
 1,911
 1,197
4,398
 4,705
 1,451
5,278
 5,479
 1,685
$40,798
 $41,163
 $2,958
$39,321
 $39,581
 $2,636
Total:          
Consumer loans          
Single family$73,781
 $76,831
 $1,456
Single family(3)
$74,893
 $77,130
 $836
Home equity2,559
 2,625
 51
2,521
 2,546
 115
76,340
 79,456
 1,507
77,414
 79,676
 951
Commercial loans          
Commercial real estate27,245
 29,247
 —
31,137
 34,164
 122
Multifamily3,190
 3,368
 455
3,102
 3,279
 366
Construction/land development6,667
 16,372
 311
5,693
 14,824
 —
Commercial business1,525
 1,671
 685
3,745
 5,205
 1,197
38,627
 50,658
 1,451
43,677
 57,472
 1,685
Total impaired loans$114,967
 $130,114
 $2,958
$121,091
 $137,148
 $2,636

(1)
Includes partial charge-offs and nonaccrual interest paid.
(2)
Unpaid principal balance does not include partial charge-offs or nonaccrual interest paid. Related allowance is calculated on net book balances not unpaid principal balances.
(3)
Includes $70.0 million in performing troubled debt restructurings ("TDRs").


1820


At December 31, 2012At December 31, 2013
(in thousands)
Recorded
investment (1)
 
Unpaid
principal
balance (2)
 
Related
allowance
Recorded
investment (1)
 
Unpaid
principal
balance (2)
 
Related
allowance
          
With no related allowance recorded:          
Consumer loans          
Single family$28,202
 $29,946
 $—
$39,341
 $41,935
 $—
Home equity2,728
 3,211
 —
1,895
 1,968
 —
30,930
 33,157
 —
41,236
 43,903
 —
Commercial loans          
Commercial real estate10,933
 12,445
 —
31,876
 45,921
 —
Multifamily508
 508
 —
508
 508
 —
Construction/land development11,097
 20,990
 —
6,148
 15,299
 —
Commercial business147
 162
 —
1,533
 7,164
 —
22,685
 34,105
 —
40,065
 68,892
 —
$53,615
 $67,262
 $—
$81,301
 $112,795
 $—
With an allowance recorded:          
Consumer loans          
Single family$46,125
 $47,553
 $2,176
$33,842
 $33,900
 $1,358
Home equity992
 1,142
 37
749
 749
 84
47,117
 48,695
 2,213
34,591
 34,649
 1,442
Commercial loans          
Commercial real estate16,540
 16,540
 1,630
Multifamily2,713
 2,891
 516
2,655
 2,832
 427
Construction/land development1,807
 1,807
 488
Commercial business2,173
 2,287
 1,521
1,322
 1,478
 702
23,233
 23,525
 4,155
3,977
 4,310
 1,129
$70,350
 $72,220
 $6,368
$38,568
 $38,959
 $2,571
Total:          
Consumer loans          
Single family$74,327
 $77,499
 $2,176
Single family(3)
$73,183
 $75,835
 $1,358
Home equity3,720
 4,353
 37
2,644
 2,717
 84
78,047
 81,852
 2,213
75,827
 78,552
 1,442
Commercial loans          
Commercial real estate27,473
 28,985
 1,630
31,876
 45,921
 —
Multifamily3,221
 3,399
 516
3,163
 3,340
 427
Construction/land development12,904
 22,797
 488
6,148
 15,299
 —
Commercial business2,320
 2,449
 1,521
2,855
 8,642
 702
45,918
 57,630
 4,155
44,042
 73,202
 1,129
Total impaired loans$123,965
 $139,482
 $6,368
$119,869
 $151,754
 $2,571
 
(1)Includes partial charge-offs and nonaccrual interest paid.
(2)Unpaid principal balance does not include partial charge-offs or nonaccrual interest paid. Related allowance is calculated on net book balances not unpaid principal balances.
(3)
Includes $70.3 million in performing TDRs.


1921


The following table provides the average recorded investment in impaired loans by portfolio segment and class.

Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Consumer loans              
Single family$79,527
 $69,419
 $77,841
 $66,967
$72,840
 $79,527
 $72,508
 $77,841
Home equity3,095
 2,860
 3,345
 2,788
2,457
 3,095
 2,524
 3,345
82,622
 72,279
 81,186
 69,755
75,297
 82,622
 75,032
 81,186
Commercial loans              
Commercial real estate27,456
 31,765
 27,775
 33,439
31,209
 27,456
 31,638
 27,775
Multifamily3,194
 5,779
 3,205
 6,512
3,114
 3,194
 3,134
 3,205
Construction/land development7,218
 19,197
 9,450
 43,656
5,768
 7,218
 5,898
 9,450
Commercial business1,696
 1,792
 1,922
 1,379
3,664
 1,696
 3,250
 1,922
39,564
 58,533
 42,352
 84,986
43,755
 39,564
 43,920
 42,352
$122,186
 $130,812
 $123,538
 $154,741
$119,052
 $122,186
 $118,952
 $123,538


20


Credit Quality Indicators

Management regularly reviews loans in the portfolio to assess credit quality indicators and to determine appropriate loan classification and grading in accordance with applicable bank regulations. The Company's risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. The Company differentiates its lending portfolios into homogeneous loans and non-homogeneous loans.

The 10 risk rating categories can be generally described by the following groupings for non-homogeneous loans:

Pass. We have five pass risk ratings which represent a level of credit quality that ranges from no well-defined deficiency or weakness to some noted weakness, however the risk of default on any loan classified as pass is expected to be remote. The five pass risk ratings are described below:

Minimal Risk. A minimal risk loan, risk rated 1-Exceptional, is to a borrower of the highest quality. The borrower has an unquestioned ability to produce consistent profits and service all obligations and can absorb severe market disturbances with little or no difficulty.

Low Risk. A low risk loan, risk rated 2-Superior, is similar in characteristics to a minimal risk loan. Balance sheet and operations are slightly more prone to fluctuations within the business cycle; however, debt capacity and debt service coverage remains strong. The borrower will have a strong demonstrated ability to produce profits and absorb market disturbances.

Modest Risk. A modest risk loan, risk rated 3-Excellent, is a desirable loan with excellent sources of repayment and no currently identifiable risk associated with collection. The borrower exhibits a very strong capacity to repay the loan in accordance with the repayment agreement. The borrower may be susceptible to economic cycles, but will have cash reserves to weather these cycles.

Average Risk. An average risk loan, risk rated 4-Good, is an attractive loan with sound sources of repayment and no material collection or repayment weakness evident. The borrower has an acceptable capacity to pay in accordance with the agreement. The borrower is susceptible to economic cycles and more efficient competition, but should have modest reserves sufficient to survive all but the most severe downturns or major setbacks.

Acceptable Risk. An acceptable risk loan, risk rated 5-Acceptable, is a loan with lower than average, but still acceptable credit risk. These borrowers may have higher leverage, less certain but viable repayment sources, have limited financial reserves and may possess weaknesses that can be adequately mitigated through collateral, structural or credit enhancement. The borrower is susceptible to economic cycles and is less resilient to negative market forces or financial events. Reserves may be insufficient to survive a modest downturn.


22


Watch. A watch loan, risk rated 6-Watch, is still pass-rated, but represents the lowest level of acceptable risk due to an emerging risk element or declining performance trend. Watch ratings are expected to be temporary, with issues resolved or manifested to the extent that a higher or lower rating would be appropriate. The borrower should have a plausible plan, with reasonable certainty of success, to correct the problems in a short period of time. Borrowers rated watch are characterized by elements of uncertainty, such as:
Borrower may be experiencing declining operating trends, strained cash flows or less-than anticipated performance. Cash flow should still be adequate to cover debt service, and the negative trends should be identified as being of a short-term or temporary nature.
The borrower may have experienced a minor, unexpected covenant violation.
Companies who may be experiencing tight working capital or have a cash cushion deficiency.
A loan may also be a watch if financial information is late, there is a documentation deficiency, the borrower has experienced unexpected management turnover, or if they face industry issues that, when combined with performance factors create uncertainty in their future ability to perform.
Delinquent payments, increasing and material overdraft activity, request for bulge and/or out- of-formula advances may be an indicator of inadequate working capital and may suggest a lower rating.
Failure of the intended repayment source to materialize as expected, or renewal of a loan (other than cash/marketable security secured or lines of credit) without reduction are possible indicators of a watch or worse risk rating.

Special Mention. A special mention loan, risk rated 7-Special Mention, has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loans or the institutions credit position at some future date. They contain unfavorable characteristics and are generally undesirable. Loans in this category are currently protected but are potentially weak and constitute an undue and unwarranted credit risk, but not to the point of a substandard classification. A special mention loan has potential weaknesses, which if not checked or corrected, weaken the loan or inadequately protect the Company’s position at some future date. Such weaknesses include:
Performance is poor or significantly less than expected. There may be a temporary debt-servicing deficiency or inadequate working capital as evidenced by a cash cushion deficiency, but not to the extent that repayment is compromised. Material violation of financial covenants is common.
Loans with unresolved material issues that significantly cloud the debt service outlook, even though a debt servicing deficiency does not currently exist.
Modest underperformance or deviation from plan for real estate loans where absorption of rental/sales units is necessary to properly service the debt as structured. Depth of support for interest carry provided by owner/guarantors may mitigate and provide for improved rating
This rating may be assigned when a loan officer is unable to supervise the credit properly, an inadequate loan agreement, an inability to control collateral, failure to obtain proper documentation, or any other deviation from prudent lending practices.
Unlike a substandard credit, there should be a reasonable expectation that these temporary issues will be corrected within the normal course of business, rather than liquidation of assets, and in a reasonable period of time.

Substandard. A substandard loan, risk rated 8-Substandard, is inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the loan. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual loans classified substandard. Loans are classified as substandard when they have unsatisfactory characteristics causing unacceptable levels of risk. A substandard loan normally has one or more well-defined weaknesses that could jeopardize repayment of the loan. The likely need to liquidate assets to correct the problem, rather than repayment from successful operations is the key distinction between special mention and substandard. The following are examples of well-defined weaknesses:
Cash flow deficiencies or trends are of a magnitude to jeopardize current and future payments with no immediate relief. A loss is not presently expected, however the outlook is sufficiently uncertain to preclude ruling out the possibility.
The borrower has been unable to adjust to prolonged and unfavorable industry or economic trends.

23


Material underperformance or deviation from plan for real estate loans where absorption of rental/sales units is necessary to properly service the debt and risk is not mitigated by willingness and capacity of owner/guarantor to support interest payments.
Management character or honesty has become suspect. This includes instances where the borrower has become uncooperative.
Due to unprofitable or unsuccessful business operations, some form of restructuring of the business, including liquidation of assets, has become the primary source of loan repayment. Cash flow has deteriorated, or been diverted, to the point that sale of collateral is now the Company’s primary source of repayment (unless this was the original source of repayment). If the collateral is under the Company’s control and is cash or other liquid, highly marketable securities and properly margined, then a more appropriate rating might be special mention or watch.
The borrower is involved in bankruptcy proceedings where collateral liquidation values are expected to fully protect the Company against loss.
There is material, uncorrectable faulty documentation or materially suspect financial information.

Doubtful. Loans classified as doubtful, risk rated 9-Doubtful, have all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work towards strengthening of the loan, classification as a loss (and immediate charge-off) is deferred until more exact status may be determined. Pending factors include proposed merger, acquisition, liquidation procedures, capital injection, and perfection of liens on additional collateral and refinancing plans. In certain circumstances, a doubtful rating will be temporary, while the Company is awaiting an updated collateral valuation. In these cases, once the collateral is valued and appropriate margin applied, the remaining un-collateralized portion will be charged-off. The remaining balance, properly margined, may then be upgraded to substandard, however must remain on non-accrual.

Loss. Loans classified as loss, risk rated 10-Loss, are considered un-collectible and of such little value that the continuance as an active Company asset is not warranted. This rating does not mean that the loan has no recovery or salvage value, but rather that the loan should be charged-off now, even though partial or full recovery may be possible in the future.

Impaired. Loans are classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due, in accordance with the terms of the original loan agreement, without unreasonable delay. This generally includes all loans classified as non-accrual and troubled debt restructurings. Impaired loans are risk rated for internal and regulatory rating purposes, but presented separately for clarification.

Homogeneous loans maintain their original risk rating until they are greater than 30 days past due, and risk rating reclassification is based primarily on the past due status of the loan. The risk rating categories can be generally described by the following groupings for commercial and commercial real estate homogeneous loans:

Watch. A homogeneous watch loan, risk rated 6, is 30-59 days past due from the required payment date at month-end.

Special Mention. A homogeneous special mention loan, risk rated 7, is 60-89 days past due from the required payment date at month-end.

Substandard. A homogeneous substandard loan, risk rated 8, is 90-179 days past due from the required payment date at month-end.

Loss. A homogeneous loss loan, risk rated 10, is 180 days and more past due from the required payment date. These loans are generally charged-off in the month in which the 180 day time period elapses.

The risk rating categories can be generally described by the following groupings for residential and home equity and other homogeneous loans:

Watch. A homogeneous retail watch loan, risk rated 6, is 60-89 days past due from the required payment date at month-end.


24


Substandard. A homogeneous retail substandard loan, risk rated 8, is 90-180 days past due from the required payment date at month-end.

Loss. A homogeneous retail loss loan, risk rated 10, becomes past due 180 cumulative days from the contractual due date. These loans are generally charged-off in the month in which the 180 day period elapses.

The following tables presentsummarize designated loan grades by loan portfolio segment and loan class.
 
At September 30, 2013At September 30, 2014
(in thousands)Pass Watch Special mention Substandard TotalPass Watch Special mention Substandard Total
                  
Consumer loans                  
Single family$729,682
 $48,950
 $15,587
 $24,773
 $818,992
$756,182
 $1,347
 $15,489
 $15,214
 $788,232
Home equity127,100
 50
 265
 2,370
 129,785
136,029
 109
 438
 1,700
 138,276
856,782
 49,000
 15,852
 27,143
 948,777
892,211
 1,456
 15,927
 16,914
 926,508
Commercial loans                  
Commercial real estate263,828
 86,418
 41,424
 8,480
 400,150
439,969
 65,048
 20,391
 4,927
 530,335
Multifamily37,447
 1,550
 3,190
 —
 42,187
57,874
 1,523
 3,101
 —
 62,498
Construction/land development65,655
 7,215
 2,920
 3,645
 79,435
291,545
 3,065
 350
 2,830
 297,790
Commercial business54,340
 7,083
 3,304
 2,820
 67,547
144,645
 23,604
 2,112
 2,865
 173,226
421,270
 102,266
 50,838
 14,945
 589,319
934,033
 93,240
 25,954
 10,622
 1,063,849
$1,278,052
 $151,266
 $66,690
 $42,088
 $1,538,096
$1,826,244
 $94,696
 $41,881
 $27,536
 $1,990,357
         
         
At December 31, 2012
(in thousands)Pass Watch Special mention Substandard Total
         
Consumer loans         
Single family$565,312
 $55,768
 $27,599
 $25,186
 $673,865
Home equity131,246
 1,337
 1,193
 2,970
 136,746
696,558
 57,105
 28,792
 28,156
 810,611
Commercial loans         
Commercial real estate217,370
 102,353
 17,931
 24,225
 361,879
Multifamily12,222
 1,569
 3,221
 —
 17,012
Construction/land development21,540
 7,243
 35,368
 6,882
 71,033
Commercial business68,134
 7,914
 462
 3,066
 79,576
319,266
 119,079
 56,982
 34,173
 529,500
$1,015,824
 $176,184
 $85,774
 $62,329
 $1,340,111

 At December 31, 2013
(in thousands)Pass Watch Special mention Substandard Total
          
Consumer loans         
Single family$817,877
 $53,711
 $12,746
 $20,579
 $904,913
Home equity132,086
 1,442
 276
 1,846
 135,650
 949,963
 55,153
 13,022
 22,425
 1,040,563
Commercial loans         
Commercial real estate368,817
 63,579
 37,758
 7,488
 477,642
Multifamily74,509
 1,544
 3,163
 —
 79,216
Construction/land development121,026
 3,414
 2,895
 3,130
 130,465
Commercial business145,760
 20,062
 586
 4,646
 171,054
 710,112
 88,599
 44,402
 15,264
 858,377
 $1,660,075
 $143,752
 $57,424
 $37,689
 $1,898,940

The Company considers ‘adversely classified assets’ to include loans graded as Substandard, Doubtful, and Loss as well as other real estate owned ("OREO"). As of September 30, 20132014 and December 31, 2012,2013, none of the Company's loans were rated Doubtful or Loss. The total amount of adversely classified assets was $38.0 million and $50.6 million as of September 30, 2014 and December 31, 2013, respectively. For a detailed discussion on credit quality, indicators used by management, see Note 5,6, Loans and Credit Quality within theour 20122013 Annual Report on Form 10-K.

Nonaccrual and Past Due Loans
Loans are placed on nonaccrual status when the full and timely collection of principal and interest is doubtful, generally when the loan becomes 90 days or more past due for principal or interest payment or if part of the principal balance has been charged off. Loans whose repayments are insured by the Federal Housing Authority ("FHA") or guaranteed by the Department of Veterans' Affairs ("VA") are generally maintained on accrual status even if 90 days or more past due.

2125


The following tables presenttable presents an aging analysesanalysis of past due loans by loan portfolio segment and loan class.

At September 30, 2013At September 30, 2014
(in thousands)
30-59 days
past due
 
60-89 days
past due
 
90 days or
more
past due
 
Total past
due
 Current 
Total
loans
 
90 days or
more past
due and
still accruing(1)
30-59 days
past due
 
60-89 days
past due
 
90 days or
more
past due
 
Total past
due
 Current 
Total
loans
 
90 days or
more past
due and
accruing(1)
                          
Consumer loans                          
Single family$10,359
 $5,170
 $56,410
 $71,939
 $747,053
 $818,992
 $43,762
$9,208
 $4,140
 $39,830
 $53,178
 $735,054
 $788,232
 $31,480
Home equity554
 100
 2,295
 2,949
 126,836
 129,785
 —
461
 109
 1,700
 2,270
 136,006
 138,276
 —
10,913
 5,270
 58,705
 74,888
 873,889
 948,777
 43,762
9,669
 4,249
 41,530
 55,448
 871,060
 926,508
 31,480
Commercial loans                          
Commercial real estate—
 —
 6,861
 6,861
 393,289
 400,150
 —
—
 —
 7,058
 7,058
 523,277
 530,335
 —
Multifamily—
 —
 —
 —
 42,187
 42,187
 —
—
 —
 —
 —
 62,498
 62,498
 —
Construction/land development—
 —
 3,544
 3,544
 75,891
 79,435
 —
—
 —
 —
 —
 297,790
 297,790
 —
Commercial business—
 —
 1,405
 1,405
 66,142
 67,547
 —
44
 —
 2,798
 2,842
 170,384
 173,226
 —
—
 —
 11,810
 11,810
 577,509
 589,319
 —
44
 —
 9,856
 9,900
 1,053,949
 1,063,849
 —
$10,913
 $5,270
 $70,515
 $86,698
 $1,451,398
 $1,538,096
 $43,762
$9,713
 $4,249
 $51,386
 $65,348
 $1,925,009
 $1,990,357
 $31,480
             
             
At December 31, 2012
(in thousands)
30-59 days
past due
 
60-89 days
past due
 
90 days or
more
past due
 
Total past
due
 Current 
Total
loans
 
90 days or
more past
due and
still accruing(1)
             
Consumer loans             
Single family$11,916
 $4,732
 $53,962
 $70,610
 $603,255
 $673,865
 $40,658
Home equity787
 242
 2,970
 3,999
 132,747
 136,746
 —
12,703
 4,974
 56,932
 74,609
 736,002
 810,611
 40,658
Commercial loans             
Commercial real estate—
 —
 6,403
 6,403
 355,476
 361,879
 —
Multifamily—
 —
 —
 —
 17,012
 17,012
 —
Construction/land development—
 —
 5,042
 5,042
 65,991
 71,033
 —
Commercial business—
 —
 2,173
 2,173
 77,403
 79,576
 —
—
 —
 13,618
 13,618
 515,882
 529,500
 —
$12,703
 $4,974
 $70,550
 $88,227
 $1,251,884
 $1,340,111
 $40,658
(1)FHA-insured and VA-guaranteed single family loans that are 90 days or more past due are maintained on accrual status if they are determined to have little to no risk of loss.
 At December 31, 2013
(in thousands)30-59 days
past due		 60-89 days
past due		 90 days or
more
past due		 Total past
due		 Current Total
loans		 
90 days or
more past
due and
accruing(1)
              
Consumer loans             
Single family$6,466
 $4,901
 $55,672
 $67,039
 $837,874
 $904,913
 $46,811
Home equity375
 75
 1,846
 2,296
 133,354
 135,650
 —
 6,841
 4,976
 57,518
 69,335
 971,228
 1,040,563
 46,811
Commercial loans             
Commercial real estate—
 —
 12,257
 12,257
 465,385
 477,642
 —
Multifamily—
 —
 —
 —
 79,216
 79,216
 —
Construction/land development—
 —
 —
 —
 130,465
 130,465
 —
Commercial business—
 —
 2,743
 2,743
 168,311
 171,054
 —
 —
 —
 15,000
 15,000
 843,377
 858,377
 —
 $6,841
 $4,976
 $72,518
 $84,335
 $1,814,605
 $1,898,940
 $46,811

(1)FHA-insured and VA-guaranteed single family loans that are 90 days or more past due are maintained on accrual status if they are determined to have little to no risk of loss.


2226



The following tables present accrualperforming and nonaccrualnonperforming loan balances by loan portfolio segment and loan class.
 
 At September 30, 2013
(in thousands)Accrual Nonaccrual Total
      
Consumer loans     
Single family$806,344
 $12,648
 $818,992
Home equity127,490
 2,295
 129,785
 933,834
 14,943
 948,777
Commercial loans     
Commercial real estate393,289
 6,861
 400,150
Multifamily42,187
 —
 42,187
Construction/land development75,891
 3,544
 79,435
Commercial business66,142
 1,405
 67,547
 577,509
 11,810
 589,319
 $1,511,343
 $26,753
 $1,538,096
At December 31, 2012At September 30, 2014
(in thousands)Accrual Nonaccrual TotalAccrual Nonaccrual Total
          
Consumer loans          
Single family$660,561
 $13,304
 $673,865
$779,882
 $8,350
 $788,232
Home equity133,776
 2,970
 136,746
136,576
 1,700
 138,276
794,337
 16,274
 810,611
916,458
 10,050
 926,508
Commercial loans          
Commercial real estate355,476
 6,403
 361,879
523,277
 7,058
 530,335
Multifamily17,012
 —
 17,012
62,498
 —
 62,498
Construction/land development65,991
 5,042
 71,033
297,790
 —
 297,790
Commercial business77,403
 2,173
 79,576
170,428
 2,798
 173,226
515,882
 13,618
 529,500
1,053,993
 9,856
(1) 
1,063,849
$1,310,219
 $29,892
 $1,340,111
$1,970,451
 $19,906
 $1,990,357
(1)Includes $6.3 million of nonperforming loans at September 30, 2014 that are guaranteed by the Small Business Administration ("SBA").

 At December 31, 2013
(in thousands)Accrual Nonaccrual Total
      
Consumer loans     
Single family$896,052
 $8,861
 $904,913
Home equity133,804
 1,846
 135,650
 1,029,856
 10,707
 1,040,563
Commercial loans     
Commercial real estate465,385
 12,257
 477,642
Multifamily79,216
 —
 79,216
Construction/land development130,465
 —
 130,465
Commercial business168,311
 2,743
 171,054
 843,377
 15,000
(1) 
858,377
 $1,873,233
 $25,707
 $1,898,940

(1)Includes $6.5 million of nonperforming loans at December 31, 2013 that are guaranteed by the SBA.
The Company had 194 loan relationships classified as troubled debt restructurings (“TDRs”) totaling $109.4 million at September 30, 2013 with related unfunded commitments of $41 thousand. The Company had 162 loan relationships classified as TDRs totaling $110.8 million at December 31, 2012 with related unfunded commitments of $25 thousand. The increase in the number of TDR loan relationships at September 30, 2013 from December 31, 2012 is primarily due to an increase in the number of single family loan TDRs, partially offset by a decline in the number of commercial construction/land development loan TDRs. TDR loans within the loans held for investment portfolio and the related reserves are included in the impaired loan tables above.


2327


Troubled Debt Restructurings

The following tables present information about TDRtroubled debt restructurings ("TDRs") activity during the periods presented.

At Three Months Ended September 30, 2013Three Months Ended September 30, 2014
(dollars in thousands)Concession type 
Number of loan
relationships
 
Recorded
investment
 
Related charge-
offs
Concession type 
Number of loan
modifications
 
Recorded
investment
 
Related charge-
offs
            
Consumer loans            
Single family            
Interest rate reduction 27
 $5,538
 $—
Interest rate reduction 18
 $3,268
 $—
Payment restructure 8
 1,626
 —
Home equity            
Interest rate reduction 2
 132
 —
Interest rate reduction 1
 220
 —
Total consumer            
Interest rate reduction 29
 $5,670
 $—
Interest rate reduction 19
 3,488
 —
Payment restructure 8
 1,626
 —
 27
 5,114
 —
      
Commercial loans      
Commercial real estate      
Interest rate reduction 1
 1,181
 —
Payment restructure —
 —
 —
Commercial business      
Forgiveness of principal 1
 391
 266
Total commercial      
Interest rate reduction 1
 1,181
 —
Payment restructure —
 —
 —
Forgiveness of principal 1
 391
 266
 2
 1,572
 266
Total loans            
Interest rate reduction 29
 $5,670
 $—
Interest rate reduction 20
 4,669
 —
Payment restructure 8
 1,626
 —
Forgiveness of principal 1
 391
 266
 29
 $6,686
 $266

At Three Months Ended September 30, 2012Three Months Ended September 30, 2013
(dollars in thousands)Concession type 
Number of loan
relationships
 
Recorded
investment
 
Related charge-
offs
Concession type 
Number of loan
modifications
 
Recorded
investment
 
Related charge-
offs
            
Consumer loans            
Single family            
Interest rate reduction 4
 $960
 $—
Interest rate reduction 27
 $5,538
 $—
Home equity            
Interest rate reduction 1
 48
 —
Interest rate reduction 2
 132
 —
Total consumer            
Interest rate reduction 5
 $1,008
 $—
Interest rate reduction 29
 5,670
 —
Commercial loans      
Commercial real estate      
Interest rate reduction 1
 $5,012
 $—
Total loans            
Interest rate reduction 6
 $6,020
 $—
Interest rate reduction 29
 $5,670
 $—


 At Nine Months Ended September 30, 2013
(dollars in thousands)Concession type 
Number of loan
relationships
 
Recorded
investment
 
Related charge-
offs
        
Consumer loans       
Single family       
 Interest rate reduction 51
 $11,300
 $—
Home equity       
 Interest rate reduction 5
 301
 —
Total consumer       
 Interest rate reduction 56
 $11,601
 $—
Total loans       
 Interest rate reduction 56
 $11,601
 $—

2428


At Nine Months Ended September 30, 2012Nine Months Ended September 30, 2014
(dollars in thousands)Concession type 
Number of loan
relationships
 
Recorded
investment
 
Related charge-
offs
Concession type 
Number of loan
modifications
 
Recorded
investment
 
Related charge-
offs
            
Consumer loans            
Single family            
Interest rate reduction 28
 $9,092
 $58
Interest rate reduction 42
 $7,455
 $—
Payment restructure 1
 273
 —
Payment restructure 10
 1,991
 —
 29
 $9,365
 $58
Home equity            
Interest rate reduction 6
 $492
 $—
Interest rate reduction 1
 220
 —
Total consumer            
Interest rate reduction 34
 $9,584
 $58
Interest rate reduction 43
 7,675
 —
Payment restructure 1
 273
 —
Payment restructure 10
 1,991
 —
 35
 $9,857
 $58
 53
 9,666
 —
      
Commercial loans            
Commercial real estate            
Interest rate reduction 1
 1,181
 —
Payment restructure 3
 4,248
 —
Commercial business      
Interest rate reduction 2
 117
 —
Forgiveness of principal 2
 599
 554
Total commercial      
Interest rate reduction 3
 1,298
 —
Payment restructure 3
 4,248
 —
Forgiveness of principal 2
 599
 554
Interest rate reduction 2
 $5,779
 $—
 8
 6,145
 554
Total loans            
Interest rate reduction 36
 $15,363
 $58
Interest rate reduction 46
 8,973
 —
Payment restructure 1
 273
 —
Payment restructure 13
 6,239
 —
 37
 $15,636
 $58
Forgiveness of principal 2
 599
 554
 61
 $15,811
 $554

 Nine Months Ended September 30, 2013
(dollars in thousands)Concession type 
Number of loan
modifications
 
Recorded
investment
 
Related charge-
offs
        
Consumer loans       
Single family       
 Interest rate reduction 51
 $11,300
 $—
Home equity       
 Interest rate reduction 5
 301
 —
Total consumer       
 Interest rate reduction 56
 11,601
 —
   56
 11,601
 —
Total loans       
 Interest rate reduction 56
 $11,601
 $—

The following table presentstables present loans that were modified as TDRs within the previous 12 months and subsequently re-defaulted during the three and nine months ended September 30, 20132014 and 20122013, respectively. A TDR loan is considered re-defaulted when it becomes doubtful that the objectives of the modifications will be met, generally when a consumer loan TDR becomes

29


60 days or more past due on principal or interest payments or when a commercial loan TDR becomes 90 days or more past due on principal or interest payments.
 
Three Months Ended September 30,Three Months Ended September 30,
2013 20122014 2013
(dollars in thousands)Number of loan relationships that re-defaulted 
Recorded
investment
 Number of loan relationships that re-defaulted 
Recorded
investment
Number of loan relationships that re-defaulted 
Recorded
investment
 Number of loan relationships that re-defaulted 
Recorded
investment
              
Consumer loans              
Single family7
 $1,017
 18
 $4,290
3
 $282
 7
 $1,017
Home equity—
 —
 —
 —
—
 —
 —
 —
7
 1,017
 18
 4,290
3
 282
 7
 1,017
Commercial loans       
Commercial real estate—
 —
 1
 7,716
Construction/land development—
 —
 —
 —
Commercial business—
 —
 1
 21
—
 —
 2
 7,737
3
 $282
 7
 $1,017
7
 $1,017
 20
 $12,027
 


25


Nine Months Ended September 30,Nine Months Ended September 30,
2013 20122014 2013
(dollars in thousands)Number of loan relationships that re-defaulted Recorded
investment		 Number of loan relationships that re-defaulted Recorded
investment		Number of loan relationships that re-defaulted 
Recorded
investment
 Number of loan relationships that re-defaulted 
Recorded
investment
              
Consumer loans              
Single family14
 $2,573
 41
 $9,551
7
 $1,010
 14
 $2,573
Home equity1
 22
 1
 34
1
 190
 1
 22
15
 2,595
 42
 9,585
8
 1,200
 15
 2,595
Commercial loans              
Commercial real estate1
 770
 1
 7,716
—
 —
 1
 770
Construction/land development—
 —
 —
 —
Commercial business—
 —
 3
 410
1
 770
 4
 8,126
—
 —
 1
 770
16
 $3,365
 46
 $17,711
8
 $1,200
 16
 $3,365


NOTE 5–4–DEPOSITS:

Deposit balances, including stated rates, were as follows.
 
(in thousands)At September 30,
2013		 At December 31,
2012
    
Noninterest-bearing accounts$351,274
 $358,831
NOW accounts 0.00% to 0.75% at September 30, 2013 and December 31, 2012272,029
 174,699
Statement savings accounts, due on demand 0.20% to 1.00% at September 30, 2013 and 0.20% to 0.85% at December 31, 2012135,428
 103,932
Money market accounts, due on demand 0.00% to 1.50% at September 30, 2013 and December 31, 2012879,122
 683,906
Certificates of deposit 0.10% to 3.92% at September 30, 2013 and 0.10% to 4.70% at December 31, 2012460,223
 655,467
 $2,098,076
 $1,976,835
(in thousands)At September 30,
2014		 At December 31,
2013
    
Noninterest-bearing accounts$557,580
 $322,952
NOW accounts, 0.00% to 1.00% at September 30, 2014 and 0.00% to 0.75% at December 31, 2013300,832
 297,966
Statement savings accounts, due on demand, 0.00% to 1.99% at September 30, 2014 and 0.20% to 2.00% at December 31, 2013184,656
 156,181
Money market accounts, due on demand, 0.00% to 1.45% at September 30, 2014 and 0.00% to 1.50% at December 31, 20131,015,266
 919,322
Certificates of deposit, 0.05% to 3.80% at September 30, 2014 and December 31, 2013367,124
 514,400
 $2,425,458
 $2,210,821

There were no$1.9 million in public funds included in deposits as of September 30, 20132014 and none at December 31, 20122013.


30


Interest expense on deposits was as follows.
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
NOW accounts$265
 $129
 $656
 $368
$289
 $265
 $835
 $656
Statement savings accounts140
 113
 358
 289
238
 140
 649
 358
Money market accounts1,060
 858
 2,890
 2,394
1,125
 1,060
 3,226
 2,890
Certificates of deposit757
 2,808
 4,174
 9,934
712
 757
 2,370
 4,174
$2,222
 $3,908
 $8,078
 $12,985
$2,364
 $2,222
 $7,080
 $8,078

The weighted-average interest rates on certificates of deposit at September 30, 20132014 and December 31, 20122013 were 0.63%0.65% and 1.59%0.71%, respectively.

Certificates of deposit outstanding as of September 30, 2013, mature as follows.
 

26


(in thousands)At September 30, 2013At September 30, 2014
  
Within one year$377,372
$235,568
One to two years31,189
82,026
Two to three years36,728
40,207
Three to four years9,157
6,044
Four to five years5,777
3,279
$460,223
$367,124

The aggregate amount of time deposits in denominations of $100 thousand or more at September 30, 20132014 and December 31, 20122013 was $143.7167.5 million and $300.4216.5 million, respectively. The aggregate amount of time deposits in denominations of more than $250 thousand at September 30, 20132014 and December 31, 20122013 was $15.019.7 million and $45.326.3 million, respectively. There were $158.083.2 million inand $144.3 million of brokered deposits as ofat September 30, 20132014 and none at December 31, 20122013., respectively.



31


NOTE 6–5–DERIVATIVES AND HEDGING ACTIVITIES:

In order toTo reduce the risk of significant interest rate fluctuations on the value of certain assets and liabilities, such as certain mortgage loans held for sale or mortgage servicing rights ("MSRs"), the Company utilizes derivatives, such as forward sale commitments, futures, option contracts, interest rate swaps and swaptions as risk management instruments in its hedging strategy. Derivative transactions are measured in terms of notional amount, which is not recorded in the consolidated statements of financial condition. The notional amount is generally not exchanged and is used as the basis for interest and other contractual payments. We held no derivatives designated as a cash flow or foreign currency hedge instruments at September 30, 20132014 or December 31, 20122013. Derivatives are reported at their respective fair values in the accounts receivable and other assets or the accounts payable and other liabilities line items on the consolidated statements of financial condition, with changes in fair value reflected in current period earnings.

As permitted under U.S. GAAP, the Company nets derivative assets and liabilities when a legally enforceable master netting agreement exists between the Company and the derivative counterparty, which are documented under industry standard master agreements and credit support annexes. The Company's master netting agreements provide that following an uncured payment default or other event of default the non-defaulting party may promptly terminate all transactions between the parties and determine a net amount due to be paid to, or by, the defaulting party. An event of default may also occur under a credit support annex if a party fails to make a collateral delivery (which remains uncured following applicable notice and grace periods). The Company's right of offset requires that master netting agreements are legally enforceable and that the exercise of rights by the non-defaulting party under these agreements will not be stayed, or avoided under applicable law upon an event of default including bankruptcy, insolvency or similar proceeding.

The collateral used under the Company's master netting agreements is typically cash, but securities may be used under agreements with certain counterparties. Receivables related to cash collateral that has been paid to counterparties is included in accounts receivable and other assets on the Company's consolidated statements of financial condition. Any securities pledged to counterparties as collateral remain on the consolidated statement of financial condition. Refer to Note 3,2, Investment Securities Available for Saleof this Form 10-Q for further information on securities collateral pledged. As ofAt September 30, 20132014 and December 31, 20122013, the Company did not hold any collateral received from counterparties under derivative transactions.

For further information on the policies that govern derivative and hedging activities, see Note 1, Summary of Significant Accounting Policies and Note 11,12, Derivatives and Hedging Activities within theour 20122013 Annual Report on Form 10-K.


27


The notional amounts and fair values for derivatives consist of the following.
 
At September 30, 2013At September 30, 2014
Notional amount Fair value derivativesNotional amount Fair value derivatives
(in thousands)  Asset Liability  Asset Liability
          
Forward sale commitments$677,538
 $2,357
 $(10,871)$1,140,752
 $1,309
 $(3,950)
Interest rate swaptions305,000
 136
 —
40,000
 23
 —
Interest rate lock commitments388,977
 13,753
 (76)457,381
 14,074
 (7)
Interest rate swaps500,997
 4,611
 (13,176)514,604
 3,499
 (4,166)
Total derivatives before netting$1,872,512
 20,857
 (24,123)$2,152,737
 18,905
 (8,123)
Netting adjustments  (5,635) 5,635
  (3,745) 3,745
Carrying value on consolidated statements of financial condition  $15,222
 $(18,488)  $15,160
 $(4,378)
 

32


At December 31, 2012At December 31, 2013
Notional amount Fair value derivativesNotional amount Fair value derivatives
(in thousands)  Asset Liability  Asset Liability
          
Forward sale commitments$1,258,152
 $621
 $(2,743)$526,382
 $3,630
 $(578)
Interest rate swaptions110,000
 858
 (199)
Interest rate lock commitments734,762
 22,548
 (20)261,070
 6,012
 (40)
Interest rate swaps361,892
 538
 (9,358)508,004
 1,088
 (9,548)
Total derivatives before netting$2,354,806
 23,707
 (12,121)$1,405,456
 11,588
 (10,365)
Netting adjustments  (1,052) 1,052
  (1,363) 1,363
Carrying value on consolidated statements of financial condition  $22,655
 $(11,069)  $10,225
 $(9,002)
 
The following tables present gross and net information about derivative instruments.
 At September 30, 2013
(in thousands)Gross fair value Netting adjustments Carrying value 
Cash collateral paid (1)
 Securities pledged Net amount
            
Derivative assets:           
Forward sale commitments$2,357
 $(992) $1,365
 $—
 $—
 $1,365
Interest rate swaps / swaptions4,747
 (4,643) 104
 —
 —
 104
Total derivatives subject to legally enforceable master netting agreements7,104
 (5,635) 1,469
 —
 —
 1,469
Interest rate lock commitments13,753
 —
 13,753
 —
 —
 13,753
Total derivative assets$20,857
 $(5,635) $15,222
 $—
 $—
 $15,222
            
Derivative liabilities:           
Forward sale commitments$(10,871) $992
 $(9,879) $8,273
 $1,467
 $(139)
Interest rate swaps(13,176) 4,643
 (8,533) 7,928
 605
 —
Total derivatives subject to legally enforceable master netting agreements(24,047) 5,635
 (18,412) 16,201
 2,072
 (139)
Interest rate lock commitments(76) —
 (76) —
 —
 (76)
Total derivative liabilities$(24,123) $5,635
 $(18,488) $16,201
 $2,072
 $(215)
 At September 30, 2014
(in thousands)Gross fair value Netting adjustments Carrying value 
Cash collateral paid (1)
 Securities pledged Net amount
            
Derivative assets$18,905
 $(3,745) $15,160
 $—
 $—
 $15,160
            
Derivative liabilities$(8,123) $3,745
 $(4,378) $3,557
 $721
 $(100)


28


 At December 31, 2012
(in thousands)Gross fair value Netting adjustments Carrying value 
Cash collateral paid (1)
 Net amount
          
Derivative assets:         
Forward sale commitments$621
 $(621) $—
 $—
 $—
Interest rate swaps538
 (431) 107
 —
 107
Total derivatives subject to legally enforceable master netting agreements1,159
 (1,052) 107
 —
 107
Interest rate lock commitments22,548
 —
 22,548
 —
 22,548
Total derivative assets$23,707
 $(1,052) $22,655
 $—
 $22,655
          
Derivative liabilities:         
Forward sale commitments$(2,743) $621
 $(2,122) $1,953
 $(169)
Interest rate swaps(9,358) 431
 (8,927) 8,927
 —
Total derivatives subject to legally enforceable master netting agreements(12,101) 1,052
 (11,049) 10,880
 (169)
Interest rate lock commitments(20) —
 (20) —
 (20)
Total derivative liabilities$(12,121) $1,052
 $(11,069) $10,880
 $(189)
 At December 31, 2013
(in thousands)Gross fair value Netting adjustments Carrying value 
Cash collateral paid (1)
 Securities pledged Net amount
            
Derivative assets$11,588
 $(1,363) $10,225
 $—
 $—
 $10,225
            
Derivative liabilities$(10,365) $1,363
 $(9,002) $8,491
 $451
 $(60)

(1)
Excludes cash collateral of $27.6$21.5 million and $18.0$18.5 million at September 30, 20132014 and December 31, 20122013, which predominantly consists of collateral transferred by the Company at the initiation of derivative transactions and held by the counterparty as security. These amounts were not netted against the derivative receivables and payables, because, at an individual counterparty level, the collateral exceeded the fair value exposure at both September 30, 20132014 and December 31, 20122013.

The ineffective portion of net gain (loss) on derivatives in fair value hedging relationships, recognized in other noninterest income on the consolidated statements of operations, for loans held for investment were $1074 thousand and $16$10 thousand for the three months ended September 30, 20132014 and 20122013, respectively, and $116$86 thousand and $64$116 thousand for the nine months ended September 30, 20132014 and 20122013, respectively.

The Company's fair value hedge accounting relationships had loan valuation asset adjustments of $3.5 million and $4.4 million and swap valuation liabilities of $3.5 million and $4.4 million at September 30, 2014 and December 31, 2013, respectively.


33


The following table presents the net gain (loss) recognized on derivatives, including economic hedge derivatives, within the respective line items in the statement of operations for the periods indicated.
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Recognized in noninterest income:              
Net gain on mortgage loan origination and sale activities (1)
$(37,017) $891
 $(17,368) $11,456
$(2,868) $(37,017) $(8,882) $(17,368)
Mortgage servicing income (2)
3,631
 4,861
 (12,392) 24,600
Mortgage servicing income (loss) (2)
2,543
 3,631
 23,381
 (12,392)
$(33,386) $5,752
 $(29,760) $36,056
$(325) $(33,386) $14,499
 $(29,760)
 
(1)Comprised of interest rate lock commitments ("IRLCs") and forward contracts used as an economic hedge of IRLCs and single family mortgage loans held for sale.
(2)Comprised of interest rate swaps, interest rate swaptions and forward contracts used as an economic hedge of single family mortgage servicing rights MSRs.



29


NOTE 7–6–MORTGAGE BANKING OPERATIONS:

Loans held for sale consisted of the following.
 
(in thousands)At September 30,
2013		 At December 31,
2012		At September 30,
2014		 At December 31,
2013
      
Single family$385,110
 $607,578
$644,965
(1) 
$279,385
Multifamily—
 13,221
53,146
 556
$385,110
 $620,799
$698,111
 $279,941
(1)The Company transferred $310.5 million of loans from the held for investment portfolio into loans held for sale in March of this year and subsequently sold $266.8 million of these loans. At June 30, 2014, the Company had transferred $17.1 million of these loans back to the held for investment portfolio.


Loans sold consisted of the following.
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Single family$1,326,888
 $1,238,879
 $3,916,918
 $2,735,893
$1,179,464
 $1,326,888
 $2,705,719
 $3,916,918
Multifamily21,998
 26,515
 87,971
 85,116
20,409
 21,998
 42,574
 87,971
$1,348,886
 $1,265,394
 $4,004,889
 $2,821,009
$1,199,873
 $1,348,886
 $2,748,293
 $4,004,889

Net gain on mortgage loan origination and sale activities, including the effects of derivative risk management instruments, consisted of the following.
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Single family:              
Servicing value and secondary marketing gains(1)
$23,076
 $56,142
 $110,760
 $120,471
Provision for repurchase losses(2)
—
 (526) —
 (2,846)
Net gain from secondary marketing activities23,076
 55,616
 110,760
 117,625
Servicing value and secondary market gains(1)
$29,866
 $23,076
 $79,658
 $110,760
Loan origination and funding fees8,302
 8,680
 24,363
 20,817
6,947
 8,302
 18,489
 24,363
Total single family31,378
 64,296
 135,123
 138,442
36,813
 31,378
 98,147
 135,123
Multifamily2,113
 1,040
 4,747
 3,241
930
 2,113
 2,019
 4,747
Other(101) —
 4,780
 —
Total net gain on mortgage loan origination and sale activities$33,491
 $65,336
 $139,870
 $141,683
$37,642
 $33,491
 $104,946
 $139,870
 
(1)
ComprisedComprised of gains and losses on interest rate lock commitments (which considers the value of servicing), single family loans held for sale, forward sale commitments used to economically hedge secondary market activities, and the estimated fair value of the repurchase or indemnity obligation recognized on new loan sales.
(2)
Represents changes in estimated probable futurethe Company's repurchase losses on previously sold loans.liability for loans that have been sold.


3034




The Company’s portfolio of loans serviced for others is primarily comprised of loans held in U.S. government and agency MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae. Loans serviced for others are not included in the consolidated statements of financial condition as they are not assets of the Company. The composition of loans serviced for others is presented below at the unpaid principal balance.

(in thousands)At September 30,
2013		 At December 31,
2012
September 30, 2014(1)
 At December 31,
2013
      
Single family      
U.S. government and agency$10,950,086
 $8,508,458
$10,007,872
 $11,467,853
Other336,158
 362,230
585,393
 327,768
11,286,244
 8,870,688
10,593,265
 11,795,621
Commercial      
Multifamily722,767
 727,118
703,197
 720,429
Other50,629
 53,235
86,589
 95,673
773,396
 780,353
789,786
 816,102
Total loans serviced for others$12,059,640
 $9,651,041
$11,383,051
 $12,611,723
(1)On June 30, 2014, the Company sold the rights to service $2.96 billion in total unpaid principal balance of single family mortgage loans serviced for Fannie Mae.

The Company has made representations and warranties that the loans sold meet certain requirements. The Company may be required to repurchase mortgage loans or indemnify loan purchasers due to defects in the origination process of the loan, such as documentation errors, underwriting errors and judgments, appraisal errors, early payment defaults and fraud. For further information on the Company's mortgage repurchase liability, see Note 8,7, Commitments, Guarantees and Contingencies. of this Form 10-Q. The following is a summary of changes in the Company's liability for estimated mortgage repurchase losses.

Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Beginning balance$1,810
 $2,119
 $1,955
 $471
Balance, beginning of period$1,235
 $1,810
 $1,260
 $1,955
Additions (1)
505
 1,018
 1,513
 3,624
518
 505
 1,070
 1,513
Realized losses (2)
(717) (1,202) (1,870) (2,160)(86) (717) (663) (1,870)
Balance, end of period$1,598
 $1,935
 $1,598
 $1,935
$1,667
 $1,598
 $1,667
 $1,598
 
(1)Includes additions for new loan sales and changes in estimated probable future repurchase losses on previously sold loans.
(2)Includes principal losses and accrued interest on repurchased loans, “make-whole” settlements, settlements with claimants and certain related expense.

Advances are made to Ginnie Mae mortgage pools for delinquent loan payments. We also fund foreclosure costs and we repurchase loans from Ginnie Mae mortgage pools prior to recovery of guaranteed amounts. Ginnie Mae advances of $7.59.6 million and $5.97.1 million were recorded in accounts receivable and other assets as of September 30, 20132014 and December 31, 20122013, respectively.

When the Company has the unilateral right to repurchase Ginnie Mae pool loans it has previously sold (generally loans that are more than 90 days past due), the Company then records the loan on its consolidated statement of financial condition. At September 30, 20132014 and December 31, 20122013, delinquent or defaulted mortgage loans currently in Ginnie Mae pools that the Company has recognized on its consolidated statements of financial condition totaled $11.813.7 million and $8.014.3 million, respectively, with a corresponding amount recorded within accounts payable and other liabilities on the consolidated statements of financial condition. The recognition of previously sold loans does not impact the accounting for the previously recognized MSRs.


3135


Revenue from mortgage servicing, including the effects of derivative risk management instruments, consisted of the following.
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Servicing income, net:              
Servicing fees and other$8,934
 $7,168
 $24,497
 $20,310
$9,350
 $8,934
 $29,311
 $24,497
Changes in fair value of single family MSRs due to modeled amortization (1)
(5,221) (5,360) (16,896) (14,382)(6,212) (5,665) (19,289) (18,305)
Amortization of multifamily MSRs(433) (598) (1,347) (1,551)(425) (433) (1,283) (1,347)
3,280
 1,210
 6,254
 4,377
2,713
 2,836
 8,739
 4,845
Risk management, single family MSRs:              
Changes in fair value due to changes in model inputs and/or assumptions (2)
(2,900) (5,565) 15,403
 (13,507)899

(2,456) (7,836)
(3) 
16,812
Net gain (loss) from derivatives economically hedging MSR3,631
 4,861
 (12,392) 24,600
2,543
 3,631
 23,381
 (12,392)
731
 (704) 3,011
 11,093
3,442
 1,175
 15,545
 4,420
Mortgage servicing income$4,011
 $506
 $9,265
 $15,470
$6,155
 $4,011
 $24,284
 $9,265
 
(1)Represents changes due to collection/realization of expected cash flows and curtailments.
(2)Principally reflects changes in model assumptions, including prepayment speed assumptions, which are primarily affected by changes in mortgage interest rates.
(3)Includes pre-tax income of $4.7 million, net of brokerage fees and prepayment reserves, resulting from the sale of single family MSRs during the second quarter ended June 30, 2014.

All MSRs are initially measured and recorded at fair value at the time loans are sold. Single family MSRs are subsequently carried at fair value with changes in fair value reflected in earnings in the periods in which the changes occur, while multifamily MSRs are subsequently carried at the lower of amortized cost or fair value.

The fair value of MSRs is determined based on the price that would be received to sell the MSRs in an orderly transaction between market participants at the measurement date. The Company determines fair value using a valuation model that calculates the net present value of estimated future cash flows. Estimates of future cash flows include contractual servicing fees, ancillary income and costs of servicing, the timing of which are impacted by assumptions, primarily expected prepayment speeds and discount rates, which relate to the underlying performance of the loans.

The initial fair value measurement of MSRs is adjusted up or down depending on whether the underlying loan pool interest rate is at a premium, discount or par. Key economic assumptions used in measuring the initial fair value of capitalized single family MSRs were as follows.
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(rates per annum) (1)
2013 2012 2013 20122014 2013 2014 2013
              
Constant prepayment rate ("CPR") (2)
8.39% 11.62% 8.87% 11.11%12.60% 8.39% 12.72% 8.87%
Discount rate10.21% 10.24% 10.25% 10.29%10.27% 10.21% 10.60% 10.25%
 
(1)Weighted average rates for sales during the period for sales of loans with similar characteristics.
(2)Represents the expected lifetime average.


3236


Key economic assumptions and the sensitivity of the current fair value for single family MSRs to immediate adverse changes in those assumptions were as follows.

(dollars in thousands)At September 30, 2013At September 30, 2014
  
Fair value of single family MSR$136,897
$115,477
Expected weighted-average life (in years)6.91
5.20
Constant prepayment rate (1)
11.63%15.46%
Impact on 10% adverse change$(6,893)
Impact on 25% adverse change$(14,523)
Impact on 25 basis points adverse change$(8,343)
Impact on 50 basis points adverse change$(17,045)
Discount rate10.50%10.60%
Impact on fair value of 100 basis points increase$(5,314)$(3,568)
Impact on fair value of 200 basis points increase$(10,232)$(6,927)
 
(1)Represents the expected lifetime average.

These sensitivities are hypothetical and should be used with caution. As the table above demonstrates, the Company’s methodology for estimating the fair value of MSRs is highly sensitive to changes in key assumptions. For example, actual prepayment experience may differ and any difference may have a material effect on MSR fair value. Changes in fair value resulting from changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumption; in reality, changes in one factor may be associated with changes in another (for example, decreases in market interest rates may provide an incentive to refinance; however, this may also indicate a slowing economy and an increase in the unemployment rate, which reduces the number of borrowers who qualify for refinancing), which may magnify or counteract the sensitivities. Thus, any measurement of MSR fair value is limited by the conditions existing and assumptions made as of a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time.

The changes in single family MSRs measured at fair value are as follows.
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Beginning balance$128,146
 $70,585
 $87,396
 $70,169
$108,869
 $128,146
 $153,128
 $87,396
Additions and amortization:       
Originations16,862
 14,121
 50,974
 31,442
11,944
 16,862
 31,664
 50,975
Purchases10
 6
 19
 65
3
 10
 8
 19
Sale of single family MSRs—
 —
 (43,248)
(3 
) 
—
Changes due to modeled amortization(1)
(5,221) (5,360) (16,896) (14,382)(6,212) (5,665) (19,289) (18,305)
Net additions and amortization11,651
 8,767
 34,097
 17,125
5,735
 11,207
 (30,865) 32,689
Changes in fair value due to changes in model inputs and/or assumptions (2)
(2,900) (5,565) 15,404
 (13,507)873
 (2,456) (6,786)
(4 
) 
16,812
Ending balance$136,897
 $73,787
 $136,897
 $73,787
$115,477
 $136,897
 $115,477
 $136,897
 
(1)Represents changes due to collection/realization of expected cash flows and curtailments.
(2)Principally reflects changes in model assumptions, including prepayment speed assumptions, which are primarily affected by changes in mortgage interest rates.
(3)On June 30, 2014, the Company sold the rights to service $2.96 billion in total unpaid principal balance of single family mortgage loans serviced for Fannie Mae.
(4)Includes pre-tax income of $5.7 million, excluding transaction costs, resulting from the sale of single family MSRs on June 30, 2014.

MSRs resulting from the sale of multifamily loans are subsequently carried at the lower of amortized cost or fair value. Multifamily MSRs are recorded at fair value and are amortized in proportion to, and over, the estimated period the net servicing income will be collected.


3337


The changes in multifamily MSRs measured at the lower of amortized cost or fair value were as follows.
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Beginning balance$9,239
 $7,655
 $8,097
 $7,112
$9,122
 $9,239
 $9,335
 $8,097
Origination597
 668
 2,652
 2,164
418
 597
 1,062
 2,652
Amortization(433) (598) (1,346) (1,551)(424) (433) (1,281) (1,346)
Ending balance$9,403
 $7,725
 $9,403
 $7,725
$9,116
 $9,403
 $9,116
 $9,403

At September 30, 20132014, the expected weighted-average life of the Company’s multifamily MSRs was 9.099.30 years. Projected amortization expense for the gross carrying value of multifamily MSRs is estimated as follows.
 
(in thousands)At September 30, 2013At September 30, 2014
  
Remainder of 2013$417
20141,566
Remainder of 2014$399
20151,402
1,551
20161,287
1,441
20171,162
1,319
2018 and thereafter3,569
20181,161
2019 and thereafter3,245
Carrying value of multifamily MSR$9,403
$9,116



34


NOTE 8–7–COMMITMENTS, GUARANTEES AND CONTINGENCIES:

Commitments

Commitments to extend credit are agreements to lend to customers in accordance with predetermined contractual provisions. These commitments may be for specific periods or contain termination clauses and may require the payment of a fee by the borrower. The total amounts of unused commitments do not necessarily represent future credit exposure or cash requirements in that commitments may expire without being drawn upon.

In the ordinary course of business, theThe Company makes certain unfunded loan commitments as part of its residentiallending activities that have not been recognized in the Company’s financial statements. These include commitments to extend credit made as part of the Company's mortgage lending activities generally in the form of a written confirmation fromand interest rate lock commitments on loans the Company intends to the sellerhold in its loans held for investment portfolio. The aggregate amount of a property that we will advance the specified funds enabling the buyer to complete the purchase of the property. Unfundedthese unrecognized unfunded loan commitments totaled $445.8 million ($380.3 million fixed-rate and $65.5 million adjustable-rate commitments)existing at September 30, 2014 and December 31, 2013 was $61.6 million and $768.918.4 million ($746.8 million fixed-rate and $22.1 million adjustable-rate commitments) at December 31, 2012., respectively.

In the ordinary course of business, the Company extends secured and unsecured open-end loans to meet the financing needs of its customers. Commitments related to unused home equity and commercial real estate lines of credit and business banking funding lines totaled $112.2 million and $91.1 million at September 30, 2013 and December 31, 2012, respectively. Undistributed construction loan commitments, where the Company has an obligation to advance funds for construction progress payments, were $97.2327.5 million and $34.5168.5 million at September 30, 20132014 and December 31, 20122013, respectively. Unused home equity and commercial banking funding lines totaled $151.9 million and $154.0 million at September 30, 2014 and December 31, 2013, respectively. The Company has recorded an allowance for credit losses on loan commitments, included in accounts payable and other liabilities on the consolidated statements of financial condition, of $200$264 thousand and $190$181 thousand at September 30, 20132014 and December 31, 20122013, respectively.


38


Guarantees

In the ordinary course of business, the Company sells loans through the Fannie Mae Multifamily Delegated Underwriting and Servicing Program (“DUS®”DUS"®)1 that are subject to a credit loss sharing arrangement. The Company services the loans for Fannie Mae and shares in the risk of loss with Fannie Mae under the terms of the DUS contracts. Under the program, the DUS lender is contractually responsible for the first 5% of losses and then shares equally in the remainder of losses with Fannie Mae with a maximum lender loss of 20% of the original principal balance of each DUS loan. For loans that have been sold through this program, and are no longer on the Company's consolidated statements of financial condition, a liability is recorded for this loss sharing arrangement under the accounting guidance for guarantees. As of September 30, 20132014 and December 31, 20122013, the total unpaid principal balance of loans sold under this program was $722.8$703.2 million and $727.1720.4 million, respectively. The Company’s reserve liability related to this arrangement totaled $2.01.8 million and $3.3$2.0 million at September 30, 20132014 and December 31, 20122013, respectively.. There were no actual losses incurred under this arrangement during the three and nine months ended September 30, 20132014 and 20122013.

Mortgage repurchase liability

In the ordinary course of business, the Company sells residential mortgage loans to GSEs that include the mortgage loans in GSE-guaranteed mortgage securitizations. In addition, the Company poolssells FHA-insured and VA-guaranteed mortgage loans that are sold to Ginnie Mae and are used to back Ginnie Mae-guaranteed securities. The Company has made representations and warranties that the loans sold meet certain requirements. The Company may be required to repurchase mortgage loans or indemnify loan purchasers due to defects in the origination process of the loan, such as documentation errors, underwriting errors and judgments, early payment defaults and fraud.

These obligations expose the Company to any credit loss on the repurchased mortgage loans after accounting for any mortgage insurance that it may receive. Generally, the maximum amount of future payments the Company would be required to make for breaches of these representations and warranties would be equal to the unpaid principal balance of such loans that are deemed to have defects that were sold to purchasers plus, in certain circumstances, accrued and unpaid interest on such loans and certain expenses.

The Company does not typically receive repurchase requests from Ginnie Mae, FHA or VA. As an originator of FHA-insured or VA-guaranteed loans, the Company is responsible for obtaining the insurance with FHA or the guarantee with the VA. If loans are later found not to meet the requirements of FHA or VA, through required internal quality control reviews or through agency audits, the Company may be required to indemnify FHA or VA against losses.  The loans remain in Ginnie Mae pools unless and until they are repurchased by the Company.  In general, once a FHA or VA loan becomes 90 days past due, the Company repurchases the FHA or VA residential mortgage loan to minimize the cost of interest advances on the loan.  If the loan is cured through

1 DUS® is a registered trademark of Fannie Mae
35



borrower efforts or through loss mitigation activities, the loan may be resold into a Ginnie Mae pool. The Company's liability for mortgage loan repurchase losses incorporates probable losses associated with such indemnification.

The total unpaid principal balance of loans sold on a servicing-retained basis that were subject to the terms and conditions of these representations and warranties totaled $11.3410.68 billion and $8.9211.89 billion as of September 30, 20132014 and December 31, 20122013, respectively. At September 30, 20132014 and December 31, 20122013, the Company had recorded a mortgage repurchase liability for loans sold on a servicing-retained and servicing-released basis, included in accounts payable and other liabilities on the consolidated statements of financial condition, of $1.61.7 million and $2.01.3 million, respectively.

Contingencies

In the normal course of business, the Company may have various legal claims and other similar contingent matters outstanding for which a loss may be realized. For these claims, the Company establishes a liability for contingent losses when it is probable that a loss has been incurred and the amount of loss can be reasonably estimated. For claims determined to be reasonably possible but not probable of resulting in a loss, there may be a range of possible losses in excess of the established liability. At September 30, 20132014, we reviewed our legal claims and determined that there were no claims that are considered to be probable or reasonably possible of resulting in a loss. As a result, the Company did not have any amounts reserved for legal claims as of September 30, 20132014.



39


NOTE 9–8–FAIR VALUE MEASUREMENT:

For a further discussion of fair value measurements, including information regarding the Company’s valuation methodologies and the fair value hierarchy, see Note 17,18, Fair Value Measurement within theour 20122013 Annual Report on Form 10-K.

Valuation Processes

The Company has various processes and controls in place to ensure that fair value measurements are reasonably estimated. The Finance Committee provides oversight and approves the Company’s Asset/Liability Management Policy ("ALMP"). The Company's ALMP governs, among other things, the application and control of the valuation models used to measure fair value. On a quarterly basis, the Company’s Asset/Liability Management Committee ("ALCO") and the Finance Committee of the Board review significant modeling variables used to measure the fair value of the Company’s financial instruments, including the significant inputs used in the valuation of single family MSRs. Additionally, at least annually ALCO obtains an independent review of the MSR valuation process and procedures, including a review of the model architecture and the valuation assumptions. The Company obtains an MSR valuation from an independent valuation firm monthly to assist with the validation of the resultsfair value estimate and the reasonableness of the assumptions used in measuring fair value.

The Company’s real estate valuations are overseen by the Company’s appraisal department, which is independent of the Company’s lending and credit administration functions. The appraisal department maintains the Company’s appraisal policy and recommends changes to the policy subject to approval by the Company’s Loan Committee and the Credit Committee of the Board. The Company’s appraisals are prepared by independent third-party appraisers and the Company’s internal appraisers. Single family appraisals are generally reviewed by the Company’s single family loan underwriters. Single family appraisals with unusual, higher risk or complex characteristics, as well as commercial real estate appraisals, are reviewed by the Company’s appraisal department.

We obtain pricing from third party service providers for determining the fair value of a substantial portion of our investment securities available for sale. We have processes in place to evaluate such third party pricing services to ensure information obtained and valuation techniques used are appropriate. For fair value measurements obtained from third party services, we monitor and review the results to ensure the values are reasonable and in line with market experience for similar classes of securities. While the inputs used by the pricing vendor in determining fair value are not provided, and therefore unavailable for our review, we do perform certain procedures to validate the values received, including comparisons to other sources of valuation (if available), comparisons to other independent market data and a variance analysis of prices by Company personnel that are not responsible for the performance of the investment securities.

Estimation of Fair Value

Fair value is based on quoted market prices, when available. In certain cases where a quoted price for an asset or liability is not available, the Company uses valuation models to estimate fair value. These models incorporate inputs such as forward yield curves, loan prepayment assumptions, expected loss assumptions, market volatilities, and pricing spreads utilizing market-

36


basedmarket-based inputs where readily available. The Company believes its valuation methods are appropriate and consistent with those that would be used by other market participants. However, imprecision in estimating unobservable inputs and other factors may result in these fair value measurements not reflecting the amount realized in an actual sale or transfer of the asset or liability in a current market exchange.

The following table summarizes the fair value measurement methodologies, including significant inputs and assumptions, and classification of the Company’s assets and liabilities.


40


Asset/Liability class  Valuation methodology, inputs and assumptions  Classification
Cash and cash equivalents  Carrying value is a reasonable estimate of fair value based on the short-term nature of the instruments.  Estimated fair value classified as Level 1.
Investment securities
Investment securities available for sale  
Observable market prices of identical or similar securities are used where available.
 
If market prices are not readily available, value is based on discounted cash flows using the following significant inputs:
 
•      Expected prepayment speeds
 
•      Estimated credit losses
 
•      Market liquidity adjustments
  Level 2 recurring fair value measurement
Investment securities held to maturityObservable market prices of identical or similar securities are used where available.

If market prices are not readily available, value is based on discounted cash flows using the following significant inputs:

•      Expected prepayment speeds

•      Estimated credit losses

•      Market liquidity adjustments		Carried at amortized cost.

Estimated fair value classified as Level 2.
Loans held for sale      
Single-family loans, including loans transferred from held for investment  
Fair value is based on observable market data, including:
 
•       Quoted market prices, where available
 
•       Dealer quotes for similar loans
 
•       Forward sale commitments
  Level 2 recurring fair value measurement
Multifamily loans  The sale price is set at the time the loan commitment is made, and as such subsequent changes in market conditions have a very limited effect, if any, on the value of these loans carried on the consolidated statements of financial condition, which are typically sold within 30 days of origination.  
Carried at lower of amortized cost or fair value.
 
Estimated fair value classified as Level 2.
Loans held for investment      
Loans held for investment, excluding collateral dependent loans  
Fair value is based on discounted cash flows, which considers the following inputs:
 
•       Current lending rates for new loans
 
•       Expected prepayment speeds
 
•       Estimated credit losses
•       Market liquidity adjustments
  
For the carrying value of loans see Note 1–Summary of Significant Accounting Policieswithin the 2012 Annual Report on of this Form 10-K10-Q..



Estimated fair value classified as Level 3.
Loans held for investment, collateral dependent  
Fair value is based on appraised value of collateral, which considers sales comparison and income approach methodologies. Adjustments are made for various factors, which may include:
 •      Adjustments for variations in specific property qualities such as location, physical dissimilarities, market conditions at the time of sale, income producing characteristics and other factors
•      Adjustments to obtain “upon completion” and “upon stabilization” values (e.g., property hold discounts where the highest and best use would require development of a property over time)
•      Bulk discounts applied for sales costs, holding costs and profit for tract development and certain other properties
  
Carried at lower of amortized cost or fair value of collateral, less the estimated cost to sell.
 
Classified as a Level 3 nonrecurring fair value measurement in periods where carrying value is adjusted to reflect the fair value of collateral.


3741


Asset/Liability class  Valuation methodology, inputs and assumptions  Classification
Mortgage servicing rights      
Single family MSRs  
For information on how the Company measures the fair value of its single family MSRs, including key economic assumptions and the sensitivity of fair value to changes in those assumptions, see Note 76, Mortgage Banking Operations. of this Form 10-Q.
  Level 3 recurring fair value measurement
Multifamily MSRs  Fair value is based on discounted estimated future servicing fees and other revenue, less estimated costs to service the loans.  
Carried at lower of amortized cost or fair value
 
Estimated fair value classified as Level 3.
Derivatives      
Interest rate swaps
Interest rate swaptions
Forward sale commitments
 Fair value is based on quoted prices for identical or similar instruments, when available.
 
When quoted prices are not available, fair value is based on internally developed modeling techniques, which require the use of multiple observable market inputs including:
 
•       Forward interest rates

•       Interest rate volatilities		 Level 2 recurring fair value measurement
Interest rate lock commitments 
The fair value considers several factors including:

•       Fair value of the underlying loan based on quoted prices in the secondary market, when available. 

•       Value of servicing

•       Fall-out factor
 
Level 3 recurring fair value measurement effective December 31, 2012.


Other real estate owned (“OREO”)  Fair value is based on appraised value of collateral.collateral, less the estimated cost to sell. See discussion of "loans held for investment, collateral dependent" above for further information on appraisals.  Carried at lower of amortized cost or fair value of collateral (Level 3), less the estimated cost to sell.
Federal Home Loan Bank stock  Carrying value approximates fair value as FHLB stock can only be purchased or redeemed at par value.  
Carried at par value.
 
Estimated fair value classified as Level 2.
Deposits      
Demand deposits  Fair value is estimated as the amount payable on demand at the reporting date.  
Carried at historical cost.
 
Estimated fair value classified as Level 2.
Fixed-maturity certificates of deposit  Fair value is estimated using discounted cash flows based on market rates currently offered for deposits of similar remaining time to maturity.  
Carried at historical cost.
 
Estimated fair value classified as Level 2.
Federal Home Loan Bank advances  Fair value is estimated using discounted cash flows based on rates currently available for advances with similar terms and remaining time to maturity.  
Carried at historical cost.
 
Estimated fair value classified as Level 2.
Long-term debt  Fair value is estimated using discounted cash flows based on current lending rates for similar long-term debt instruments with similar terms and remaining time to maturity.  
Carried at historical cost.
 
Estimated fair value classified as Level 2.



3842


The following table presents the levels of the fair value hierarchy for the Company’s assets and liabilities measured at fair value on a recurring basis.
 
(in thousands)Fair Value at September 30, 2013 Level 1 Level 2 Level 3Fair Value at September 30, 2014 Level 1 Level 2 Level 3
              
Assets:              
Investment securities available for sale              
Mortgage backed securities:              
Residential$144,263
 $—
 $144,263
 $—
$110,837
 $—
 $110,837
 $—
Commercial13,720
 —
 13,720
 —
13,571
 —
 13,571
 —
Municipal bonds147,441
 —
 147,441
 —
123,042
 —
 123,042
 —
Collateralized mortgage obligations:              
Residential153,466
 —
 153,466
 —
54,888
 —
 54,888
 —
Commercial16,991
 —
 16,991
 —
15,632
 —
 15,632
 —
Corporate debt securities69,963
 —
 69,963
 —
72,112
 —
 72,112
 —
U.S. Treasury securities27,747
 —
 27,747
 —
42,014
 —
 42,014
 —
Single family mortgage servicing rights136,897
 —
 —
 136,897
115,477
 —
 —
 115,477
Single family loans held for sale385,110
 —
 385,110
 —
614,876
 —
 614,876
 —
Derivatives              
Forward sale commitments2,357
 —
 2,357
 —
1,309
 —
 1,309
 —
Interest rate swaptions136
 —
 136
 —
23
 —
 23
 —
Interest rate lock commitments13,753
 —
 —
 13,753
14,074
 —
 —
 14,074
Interest rate swaps4,611
 —
 4,611
 —
3,499
 —
 3,499
 —
Total assets$1,116,455
 $—
 $965,805
 $150,650
$1,181,354
 $—
 $1,051,803
 $129,551
Liabilities:              
Derivatives              
Forward sale commitments$10,871
 $—
 $10,871
 $—
$3,950
 $—
 $3,950
 $—
Interest rate lock commitments76
 —
 —
 76
7
 —
 —
 7
Interest rate swaps13,176
 —
 13,176
 —
4,166
 —
 4,166
 —
Total liabilities$24,123
 $—
 $24,047
 $76
$8,123
 $—
 $8,116
 $7



3943


(in thousands)Fair Value at December 31, 2012 Level 1 Level 2 Level 3Fair Value at December 31, 2013 Level 1 Level 2 Level 3
              
Assets:              
Investment securities available for sale              
Mortgage backed securities:              
Residential$62,853
 $—
 $62,853
 $—
$133,910
 $—
 $133,910
 $—
Commercial14,380
 —
 14,380
 —
13,433
 —
 13,433
 —
Municipal bonds129,175
 —
 129,175
 —
130,850
 —
 130,850
 —
Collateralized mortgage obligations:              
Residential170,199
 —
 170,199
 —
90,327
 —
 90,327
 —
Commercial9,043
 —
 9,043
 —
16,845
 —
 16,845
 —
Corporate debt securities68,866
 —
 68,866
 —
U.S. Treasury securities30,679
 —
 30,679
 —
27,452
 —
 27,452
 —
Single family mortgage servicing rights87,396
 —
 —
 87,396
153,128
 —
 —
 153,128
Single family loans held for sale607,578
 —
 607,578
 —
279,385
 —
 279,385
 —
Derivatives              
Forward sale commitments621
 —
 621
 —
3,630
 —
 3,630
 —
Interest rate swaptions858
 —
 858
 —
Interest rate lock commitments22,548
 —
 —
 22,548
6,012
 —
 —
 6,012
Interest rate swaps538
 —
 538
 —
1,088
 —
 1,088
 —
Total assets$1,135,010
 $—
 $1,025,066
 $109,944
$925,784
 $—
 $766,644
 $159,140
Liabilities:              
Derivatives              
Forward sale commitments$2,743
 $—
 $2,743
 $—
$578
 $—
 $578
 $—
Interest rate swaptions199
 —
 199
 —
Interest rate lock commitments20
 —
 —
 20
40
 —
 —
 40
Interest rate swaps9,358
 —
 9,358
 —
9,548
 —
 9,548
 —
Total liabilities$12,121
 $—
 $12,101
 $20
$10,365
 $—
 $10,325
 $40

There were no transfers between levels of the fair value hierarchy during the three and nine months ended September 30, 20132014 and 20122013.

Level 3 Recurring Fair Value Measurements

The Company's level 3 recurring fair value measurements consist of single family mortgage servicing rights and as of December 31, 2012, interest rate lock commitments, which are accounted for as derivatives. For information regarding fair value changes and activity for single family MSRs during the three and nine months ended September 30, 20132014 and 20122013, see Note 7,6, Mortgage Banking Operations. of this Form 10-Q.


44


The following table presents fair value changes and activity for level 3 interest rate lock commitments.
Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)Three Months Ended
September 30,		 Nine Months Ended
September 30,		2014 2013 2014 2013
          
Beginning balance, net$406
 $22,528
$17,406
 $406
 $5,972
 $22,528
Total realized/unrealized gains(1)
28,538
 102,231
23,844
 28,538
 78,506
 102,231
Settlements(15,267) (111,082)(27,183) (15,267) (70,411) (111,082)
Ending balance, net$13,677
 $13,677
$14,067
 $13,677
 $14,067
 $13,677

(1)
All realized and unrealized gains and losses are recognized in earnings as net gain from mortgage loan origination and sale activities on the consolidated statementstatements of operations. For the three and nine months ended September 30, 2013 thereThere were net unrealized (losses) gains of $405 thousand and $13.3 million for the three months ended $13.3 millionSeptember 30, 2014 and $13.72013, respectively, and $27.3 million and $13.7 million of net unrealized gains (losses) for the nine months ended September 30, 2014 and 2013, respectively, recognized on interest rate lock commitments outstanding at the beginning of the period and still outstanding at September 30, 2014 and 2013., respectively.
In the first quarter of 2013, the Company refined the valuation methodology used for interest rate lock commitments to reflect assumptions that the Company believes a market participant would consider under current market conditions. This change in

40


accounting estimate resulted in an increase in fair value of $4.3 million to the Company's interest rate lock commitments outstanding at March 31, 2013.

The following information presents significant Level 3 unobservable inputs used to measure fair value of interest rate lock commitments.

(dollars in thousands)At September 30, 2013At September 30, 2014
Fair Value 
Valuation
Technique
 
Significant Unobservable
Input
 Low High Weighted AverageFair Value 
Valuation
Technique
 
Significant Unobservable
Input
 Low High Weighted Average
                      
Interest rate lock commitments, net$13,677
 Income approach Fall out factor 0.5% 100.0% 16.4%$14,067
 Income approach Fall out factor 0.63% 79.56% 16.14%
  Value of servicing 0.36% 2.14% 0.98%  Value of servicing 0.51% 2.14% 1.03%

(dollars in thousands)At December 31, 2012
Fair Value 
Valuation
Technique
 
Significant Unobservable
Input
 Low High Weighted Average
            
Interest rate lock commitments, net$22,528
 Income Approach Fall out factor 0.4% 59.3% 16.8%
     Value of servicing 0.50% 2.18% 1.04%
The fair value of interest rate lock commitments decreases in value upon an increase in the fall-out factor and increases in value upon an increase in the value of servicing. Changes in the fall-out factor and value of servicing do not increase or decrease based on movements in the other significant unobservable input.
(dollars in thousands)At December 31, 2013
Fair Value 
Valuation
Technique
 
Significant Unobservable
Input
 Low High Weighted Average
            
Interest rate lock commitments, net$5,972
 Income approach Fall out factor 0.5% 97.0% 17.8%
     Value of servicing 0.62% 2.65% 1.22%

Nonrecurring Fair Value Measurements

Certain assets held by the Company are not included in the tables above, but are measured at fair value on a nonrecurring basis. These assets include certain loans held for investment and other real estate owned that are carried at the lower of cost or fair value of the underlying collateral, less the estimated cost to sell. The estimated fair values of real estate collateral are generally based on internal evaluations and appraisals of such collateral, which use the market approach and income approach methodologies. All impaired loans are subject to an internal evaluation completed quarterly by management as part of the allowance process.

The fair value of commercial properties are generally based on third-party appraisals that consider recent sales of comparable properties, including their income generating characteristics, adjusted (generally based on unobservable inputs) to reflect the general assumptions that a market participant would make when analyzing the property for purchase. The Company uses a fair value of collateral technique to apply adjustments to the appraisal value of certain commercial loans held for investment that are collateralized by real estate. During the three and nine months ended September 30, 2014, the Company recorded no adjustments to the appraisal values of certain commercial loans held for investment that are collateralized by real estate. The Company uses a fair value of collateral technique to apply adjustments to the stated value of certain commercial loans held for investment that are not collateralized by real estate. During the three months ended September 30, 2014, the Company applied a range of stated value adjustments of 0.0% to 98.0%, with a weighted average rate of 18.6%. During the nine months ended September 30, 2014, the Company applied a range of stated value adjustments of 0.0% to 98.0%, with a weighted average rate of 22.5%. During the three months ended September 30, 2014, the Company used a fair value of collateral technique to apply an adjustment to the appraisal value of certain OREO using a range of discount adjustments of 0.0% to 18.0%, with a weighted

45


average rate of 2.5%. During the nine months ended September 30, 2014, the Company applied a range of discount adjustments of 0.0% to 18.0%, with a weighted average rate of 0.4%. During the three and nine months ended September 30, 2013, the Company did not apply any discount adjustments to the appraisal value of loans held for investment or OREO.

Residential properties are generally based on unadjusted third-party appraisals. Factors considered in determining the fair value include geographic sales trends, the value of comparable surrounding properties as well as the condition of the property.

These adjustments may increase or decrease an appraised value and can vary significantly depending on the location, physical characteristics and income producing potential of each individual property. The quality and volume of market information available at the time of the appraisal can vary from period-to-period and cause significant changes to the nature and magnitude of the unobservable inputs used. Given these variations, changes in these unobservable inputs are generally not a reliable indicator for how fair value will increase or decrease from period to period.

The following tables present assets that werehad changes in their recorded at fair value during the three and nine months ended September 30, 20132014 and 20122013 and still held at the end of the respective reporting period.

 Three Months Ended September 30, 2014
(in thousands)Fair Value of Assets Held at September 30, 2014 Level 1 Level 2 Level 3 Total Gains (Losses)
          
Loans held for investment(1)
$22,379
 $—
 $—
 $22,379
 $(82)
Other real estate owned(2)
1,017
 —
 —
 1,017
 (93)
Total$23,396
 $—
 $—
 $23,396
 $(175)

 Three Months Ended September 30, 2013
(in thousands)Fair Value of Assets Held at September 30, 2013 Level 1 Level 2 Level 3 Total Gains (Losses)
          
Loans held for investment(1)
$37,853
 $—
 $—
 $37,853
 $(760)
Other real estate owned(2)
1,847
 —
 —
 1,847
 (174)
Total$39,700
 $—
 $—
 $39,700
 $(934)

Three Months Ended September 30, 2012Nine Months Ended September 30, 2014
(in thousands)Fair Value of Assets Held at September 30, 2012 Level 1 Level 2 Level 3 Total LossesFair Value of Assets Held at September 30, 2014 Level 1 Level 2 Level 3 Total Gains (Losses)
                  
Loans held for investment(1)
$34,699
 $—
 $—
 $34,699
 $(1,817)$25,786
 $—
 $—
 $25,786
 $(495)
Other real estate owned(2)
5,738
 —
 —
 5,738
 (2,464)6,831
 —
 —
 6,831
 (69)
Total$40,437
 $—
 $—
 $40,437
 $(4,281)$32,617
 $—
 $—
 $32,617
 $(564)


4146


 Nine Months Ended September 30, 2013
(in thousands)Fair Value of Assets Held at September 30, 2013 Level 1 Level 2 Level 3 Total Gains (Losses)
          
Loans held for investment(1)
$37,853
 $—
 $—
 $37,853
 $(1,510)
Other real estate owned(2)
10,398
 —
 —
 10,398
 (2,589)
Total$48,251
 $—
 $—
 $48,251
 $(4,099)

 Nine Months Ended September 30, 2012
(in thousands)Fair Value of Assets Held at September 30, 2012 Level 1 Level 2 Level 3 Total Losses
          
Loans held for investment(1)
$35,659
 $—
 $—
 $35,659
 $(5,324)
Other real estate owned(2)
11,035
 —
 —
 11,035
 (5,554)
Total$46,694
 $—
 $—
 $46,694
 $(10,878)
 
(1)Represents the carrying value of loans for which adjustments are based on the fair value of the collateral.
(2)Represents other real estate owned where an updated fair value of collateral is used to adjust the carrying amount subsequent to the initial classification as other real estate owned.

The following table presents significant Level 3 unobservable inputs used to measure fair value on a nonrecurring basis during the nine months ended September 30, 2013 and the three and nine months ended September 30, 2012 for assets still held at the end of the period. For the three months ended September 30, 2013 there were no significant unobservable inputs used to measure fair value on a nonrecurring basis.
(dollars in thousands)
Fair Value of Assets Held at September 30, 2013 (1)
 
Valuation
Technique
 
Significant Unobservable
Input
 
Nine Months Ended September 30,
 2013
   Low High Weighted Average
            
Loans held for investment$14,605
 Market approach 
Comparable sale adjustments(2)
 0% 45% 20%
 14,605
 Income approach Capitalization rate 6.4% 10.8% 8.2%
     Discount rate 8.2% 9.5% 8.9%
Other real estate owned$5,814
 Market approach 
Comparable sale adjustments(2)
 0% 50% 25%

(dollars in thousands)
Fair Value of Assets Held at September 30, 2012 (1)
 
Valuation
Technique
 
Significant Unobservable
Input
 
Three Months Ended September 30,
 2012
   Low High Weighted Average
            
Loans held for investment$34,699
 Market approach 
Comparable sale adjustments(2)
 3% 45% 24%
 10,462
 Income approach Capitalization rate 5.0% 9.0% 7.0%
Other real estate owned$5,738
 Market approach 
Comparable sale adjustments(2)
 1% 13% 7%



42


(dollars in thousands)
Fair Value of Assets Held at September 30, 2012 (1)
 
Valuation
Technique
 
Significant Unobservable
Input
 
Nine Months Ended September 30,
 2012
   Low High Weighted Average
            
Loans held for investment$35,659
 Market approach 
Comparable sale adjustments(2)
 1% 45% 23%
     
Other discounts(3)
 28% 74% 51%
 10,975
 Income approach Capitalization rate 6.0% 11.0% 8.5%
Other real estate owned$11,035
 Market approach 
Comparable sale adjustments(2)
 0% 70% 35%
     
Other discounts(3)
 4% 64% 34%

(1)Assets that are valued using more than one valuation technique are presented within multiple categories for each valuation technique used. Excludes unobservable inputs that we consider, both individually and in the aggregate, to have been insignificant relative to our overall nonrecurring Level 3 measurements recorded during the period.
(2)Represents the range of net adjustments reflecting differences between a comparable sale and the property being appraised, expressed as an absolute value.
(3)Includes bulk sale discounts applied to the aggregate retail value of tract development properties, accelerated marketing period discounts and time-hold or other discounts applied to derive the “as is” market value of certain properties requiring a holding period before reaching a state of feasibility or completion (e.g., “upon completion” or "upon stabilization" value) and management discounts based on the Company's experience with actual liquidation values.

The Company's property appraisals are primarily based on the market approach and income approach methodologies, which consider recent sales of comparable properties, including their income generating characteristics, and then make adjustments to reflect the general assumptions that a market participant would make when analyzing the property for purchase. These adjustments may increase or decrease an appraised value and can vary significantly depending on the location, physical characteristics and income producing potential of each individual property. Additionally, the quality and volume of market information available at the time of the appraisal can vary from period-to-period and cause significant changes to the nature and magnitude of comparable sale adjustments. Given these variations, comparable sale adjustments are generally not a reliable indicator for how fair value will increase or decrease from period to period. Under certain circumstances, management discounts are applied based on specific characteristics of an individual property and the Company's experience with actual liquidation values.

In addition to the instruments disclosed in the table above, certain nonrecurring fair value measurements of residential
properties were based on unadjusted third-party appraisals. Factors considered in determining the fair value include geographic
sales trends, the value of comparable surrounding properties as well as the condition of the property.


43


Fair Value of Financial Instruments

The following presents the carrying value, estimated fair value and the levels of the fair value hierarchy for the Company’s financial instruments other than assets and liabilities measured at fair value on a recurring basis.
 
At September 30, 2013At September 30, 2014
(in thousands)
Carrying
Value
 
Fair
Value
 Level 1 Level 2 Level 3
Carrying
Value
 
Fair
Value
 Level 1 Level 2 Level 3
                  
Assets:                  
Cash and cash equivalents$37,906
 $37,906
 $37,906
 $—
 $—
$34,687
 $34,687
 $34,687
 $—
 $—
Investment securities held to maturity17,852
 18,116
 —
 18,116
 —
Loans held for investment1,510,169
 1,525,432
 —
 —
 1,525,432
1,964,762
 2,006,926
 —
 —
 2,006,926
Loans held for sale - transferred from held for investment30,089
 30,089
 —
 30,089
 —
Loans held for sale – multifamily53,146
 53,147
 —
 53,147
 —
Mortgage servicing rights – multifamily9,403
 10,899
 —
 —
 10,899
9,116
 10,790
 —
 —
 10,790
Federal Home Loan Bank stock35,370
 35,370
 —
 35,370
 —
34,271
 34,271
 —
 34,271
 —
Liabilities:                  
Deposits$2,098,076
 $1,982,714
 $—
 $1,982,714
 $—
$2,425,458
 $2,426,678
 $—
 $2,426,678
 $—
Federal Home Loan Bank advances338,690
 341,555
 —
 341,555
 —
598,590
 601,306
 —
 601,306
 —
Securities sold under agreements to repurchase14,225
 14,225
 —
 14,225
 —
Long-term debt61,857
 60,239
 —
 60,239
 —
61,857
 60,239
 —
 60,239
 —
 
At December 31, 2012At December 31, 2013
(in thousands)
Carrying
Value
 
Fair
Value
 Level 1 Level 2 Level 3
Carrying
Value
 
Fair
Value
 Level 1 Level 2 Level 3
                  
Assets:                  
Cash and cash equivalents$25,285
 $25,285
 $25,285
 $—
 $—
$33,908
 $33,908
 $33,908
 $—
 $—
Investment securities held to maturity17,133
 16,887
 —
 16,887
 —
Loans held for investment1,308,974
 1,340,882
 —
 —
 1,340,882
1,871,813
 1,900,349
 —
 —
 1,900,349
Loans held for sale – multifamily13,221
 14,810
 —
 14,810
 —
556
 556
 —
 556
 —
Mortgage servicing rights – multifamily8,097
 9,497
 —
 —
 9,497
9,335
 10,839
 —
 —
 10,839
Federal Home Loan Bank stock36,367
 36,367
 —
 36,367
 —
35,288
 35,288
 —
 35,288
 —
Liabilities:                  
Deposits$1,976,835
 $1,979,925
 $—
 $1,979,925
 $—
$2,210,821
 $2,058,533
 $—
 $2,058,533
 $—
Federal Home Loan Bank advances259,090
 263,209
 —
 263,209
 —
446,590
 449,109
 —
 449,109
 —
Long-term debt61,857
 60,241
 —
 60,241
 —
64,811
 63,849
 —
 63,849
 —


47


Excluded from the fair value tables above are certain off-balance sheet loan commitments such as unused home equity lines of credit, business banking line funds and undisbursed construction funds. A reasonable estimate of the fair value of these instruments is the carrying value of deferred fees plus the related allowance for credit losses, which amounted to $440 thousand2.5 million and $216977 thousand at September 30, 20132014 and December 31, 20122013, respectively.



44


NOTE 10–9–EARNINGS PER SHARE:

The following table summarizes the calculation of earnings per share for the three and nine months ended September 30, 2013 and 2012.share.
 
For the Three Months Ended
September 30,		 For the Nine Months Ended
September 30,		Three Months Ended September 30, Nine Months Ended September 30,
(in thousands, except share and per share data)2013 2012 2013 20122014 2013 2014 2013
              
Net income$1,662
 $21,991
 $24,670
 $60,628
$4,975
 $1,662
 $16,638
 $24,670
Weighted average shares:              
Basic weighted-average number of common shares outstanding14,388,559
 14,335,950
 14,374,943
 12,960,212
14,805,780
 14,388,559
 14,797,019
 14,374,943
Dilutive effect of outstanding common stock equivalents (1)
402,112
 363,082
 418,484
 454,263
162,458
 402,112
 160,015
 418,484
Diluted weighted-average number of common stock outstanding14,790,671
 14,699,032
 14,793,427
 13,414,475
14,968,238
 14,790,671
 14,957,034
 14,793,427
Earnings per share:              
Basic earnings per share$0.12
 $1.53
 $1.72
 $4.68
$0.34
 $0.12
 $1.12
 $1.72
Diluted earnings per share$0.11
 $1.50
 $1.67
 $4.52
$0.33
 $0.11
 $1.11
 $1.67
 
(1)
Excluded from the computation of diluted earnings per share (due to their antidilutive effect) for the three and nine months ended September 30, 20132014 and 20122013 were certain stock options and unvested restricted stock issued to key senior management personnel and directors of the Company. The aggregate number of common stock equivalents related to such options and unvested restricted shares, which could potentially be dilutive in future periods, was 112,765104,514 and 50,978112,765 at September 30, 20132014 and 20122013, respectively.


NOTE 10–SHARE-BASED COMPENSATION PLANS:

For the three months ended September 30, 2014 and 2013, $416 thousand and $273 thousand of compensation costs, respectively, were recognized for share-based compensation awards. For the nine months ended September 30, 2014 and 2013, $1.1 million and $808 thousand of compensation costs, respectively, was recognized for share-based compensation awards.

2014 Equity Incentive Plan

In May 2014, the shareholders approved the Company's 2014 Equity Incentive Plan (the “2014 EIP”). Under the 2014 EIP, all of the Company’s officers, employees, directors and/or consultants are eligible to receive awards. Awards which may be granted under the 2014 EIP include incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock awards, restricted stock units, unrestricted stock, performance share awards and performance compensation awards. The maximum amount of HomeStreet, Inc. common stock available for grant under the 2014 EIP is 900,000 shares, which includes shares of common stock that were still available for issuance under the 2010 Plan and the 2011 Plan.


48


Nonqualified Stock Options

The Company grants nonqualified options to key senior management personnel. A summary of changes in nonqualified stock options granted for the nine months ended September 30, 2014, is as follows.
 Number 
Weighted
Average
Exercise Price
 
Weighted
Average
Remaining
Contractual
Term (in yrs.)
 
Aggregate
Intrinsic Value (2)
(in thousands)
        
Options outstanding at December 31, 2013654,216
 $11.54
 8.1 $5,559
Cancelled or forfeited(9,688) 11.00
 7.4 59
Exercised(43,504) 2.98
 6.4 734
Options outstanding at September 30, 2014601,024
 12.16
 7.5 3,170
Options that are exercisable and expected to be exercisable (1)
597,664
 12.17
 7.5 3,150
Options exercisable382,539
 $11.64
 7.4 $2,164
(1)Adjusted for estimated forfeitures.
(2)Intrinsic value is the amount by which fair value of the underlying stock exceeds the exercise price.

Under this plan, 43,504 options have been exercised during the nine months ended September 30, 2014, resulting in cash received and related income tax benefits totaling $897 thousand. At September 30, 2014, there was $500 thousand of total unrecognized compensation costs related to stock options. Compensation costs are recognized over the requisite service period, which typically is the vesting period. Unrecognized compensation costs are expected to be recognized over the remaining weighted-average requisite service period of six months.

Restricted Shares

The Company grants restricted shares to key senior management personnel and directors. A summary of the status of restricted shares follows.
 Number 
Weighted
Average
Grant Date Fair Value
    
Restricted shares outstanding at December 31, 201353,951
 $18.18
Granted74,645
 17.99
Vested(8,559) 15.39
Restricted shares outstanding at September 30, 2014120,037
 18.26
Nonvested at September 30, 2014120,037
 $18.26

At September 30, 2014, there was $1.7 million of total unrecognized compensation costs related to nonvested restricted shares. Unrecognized compensation costs are generally expected to be recognized over a weighted average period of 2.3 years. Restricted shares granted to non-employee directors vest one-third at each one year anniversary from the grant date.

Certain restricted stock awards granted to senior management during the second quarter of 2014 contain both service conditions and performance conditions. Performance share units ("PSUs") are stock awards where the number of shares ultimately received by the employee depends on the company’s performance against specified targets and vest over a three-year period. The fair value of each PSU is determined on the grant date, based on the company’s stock price, and assumes that performance targets will be achieved. Over the performance period, the number of shares of stock that will be issued is adjusted upward or downward based upon the probability of achievement of performance targets. The ultimate number of shares issued and the related compensation cost recognized as expense will be based on a comparison of the final performance metrics to the specified targets. Compensation cost will be recognized over the requisite three-year service period on a straight-line basis and adjusted for changes in the probability that the performance targets will be achieved.


49


NOTE 11–BUSINESS SEGMENTS:

The Company's business segments are determined based on the products and services provided, as well as the nature of the related business activities, and they reflect the manner in which financial information is currently evaluated by management.

As a result of a change in the manner in which management evaluates strategic decisions, commencing with the second quarter of 2013, the Company realigned its business segments and organized them into two lines of business: Commercial and Consumer Banking segment and Mortgage Banking segment. In conjunction with this realignment, the Company modified its internal reporting to provide discrete financial information to management for these two business segments. The information that follows has been revised to reflect the current business segments.

A description of the Company's business segments and the products and services that they provide is as follows.

Commercial and Consumer Banking provides diversified financial products and services to our commercial and consumer customers through bank branches and through ATMs, online, mobile and telephone banking. These products and services include deposit products; residential, consumer, business and businessagricultural portfolio loans; non-deposit investment products; insurance products and cash management services. We originate residential and commercial construction loans, bridge loans and permanent loans for our portfolio primarily on single family residences, and on office, retail, industrial and multifamily property types. We originate commercialmultifamily real estate loans including multifamily lending through our Fannie Mae DUS business, whereby loans are sold to or securitized by Fannie Mae, while the Company generally retains the servicing rights. This segment is also responsible for the management of the Company's portfolio of investment securities.

Mortgage Banking originates and purchases single family residential mortgage loans for sale in the secondary markets. We have become a rated originator and servicer of non-conforming jumbo loans, allowing us to sell these loans to other securitizers. We also purchase loans from Windermere Mortgage ServicesWMS Series LLC through a correspondent arrangement with that company. The majority of our mortgage loans are sold to or securitized by Fannie Mae, Freddie Mac or Ginnie Mae, while we retain the right to service these loans. On occasion, we may sell a portion of our MSR portfolio. A small percentage of our loans are brokered to other lenders or sold on a servicing-released basis to correspondent lenders. We manage the loan funding and the interest rate risk associated with the secondary market loan sales and the retained single family mortgage servicing rights within this business segment.


45


Financial highlights by operating segment were as follows.

 Three Months Ended September 30, 2013
(in thousands)
Mortgage
Banking
 
Commercial and
Consumer Banking
 Total
      
Condensed income statement:     
Net interest income (1)
$4,493
 $15,919
 $20,412
(Reversal of) provision for credit losses—
 (1,500) (1,500)
Noninterest income36,945
 1,229
 38,174
Noninterest expense44,539
 13,577
 58,116
Income (loss) before income taxes(3,101) 5,071
 1,970
Income tax expense (benefit)(911) 1,219
 308
Net income (loss)$(2,190) $3,852
 $1,662
Average assets$656,697
 $2,129,597
 $2,786,294


 Three Months Ended September 30, 2012
(in thousands)
Mortgage
Banking
 
Commercial and
Consumer Banking
 Total
      
Condensed income statement:     
Net interest income (1)
$4,424
 $12,096
 $16,520
Provision for credit losses—
 5,500
 5,500
Noninterest income66,617
 2,474
 69,091
Noninterest expense32,632
 13,302
 45,934
Income (loss) before income taxes38,409
 (4,232) 34,177
Income tax expense (benefit)14,090
 (1,904) 12,186
Net income (loss)$24,319
 $(2,328) $21,991
Average assets$670,715
 $1,772,975
 $2,443,690

Nine Months Ended September 30, 2013Three Months Ended September 30, 2014
(in thousands)
Mortgage
Banking
 
Commercial and
Consumer Banking
 Total
Mortgage
Banking
 
Commercial and
Consumer Banking
 Total
          
Condensed income statement:          
Net interest income (1)
$12,375
 $40,687
 $53,062
$5,145
 $20,163
 $25,308
Provision for credit losses—
 900
 900
—
 —
 —
Noninterest income149,517
 5,156
 154,673
42,153
 3,660
 45,813
Noninterest expense127,879
 42,748
 170,627
45,228
 18,930
 64,158
Income before income taxes34,013
 2,195
 36,208
2,070
 4,893
 6,963
Income tax expense (benefit)11,663
 (125) 11,538
Income tax expense629
 1,359
 1,988
Net income$22,350
 $2,320
 $24,670
$1,441
 $3,534
 $4,975
Average assets$641,336
 $1,996,713
 $2,638,049
$697,601
 $2,584,404
 $3,282,005



4650


Nine Months Ended September 30, 2012Three Months Ended September 30, 2013
(in thousands)
Mortgage
Banking
 
Commercial and
Consumer Banking
 Total
Mortgage
Banking
 
Commercial and
Consumer Banking
 Total
          
Condensed income statement:          
Net interest income (1)
$9,697
 $34,454
 $44,151
$4,317
 $16,095
 $20,412
Provision for credit losses—
 7,500
 7,500
Provision (reversal of provision) for credit losses—
 (1,500) (1,500)
Noninterest income158,832
 7,257
 166,089
34,696
 3,478
 38,174
Noninterest expense80,777
 46,848
 127,625
43,468
 14,648
 58,116
Income (loss) before income taxes87,752
 (12,637) 75,115
Income tax expense (benefit)16,935
 (2,448) 14,487
Net income (loss)$70,817
 $(10,189) $60,628
(Loss) income before income taxes(4,455) 6,425
 1,970
Income tax (benefit) expense(1,260) 1,568
 308
Net (loss) income$(3,195) $4,857
 $1,662
Average assets$506,098
 $1,870,076
 $2,376,174
$619,962
 $2,166,332
 $2,786,294

 Nine Months Ended September 30, 2014
(in thousands)
Mortgage
Banking
 
Commercial and
Consumer Banking
 Total
      
Condensed income statement:     
Net interest income (1)
$11,368
 $59,799
 $71,167
Provision (reversal of provision) for credit losses—
 (1,500) (1,500)
Noninterest income120,938
 13,232
 134,170
Noninterest expense124,563
 58,657
 183,220
Income before income taxes7,743
 15,874
 23,617
Income tax expense2,508
 4,471
 6,979
Net income$5,235
 $11,403
 $16,638
Average assets$571,063
 $2,552,154
 $3,123,217

 Nine Months Ended September 30, 2013
(in thousands)
Mortgage
Banking
 
Commercial and
Consumer Banking
 Total
      
Condensed income statement:     
Net interest income (1)
$12,050
 $41,012
 $53,062
Provision for credit losses—
 900
 900
Noninterest income145,083
 9,590
 154,673
Noninterest expense126,215
 44,412
 170,627
Income before income taxes30,918
 5,290
 36,208
Income tax expense10,786
 752
 11,538
Net income$20,132
 $4,538
 $24,670
Average assets$602,443
 $2,025,785
 $2,628,228
 
(1)Net interest income is the difference between interest earned on assets and the cost of liabilities to fund those assets. Interest earned includes actual interest earned on segment assets and, if the segment has excess liabilities, interest credits for providing funding to the other segment. The cost of liabilities includes interest expense on segment liabilities and, if the segment does not have enough liabilities to fund its assets, a funding charge based on the cost of excess liabilities from another segment.



51


NOTE 12–SUBSEQUENT EVENTS:

On November 1, 2013, the Company completed its acquisition of Fortune Bank and YNB Financial Services Corp. (“YNB”), the parent of Yakima National Bank. The Company acquired allhas evaluated subsequent events through the time of the voting equity interests of Fortune Bankfiling this Quarterly Report on Form 10-Q and YNB. Immediately following completion of the acquisitions, YNB was merged into HomeStreet, Inc. Additionally, Fortune Bank and Yakima National Bank were merged into HomeStreet Bank. The combined organization had approximately $3.10 billion in assets on a pro forma basis as of September 30, 2013.
The primary objective for the acquisitions is to grow the Company’s Commercial and Consumer Banking business. Additionally, the acquisition of Yakima National Bank expands the Company's geographic footprint, which is consistent with our ongoing growth strategy. The operating results of the Company for the three months ended September 30, 2013 do not include the operating results of Fortune Bank and YNB as the acquisition did not close until November 1, 2013. It is not practical to present financial information relatedhas concluded that there are no significant events that occurred subsequent to the acquisitions atbalance sheet date but prior to the filing of this time becausereport that would have a material impact on the fair value measurement of assets acquired and liabilities assumed has not been finalized.
On October 24, 2013, the Company announced that its board of directors approved a common stock dividend of $0.11 per share, payable on November 25, 2013 to shareholders of record as of November 4, 2013.consolidated financial statements.



4752


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

This Form 10-Q and the documents incorporated by reference contain, in addition to historical information, “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements relate to our future plans, objectives, expectations, intentions and financial performance, and assumptions that underlie these statements. All statements other than statements of historical fact are “forward-looking statements” for the purposes of these provisions. When used in this Form 10-Q, terms such as “anticipates,” “believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should,” or “will” or the negative of those terms or other comparable terms are intended to identify such forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause industry trends or actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Our actual results may differ significantly from the results discussed in such forward-looking statements.statements, and we may take actions that differ from our current plans and expectations. All statements other than statements of historical fact are “forward-looking statements” for the purposes of these provisions, including:

any projections of revenues, estimated operating expenses or other financial items;
any statements of the plans and objectives of management for future operations or programs;
any statements regarding future operations, plans, or regulatory or shareholder approvals;
any statements concerning proposed new products or services;
any statements regarding pending or future mergers, acquisitions or acquisitions;other transactions; and
any statement regarding future economic conditions or performance, and any statement of assumption underlying any of the foregoing.

These and other forward looking statements are, among other things, attempts to predict the future and, as such, may not come to pass. A wide variety of events, circumstances and conditions may cause us to fall short of management's expectations as expressed herein, or to deviate from the plans and intentions we have described in this report. Some of the factors that may cause us to fall short of expectations or to deviate from our intended courses of action include:

the qualifying disclosures and other factors referenced in this Form 10-Q including, but not limited to, those listed under Item 1A “Risk Factors” and “Management's Discussion and Analysis of Financial Condition and Results of Operations;”
implementation of new capital requirements under the Basel III rules and related regulations;
our ability to manage the credit risks of our lending activities, including potential increases in loan delinquencies, nonperforming assets and write offs, decreased collateral values, inadequate loan reserve amounts and the effectiveness of our hedging strategies;
our ability to grow our geographic footprint and our various lines of business, and to manage that growth effectively, including our effectiveness in managing the associated costs and in generating the expected revenues and strategic benefits;
our ability to complete our pending acquisitionsacquisition, including resolution of any related litigation, and effectively integrate those into
Simplicity with our operations;
our ability to maintain our data security, including unauthorized electronic access, physical custody and inadvertent disclosure, and including potential reputational harm and litigation risks;
our ability to implement and maintain appropriate disclosure controls and procedures and internal controls over financial reporting;
general economic conditions, either nationally or in our market area, including increases in mortgage interest rates, declines in housing refinance activities, employment trends, business contraction, consumer confidence, real estate values and other recessionary pressures;
the impact of and our ability to anticipate and respond effectively to changes in the levels of general interest rates, mortgage interest rates, deposit interest rates, our net interest margin and funding sources;
compliance with regulatory requirements, including laws and regulations such as those related to the Dodd-Frank Act and new rules being promulgated under that Act, Basel III capital requirements and related regulations, as well as

53


restrictions that may be imposed by our federal and state regulatory authorities, including the extent to which regulatory initiatives may affect our capital, liquidity and earnings;
the effect on our mortgage origination and resale operations of changes in mortgage markets generally, including the uncertain impact on the market for non-qualified mortgage loans resulting from regulations takingwhich took effect in January 2014, as well as in monetary policies and economic trends and initiatives as those events affect our mortgage origination and servicing operations;

48


compliance with requirements of investors and/or government-owned or sponsored entities, including Fannie Mae, Freddie Mac, Ginnie Mae, the Federal Housing Administration (the “FHA”) the Department of Housing and Urban Development (“HUD”) and the Department of Veterans' Affairs (the “VA”);
costs associated with the integration of new personnel from growth through acquisitions and hiring initiatives, including increased salary costs, as well as time and attention from our management team that is needed to identify, investigate and successfully complete such acquisitions;
our ability to control costs while meeting operational needs and retaining key members of our senior management team and other key managers and business producers; and
competition.

WeUnless required by law, we do not intend to update any of the forward-looking statements after the date of this report, whetherForm 10-Q to conform these statements to actual results or changes in our expectations or otherwise.expectations. Readers are cautioned not to place undue reliance on these forward-looking statements.statements, which apply only as of the date of this Form 10-Q.

Except as otherwise noted, references to “we,” “our,” “us” or “the Company” refer to HomeStreet, Inc. and its subsidiaries that are consolidated for financial reporting purposes.

You may review a copy of this quarterly report on Form 10-Q, including exhibits and any schedule filed therewith, and obtain copies of such materials at prescribed rates, at the Securities and Exchange Commission's Public Reference Room at, 100 F Street, NE, Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission maintains a website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants, such as HomeStreet, Inc., that file electronically with the Securities and Exchange Commission. Copies of our Securities Exchange Act reports also are available from our investor relations website, http://ir.homestreet.com. Except as otherwise expressly noted in that section of our investor relations website, information contained in or linked from our websites is not incorporated into and does not constitute a part of this report.


4954


Summary Financial Data
 At or for the Quarter Ended 
At or for the Nine
Months Ended
 At or for the Quarter Ended 
At or for the Nine
Months Ended
(dollars in thousands, except share data) Sept. 30,
2013		 Jun. 30,
2013		 Mar. 31,
2013		 Dec. 31,
2012		 Sept. 30,
2012		 Sept. 30,
2013		 Sept. 30,
2012		 Sept. 30,
2014		 Jun. 30,
2014		 Mar. 31,
2014		 Dec. 31,
2013		 Sept. 30,
2013		 Sept. 30,
2014		 Sept. 30,
2013
                            
Income statement data (for the period ended):                            
Net interest income $20,412
 $17,415
 $15,235
 $16,591
 $16,520
 $53,062
 $44,151
 $25,308
 $23,147
 $22,712
 $21,382
 $20,412
 $71,167
 $53,062
(Reversal of) provision for credit losses (1,500) 400
 2,000
 4,000
 5,500
 900
 7,500
Provision (reversal of provision) for credit losses —
 —
 (1,500) —
 (1,500) (1,500) 900
Noninterest income 38,174
 57,556
 58,943
 71,932
 69,091
 154,673
 166,089
 45,813
 53,650
 34,707
 36,072
 38,174
 134,170
 154,673
Noninterest expense 58,116
 56,712
 55,799
 55,966
 45,934
 170,627
 127,625
 64,158
 62,971
 56,091
 58,868
 58,116
 183,220
 170,627
Net income before taxes 1,970
 17,859
 16,379
 28,557
 34,177
 36,208
 75,115
Income tax expense 308
 5,791
 5,439
 7,060
 12,186
 11,538
 14,487
Net income $1,662
 $12,068
 $10,940
 $21,497
 $21,991
 $24,670
 $60,628
Basic earnings per common
share (1)
 $0.12
 $0.84
 $0.76
 $1.50
 $1.53
 $1.72
 $4.68
Diluted earnings per common share (1)
 $0.11
 $0.82
 $0.74
 $1.46
 $1.50
 $1.67
 $4.52
Net income (loss) before tax expense (benefit) 6,963
 13,826
 2,828
 (1,414) 1,970
 23,617
 36,208
Income tax expense (benefit) 1,988
 4,464
 527
 (553) 308
 6,979
 11,538
Net income (loss) $4,975
 $9,362
 $2,301
 $(861) $1,662
 $16,638
 $24,670
Basic earnings (loss) per common share $0.34
 $0.63
 $0.16
 $(0.06) $0.12
 $1.12
 $1.72
Diluted earnings (loss) per common share $0.33
 $0.63
 $0.15
 $(0.06) $0.11
 $1.11
 $1.67
Common shares outstanding (1)
 14,422,354
 14,406,676
 14,400,206
 14,382,638
 14,354,972
 14,422,354
 14,354,972
 14,852,971
 14,849,692
 14,846,519
 14,799,991
 14,422,354
 14,852,971
 14,422,354
Weighted average common shares:                            
Basic 14,388,559
 14,376,580
 14,359,691
 14,371,120
 14,335,950
 14,374,943
 12,960,212
 14,805,780
 14,800,853
 14,784,424
 14,523,405
 14,388,559
 14,797,019
 14,374,943
Diluted 14,790,671
 14,785,481
 14,804,129
 14,714,166
 14,699,032
 14,793,427
 13,414,475
 14,968,238
 14,954,998
 14,947,864
 14,523,405
 14,790,671
 14,957,034
 14,793,427
Shareholders’ equity per share $18.60
 $18.62
 $18.78
 $18.34
 $16.82
 $18.60
 16.82
 $19.83
 $19.41
 $18.42
 $17.97
 $18.60
 $19.83
 18.60
Financial position (at period end):                            
Cash and cash equivalents $37,906
 $21,645
 $18,709
 $25,285
 $22,051
 $37,906
 $22,051
 $34,687
 $74,991
 $47,714
 $33,908
 $37,906
 $34,687
 $37,906
Investment securities available for sale 573,591
 538,164
 415,238
 416,329
 414,050
 573,591
 414,050
Investment securities 449,948
 454,966
 446,639
 498,816
 574,894
 449,948
 574,894
Loans held for sale 385,110
 471,191
 430,857
 620,799
 535,908
 385,110
 535,908
 698,111
 549,440
 588,465
 279,941
 385,110
 698,111
 385,110
Loans held for investment, net 1,510,169
 1,416,439
 1,358,982
 1,308,974
 1,268,703
 1,510,169
 1,268,703
 1,964,762
 1,812,895
 1,662,623
 1,871,813
 1,510,169
 1,964,762
 1,510,169
Mortgage servicing rights 146,300
 137,385
 111,828
 95,493
 81,512
 146,300
 81,512
 124,593
 117,991
 158,741
 162,463
 146,300
 124,593
 146,300
Other real estate owned 12,266
 11,949
 21,664
 23,941
 17,003
 12,266
 17,003
 10,478
 11,083
 12,089
 12,911
 12,266
 10,478
 12,266
Total assets 2,854,323
 2,776,124
 2,508,251
 2,631,230
 2,511,269
 2,854,323
 2,511,269
 3,474,656
 3,235,676
 3,124,812
 3,066,054
 2,854,323
 3,474,656
 2,854,323
Deposits 2,098,076
 1,963,123
 1,934,704
 1,976,835
 1,981,814
 2,098,076
 1,981,814
 2,425,458
 2,417,712
 2,371,358
 2,210,821
 2,098,076
 2,425,458
 2,098,076
FHLB advances 338,690
 409,490
 183,590
 259,090
 131,597
 338,690
 131,597
Federal Home Loan Bank advances 598,590
 384,090
 346,590
 446,590
 338,690
 598,590
 338,690
Repurchase agreements 14,225
 14,681
 —
 —
 —
 14,225
 —
Shareholders’ equity 268,208
 268,321
 270,405
 263,762
 241,499
 268,208
 241,499
 294,568
 288,249
 273,510
 265,926
 268,208
 294,568
 268,208
Financial position (averages):                            
Investment securities available for sale $556,862
 $512,475
 $422,761
 $418,261
 $411,916
 $497,857
 $408,320
Investment securities $457,545
 $447,458
 $477,384
 $565,869
 $556,862
 $460,723
 $497,857
Loans held for investment 1,475,011
 1,397,219
 1,346,100
 1,297,615
 1,270,652
 1,406,582
 1,304,526
 1,917,503
 1,766,788
 1,830,330
 1,732,955
 1,475,011
 1,838,526
 1,406,582
Total interest-earning assets 2,474,397
 2,321,195
 2,244,563
 2,244,727
 2,187,059
 2,347,560
 2,140,383
 2,952,916
 2,723,687
 2,654,078
 2,624,287
 2,474,397
 2,777,988
 2,347,560
Total interest-bearing deposits 1,488,076
 1,527,732
 1,543,645
 1,609,075
 1,625,437
 1,519,615
 1,656,874
 1,861,164
 1,900,681
 1,880,358
 1,662,180
 1,488,076
 1,880,664
 1,519,615
FHLB advances 374,682
 307,296
 147,097
 122,516
 112,839
 277,192
 83,523
Federal Home Loan Bank advances 442,409
 350,271
 323,832
 343,366
 374,682
 372,605
 277,192
Repurchase agreements —
 10,913
 —
 558
 18,478
 3,638
 23,597
 11,149
 1,129
 —
 —
 —
 4,134
 3,638
Total interest-bearing liabilities 2,045,155
 1,917,098
 1,752,599
 1,794,006
 1,818,611
 1,906,023
 1,825,851
 2,376,579
 2,313,937
 2,267,904
 2,232,456
 2,045,155
 2,319,872
 1,906,023
Shareholders’ equity 271,286
 280,783
 274,355
 262,163
 231,361
 275,463
 193,308
 295,229
 284,365
 272,596
 268,328
 271,286
 284,146
 275,463

5055


Summary Financial Data (continued)
 At or for the Quarter Ended At or for the Nine
Months Ended		 At or for the Quarter Ended At or for the Nine
Months Ended		 
(dollars in thousands, except share data) Sept. 30,
2013		 Jun. 30,
2013		 Mar. 31,
2013		 Dec. 31,
2012		 Sept. 30,
2012		 Sept. 30,
2013		 Sept. 30,
2012		 Sept. 30,
2014		 Jun. 30,
2014		 Mar. 31,
2014		 Dec. 31,
2013		 Sept. 30,
2013		 Sept. 30,
2014		 Sept. 30,
2013		 
                             
Financial performance:                             
Return on average common shareholders’
equity (2)
 2.45% 17.19% 15.95% 32.80% 38.02% 11.94% 41.82%
Return on average assets 0.24% 1.86% 1.75% 3.46% 3.60% 1.25% 3.40%
Return on average shareholders’
equity (1)
 6.74% 13.17% 3.38% (1.28)% 2.45% 7.81% 11.94% 
Return on average total assets 0.61% 1.22% 0.30% (0.12)% 0.24% 0.71% 1.25% 
Net interest
margin (3)(2)
 3.41% 3.10% 2.81%
(4) 
3.06% 3.12% 3.12%
(4) 
2.83% 3.50% 3.48% 3.51% 3.34 % 3.41% 3.50% 3.12%
(3) 
Efficiency ratio (5)(4)
 99.20% 75.65% 75.22% 63.22% 53.65% 82.14% 60.70% 90.21% 82.00% 97.69% 102.46 % 99.20% 89.23% 82.14% 
Asset quality:                             
Allowance for credit losses $24,894
 $27,858
 $28,594
 $27,751
 $27,627
 $24,894
 $27,627
 $22,111
 $22,168
 $22,317
 $24,089
 $24,894
 $22,111
 $24,894
 
Allowance for loan losses/total loans 1.61% 1.92% 2.05% 2.06% 2.12% 1.61% 2.12% 1.10%
(5) 
1.19%
(5) 
1.31%
(5) 
1.26 %
(5) 
1.61% 1.10%
(5) 
1.61% 
Allowance for loan losses/nonaccrual loans 92.30% 93.11% 88.40% 92.20% 71.80% 92.30% 71.80% 109.75% 103.44% 96.95% 93.00 % 92.30% 109.75% 92.30% 
Total nonaccrual
loans (6)
 $26,753
 $29,701
 $32,133
 $29,892
 $38,247
 $26,753
 $38,247
 $19,906
(7) 
$21,197
(7) 
$22,823
(7) 
$25,707
(7) 
$26,753
 $19,906
(7) 
$26,753
 
Nonaccrual loans/total loans 1.74% 2.06% 2.32% 2.24% 2.95% 1.74% 2.95% 1.00% 1.16% 1.35% 1.36 % 1.74% 1.00% 1.74% 
Other real estate owned $12,266
 $11,949
 $21,664
 $23,941
 $17,003
 $12,266
 $17,003
 $10,478
 $11,083
 $12,089
 $12,911
 $12,266
 $10,478
 $12,266
 
Total nonperforming assets $39,019
 $41,650
 $53,797
 $53,833
 $55,250
 $39,019
 $55,250
 $30,384
(7) 
$32,280
(7) 
$34,912
(7) 
$38,618
(7) 
$39,019
 $30,384
 $39,019
 
Nonperforming assets/total assets 1.37% 1.50% 2.14% 2.05% 2.20% 1.37% 2.20% 0.87% 1.00% 1.12% 1.26 % 1.37% 0.87% 1.37% 
Net charge-offs $1,464
 $1,136
 $1,157
 $3,876
 $4,998
 $3,757
 $22,673
 $57
 $149
 $272
 $805
 $1,464
 $478
 $3,757
 
Regulatory capital ratios for the Bank:           
 
           
 
 
Tier 1 leverage capital (to average assets) 10.85% 11.89% 11.97% 11.78% 10.86% 10.85% 10.86% 9.63% 10.17% 9.94% 9.96 % 10.85% 9.63% 10.85% 
Tier 1 risk-based capital (to risk-weighted assets) 17.19% 17.89% 19.21% 18.05% 16.76% 17.19% 16.76% 13.03% 13.84% 13.99% 14.12 % 17.19% 13.03% 17.19% 
Total risk-based capital (to risk-weighted assets) 18.44% 19.15% 20.47% 19.31% 18.01% 18.44% 18.01% 13.96% 14.84% 15.04% 15.28 % 18.44% 13.96% 18.44% 
Other data:           

 

           

 

 
Full-time equivalent employees (ending) 1,426
 1,309
 1,218
 1,099
 998
 1,426
 998
 1,598
 1,546
 1,491
 1,502
 1,426
 1,598
 1,426
 

(1)Share and per share data shown after giving effect to the 2-for-1 forward stock splits effective March 6, 2012 and November 5, 2012.
(2)Net earnings available to common shareholders divided by average common shareholders’ equity.
(3)(2)Net interest income divided by total average interest-earning assets on a tax equivalent basis.
(4)(3)
Net interest margin for the first quarter of 2013 included $1.4 million in interest expense related to the correction of the cumulative effect of an error in prior years, resulting from the under accrual of interest due on the Trust Preferred Securities ("TruPS") for which the Company had deferred the payment of interest. Excluding the impact of the prior period interest expense correction, the net interest margin was 3.06% for the quarter ended March 31, 2013 and 3.21% for the nine months ended September 30, 2013.
(5)(4)Noninterest expense divided by total revenue (net interest income and noninterest income).
(5)
Includes loans acquired with bank acquisitions. Excluding acquired loans, allowance for loan losses/total loans was 1.18%, 1.31%, 1.46% and 1.40% at September 30, 2014, June 30, 2014, March 31, 2014 and December 31, 2013, respectively.
(6)Generally, loans are placed on nonaccrual status when they are 90 or more days past due.
(7)
Includes $6.3 million, $6.5 million, $6.6 million and $6.5 million of nonperforming loans at September 30, 2014, June 30, 2014, March 31, 2014 and December 31, 2013, respectively, that are guaranteed by the Small Business Administration ("SBA").


5156



 At or for the Quarter Ended At or for the Nine
Months Ended		 At or for the Quarter Ended At or for the Nine
Months Ended
(in thousands) Sept. 30,
2013		 Jun. 30,
2013		 Mar. 31,
2013		 Dec. 31,
2012		 Sept. 30,
2012		 Sept. 30,
2013		 Sept. 30,
2012		 Sept. 30,
2014		 Jun. 30,
2014		 Mar. 31,
2014		 Dec. 31,
2013		 Sept. 30,
2013		 Sept. 30,
2014		 Sept. 30,
2013
                            
SUPPLEMENTAL DATA:                            
Loans serviced for others                            
Single family $11,286,244
 $10,404,613
 $9,701,396
 $8,870,688
 $8,109,669
 $11,286,244
 $8,109,669
 $10,593,265
 $9,895,074
 $12,198,479
 $11,795,621
 $11,286,244
 $10,593,265
 $11,286,244
Multifamily 722,767
 720,368
 737,007
 727,118
 760,820
 722,767
 760,820
 703,197
 704,997
 721,464
 720,429
 722,767
 703,197
 722,767
Other 50,629
 51,058
 52,825
 53,235
 53,617
 50,629
 53,617
 86,589
 97,996
 99,340
 95,673
 50,629
 86,589
 50,629
Total loans serviced for others $12,059,640
 $11,176,039
 $10,491,228
 $9,651,041
 $8,924,106
 $12,059,640
 $8,924,106
 $11,383,051
 $10,698,067
 $13,019,283
 $12,611,723
 $12,059,640
 $11,383,051
 $12,059,640
                            
Loan production volumes:                            
Single family mortgage closed
loans (1) (2)
 $1,187,061
 $1,307,286
 $1,192,156
 $1,518,971
 $1,368,238
 $3,686,503
 $3,149,196
 $1,294,895
 $1,100,704
 $674,283
 $773,146
 $1,187,061
 $3,069,882
 $3,686,503
Single family mortgage interest rate lock commitments(2)
 786,147
 1,423,290
 1,035,822
 1,254,954
 1,313,182
 3,245,259
 3,531,713
 1,167,677
 1,201,665
 803,308
 662,015
 786,147
 3,172,650
 3,245,259
Single family mortgage loans sold(2)
 1,326,888
 1,229,686
 1,360,344
 1,434,947
 1,238,879
 3,916,918
 2,735,893
 1,179,464
 906,342
 619,913
 816,555
 1,326,888
 2,705,719
 3,916,918
Multifamily mortgage originations 10,734
 14,790
 49,119
 40,244
 20,209
 74,643
 71,830
 60,699
 23,105
 11,343
 16,325
 10,734
 95,147
 74,643
Multifamily mortgage loans sold 21,998
 15,386
 50,587
 33,689
 26,515
 87,971
 85,116
 20,409
 15,902
 6,263
 15,775
 21,998
 42,574
 87,971

(1)Represents single family mortgage closed loanproduction volume designated for sale to the secondary market during each respective period.
(2)Includes loans originated by Windermere MortgageWMS Series Services LLC ("WMS") and purchased by HomeStreet Bank.


5257


This report contains forward-looking statements. For a discussion about such statements, including the risks and uncertainties inherent therein, see “Forward-Looking Statements.” Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes presented elsewhere in this report and in HomeStreet, Inc.'s 20122013 Annual Report on Form 10-K.


Management’s Overview of Third Quarter 20132014 Financial Performance

We are a diversified financial services company founded in 1921 and headquartered in Seattle, Washington, serving customers primarily in the Pacific Northwest, California and Hawaii. HomeStreet, Inc. (the "Company") is principally engaged in real estate lending, including mortgage banking activities, and commercial and consumer banking. Our primary subsidiaries are HomeStreet Bank (the "Bank") and HomeStreet Capital Corporation. The Bank is a Washington state-chartered savings bank that provides residentialmortgage and commercial loans, deposit products and services, non-deposit investment products, private banking and cash management services. Our primary loan products include single family residential mortgages, loans secured by commercial real estate, construction loans for residential and commercial real estate construction,projects, commercial business loans and commercial businessagricultural loans. HomeStreet Capital Corporation, a Washington corporation, originates, sells and services multifamily mortgage loans under the Fannie Mae Delegated Underwriting and Servicing Program (“DUS"®)1in conjunction with HomeStreet Bank. Doing business as HomeStreet Insurance Agency, we provide insurance products and services for consumers and businesses. We also offer single family home loans through our partial ownership in an affiliated business arrangement with WMS Series LLC, whose businesses are known as Windermere Mortgage Services Series LLC (“WMS LLC”).and Penrith Home Loans.

We generate revenue by earning “net interest income” and “noninterest income.” Net interest income is primarily the difference between our interest income earned on loans and investment securities less the interest we pay on deposits and other borrowings. We earn noninterest income from the origination, sale and servicing of loans and from fees earned on deposit services and investment and insurance sales.

At September 30, 20132014, we had total assets of $2.85$3.47 billion,, net loans held for investment of $1.51$1.96 billion,, deposits of $2.1$2.43 billion and shareholders’ equity of $294.6 million.$268.2 million.

On August 15, 2013, the Company paid a common stock dividend of $0.11 per share to shareholders.

On October 25, 2013, the Company announced that its board of directors approved a common stock dividend of $0.11 per share, payable on November 25, 2013 to shareholders of record as of November 4, 2013.

On November 1, 2013, the Company completed its acquisition of Fortune Bank and YNB Financial Services Corp. (“YNB”), the parent of Yakima National Bank. Immediately following completion of the acquisitions, YNB was merged into HomeStreet, Inc. Additionally, Fortune Bank and Yakima National Bank were merged into HomeStreet Bank. The combined organization had approximately $3.10 billion in assets on a pro forma basis as of September 30, 2013.
The acquisition of the two banks, along with the pending acquisition of two retail deposit branches from AmericanWest Bank, increases the Company's total assets by approximately $290 million and the total number of HomeStreet Bank retail deposit branches to 30.

Results for the third quarter of 2013 compared to third quarter of 20122014 reflect the continued growth of our mortgage banking business and investments to expand our commercial and consumer business. Since September 2012,2013, we have increased our lending capacity by adding loan officersorigination and operations personnel in single familyall of our lending commercial real estate lending, and commercial business lending.lines of business. We opened 17 mortgage lending offices, a newadded 19 home loan centers, one commercial lending officecenter, one residential construction center and three new10 retail deposit branches, four de novo and six from acquisitions, to bring our total home loan centers to 55, our total commercial centers to five and our total retail deposit branches to 33.
On September 29, 2014, HomeStreet announced plans to merge with Simplicity Bancorp, Inc., a Maryland corporation and savings and loan holding company headquartered in Covina, California. HomeStreet will be the surviving company in the merger. Immediately following the merger, Simplicity Bank, a federally chartered savings bank branches. In addition, we expanded our rangeinstitution, will merge with HomeStreet Bank with HomeStreet Bank continuing as the resulting bank’s name and brand. The transaction, structured as a stock-for-stock merger, is expected to have a total value of services by addingapproximately $128.0 million as of the announcement date. On a new private banking department.pro forma basis, the combined company will have approximately $4.32 billion in assets, total deposits of approximately $3.09 billion and loans held for investment of approximately $2.69 billion as of September 30, 2014. At the time of the anticipated closing, the combined company is expected to have a network of more than 100 retail deposit branches and stand-alone lending centers in six states. Upon completion of the merger, the resulting bank will operate under the HomeStreet Bank name and brand. The transaction is expected to be completed in the first quarter of 2015, after obtaining certain approvals of the shareholders of each company and the necessary regulatory approvals.

DuringOn January 1, 2015, the quarter,Company and the Bank will become subject to new capital standards commonly referred to as “Basel III” which raise our minimum capital requirements. For more on the Basel III requirements as they apply to us, please see “Capital Management – New Capital Regulations" within the Liquidity and Capital Resources section of this Form 10-Q. In preparation for the higher capital targets under these new regulatory requirements and to better diversify our balance sheet and improve our risk profile, we experienced changes insold single family mortgage loans that previously were held for investment and sold single family mortgage servicing rights during the first half of the year.

We continued to execute our strategy of diversifying earnings by expanding the commercial and consumer banking business; growing our mortgage market associated with elevated mortgage interest rates. Significant decreases in mortgage refinancing activity were only partially offset by a slow-growing purchase mortgage market. We expect to grow our purchase mortgage and overallbanking market share as totalin existing and new markets; growing and improving the quality of our deposits; and bolstering our processing, compliance and risk management capabilities. Despite substantial growth in home loan centers and mortgage market originations declineproduction personnel, our production volume has been less than expected due in part to macroeconomic forces and the mortgage origination market continues to transition away from one dominated by mortgage refinancing, largely due to an increase in interest rates that has made refinancing less attractive in recent months. We continue to focus on the purchase mortgage market by developing additional targeted shared marketing relationships with builders, real estate agents and other real estate professionals and hiring loan officers who have proven track records in generating home purchase mortgage loans.


1 DUS® is a registered trademark of Fannie Mae
5358 



sluggishness in our markets. In recent periods we have experienced very low levels of homes available for sale in many of the markets in which we operate. The lack of housing inventory has had a downward impact on the volume of mortgage loans that we originate.  Further, it has resulted in elevated costs, as a significant amount of loan processing and underwriting that we perform are to qualifying borrowers for mortgage loan transactions that never materialize. The lack of inventory of homes for sale may continue to have an adverse impact on mortgage loan volumes into the foreseeable future.

Consolidated Financial Performance

 At or for the Three Months
Ended September 30,		 Percent Change At or for the Nine Months
Ended September 30,		 Percent Change At or for the Three Months
Ended September 30,		 Percent Change At or for the Nine Months
Ended September 30,		 Percent Change
(in thousands, except per share data and ratios) 2013 2012 2013 vs. 2012 2013 2012 2013 vs. 2012 2014 2013 2014 vs. 2013 2014 2013 2014 vs. 2013
                        
Selected statement of operations data                        
Total net revenue $58,586
 $85,611
 (32)% $207,735
 $210,240
 (1)% $71,121
 $58,586
 21 % $205,337
 $207,735
 (1)%
Total noninterest expense 58,116
 45,934
 27
 170,627
 127,625
 34
 64,158
 58,116
 10
 183,220
 170,627
 7
(Reversal of) provision for credit losses (1,500) 5,500
 NM
 900
 7,500
 (88)
Provision (reversal of provision) for credit losses —
 (1,500) (100) (1,500) 900
 NM
Income tax expense 308
 12,186
 (97) 11,538
 14,487
 (20) 1,988
 308
 545
 6,979
 11,538
 (40)
Net income $1,662
 $21,991
 (92) $24,670
 $60,628
 (59) $4,975
 $1,662
 199 % $16,638
 $24,670
 (33)%
                        
Financial performance                        
Diluted earnings per common share $0.11
 $1.50
 (93)% $1.67
 $4.52
 (63)% $0.33
 $0.11
 

 $1.11
 $1.67
 

Return on average common shareholders’ equity 2.45% 38.02% NM
 11.94% 41.82% NM
 6.74% 2.45% 

 7.81% 11.94%  
Return on average assets 0.24% 3.60% NM
 1.25% 3.40% NM
 0.61% 0.24% 

 0.71% 1.25%  
Net interest margin 3.41% 3.12% NM
 3.12% 2.83% NM
 3.50% 3.41% 

 3.50% 3.12%
(1) 
 
                        
Capital ratios (Bank only)                        
Tier 1 leverage capital (to average assets) 10.85% 10.86% NM
 10.85% 10.86% NM
 9.63% 10.85%   9.63% 10.85%  
Tier 1 risk-based capital (to risk-weighted assets) 17.19% 16.76% NM
 17.19% 16.76% NM
 13.03% 17.19%   13.03% 17.19%  
Total risk-based capital (to risk-weighted assets) 18.44% 18.01% NM
 18.44% 18.01% NM
 13.95% 18.44%   13.95% 18.44%  
NM = Not meaningful            
(1)Net interest margin for the first quarter of 2013 included $1.4 million in interest expense related to the correction of the cumulative effect of an error in prior years, resulting from the under accrual of interest due on the TruPS for which the Company had deferred the payment of interest. Excluding the impact of the prior period interest expense correction, the net interest margin was 3.21% for the nine months ended September 30, 2013.

For the third quarter of 20132014, net income was $5.0 million, or $0.33 per diluted share, compared to $1.7 million, or $0.11$0.11 per diluted share compared with $22.0 million, or $1.50 per diluted share a year ago. Return on equity for the third quarter of 2013. Return on equity was 6.74% for the third quarter of 2014 (on an annualized basis) was 2.45%, compared to 38.02%2.45% for the same period last year, while return on average assets was 0.61% for the third quarter of 20132014 (on an annualized basis) was 0.24%, compared to 3.60%0.24% for the same period a year ago.last year.

Commercial and Consumer Banking Segment Results

Commercial and Consumer Banking segment net income increasedwas $3.5 million in the third quarter of 2014, compared to $3.9$4.9 million in the third quarter of 2013 from a.

Commercial and Consumer Banking segment net lossinterest income was $20.2 million for the third quarter of 2014, an increase of $2.34.1 million, or 25.3%, from $16.1 million for the third quarter of 2013, primarily due to growth in average balances of loans held for investment, both from originations and from our acquisitions in the fourth quarter of 2013.

In recognition of the Company's improving credit trends and lower charge-offs, the Company recorded no provision in the third quarter of 2012, due2014 compared to a reversal to the provision for credit losses and an increase in net interest income, which reflects improvements in our loan credit quality and in our deposit product and pricing strategy. The continued improvement in the compositionrelease of deposits was primarily the result$1.5 million of our successful efforts to attract transaction and savings deposit balances through effective brand marketing and the growth of our retail deposit branch network.

Improved credit quality of the Company's loan portfolio resulted in a $1.5 million reversal to the provision for credit lossesreserves in the third quarter of 2013. Provision of Net charge-offs were $57 thousand

59


$5.5 million was recorded in the third quarter of 20122014. Net charge-offs were $1.5, a decrease of $1.4 million, or 96.1%, from $1.5 million in the third quarter of 2013 compared to $5.0 million in the third quarter of 2012. Overall, the allowance for loan losses (which excludes the allowance for unfunded commitments) was 1.61%1.10% of loans held for investment at September 30, 2014 compared to 1.61% at September 30, 2013, compared to 2.12% at September 30, 2012, reflecting which primarily reflected the improved credit quality of the Company's loan portfolio. Excluding acquired loans, the allowance for loan losses was 1.18% of loans held for investment at September 30, 2014. Nonperforming assets of $39.0$30.4 million,, or 1.37%0.87% of total assets at September 30, 20132014, were down significantly from September 30, 20122013 when nonperforming assets were $55.3$39.0 million,, or 2.20%1.37% of total assets.

Commercial and Consumer Banking segment noninterest expense of $18.9 million increased 2.1% to $13.6$4.3 million, or 29.2%, from $14.6 million in the third quarter of 20122013, primarily relateddue to increased salariescosts from fourth quarter 2013 acquisitions and related costs, reflecting the continued organic growth of our commercial real estate and commercial business lending units and the expansion of our branch banking network. We added 10 retail deposit branches, four de novo and six from acquisitions, and increased the segment's headcount by 20% during the twelve-month period.


54


Mortgage Banking Segment Results

Mortgage Banking segment recordednet income was $1.4 million in the third quarter of 2014, compared to a net loss of $2.2$3.2 million in the third quarter of 2013 compared to. The increase in net income is primarily due to higher noninterest income resulting from higher interest rate lock commitment volumes.

Mortgage Banking noninterest income of $24.3$42.2 million increased $7.5 million, or 21.5%, from $34.7 million in the third quarter of 20122013. The decrease, primarily due to a 48.5% increase in net income was primarily driven by substantially lower mortgage interest rate lock commitment volumes, and lower gain on sale margins. Commitment volume declined due to the rise in mortgage interest rates that caused a significant decrease in refinancing activity that was only partially offset by a slow-growing purchaselower secondary market margins. Increased commitment volumes reflect, in part, sharp increases in market interest rates late in the second quarter of 2013 which negatively impacted third quarter 2013 origination activity. Additionally, we have expanded our mortgage market.production offices and increased our mortgage production personnel by 26.8% at September 30, 2014 compared to September 30, 2013. At the same time, secondary market profit margins have declined, as the mortgage market became substantially more competitive as lenders tried to secure a reliable flow of production through reduced prices. Closed loan volume was, however, substantially higher than the volume of new interest rate lock commitments. This imbalance in the quarter negatively affected earnings, as a majority of our mortgage revenue is recognized at the date of interest rate lock, while a majority of our origination costs, including commissions, are recognized upon funding the loan.competitive pricing.

Mortgage Banking noninterest expense of $45.2 million increased 36.5% to $44.5$1.8 million, or 4.0%, from the third quarter of 2012. The $11.9$43.5 million increase in noninterest expense primarily related to the addition of mortgage originators and mortgage fulfillment personnel as we grow our single family mortgage lending network.

Income Tax Expense

Our consolidated income tax expense was $308 thousand in the third quarter of 2013 compared, primarily due to $12.2 millionhigher commission and incentive expense and general and administrative expenses resulting from a 9.1% increase in closed loan volumes and overall growth in personnel and expansion into new markets. We added 19 home loan centers and increased the third quarter of 2012. Our estimated annual effective income tax rate was 31.9% as compared to an annual effective tax rate of 20.8% for 2012. The lower effective income tax rate in 2012 compared to 2013 primarily reflectedsegment's headcount by 7.7% during the benefit of a full reversal of deferred tax asset valuation allowances during 2012.twelve-month period.

Regulatory Matters

The Bank continued to remainremains well-capitalized, with a Tier 1 leverage capital ratio of 10.85% and total risk-based capital ratioratios at September 30, 2014 of 9.63% and 13.96%, respectively, compared with 10.85% and 18.44% at September 30, 2013. The decline in the Bank's capital ratios from September 30, 2013 was primarily attributable to the fourth quarter 2013 cash acquisitions of Fortune Bank, Yakima National Bank and two branches from AmericanWest Bank, which resulted in $14.4 million of net intangible assets at September 30, 2014 which are not included as capital for regulatory purposes and resulted in an increase in average and risk-weighted assets, as well as overall growth in total risk-weighted assets.

On January 1, 2015, the Company and the Bank will become subject to new capital standards commonly referred to as “Basel III” which raise our minimum capital requirements. For more on the Basel III requirements as they apply to us, please see “Capital Management – New Capital Regulations" within the Liquidity and Capital Resources section of this Form 10-Q. In preparation for the higher capital targets under these new regulatory requirements and to better diversify our balance sheet and improve our risk profile, we sold single family mortgage loans that previously were held for investment and sold single family mortgage servicing rights during the first half of the year.


60


Critical Accounting Policies and Estimates

Our significant accounting policies are fundamental to understanding our results of operations and financial condition because they require that we use estimates and assumptions that may affect the value of our assets or liabilities and financial results. Three of these policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. These policies govern:
Allowance for Loan Losses
Fair Value of Financial Instruments, Single Family MSRsmortgage servicing rights ("MSRs") and other real estate owned ("OREO")
Income Taxes

These policies and estimates are described in further detail in Part II, Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 1, Summary of Significant Accounting Policies within theour 20122013 Annual Report on Form 10-K.


5561


Results of Operations
 
Average Balances and Rates

Average balances, together with the total dollar amounts of interest income and expense, on a tax equivalent basis related to such balances and the weighted average rates, were as follows.

Three Months Ended September 30,Three Months Ended September 30,
2013 20122014 2013
(in thousands)
Average
Balance
 Interest 
Average
Yield/Cost
 
Average
Balance
 Interest 
Average
Yield/Cost
Average
Balance
 Interest 
Average
Yield/Cost
 
Average
Balance
 Interest 
Average
Yield/Cost
                      
Assets:                      
Interest-earning assets: (1)
                      
Cash & cash equivalents$37,671
 $17
 0.24% $50,056
 $24
 0.15%
Cash and cash equivalents$27,631
 $13
 0.19% $37,671
 $17
 0.24%
Investment securities556,862
 4,452
 3.20% 411,916
 3,013
 2.93%457,545
 3,141
 2.72% 556,862
 4,452
 3.20%
Loans held for sale404,853
 4,004
 3.96% 454,435
 4,083
 3.59%550,237
 5,393
 3.89% 404,853
 4,004
 3.96%
Loans held for investment1,475,011
 15,453
 4.18% 1,270,652
 14,464
 4.54%1,917,503
 20,402
 4.22% 1,475,011
 15,453
 4.18%
Total interest-earning assets2,474,397
 23,926
 3.88% 2,187,059
 21,584
 3.94%2,952,916
 28,949
 3.89% 2,474,397
 23,926
 3.88%
Noninterest-earning assets (2)
311,897
     256,631
    329,089
     311,897
    
Total assets$2,786,294
     $2,443,690
    $3,282,005
     $2,786,294
    
Liabilities and shareholders’ equity:                      
Deposits:                      
Interest-bearing demand accounts$254,277
 265
 0.41% $155,947
 128
 0.33%$281,820
 301
 0.42% $254,277
 265
 0.41%
Savings accounts123,444
 140
 0.45% 98,711
 114
 0.46%174,849
 238
 0.54% 123,444
 140
 0.45%
Money market accounts848,300
 1,060
 0.50% 655,123
 857
 0.52%1,001,709
 1,125
 0.45% 848,300
 1,060
 0.50%
Certificate accounts262,055
 663
 0.92% 715,656
 2,809
 1.56%402,786
 700
 0.69% 383,221
 762
 0.79%
Total interest-bearing deposits1,488,076
 2,128
 0.57% 1,625,437
 3,908
 0.96%1,861,164
 2,364
 0.50% 1,609,242
 2,227
 0.57%
FHLB advances374,682
 434
 0.46% 112,839
 297
 1.19%
Federal Home Loan Bank advances442,409
 509
 0.46% 374,682
 434
 0.46%
Securities sold under agreements to repurchase—
 —
 —% 18,478
 19
 0.14%11,149
 6
 0.21% —
 —
 —%
Long-term debt61,231
 274
 1.75% 61,857
 305
 1.97%61,857
 271
 1.74% 61,231
 274
 1.75%
Other borrowings121,166
 99
 0.31% —
 4
 —%—
 20
 —% —
 —
 —%
Total interest-bearing liabilities2,045,155
 2,935
 0.57% 1,818,611
 4,533
 0.99%2,376,579
 3,170
 0.53% 2,045,155
 2,935
 0.57%
Noninterest-bearing liabilities469,853
     393,718
    610,197
     469,853
    
Total liabilities2,515,008
     2,212,329
    2,986,776
     2,515,008
    
Shareholders’ equity271,286
     231,361
    295,229
     271,286
    
Total liabilities and shareholders’ equity$2,786,294
     $2,443,690
    $3,282,005
     $2,786,294
    
Net interest income (3)
  $20,991
     $17,051
    $25,779
     $20,991
  
Net interest spread    3.31%     2.95%    3.36%     3.31%
Impact of noninterest-bearing sources    0.10%     0.17%    0.14%     0.10%
Net interest margin    3.41%     3.12%    3.50%     3.41%
 
(1)The average balances of nonaccrual assets and related income, if any, are included in their respective categories.
(2)Includes former loan balances that have been foreclosed and are now reclassified to OREO.
(3)
Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $579471 thousand and $531579 thousand for the quartersthree months ended September 30, 20132014 and September 30, 20122013, respectively. The estimated federal statutory tax rate was 35% for the periods presented.



5662


Nine Months Ended September 30,Nine Months Ended September 30, 
2013 20122014 2013 
(in thousands)
Average
Balance
 Interest 
Average
Yield/Cost
 
Average
Balance
 Interest 
Average
Yield/Cost
Average
Balance
 Interest 
Average
Yield/Cost
 
Average
Balance
 Interest 
Average
Yield/Cost
 
                       
Assets:                       
Interest-earning assets: (1)
                       
Cash & cash equivalents$27,488
 $46
 0.26% $116,789
 $208
 0.24%
Cash and cash equivalents$30,793
 $45
 0.19% $27,488
 $46
 0.26% 
Investment securities497,857
 11,175
 2.99% 408,320
 8,358
 2.73%460,723
 10,005
 2.90% 497,857
 11,175
 2.99% 
Loans held for sale415,633
 11,218
 3.60% 310,748
 8,544
 3.67%447,946
 12,863
 3.84% 415,633
 11,218
 3.60% 
Loans held for investment1,406,582
 43,795
 4.13% 1,304,526
 43,906
 4.49%1,838,526
 59,089
 4.30% 1,406,582
 43,795
 4.13% 
Total interest-earning assets2,347,560
 66,234
 3.75% 2,140,383
 61,016
 3.80%2,777,988
 82,002
 3.95% 2,347,560
 66,234
 3.75% 
Noninterest-earning assets (2)
280,668
     235,791
    345,229
     280,668
     
Total assets$2,628,228
     $2,376,174
    $3,123,217
     $2,628,228
     
Liabilities and shareholders’ equity:                       
Deposits:                       
Interest-bearing demand accounts$224,942
 656
 0.39% $148,288
 368
 0.33%$268,282
 657
 0.33% $224,942
 656
 0.39% 
Savings accounts114,023
 358
 0.42% 85,376
 290
 0.45%166,896
 657
 0.53% 114,023
 358
 0.42% 
Money market accounts776,267
 2,890
 0.50% 592,195
 2,390
 0.54%969,262
 3,224
 0.44% 776,267
 2,890
 0.50% 
Certificate accounts404,383
 4,080
 1.24% 831,015
 9,937
 1.60%476,224
 2,542
 0.71% 448,315
 4,189
 1.25% 
Total interest-bearing deposits1,519,615
 7,984
 0.69% 1,656,874
 12,985
 1.05%1,880,664
 7,080
 0.50% 1,563,547
 8,093
 0.69% 
FHLB advances277,192
 1,113
 0.53% 83,523
 1,506
 2.40%
Federal Home Loan Bank advances372,605
 1,366
 0.49% 277,192
 1,113
 0.53% 
Securities sold under agreements to repurchase3,638
 11
 0.40% 23,597
 69
 0.39%4,134
 7
 0.23% 3,638
 11
 0.40% 
Long-term debt61,646
 2,274
(3) 
4.86%
(3) 
61,857
 1,041
 2.24%62,469
 851
 1.82% 61,646
 2,274
(3) 
4.86%
(3) 
Other borrowings43,932
 109
 0.31% —
 12
 —%—
 32
 —% —
 —
 —% 
Total interest-bearing liabilities1,906,023
 11,491
 0.79% 1,825,851
 15,613
 1.14%2,319,872
 9,336
 0.54% 1,906,023
 11,491
 0.79% 
Noninterest-bearing liabilities446,742
     357,015
    519,199
     446,742
     
Total liabilities2,352,765
     2,182,866
    2,839,071
     2,352,765
     
Shareholders’ equity275,463
     193,308
    284,146
     275,463
     
Total liabilities and shareholders’ equity$2,628,228
     $2,376,174
    $3,123,217
     $2,628,228
     
Net interest income (4)
  $54,743
     $45,403
    $72,666
     $54,743
   
Net interest spread    2.96%     2.66%    3.41%     2.96% 
Impact of noninterest-bearing sources    0.16%     0.17%    0.09%     0.16% 
Net interest margin    3.12%
(3) 
    2.83%    3.50%     3.12%
(3) 

(1)The average balances of nonaccrual assets and related income, if any, are included in their respective categories.
(2)Includes former loan balances that have been foreclosed and are now reclassified to OREO.
(3)
Interest expense for the nine months ended September 30,first quarter of 2013 included $1.4 million recorded in the first quarter of 2013 related to the correction of the cumulative effect of an immaterial error in prior years, resulting from the under accrual of interest due on our Trust Preferred Securitiesthe TruPS for which the Company had deferred the payment of interest. Excluding the impact of the prior period interest expense correction, the net interest margin was 3.21% for the nine months ended 3.21%September 30, 2013.
(4)
Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities of $1.7$1.5 million and $1.3$1.7 million for the nine months ended September 30, 20132014 and September 30, 20122013, respectively. The estimated federal statutory tax rate was 35% for the periods presented.


5763


Interest on Nonaccrual Loans

We do not include interest collected on nonaccrual loans in interest income. When we place a loan on nonaccrual status, we reverse the accrued unpaid interest receivable against interest income and amortization of any net deferred fees is suspended. Additionally, if ainterest is received on nonaccrual loan is placed back on accrual status or paid off,loans, the accumulated interest collected on the loan is recognized atas an adjustment to the timecost basis of the loan is removed from nonaccrual status.loan. The net increase/(decrease)decrease to interest income due to adjustments made for nonaccrual loans, including the effect of additional interest income that would have been recorded during the period if the loans had been accruing, was $(232)$713 thousand and $95 thousand1.2 million for the three months ended September 30, 20132014 and 20122013, respectively, and $(557) thousand$2.2 million and $(1.0)$3.6 million for the nine months ended September 30, 20132014 and 20122013, respectively.

Net Income

Net income was $5.0 million for the three months ended September 30, 2014, an increase of $3.3 million from net income of $1.7 million for the three months ended September 30, 2013, primarily due to higher average balances of interest-earning assets and higher net gain on mortgage loan origination and sale activities. For the first nine months of 2014, net income was $16.6 million, a decrease of $8.0 million, or 32.6%, from $24.7 million for the first nine months of 2013. The decline in net income from the first nine months of 2013 mainly resulted from a decrease in noninterest income, primarily due to a significantly lower gain on mortgage loan origination and sale activities driven by lower single family interest rate lock commitments. Included in noninterest income for the first nine months of 2014 were a $4.7 million pre-tax net increase in mortgage servicing income resulting from the sale of MSRs and a $4.6 million pre-tax gain on single family mortgage origination and sale activities from the sale of loans that were originally held for investment. No similar transactions occurred in the first nine months of 2013.

Net Interest Income

Our earnings dependprofitability depends significantly on net interest income, which is the difference between income earned on our interest-earning assets, primarily loans and investment securities, and interest paid on interest-bearing liabilities. Our interest-bearing liabilities consist primarily of deposits and borrowed funds, including our outstanding Trust Preferred Securities ("TruPS")trust preferred securities and advances from the Federal Home Loan Bank of Seattle ("FHLB").

Net interest income on a tax equivalent basis was $25.8 million for the $21.0third quarter of 2014, an increase of $4.8 million, or 22.8%, from $21.0 million for the third quarter of 2013, an increase of $3.9 million, or 23.1%, from $17.1 million for the third quarter of 2012. For the first nine months of 2013,2014, net interest income was $54.7$72.7 million,, an increase of $9.3$17.9 million,, or 20.6%32.7%, from $45.4$54.7 million for the first nine months of 2013. The net interest margin for the third quarter of 2014 improved to 3.50% from 3.41% in the same period last year. During the third quarter of 2013, total interest income increasedand improved to 3.50% for the nine months ended $2.3 millionSeptember 30, 2014 from 3.12% for the third quarter of 2012, while total interest expense declined $1.6 million from the third quarter of 2012.same period last year. The net interest margin forincrease from the third quarter of 2013 improved to 3.41%resulted from 3.12%higher yields on higher average balances of loans held for investment. Included in the third quarter of 2012, and improved to 3.12%interest expense for the nine months ended September 30, 2013 was expense of $1.4 million related to the correction of the cumulative effect of an immaterial error in prior years, resulting from 2.83%the under accrual of interest due on the TruPS for which the Company had deferred the payment of interest. Excluding the impact of the prior period interest expense correction, the net interest margin for the same period last year. Improvement in the margin from thenine months ended third quarter of 2012September 30, 2013 resulted from a 42 basis point decline in our average interest-bearing cost of funds, due in large part to the re-pricing of maturing time deposits. This improvement was partially offset by a 6 basis point decline in our yield on interest-earning assets, largely due to increased balances of single family adjustable-rate mortgage loans.3.21%.

Total average interest-earning assets increased from the three and nine months ended September 30, 20122013, primarily as a result of growth in the investment securities portfolio and new portfolio loan originations, being partially offset by a decrease inaverage loans held for sale. The increase in average balances of portfolio loans reflects our year-over-year growth in loan production volumeinvestment, both from all of our commercialoriginations and consumer business lines.from fourth quarter 2013 acquisitions. Total average interest-bearing deposit balances increased from the prior periods mostly as a result of an increaseprimarily due to acquisition-related and organic growth in transaction and savings deposits, partially offset by a decline in higher-cost retail certificates of deposits.

Total interest income on a tax equivalent basis of $23.9$28.9 million in the third quarter of 2014 increased $5.0 million, or 21.0%, from $23.9 million in the third quarter of 2013, increased $2.3 million, or 10.9%, from $21.6 million in the third quarter of 2012, primarily driven by higher average balances of portfolio loans and investment securities. The increase in interest income was also the result of higher yields on higher average balances of investment securities, theloans held for investment. Average balances of whichloans held for investment increased $144.9$442.5 million, or 30.0%, or 35.2%, infrom the third quarter of 2013 from the third quarter of 2012.
These increases were partially offset by increased balances of lower-yielding single family adjustable-rate mortgage loans. Yields on portfolio loans decreased 36 basis points compared to the third quarter of 2012.2013. For the first nine months of 2013,2014, interest income was $66.2$82.0 million,, an increase of $5.2$15.8 million,, or 8.6%23.8%, from $61.0$66.2 million in the same period last year resulting from higher yields on higher average balances of loans held for sale and held for investment and a higher average balance and yield on investment securities.investment.

Total interest expense of $3.2 million in the third quarter of 2014 increased $235 thousand, or 8.0%, from $2.9 million in the third quarter of 2013. Higher average balances of interest-bearing deposits in the third quarter of 2014 were primarily offset by a 7 basis point reduction in the cost of interest-bearing deposits. For the first nine months of 2014, interest expense was $9.3 million, a decrease of $2.2 million, or 18.8%, from $11.5 million in the nine months ended September 30, 2013, reflecting a 19 basis point decrease in the cost of interest-bearing deposits. Included in interest expense for the nine months ended September 30, 2013 was expense of $1.4 million related to the correction of the cumulative effect of an immaterial error in prior years, resulting from the under accrual of interest due on the TruPS for which the Company had deferred the payment of interest.

64



Provision for Credit Losses

In recognition of our improving credit trends and lower charge-offs, we recorded no provision in the third quarter of 2014, compared to a reversal of provision of $1.5 million in the third quarter of 2013. For the nine months ended September 30, 2014, we recorded a reversal of provision of $1.5 million, compared to a provision of $900 thousand during the same period in the prior year. Nonaccrual loans declined to $19.9 million at September 30, 2014, a decrease of $5.8 million, or 22.6%, from $25.7 million at December 31, 2013. Nonaccrual loans as a percentage of total loans was 1.00% at September 30, 2014 compared to 1.36% at December 31, 2013.

Net charge-offs of $2.9 million57 thousand in the third quarter of 20132014 decreasedwere down $1.6 million, or 35.3%, from $4.51.4 million in the third quarter of 2012. This decrease was primarily due to a $453.6 million, or 63.4%, decline in the average balance of higher-yielding certificates of deposit, partially offset by a $98.3 million, or 63.1%, increase in the average balance of lower-cost transaction and savings deposits. Also contributing to the decrease in interest expense in the third quarter of 2013 compared to the third quarter of 2012 was the restructuring of FHLB advances, prepaying certain long-term advances and using short-term FHLB advances to meet short-term mortgage origination and sales funding needs, which contributed to a 73 basis point decline in interest cost on FHLB advances. For the first nine months of 2013, interest expense was $11.5 million, a decrease of $4.1 million, or 26.4%, from $15.6 million in the same period last year, primarily driven by a decline in the average balance of higher-cost certificates of deposit, partially offset by an increase in the average balance of transaction and savings deposits.


58


Provision for Credit Losses

Improved credit quality of the Company's loan portfolio resulted in a $1.5 million reversal to the provision for credit losses in the third quarter of 2013, compared to a provision for credit losses of $5.5 million recorded in the third quarter of 2012. For the first nine months of 2013, loan loss provision was $900 thousand compared to $7.5 million in the same period last year. Nonperforming assets ("NPAs") were $39.0 million at September 30, 2013 compared to $53.8 million at December 31, 2012. Nonaccrual loans of $26.8 million at September 30, 2013 decreased $3.1 million, or 10.5%, from $29.9 million at December 31, 2012.

Netnet charge-offs of $1.5 million in the third quarter of 2013 were down $3.5 million from net charge-offs of $5.0 million in the third quarter of 2012. For the first nine months of 2013,2014, net charge-offs were $3.8 million$478 thousand compared to $22.7$3.8 million in the same period last year. The decrease in net charge-offs in 2013 asthe three and nine months ended September 30, 2014 compared to the same periods of 20122013 was primarily due to lower charge-offs on residentialsingle family and commercial construction loans during 2013.real estate loans. For a more detailed discussion on our allowance for loan losses and related provision for loan losses, see Credit Risk Management within Management’s Discussion and Analysis inof this Form 10-Q.

Noninterest Income

Noninterest income was $45.8 million in the $38.2third quarter of 2014, an increase of $7.6 million, or 20.0%, from $38.2 million in the third quarter of 2013, a decrease of $30.9 million, or 44.7%, from $69.1 million in the third quarter of 2012. For the first nine months of 2013,2014, noninterest income was $154.7$134.2 million,, a decrease of $11.4$20.5 million,, or 6.9%13.3%, from $166.1$154.7 million in the same period last year. Our noninterest income is heavily dependent upon our single family mortgage banking activities, which are comprised of mortgage origination and sale activities andas well as mortgage servicing activities. The level of our mortgage banking activity fluctuates and is influenced by mortgage interest rates, the economy, employment and housing supply and affordability, among other factors. The decreaseincrease in noninterest income in the third quarter of 20132014 as compared to the third quarter of 20122013 was primarily the result of lowerhigher net gain on mortgage loan origination and sale revenue, primarily the result of a 40.1% decrease inactivities due mostly to increased interest rate lock commitments, mostly related to substantially lower refinancing activities.commitment volumes and a $2.1 million increase in mortgage servicing income. Our single family mortgage interest rate lock commitments decreasedof $1.17 billion in the 40.1%third quarter of 2014 increased 48.5% compared to $786.1$786.1 million in the third quarter of 2013 compared to $1.31 billion. Included in noninterest income for the first nine months of 2014 were a $4.7 million pre-tax net increase in mortgage servicing income resulting from the sale of MSRs and a $4.6 million pre-tax gain on single family mortgage origination and sale activities from the sale of loans that were originally held for investment. No similar transactions occurred in the third quarterfirst nine months of 2012.2013.

65


Noninterest income consisted of the following.
 
Three Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
Three Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
(in thousands)2013 2012 2013 2012 2014 2013 2014 2013 
                              
Noninterest income                              
Net gain on mortgage loan origination and sale activities (1)
$33,491
 $65,336
 $(31,845) (49)% $139,870
 $141,683
 $(1,813) (1)%$37,642
 $33,491
 $4,151
 12 % $104,946
(2) 
$139,870
 $(34,924) (25)%
Mortgage servicing income4,011
 506
 3,505
 693
 9,265
 15,470
 (6,205) (40)6,155
 4,011
 2,144
 53
 24,284
(3) 
9,265
 15,019
 162
(Loss) income from Windermere Mortgage Services Series LLC(550) 1,188
 (1,738) NM
 1,063
 3,748
 (2,685) (72)
Income (loss) from WMS Series LLC(122) (550) 428
 (78) (69) 1,063
 (1,132) (106)
Loss on debt extinguishment—
 —
 —
 NM
 —
 (939) 939
 NM
2
 —
 2
 NM
 (573) —
 (573) NM
Depositor and other retail banking fees791
 756
 35
 5
 2,273
 2,262
 11
 —
944
 791
 153
 19
 2,676
 2,273
 403
 18
Insurance commissions242
 192
 50
 26
 612
 551
 61
 11
(Loss) gain on securities available for sale(184) 397
 (581) NM
 6
 1,349
 (1,343) (100)
Insurance agency commissions256
 242
 14
 6
 892
 612
 280
 46
Gain (loss) on securities available for sale480
 (184) 664
 (361) 1,173
 6
 1,167
 19,450
Other373
 716
 (343) (48) 1,584
 1,965
 (381) (19)456
 373
 83
 22
 841
 1,584
 (743) (47)
Total noninterest income$38,174
 $69,091
 $(30,917) (45)% $154,673
 $166,089
 $(11,416) (7)%$45,813
 $38,174
 $7,639
 20 % $134,170
 $154,673
 $(20,503) (13)%
NM = not meaningful      

       
      

       
(1)Single family and multifamily mortgage banking activities.
(2)Includes $4.6 million in pre-tax gain during the first six months of 2014 from the sale of loans that were originally held for investment.
(3)Includes pre-tax income of $4.7 million, net of transaction costs, resulting from the sale of single family MSRs during the quarter ended June 30, 2014.


59


The significant components of our noninterest income are described in greater detail, as follows.

Net gain on mortgage loan origination and sale activities consisted of the following.

 Three Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
(in thousands)2013 2012   2013 2012  
                
Single family:               
Servicing value and secondary marketing gains(1)
$23,076
 $56,142
 $(33,066) (59)% $110,760
 $120,471
 $(9,711) (8)%
Provision for repurchase losses(2)
—
 (526) 526
 (100) —
 (2,846) 2,846
 (100)
Net gain from secondary marketing activities23,076
 55,616
 (32,540) (59) 110,760
 117,625
 (6,865) (6)
Loan origination and funding fees8,302
 8,680
 (378) (4) 24,363
 20,817
 3,546
 17
Total single family31,378
 64,296
 (32,918) (51) 135,123
 138,442
 (3,319) (2)
Multifamily2,113
 1,040
 1,073
 103
 4,747
 3,241
 1,506
 46
Net gain on mortgage loan origination and sale activities$33,491
 $65,336
 $(31,845) (49)% $139,870
 $141,683
 $(1,813) (1)%
 Three Months Ended September 30, 
Dollar 
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
(in thousands)2014 2013   2014 2013  
                
Single family held for sale:               
Servicing value and secondary market gains(1)
$29,866
 $23,076
 $6,790
 29 % $79,658
 $110,760
 $(31,102) (28)%
Loan origination and funding fees6,947
 8,302
 (1,355) (16) 18,489
 24,363
 (5,874) (24)
Total single family held for sale36,813
 31,378
 5,435
 17
 98,147
 135,123
 (36,976) (27)
Multifamily930
 2,113
 (1,183) (56) 2,019
 4,747
 (2,728) (57)
Other(101) —
 (101) NM
 4,780
(2) 
—
 4,780
 NM
Net gain on mortgage loan origination and sale activities$37,642
 $33,491
 $4,151
 12 % $104,946
 $139,870
 $(34,924) (25)%
NM = not meaningful               
 
(1)Comprised of gains and losses on interest rate lock commitments (which considers the value of servicing), single family loans held for sale, forward sale commitments used to economically hedge secondary market activities, and changes in the estimated fair value of theCompany's repurchase or indemnity obligation recognized on new loan sales.liability for loans that have been sold.
(2)Represents changesIncludes $4.6 million in estimated probable future repurchase losses on previously sold loans.pre-tax gain during the first six months of 2014 from the sale of loans that were originally held for investment.


66


Single family production volumes related to loans designated for sale consisted of the following.
 Three Months Ended September 30, 
Dollar
Change
 
Percent
Change
 Nine Months Ended September 30, 
Dollar
Change
 
Percent
Change
(in thousands)2014 2013   2014 2013  
                
Single family mortgage closed loan volume (1)
$1,294,895
 $1,187,061
 $107,834
 9% $3,069,882
 $3,686,503
 $(616,621) (17)%
Single family mortgage interest rate lock commitments (1)
1,167,677
 786,147
 381,530
 49
 3,172,650
 3,245,259
 (72,609) (2)
(1)Includes loans originated by WMS Series LLC and purchased by HomeStreet Bank.

During the third quarter of 2014, single family closed loan production increased 9.1% and single family interest rate lock commitments increased 48.5% compared to the third quarter of 2013. For the first nine months of 2014, single family closed loan production decreased 16.7% and single family interest rate lock commitments decreased 2.2% compared to the same period last year. These decreases were mainly the result of higher mortgage interest rates beginning in the second quarter of 2013 that led to a reduction in refinance mortgage activity since then.

Net gain on mortgage loan origination and sale activities was $37.6 million for the third quarter of 2014, an increase of $4.2 million, or 12.4%, from $33.5 million for the third quarter of 2013, a decrease of $31.8 million, or 48.7%, from $65.3 million for the third quarter of 2012, primarily driven by lower. This increase predominantly reflected higher mortgage loan origination and sale revenue, mostly due to an increase in mortgage interest rates that has led to substantially lower interest rate lock volume and lower profit margins.commitment volumes as a result of the expansion of our mortgage lending operations. Mortgage production personnel grew by approximately 26.8% at September 30, 2014 compared to September 30, 2013.

For the first nine months of 2013,2014, net gain on mortgage loan origination and sale activities was $139.9$104.9 million,, a decrease of $1.8$34.9 million,, or 1.3%25.0%, from $141.7$139.9 million in the same period last year. Significant decreases in mortgage refinance activities were partially offset by a slow growing mortgage purchase market and the expansion of our mortgage lending operations as we added approximately 80operations. Included in net gain on mortgage production personnel duringloan origination and sale activities for the first nine months of 2013.2014 was a $4.6 million pre-tax gain on single family mortgage origination and sale activities from the sale of loans that were originally held for investment.

Single family production volumes related to loans designated for sale consisted of the following.
 Three Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
(in thousands)2013 2012   2013 2012  
                
Production volumes:               
Single family mortgage closed loan volume (1) (2)
$1,187,061
 $1,368,238
 $(181,177) (13)% $3,686,503
 $3,149,196
 $537,307
 17 %
Single family mortgage interest rate lock commitments (2)
786,147
 1,313,182
 (527,035) (40) 3,245,259
 3,531,713
 (286,454) (8)
(1)Represents single family mortgage originations designated for sale during each respective period.
(2)Includes loans originated by Windermere Mortgage Series Services LLC ("WMS") and purchased by HomeStreet Bank.

During the third quarter of 2013, single family closed loan production decreased 13.2% and single family interest rate lock commitments decreased 40.1% as compared to the third quarter of 2012. For the first nine months of 2013, single family closed loan production increased 17.1% and single family interest rate lock commitments decreased 8.1% as compared to the same period last year. Our production mix continued to shift to the purchase mortgage market during the third quarter of 2013, as interest rate lock commitments were comprised of 80% purchase and 20% refinance mortgage transactions.


60


The Company records a liability for estimated mortgage repurchase losses, which has the effect of reducing net gain on mortgage loan origination and sale activities. The following table presents the effect of changes in the Company's mortgage repurchase liability within the respective line items of net gain on mortgage loan origination and sale activities. For further information on the Company's mortgage repurchase liability, see Note 7, Commitments, Guarantees and Contingencies in this Form 10-Q.
 Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 2012
        
Effect of changes to the mortgage repurchase liability:       
Servicing value and secondary marketing gains(1)
$(505) $(492) $(1,513) $(776)
Provision for repurchase losses(2)
—
 (526) —
 (2,848)
 $(505) $(1,018) $(1,513) $(3,624)
 Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2014 2013 2014 2013
        
Effect of changes to the mortgage repurchase liability recorded in net gain on mortgage loan origination and sale activities:       
New loan sales (1)
$(518) $(505) $(1,070) $(1,513)
 $(518) $(505) $(1,070) $(1,513)
 
(1)Represents the estimated fair value of the repurchase or indemnity obligation recognized as a reduction of proceeds on new loan sales.
(2)Represents changes in estimated probable future repurchase losses on previously sold loans.

67

For further information on the Company's mortgage repurchase liability, see Note 8, Commitments, Guarantees and Contingencies in this Form 10-Q.

Mortgage servicing income consisted of the following.

Three Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
Three Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
(in thousands)2013 2012 2013 2012 2014 2013 2014 2013 
                              
Servicing income, net:                              
Servicing fees and other$8,934
 $7,168
 $1,766
 25 % $24,497
 $20,310
 $4,187
 21 %$9,350
 $8,934
 $416
 5 % $29,311
 $24,497
 $4,814
 20 %
Changes in fair value of MSRs due to modeled amortization (1)
(5,221) (5,360) 139
 (3) (16,896) (14,382) (2,514) 17
(6,212) (5,665) (547) 10
 (19,289) (18,305) (984) 5
Amortization(433) (598) 165
 (28) (1,347) (1,551) 204
 (13)
Amortization of multifamily MSRs(425) (433) 8
 (2) (1,283) (1,347) 64
 (5)
3,280
 1,210
 2,070
 171 % 6,254
 4,377
 1,877
 43 %2,713
 2,836
 (123) (4) 8,739
 4,845
 3,894
 80
Risk management:                              
Changes in fair value of MSRs due to changes in model inputs and/or assumptions (2)
(2,900) (5,565) $2,665
 (48)% 15,403
 (13,507) $28,910
 (214)%899
 (2,456) 3,355
 (137) (7,836)
(3) 
16,812
 (24,648) (147)
Net gain from derivatives economically hedging MSRs3,631
 4,861
 (1,230) (25) (12,392) 24,600
 (36,992) (150)
Net gain (loss) from derivatives economically hedging MSRs2,543
 3,631
 (1,088) (30) 23,381
 (12,392) 35,773
 (289)
731
 (704) 1,435
 NM
 3,011
 11,093
 (8,082) (73)3,442
 1,175
 2,267
 193
 15,545
 4,420
 11,125
 252
Mortgage servicing income$4,011
 $506
 $3,505
 693 % $9,265
 $15,470
 $(6,205) (40)%$6,155
 $4,011
 $2,144
 53 % $24,284
 $9,265
 $15,019
 162 %
NM = not meaningful                              

(1)
Represents changes due to collection/realization of expected cash flows and curtailments.
(2)
Principally reflects changes in model assumptions, including prepayment speed assumptions, which are primarily affected by changes in mortgage interest rates.
(3)Includes pre-tax income of $4.7 million, net of brokerage fees and prepayment reserves, resulting from the sale of single family MSRs during the during the quarter ended June 30, 2014.

For the third quarter of 20132014, mortgage servicing income was $4.06.2 million, an increase of $3.5$2.1 million, or 53.5%, from $506 thousand$4.0 million in the third quarter of 20122013, primarily driven by increased servicing fees collected in the quarter on the Company's single family mortgage servicing anddue to improved mortgage servicing rights ("MSR") risk management results.

For the first nine months of 2013, mortgage servicing income was $9.3 million, a decrease of $6.2 million from $15.5 million in the first nine months of 2012. This decrease was primarily due to MSR risk management results which representsrepresent changes in the fair value of single family MSRs due to changes in model inputs and assumptions net of the gain/(loss) from derivatives economically hedging MSRs. The fair value of MSRs is sensitive to changes in interest rates, primarily due to the effect on prepayment speeds. MSRs typically decrease in value when interest rates decline because declining interest rates tend to increase mortgage prepayment speeds and therefore reduce the expected life of the net servicing cash flows of the MSR asset. Certain other changes in MSR fair value relate to factors other than interest rate changes and are generally not within the scope

61


of the Company's MSR economic hedging strategy. These factors may include but are not limited to the impact of changes to the housing price index, the level of home sales activity, changes to mortgage spreads, valuation discount rates, costs to service and policy changes by U.S. government agencies.

The net performance of theour MSR risk management activities for the third quarter of 20132014 was a gain of $731 thousand$3.4 million compared to a lossgain of $704 thousand$1.2 million in the third quarter of 20122013. For the first nine months of 2013, the net performance of the MSR risk management activities was a gain of $3.0 million compared to a gain of $11.1 million for the same period last year. The lowerhigher hedging gain in 20132014 largely reflects lowerreflected higher sensitivity to interest rates for the Company's MSRs, which enabledled the Company toreduce increase the notional amount of derivative instruments used to economically hedge MSRs. The lowerhigher notional amount of derivative instruments, along with a flattersteeper yield curve, resulted in lowerhigher net gains from MSR risk management, which negativelypositively impacted mortgage servicing income. In addition, MSR risk management results for 20132014 reflectreflected the impact on the fair value of MSRs due toof changes in model inputs and assumptions related to factors other than interest rate changes. Such factors included changes to the FHA streamlined refinance program and higher expected home values, both of which generally lead to higherhistorically low prepayment speeds experienced during 2014 resulting in lower projected prepayment speeds, and a decline in income from MSR risk management activities in 2013.speeds.

Mortgage servicing fees collected in the third quarter of 20132014 were $8.9$9.4 million,, an increase of $1.8 million,$416 thousand, or 24.6%4.7%, from $7.2$8.9 million in the third quarter of 20122013. Our loans serviced for others portfolio increasedwas $11.38 billion at September 30, 2014 compared to $12.61 billion at $12.06December 31, 2013 and $12.06 billion at September 30, 2013 from $9.65. The lower balance at quarter end was the result of the June 30, 2014 sale of the rights to service $2.96 billion at December 31, 2012 and $8.92 billion at September 30, 2012. of single family mortgage loans. Mortgage servicing fees collected in future periods will be negatively impacted in the short term because the balance of the loans serviced for others portfolio was reduced as a consequence of this sale.


68


(Loss) incomeIncome (loss) from Windermere Mortgage ServicesWMS Series LLC in the third quarter of 20132014 was a loss of $550$122 thousand compared to incomea loss of $1.2 million$550 thousand in the third quarter of 20122013. The decreaseimprovement in 20132014 was primarily due to decreaseda 3.6% increase in interest rate lock commitments and a 24.4% decrease in closed loan volume, which were$114.7 million and $145.8 million, respectively, for the three months ended September 30, 2014 compared to $110.7 million and $192.9 million, respectively, for the three months ended September 30, 2013 compared to $224.1 million and $268.4 million, respectively, for the same period in 20122013.

Depositor and other retail banking fees for the three and nine months ended September 30, 2014 increased from the three and nine months ended September 30, 2013 were relatively consistent with 2012 results., primarily driven by an increase in the number of transaction accounts as we grow our retail deposit branch network. The following table presents the composition of depositor and other retail banking fees for the periods indicated.
 
Three Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
Three Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
(in thousands)2013 2012 2013 2012 2014 2013 2014 2013 
                              
Fees:                              
Monthly maintenance and deposit-related fees$387
 $387
 $—
 — % $1,106
 $1,157
 $(51) (4)%$423
 $387
 $36
 9 % $1,241
 $1,106
 $135
 12 %
Debit Card/ATM fees381
 340
 41
 12
 1,104
 1,030
 74
 7
511
 381
 130
 34
 1,397
 1,104
 293
 27
Other fees23
 29
 (6) (21) 63
 75
 (12) (16)10
 23
 (13) (57) 38
 63
 (25) (40)
Total depositor and other retail banking fees$791
 $756
 $35
 5 % $2,273
 $2,262
 $11
 — %$944
 $791
 $153
 19 % $2,676
 $2,273
 $403
 18 %

Noninterest Expense

Noninterest expense was $64.2 million in the $58.1third quarter of 2014, an increase of $6.0 million, or 10.4%, from $58.1 million in the third quarter of 2013, an increase of $12.2 million, or 26.5%, from $45.9 million in the third quarter of 2012. For the first nine months of 2013,2014, noninterest expense was $170.6$183.2 million,, an increase of $43.0$12.6 million,, or 33.7%7.4%, from $127.6$170.6 million for the same period last year. The increase in noninterest expense in the third quarter of 2014was primarily the result of increased salarya $2.9 million increase in salaries and related costs, a $1.5 million increase in occupancy, and a $1.1 million increase in general and administrative expenses resulting fromcosts. The increase in noninterest expense for the three and nine months of 2014 compared to prior year was primarily a result of the integration of our acquisitions and a 12.1% growth in personnel as we continue to expandin connection with our continued expansion of our mortgage banking and commercial and consumer businesses. These additions to personnel were partially offset by attrition and position eliminations in mortgage production, mortgage operations, and in commercial lending and administration. We have been eliminating positions since the fourth quarter of 2013 in response to a slowdown in mortgage activity as well as the integration of our acquisitions and we expect such eliminations to improve efficiency and performance.


62


Noninterest expense consisted of the following.
Three Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
Three Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
(in thousands)2013 2012 2013 2012 2014 2013 2014 2013 
                              
Noninterest expense                              
Salaries and related costs$39,689
 $31,573
 $8,116
 26 % $113,330
 $81,148
 $32,182
 40 %$42,604
 $39,689
 $2,915
 7 % $118,681
 $113,330
 $5,351
 5 %
General and administrative9,234
 7,148
 2,086
 29
 30,434
 19,304
 11,130
 58
10,326
 9,234
 1,092
 12
 31,593
 30,434
 1,159
 4
Legal844
 312
 532
 171
 2,054
 1,471
 583
 40
630
 844
 (214) (25) 1,571
 2,054
 (483) (24)
Consulting884
 1,069
 (185) (17) 2,343
 1,746
 597
 34
628
 884
 (256) (29) 2,182
 2,343
 (161) (7)
Federal Deposit Insurance Corporation assessments227
 794
 (567) (71) 937
 2,751
 (1,814) (66)682
 227
 455
 200
 1,874
 937
 937
 100
Occupancy3,484
 2,279
 1,205
 53
 9,667
 6,160
 3,507
 57
4,935
 3,484
 1,451
 42
 14,042
 9,667
 4,375
 45
Information services3,552
 2,411
 1,141
 47
 10,122
 6,128
 3,994
 65
4,220
 3,552
 668
 19
 13,597
 10,122
 3,475
 34
Net cost of operation and sale of other real estate owned202
 348
 (146) (42) 1,740
 8,917
 (7,177) (80)133
 202
 (69) (34) (320) 1,740
 (2,060) (118)
Total noninterest expense$58,116
 $45,934
 $12,182
 27 % $170,627
 $127,625
 $43,002
 34 %$64,158
 $58,116
 $6,042
 10 % $183,220
 $170,627
 $12,593
 7 %


69


The significant components of our noninterest expense are described in greater detail, as follows.

Salaries and related costs were $42.6 million in the $39.7third quarter of 2014, an increase of $2.9 million, or 7.3%, from $39.7 million in the third quarter of 2013, an increase of $8.1 million, or 25.7%, from $31.6 million in the third quarter of 2012. For the first nine months of 2013,2014, salaries and related costs were $113.3$118.7 million,, an increase of $32.2$5.4 million,, or 39.7%4.7%, from $81.1$113.3 million for the same period last year. The increaseThese increases primarily resulted from a $7.2 million and $30.9 million12.1% increase in salaries and related costs, including commissions, for the third quarter and first nine months of 2013, respectively, due to the overall growth in our mortgage lending and commercial and consumer business lines. Atfull-time equivalent employees at September 30, 2013, we had increased our full-time equivalent employees by 42.9%2014 fromcompared to September 30, 20122013.

General and administrative expense was $10.3 million in the $9.2third quarter of 2014, an increase of $1.1 million, or 11.8%, from $9.2 million in the third quarter of 2013, an increase of $2.1 million, or 29.2%, from $7.1 million in the third quarter of 2012. For the first nine months of 2013,2014, general and administrative expenses were $30.4$31.6 million,, an increase of $11.1$1.2 million,, or 57.7%3.8%, from $19.3$30.4 million for the same period last year. These expenses include general office and equipment expense, marketing, taxes and insurance. The increase in general and administrative expense was primarily due to Company growth and increased marketing expenses.

Income Tax Expense

IncomeThe Company's income tax expense was $308 thousand in$2.0 million inclusive of discrete items, representing an income tax rate of 28.6% for the third quarter of 2014. In the third quarter of 2013, the Company’s tax expense was $308 thousand, inclusive of discrete items, representing an effective rate of 15.6%. For the first nine months of 2014, income tax expense was $7.0 million, inclusive of discrete items, compared to $12.2$11.5 million, in inclusive of discrete items, for the third quarter of 2012.same period last year. Our estimated annual effective income tax rate was 31.9% as29.6%, inclusive of discrete items, for the nine months ended September 30, 2014, compared to an annual effective tax rate of 31.6% for the year end 20.8%2013 for 2012. The lower. Our effective income tax rate in 2012 primarily reflectedthe three and nine months ended September 30, 2014 differed from the Federal statutory tax rate of 35% due to the benefit of a full reversaltax-exempt interest income, the benefit of deferredlow income housing tax asset valuation allowances during 2012.credit investments, and the impact of updated state income tax for Oregon, Hawaii, California, and Idaho.  Included in income tax expense for the first nine months of 2014 are $613 thousand of discrete tax items related to the adoption of ASU 2014-01, recorded in the first quarter, and federal return to provision true ups and updates to the effective state tax rate.


Review of Financial Condition – Comparison of September 30, 20132014 to December 31, 20122013

Total assets were $2.85$3.47 billion at September 30, 20132014 and $2.63$3.07 billion at December 31, 20122013. The increase in total assets was primarily due to a $157.3$418.2 million increase in investment securitiesloans held for sale and a $201.2$92.9 million increase in portfolio loans held for investment, partially offset by a $235.7$48.9 million decrease in investment securities. The increase in loan balances was the result of the organic growth of the Company, partially offset by the transfer of $310.5 million of single family mortgage loans out of the held for investment portfolio and into loans held for sale.sale in March of this year and the subsequent sale of $266.8 million of these loans.

Cash and cash equivalents was $37.9$34.7 million at September 30, 20132014 compared to $25.3$33.9 million at December 31, 20122013, an increase of $12.6 million,$779 thousand, or 49.9%2.3%.

Investment securities available for sale were $573.6$449.9 million at September 30, 20132014 compared to $416.3$498.8 million at December 31, 20122013, an increasea decrease of $157.3$48.9 million, or 9.8%, or 37.8%. The higher balanceprimarily due to sales of our investment securities portfolio reflects management's decision in the second quarter of 2013 to increase this component of the overall asset mix and to add corporate debt securities to the Company's portfolio. With the Company's improved credit position and excess capital, the investment in corporate debt securities provides diversification in the portfolio with minimal additional credit risk.securities.

We primarily hold investment securities for liquidity purposes, while also creating a relatively stable source of interest income. We designated substantially all securities as available for sale. We held securities having a carrying value of $17.9 million at September 30, 2014, which were designated as held to maturity.


70


The following table details the composition of our our investment securities available for sale by dollar amount and as a percentage of the total available for sale securities portfolio.
 

63


At September 30, 2013 At December 31, 2012At September 30, 2014 At December 31, 2013
(in thousands)Fair Value Percent Fair Value PercentFair Value Percent Fair Value Percent
              
Investment securities available for sale:              
Mortgage-backed securities:              
Residential$144,263
 25.2% $62,853
 15.1%$110,837
 25.7% $133,910
 27.8%
Commercial13,720
 2.4
 14,380
 3.5
13,571
 3.1
 13,433
 2.8
Municipal bonds147,441
 25.7
 129,175
 31.0
123,042
 28.5
 130,850
 27.2
Collateralized mortgage obligations:  
   
  
   
Residential153,466
 26.8
 170,199
 40.9
54,888
 12.7
 90,327
 18.8
Commercial16,991
 3.0
 9,043
 2.2
15,632
 3.6
 16,845
 3.5
Corporate debt securities69,963
 12.2
 —
 —
72,112
 16.7
 68,866
 14.3
U.S. Treasury securities27,747
 4.8
 30,679
 7.4
42,014
 9.7
 27,452
 5.7
Total investment securities available for sale$573,591
 100.0% $416,329
 100.0%$432,096
 100.0% $481,683
 100.0%
 
Loans held for sale were $385.1$698.1 million at September 30, 20132014 compared to $620.8$279.9 million at December 31, 20122013, a decreasean increase of $235.7$418.2 million,, or 38.0%149.4%. Loans held for sale include single family and multifamily residential loans, typically sold within 30 days of closing the loan. The decreaseincrease in the loans held for sale wasbalance is primarily the result of risingdue to increased single family mortgage interest rates and declining refinancingclosed loan volume coupled with low housing inventories that have constrainedduring the purchase mortgage market.quarter.

Loans held for investment, net were $1.51$1.96 billion at September 30, 20132014 compared to $1.31$1.87 billion at December 31, 20122013, ana increase of $201.2$92.9 million,, or 15.4%5.0%. Our single family loan portfolio increased $145.1decreased $116.7 million from December 31, 20122013, as the Company transferred $310.5 million of single family mortgage loans out of the portfolio and into loans held for sale in March of this year. Our construction loans, including commercial construction and residential construction, increased $167.3 million from December 31, 2013, primarily as a result of increasedfrom new originations of mortgages that exceed conventional conforming loan limits. Ourin our commercial real estate and multifamily loan balances increased a combinedresidential construction lending business.

Mortgage servicing rights $63.4were $124.6 million at September 30, 2014 fromcompared to $162.5 million at December 31, 20122013 as we continued, a decrease of $37.9 million, or 23.3%. The decline in the size of our servicing portfolio was the result of a strategic decision to growsell a portion of our commercial real estate lending business. These increases were partially offset by a $12.0 million decreasesingle family MSRs to increase capital in commercial businesspreparation for compliance with the new Basel III regulatory capital standards. During the second quarter of 2014, the Company sold the rights to service $2.96 billion of single family mortgage loans as unscheduled payoffs were greater than loan originations during the first nine months of 2013.serviced for Fannie Mae.


71


The following table details the composition of our loans held for investment portfolio by dollar amount and as a percentage of our total loan portfolio.

At September 30, 2013 At December 31, 2012At September 30, 2014 At December 31, 2013
(in thousands)Amount Percent Amount PercentAmount Percent Amount Percent
              
Consumer loans              
Single family$818,992
 53.2% $673,865
 50.3%$788,232
 39.6% $904,913
 47.7%
Home equity129,785
 8.4
 136,746
 10.2
138,276
 6.9
 135,650
 7.1
948,777
 61.6
 810,611
 60.5
926,508
 46.5
 1,040,563
 54.8
Commercial loans              
Commercial real estate (1)
400,150
 26.0
 361,879
 27.0
530,335
 26.6
 477,642
 25.1
Multifamily42,187
 2.7
 17,012
 1.3
62,498
 3.1
 79,216
 4.2
Construction/land development79,435
 5.2
 71,033
 5.3
297,790
 15.0
 130,465
 6.9
Commercial business67,547
 4.5
 79,576
 5.9
173,226
 8.8
 171,054
 9.0
589,319
 38.4
 529,500
 39.5
1,063,849
 53.5
 858,377
 45.2
1,538,096
 100.0% 1,340,111
 100.0%1,990,357
 100.0% 1,898,940
 100.0%
Net deferred loan fees and costs(3,233)   (3,576)  (3,748)   (3,219)  
1,534,863
   1,336,535
  1,986,609
   1,895,721
  
Allowance for loan losses(24,694)   (27,561)  (21,847)   (23,908)  
$1,510,169
   $1,308,974
  $1,964,762
   $1,871,813
  
 
(1)
September 30, 20132014 and December 31, 20122013 balances comprised of $95.3$137.5 million and $94.9156.7 million of owner occupied loans, respectively, and $304.9392.8 million and $267.0320.9 million of non-owner occupied loans, respectively.

Accounts receivable and other assetsDeposits was $128.9 millionwere $2.43 billion at September 30, 20132014 compared to $88.8 million$2.21 billion at December 31, 20122013, an increase of $40.1 million, or 45.2%. This increase was primarily due to a $10.6 million investment in an affordable

64


housing project and an increase in cash provided to counterparties as collateral for derivative positions used to hedge our mortgage servicing rights and mortgage banking activities. A receivable is recorded for the amount of cash delivered as collateral.

Deposits were $2.10 billion at September 30, 2013 compared to $1.98 billion at December 31, 2012, an increase of $121.2$214.6 million, or 6.1%9.7%. This increase was due to higher balances of transaction and savings deposits, which were $1.42$1.77 billion at September 30, 20132014, an increase of $375.2$234.8 million,, or 35.9%15.3%, from $1.05$1.54 billion at December 31, 20122013. Largely offsetting, reflecting the increases in transactionorganic growth and savings deposits was the managed reductionexpansion of certificatesour branch banking network. Certificates of deposit balances which were $460.2$367.1 million at September 30, 20132014, a decrease of $195.2$147.3 million,, or 30%28.6%, from $655.5$514.4 million at December 31, 20122013. This improvement in the composition of deposits was primarily the result of our successful efforts to attract transaction and savings deposit balances through effective brand marketing.

The following table details the composition of our depositsDeposit balances by dollar amount and as a percentage of our total deposits.deposits were as follows for the periods indicated:

(in thousands) At September 30, 2013 At December 31, 2012 At September 30, 2014 At December 31, 2013
 Amount Percent Amount Percent Amount Percent Amount Percent
                
Deposits by Product:        
Noninterest-bearing accounts - checking and savings $134,725
 6% $83,563
 4% $271,669
 11.2% $199,943
 9.0%
Interest-bearing transaction and savings deposits:                
NOW accounts 272,029
 13
 174,699
 9
 300,832
 12.4
 262,138
 11.9
Statement savings accounts due on demand 135,428
 7
 103,932
 5
 184,656
 7.6
 156,181
 7.1
Money market accounts due on demand 879,122
 42
 683,906
 35
 1,015,266
 41.9
 919,322
 41.6
Total interest-bearing transaction and savings deposits 1,286,579
 62
 962,537
 49
 1,500,754
 61.9
 1,337,641
 60.6
Total transaction and savings deposits 1,421,304
 68
 1,046,100
 53
 1,772,423
 73.1
 1,537,584
 69.6
Certificates of deposit 460,223
 22
 655,467
 33
 367,124
 15.1
 514,400
 23.3
Noninterest-bearing accounts - other 216,549
 10
 275,268
 14
 285,911
 11.8
 158,837
 7.1
Total deposits $2,098,076
 100% $1,976,835
 100% $2,425,458
 100.0% $2,210,821
 100.0%

Federal Home Loan Bank advances were $338.7$598.6 million at September 30, 20132014 compared to $259.1$446.6 million at December 31, 20122013, an increase of $79.6$152.0 million,, or 30.7%34.0%. The increase was the result of higher overall asset balances, as the Company uses these borrowings to primarily fund our mortgage banking and securities investment activities.


72


Accounts payable and other liabilitiesLong-term debt were $87.5was $61.9 million at September 30, 20132014 compared to $69.7$64.8 million at December 31, 20122013, an increasea decrease of $17.8$3.0 million,, or 25.6%4.6%. This increase was primarily due to the change in the fair value of derivatives used for MSR risk management, partially offset byDuring the first quarter 2013 payment of $13.52014, we redeemed $3.0 million of TruPS that were acquired as part of the acquisition of YNB in net deferred interest payable due on its outstanding TruPS.2013.

Shareholders’ Equity

Shareholders' equity was $268.2$294.6 million at September 30, 20132014 compared with $263.8to $265.9 million at December 31, 20122013. This increase included net income of $24.7$16.6 million, partially offset by a and other comprehensive lossincome of $18.3$11.5 million recognized during the nine months ended September 30, 20132014. The, partially offset by dividend payments of $1.6 million during the first quarter of 2014. Other comprehensive lossincome represents unrealized lossesgains in the valuation of our investment securities portfolio at September 30, 20132014 as a result of the increase in interest rates experienced in the latter part of the second quarter of 2013..

On August 29, 2013, the Company paid a common stock dividend of $0.11 per share payable to shareholders of record as of August 5, 2013.

As a result of the above, shareholders’Shareholders’ equity, on a per share basis, increased towas $18.6019.83 per share at September 30, 20132014, up from $18.34compared to $17.97 per share at December 31, 20122013.


65


Return on Equity and Assets

The following table presents certain information regarding our returns on average equity and average total assets. Return on equity ratios for the periods shown may not be comparable due to the impact and timing of the Company's initial public offering of common stock completed in February 2012 and changes in the annual effective income tax rate between periods. During 2012, the Company benefited from the full reversal of its deferred tax asset valuation allowances.
 
At or for the Three Months
Ended September 30,		 At or for the Nine Months
Ended September 30,		At or for the Three Months
Ended September 30,		 At or for the Nine Months
Ended September 30,
2013 2012 2013 20122014 2013 2014 2013
              
Return on assets (1)
0.24% 3.60% 1.25% 3.40%0.61% 0.24% 0.71% 1.25%
Return on equity (2)
2.45% 38.02% 11.94% 41.82%6.74% 2.45% 7.81% 11.94%
Equity to assets ratio (3)
9.74% 9.47% 10.48% 8.14%9.00% 9.74% 9.10% 10.48%
 
(1)Net income (annualized) divided by average total assets (annualized).assets.
(2)Net incomeearnings (loss) available to common shareholders (annualized) divided by average equity (annualized).common shareholders’ equity.
(3)Average equity divided by average total assets.

Business Segments

The Company's business segments are determined based on the products and services provided, as well as the nature of the related business activities, and they reflect the manner in which financial information is currently evaluated by management.

As a resultThis process is dynamic and is based on management's current view of a change in the manner in which management evaluates strategic decisions, commencingCompany's operations and is not necessarily comparable with the second quarter of 2013, the Company realigned itssimilar information for other financial institutions. We define our business segments by product type and organized them into two lines of business: Commercialcustomer segment. If the management structure or the allocation process changes, allocations, transfers and Consumer Banking and Mortgage Banking. In conjunction with this realignment, the Company modified its internal reporting to provide discrete financial information to management for these two business segments.assignments may change. The information that follows has been revised to reflect the current business segments.

A description of the Company's business segments and the products and services that they providemanner in which financial information is as follows.currently evaluated by management.

Commercial and Consumer Banking Segment

Commercial and Consumer Banking provides diversified financial products and services to our commercial and consumer customers through bank branches and through ATMs, online, mobile and telephone banking. These products and services include deposit products; residential, consumer, business and businessagricultural portfolio loans; non-deposit investment products; insurance products and cash management services. We originate residential and commercial construction loans, bridge loans and permanent loans for our portfolio primarily on single family residences, and on office, retail, industrial and multifamily property types. We originate commercialmultifamily real estate loans including multifamily lending through our Fannie Mae DUS business, whereby loans are sold to or securitized by Fannie Mae, while the Company generally retains the servicing rights. As of September 30, 20132014, our bank branch network consists of 2333 branches primarily in the Pacific Northwest and Hawaii. At September 30, 20132014 and December 31, 20122013, our transaction and savings deposits totaled $1.42$1.77 billion and $1.05$1.54 billion, respectively, and our loan portfolio totaled $1.511.96 billion and $1.311.87 billion, respectively. This segment is also responsible for the management of the Company's portfolio of investment securities.


6673


Commercial and Consumer Banking segment results are detailed below.

Three Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
Three Months Ended
September 30,		  
Change		 
Percent
Change
 Nine Months Ended
September 30,		 

Change
 
Percent
Change
(in thousands)2013 2012 2013 2012 2014 2013 2014 2013 
                              
Net interest income$15,919
 $12,096
 $3,823
 32 % $40,687
 $34,454
 $6,233
 18 %$20,163
 $16,095
 $4,068
 25 % $59,799
 $41,012
 $18,787
 46 %
(Reversal of) provision for credit losses(1,500) 5,500
 (7,000) NM
 900
 7,500
 (6,600) (88)
Provision for credit losses—
 (1,500) 1,500
 (100) (1,500) 900
 (2,400) NM
Noninterest income1,229
 2,474
 (1,245) (50) 5,156
 7,257
 (2,101) (29)3,660
 3,478
 182
 5
 13,232
(1) 
9,590
 3,642
 38
Noninterest expense13,577
 13,302
 275
 2
 42,748
 46,848
 (4,100) (9)18,930
 14,648
 4,282
 29
 58,657
 44,412
 14,245
 32
Income (loss) before income taxes5,071
 (4,232) 9,303
 NM
 2,195
 (12,637) 14,832
 NM
Income (loss) before income tax expense (benefit)4,893
 6,425
 (1,532) (24) 15,874
 5,290
 10,584
 200
Income tax expense (benefit)1,219
 (1,904) 3,123
 NM
 (125) (2,448) 2,323
 (95)1,359
 1,568
 (209) (13) 4,471
 752
 3,719
 495
Net income (loss)$3,852
 $(2,328) $6,180
 NM
 $2,320
 $(10,189) $12,509
 NM
$3,534
 $4,857
 $(1,323) (27)% $11,403
 $4,538
 $6,865
 151
                              
Average assets$2,129,597
 $1,772,975
 $356,622
 20 % $1,996,713
 $1,870,076
 $126,637
 7 %$2,584,404
 $2,166,332
 $418,072
 19 % $2,552,154
 $2,025,785
 $526,369
 26 %
Pre-tax pre-provision profit (loss) (1)
3,571
 1,268
 2,303
 182
 3,095
 (5,137) 8,232
 NM
Efficiency ratio (2)
79.18% 91.30% NM
 NM
 93.25% 112.32% NM
 NM
79.46% 74.84%     80.32% 87.77%    
Full-time equivalent employees (ending)504
 377
 NM
 34
 504
 377
 NM
 34
605
 504
 101
 20
 605
 504
 101
 20
Multifamily net gain on mortgage loan origination and sale activity$2,113
 $1,040
 1,073
 103
 $4,747
 $3,241
 1,506
 46
Net gain on mortgage loan origination and sale activities:               
Multifamily930
 2,113
 (1,183) —
 2,019
 4,747
 (2,728) —
Other(101) —
 (101) NM 4,780
(1) 
—
 4,780
 NM
$829
 $2,113
 $(1,284) $—
 $6,799
 $4,747
 $2,052
 $—
                              
Production volumes:                              
Multifamily mortgage originations10,734
 20,209
 (9,475) (47) 74,643
 71,830
 2,813
 4
60,699
 10,734
 49,965
 465
 95,147
 74,643
 20,504
 27
Multifamily mortgage loans sold21,998
 26,515
 (4,517) (17) 87,971
 85,116
 2,855
 3
$20,409
 $21,998
 $(1,589) (7)% $42,574
 $87,971
 $(45,397) (52)%
NM = not meaningful                              

(1)
Pre-tax pre-provision profit is total net revenue (net interest income and noninterest income) less noninterest expense. The Company believesIncludes $4.6 million in pre-tax gain during the first six months of 2014 from the sale of loans that this financial measure is useful in assessing the ability of a lending institution to generate income in excess of its provisionwere originally held for credit losses.investment.
(2)
Noninterest expense divided by total net revenue (net interest income and noninterest income).

Commercial and Consumer Banking net income was $3.5 million for the $3.9third quarter of 2014, a decrease of $1.3 million from net income of $4.9 million for the third quarter of 2013, improved by $6.2 million from a. The decrease in net loss of $2.3 million forincome in the third quarter of 20122014. was primarily the result of a $1.5 million reversal of provision in the third quarter of 2013 compared to no provision recorded in the third quarter of 2014 as well as higher salaries and related costs and other expenses in the third quarter of 2014 related to fourth quarter 2013 acquisitions and organic growth. These were partially offset by a $4.1 million increase in net interest income, resulting from higher average balances of interest-earning assets related to our fourth quarter 2013 acquisitions. For the first nine months of 2013,2014, Commercial and Consumer Banking had net income of $2.3was $11.4 million,, improved by $12.5$6.9 million, from a net loss of $10.2$4.5 million for the first nine months of 20122013. Included in net income for the first nine months of 2014 was a $4.6 million pre-tax gain on single family mortgage origination and sale activities resulting from the sales of loans in the first half of 2014 that were originally designated as held for investment.

. ImprovedIn recognition of our improving credit quality of the Company's loan portfolio resulted in a $1.5 million reversal to thetrends and lower charge-offs, we recorded no provision for credit losses in the third quarter of 20132014, compared to a reversal of provision of $5.5$1.5 million in the third quarter of 20122013. Additionally,For the increasenine months ended September 30, 2014, we recorded a reversal of provision of $1.5 million, compared to a provision of $900 thousand during the same period in net income in 2013 was the result of an increase in net interest income, which reflects improvements in our deposit product and pricing strategy. That strategy resulted in our reducing higher-cost deposits and converting customers with maturing certificates of deposit to transaction and savings deposits.prior year.



6774


Commercial and Consumer Banking segment servicing income consisted of the following.

Three Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
Three Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
(in thousands)2013 2012 2013 2012 2014 2013 2014 2013 
                              
Servicing income, net:                              
Servicing fees and other$789
 $1,017
 $(228) (22)% $2,341
 $2,569
 $(228) (9)%$1,289
 $789
 $500
 63 % $3,196
 $2,341
 $855
 37 %
Amortization of multifamily MSRs(433) (598) 165
 (28) (1,347) (1,551) 204
 (13)(425) (433) 8
 (2) (1,283) (1,347) 64
 (5)
Commercial mortgage servicing income$356
 $419
 $(63) (15)% $994
 $1,018
 $(24) (2)%$864
 $356
 $508
 143 % $1,913
 $994
 $919
 92 %


Commercial and Consumer Banking segment loans serviced for others consisted of the following.

(in thousands)At September 30,
2013		 At December 31,
2012		At September 30,
2014		 At December 31,
2013
      
Commercial   
Multifamily$722,767
 $727,118
$703,197
 $720,429
Other50,629
 53,235
86,589
 95,673
Total commercial loans serviced for others$773,396
 $780,353
$789,786
 $816,102

Commercial and Consumer Banking segment noninterest expense of $13.6$18.9 million increased $275 thousand,$4.3 million, or 2.1%29.2%, from $13.3$14.6 million in the third quarter of 20122013, primarily due to increased salaries and related costs, reflecting the growth of our commercial real estate and commercial business lending units and the expansion of our branch banking network.network, including growth through acquisitions.


Mortgage Banking Segment

Mortgage Banking originates and purchases single family residential mortgage loans for sale in the secondary markets. We have become a rated originator and servicer of non-conforming jumbo loans, allowing us to sell these loans to other securitizers. We also purchase loans from Windermere Mortgage ServicesWMS Series LLC through a correspondent arrangement between HomeStreet Bank andwith that company. The majority of our mortgage loans are sold to or securitized by Fannie Mae, Freddie Mac or Ginnie Mae, while we retain the right to service these loans. On occasion, we may sell a portion of our MSR portfolio. A small percentage of our loans are brokered to other lenders or sold on a servicing-released basis to correspondent lenders. We manage the loan funding and the interest rate risk associated with the secondary market loan sales and the retained single family mortgage servicing rights within this business segment.


6875


Mortgage Banking segment results are detailed below.

Three Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar 
Change
 
Percent
Change
Three Months Ended
September 30,		 Change 
Percent
Change
 Nine Months Ended
September 30,		 
 
Change
 
Percent
Change
(in thousands)2013 2012 2013 2012 2014 2013 2014 2013 
                              
Net interest income$4,493
 $4,424
 $69
 2 % $12,375
 $9,697
 $2,678
 28 %$5,145
 $4,317
 $828
 19 % $11,368
 $12,050
 $(682) (6)%
Noninterest income36,945
 66,617
 (29,672) (45) 149,517
 158,832
 (9,315) (6)42,153
 34,696
 7,457
 21
 120,938
 145,083
 (24,145) (17)
Noninterest expense44,539
 32,632
 11,907
 36
 127,879
 80,777
 47,102
 58
45,228
 43,468
 1,760
 4
 124,563
 126,215
 (1,652) (1)
(Loss) income before income taxes(3,101) 38,409
 (41,510) NM
 34,013
 87,752
 (53,739) (61)
Income tax (benefit) expense(911) 14,090
 (15,001) NM
 11,663
 16,935
 (5,272) (31)
Net (loss) income$(2,190) $24,319
 $(26,509) NM
 $22,350
 $70,817
 $(48,467) (68)
Income before income tax expense2,070
 (4,455) 6,525
 NM
 7,743
 30,918
 (23,175) (75)
Income tax expense629
 (1,260) 1,889
 NM
 2,508
 10,786
 (8,278) (77)
Net income$1,441
 $(3,195) $4,636
 NM
 $5,235
 $20,132
 $(14,897) (74)%
    
              
          
Average assets$656,697
 $670,715
 $(14,018) (2)% $641,336
 $506,098
 $135,238
 27 %$697,601
 $619,962
 $77,639
 13 % $571,063
 $602,443
 $(31,380) (5)%
Efficiency ratio (1)
107.48% 45.93% NM
 NM
 78.99% 47.93% NM
 NM
95.62% 111.42%     94.15% 80.32%    
Full-time equivalent employees (ending)922
 621
 NM
 48
 922
 621
 NM
 48
993
 922
 71
 8
 993
 922
 71
 8
Production volumes for sale to the secondary market:                              
Single family mortgage closed loan volume (2)(3)
1,187,061
 1,368,238
 (181,177) (13) 3,686,503
 3,149,196
 537,307
 17
$1,294,895
 $1,187,061
 $107,834
 9
 $3,069,882
 $3,686,503
 $(616,621) (17)
Single family mortgage interest rate lock commitments(2)
786,147
 1,313,182
 (527,035) (40) 3,245,259
 3,531,713
 (286,454) (8)1,167,677
 786,147
 381,530
 49
 3,172,650
 3,245,259
 (72,609) (2)
Single family mortgage loans sold(2)
1,326,888
 1,238,879
 88,009
 7
 3,916,918
 2,735,893
 1,181,025
 43
$1,179,464
 $1,326,888
 $(147,424) (11)% $2,705,719
 $3,916,918
 $(1,211,199) (31)%
(1)
Noninterest expense divided by total net revenue (net interest income and noninterest income).
(2)
Includes loans originated by Windermere MortgageWMS Series Services LLC ("WMS") and purchased by HomeStreet Bank.
(3)
Represents single family mortgage production volume designated for sale to the secondary market during each respective period.

Mortgage Banking net income was $1.4 million for the third quarter of 2014, compared to a net loss was $2.2of $3.2 million for the third quarter of 2013, a decrease of $26.5 million from net income of $24.3 million for the third quarter of 2012. For the first nine months of 2013,2014, Mortgage Banking net income was $22.4$5.2 million,, a decrease of $48.5$14.9 million,, or 68.4%74.0%, from net income of $70.8$20.1 million for the first nine months of 2012.2013. The decreaseincrease in Mortgage Banking net income for the third quarter of 2013 was driven2014 primarily by higher mortgage interest rates that led to a sharp decrease inreflected increased interest rate lock commitment volume asfrom the expansion of our mortgage production offices and a substantial amount of the gain on loan origination and sale activities is recognized at the time of interest rate lock, as well as the imbalance between the volume of interest rate lock commitments and closed loans. In periods where the volume of closed loans significantly exceeds the volume of interest rate lock commitments, noninterest expense will be higher relative to noninterest income because variable costs, notably commissions and incentives, are recognized at the time of closing the loan.  In the third quarter of 2013, single family26.8% increase in mortgage closed loans of $1.19 billion were 51.0% greater than interest rate lock commitments of $786.1 million.production personnel year over year.


6976


Mortgage Banking net gain on sale to the secondary market is detailed in the following table.
  Three Months Ended
September 30,		 Nine Months Ended
September 30,
(in thousands) 2013 2012 2013 2012
         
Net gain on mortgage loan origination and sale activities:(1)
        
Single family:        
Servicing value and secondary marketing gains(2)
 $23,076
 $56,142
 $110,760
 $120,471
Provision for repurchase losses(3)
 —
 (526) —
 (2,846)
Net gain from secondary marketing activities 23,076
 55,616
 110,760
 117,625
Loan origination and funding fees 8,302
 8,680
 24,363
 20,817
Total mortgage banking net gain on mortgage loan origination and sale activities(1)
 $31,378
 $64,296
 $135,123
 $138,442
         
Composite Margin (in basis points):        
Servicing value and secondary marketing gains / interest rate lock commitments(4)
 294
 424
 328
 333
Loan origination and funding fees / retail mortgage originations(5)
 81
 77
 77
 83
Composite Margin 375
 501
 405
 416
  Three Months Ended
September 30,		 Nine Months Ended
September 30,
(in thousands) 2014 2013 2014 2013
         
Net gain on mortgage loan origination and sale activities:(1)
        
Single family:        
Servicing value and secondary market gains(2)
 $29,866
 $23,076
 $79,658
 $110,760
Loan origination and funding fees 6,947
 8,302
 18,489
 24,363
Total mortgage banking net gain on mortgage loan origination and sale activities(1)
 $36,813
 $31,378
 $98,147
 $135,123
(1)
Excludes inter-segment activities.
(2)
Comprised of gains and losses on interest rate lock commitments (which considers the value of servicing), single family loans held for sale, forward sale commitments used to economically hedge secondary market activities, and the estimated fair value of the repurchase or indemnity obligation recognized on new loan sales.
(3)
Represents changes in estimated probable future repurchase losses on previously sold loans.
(4)
Servicing value and secondary marketing gains have been aggregated and are stated as a percentage of interest rate lock commitments. In previous quarters, the value of originated mortgage servicing rights was presented as a separate component of the composite margin and stated as a percentage of mortgage loans sold. Prior periods have been revised to conform to the current presentation.
(5)
Loan origination and funding fees is stated as a percentage of mortgage originations from the retail channel and excludes mortgage loans purchased from WMS.

Net gain on mortgage loan origination and sale activities was $31.436.8 million for the third quarter of 20132014, a decreasean increase of $32.9$5.4 million,, or 51.2%17.3%, from $64.3$31.4 million in the third quarter of 20122013. This decreaseincrease is primarily the result of the 40.1% decreasea 48.5% increase in interest rate lock commitments, which was heavilymainly driven by an increasethe expansion of our mortgage production offices. Since September 2013, we have increased our home lending capacity and expanded our lending footprint by adding 19 home loan centers, including 12 in mortgage interest rates that ledCalifornia, to a decrease in refinance mortgage volume and the shiftbring our total home loan centers to a purchase mortgage-dominated market.55.

Due to differences in the timing of revenue recognition between components of the gain on loan origination and sale activities, the Company analyzes the profitability of these activities using a 'Composite Margin,' which is comprised of the ratios of the components to their respective populations of interest rate lock commitments and closed loans. The Composite Margin for the third quarter of 2013 was 375 basis points, down from 501 basis points in the third quarter of 2012. The decrease from the prior year is primarily the result of increased price competition resulting from lower industry application volume and the shift to a purchase mortgage-dominated market. In addition, due to the impact of changes in the FHA mortgage insurance program, we experienced a reduction in FHA-insured mortgage loan originations that historically have had higher profit margins on their origination and sale.

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Mortgage Banking servicing income consisted of the following.

Three Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
Three Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
 Nine Months Ended
September 30,		 
Dollar
Change
 
Percent
Change
(in thousands)2013 2012 2013 2012 2014 2013 2014 2013 
                              
Servicing income, net:                              
Servicing fees and other$8,145
 $6,151
 $1,994
 32 % $22,156
 $17,741
 $4,415
 25 %$8,061
 $8,145
 $(84) (1)% $26,115
 $22,156
 $3,959
 18 %
Changes in fair value of MSRs due to modeled amortization (1)
(5,221) (5,360) 139
 (3) (16,896) (14,382) (2,514) 17
(6,212) (5,665) (547) 10
 (19,289) (18,305) (984) 5
2,924
 791
 2,133
 270 % 5,260
 3,359
 (1,226) (36)%1,849
 2,480
 (631) (25) 6,826
 3,851
 2,975
 77
Risk management:                              
Changes in fair value of MSRs due to changes in model inputs and/or assumptions (2)
(2,900) (5,565) $2,665
 (48)% 15,403
 (13,507) $28,910
 (214)%899
 (2,456) $3,355
 (137) (7,836)
(3 
) 
16,812
 $(24,648) (147)
Net gain from derivatives economically hedging MSRs3,631
 4,861
 (1,230) (25) (12,392) 24,600
 (36,992) (150)2,543
 3,631
 (1,088) (30) 23,381
 (12,392) 35,773
 (289)
731
 (704) 1,435
 NM
 3,011
 11,093
 (9,658) (87)3,442
 1,175
 2,267
 193
 15,545
 4,420
 11,125
 252
Mortgage servicing income$3,655
 $87
 $3,568
 NM
 $8,271
 $14,452
 $(10,884) (75)%
NM = not meaningful               
Mortgage Banking servicing income$5,291
 $3,655
 $1,636
 45 % $22,371
 $8,271
 $14,100
 170 %
(1)
Represents changes due to collection/realization of expected cash flows and curtailments.
(2)
Principally reflects changes in model assumptions, including prepayment speed assumptions, which are primarily affected by changes in mortgage interest rates.

(3)Includes pre-tax income of $4.7 million, net of brokerage fees and prepayment reserves, resulting from the second quarter 2014 sale of single family MSRs.
Single family mortgage servicing income of $5.3 million in the $3.7third quarter of 2014increased $1.6 million, or 45%, from $3.7 million in the third quarter of 2013increased$3.6 million from the third quarter of 2012. This increase was, primarily due to increased servicing fees collected in the quarter on the Company's single family mortgage servicing and improved mortgage servicing rights ("MSR") risk management results. Risk management results represent changes in the fair value of single family MSRs due to changes in model inputs and assumptions net of the gain/(loss) from derivatives economically hedging MSRs. 
SingleFor the first nine months of 2014, single family mortgage servicing income of $8.3$22.4 million increased $14.1 million, or 170.5%, from $8.3 million for the first nine months of 2013, decreased $10.9 million from primarily as a result of improved risk management results and

77


servicing fees collected. Included in risk management results for the first nine months of 2012, primarily due to risk management activities.2014 is $4.7 million of pre-tax income recognized from the second quarter 2014 sale of single family MSRs.
Single family mortgage servicing fees collected in the third quarter of 2013increased$2.0 million2014, decreased $84 thousand, or 32.4%1.0%, from the third quarter of 20122013 resulting from growth in. As a result of the June 30, 2014 sale of single family MSRs, the portfolio of single family loans serviced for others. The portfolioothers decreased to $10.59 billion at September 30, 2014 compared to $11.29 billion at September 30, 2013. Mortgage servicing fees collected in future periods will be negatively impacted in the short term because the balance of single familythe loans serviced for others increased to $11.29 billion at quarter end compared to $8.87 billion at December 31, 2012 and $8.11 billion at September 30, 2012.portfolio was reduced as a consequence of this sale.

Single family loans serviced for others consisted of the following.

(in thousands)At September 30,
2013		 At December 31,
2012		At September 30,
2014		 At December 31,
2013
      
Single family   
U.S. government and agency$10,950,086
 $8,508,458
$10,007,872
 $11,467,853
Other336,158
 362,230
585,393
 327,768
Total single family loans serviced for others$11,286,244
 $8,870,688
$10,593,265
 $11,795,621

Mortgage Banking noninterest expense of $44.5$45.2 million increased $11.9 million, or 36.5%, from $32.6 million in the third quarter of 2012. This increase was primarily attributable to increased salaries and related costs due to our continued growth in loan production personnel and our expansion in new markets.

71


Mortgage Banking net loss of $2.2 million2014 forincreased $1.8 million, or 4.0%, from $43.5 million in the third quarter of 2013 was driven, primarily bydue to higher commission and incentive expense, as closed loan volumes increased 9.1% from the sharp decrease in interest rate lock commitment volume, as a substantial amount of the gain on loan origination and sale activities is recognized at the time of rate lock, as well as the imbalance between the volume of interest rate lock commitments and closed loans.  In periods where the volume of closed loans significantly exceeds the volume of interest rate lock commitments, noninterest expense will be higher relative to noninterest income because variable costs, notably commissions and incentives, are recognized at the time of closing the loan. In the third quarter of 2013 single family mortgage closed loans of $1.19 billion were 51.0% greater than interest rate lock commitments of $786.1 million., and higher general and administrative expenses resulting from our expansion into new markets.

Off-Balance Sheet Arrangements

In the normal course of business, we are a party to financial instruments with off-balance sheet risk. These financial instruments (which include but are not limited to commitments to originate loans and commitments to purchase loans) include potential credit risk in excess of the amount recognized in the accompanying consolidated financial statements. These transactions are designed to (1) meet the financial needs of our customers, (2) manage our credit, market or liquidity risks, (3) diversify our funding sources and/or (4) optimize capital.

For more information on off-balance sheet arrangements, including derivative counterparty credit risk, see the Off-Balance Sheet Arrangements and Commitments, Guarantees and Contingencies discussions within Part II, Item 7 Management's Discussion and Analysis in our 20122013 Annual Report on Form 10-K, as well as Note 13,14, Commitments, Guarantees and Contingencies within thein our 20122013 Annual Report on Form 10-K and Note 8,7, Commitments, Guarantees and Contingencies in this Form 10-Q.

Enterprise Risk Management

All financial institutions manage and control a variety of business and financial risks that can significantly affect their financial performance. Among these risks are credit risk; market risk, which includes interest rate risk and price risk; liquidity risk; and operational risk. We are also subject to risks associated with compliance/legal, strategic and reputational matters.
For more information on how we manage these business, financial and other risks, see the Enterprise Risk Management discussion within Part II, Item 7 Management's Discussion and Analysis in our 20122013 Annual Report on Form 10-K.

78


Credit Risk Management

The following discussion highlights developments since December 31, 20122013 and should be read in conjunction with the Credit Risk Management discussion within Part II, Item 7 Management's Discussion and Analysis in our 20122013 Annual Report on Form 10-K.

Loan Underwriting Standards

Our underwriting standards for single family and home equity loans require evaluating and understanding a borrower’s credit, collateral and ability to repay the loan. Credit is determined based on how well a borrower manages their current and prior debts, documented by a credit report that provides credit scores and the borrower’s current and past information about their credit history. Collateral is based on the type and use of property, occupancy and market value, largely determined by property appraisals. A borrower's ability to repay the loan is based on several factors, including employment, income, current debt, assets and level of equity in the property. We also consider loan-to-property value and debt-to-income ratios, loan amount and lien position in assessing whether to originate a loan. Single family and home equity borrowers are particularly susceptible to downturns in economic trends that negatively affect housing prices and demand and levels of unemployment.

For commercial, multifamily and construction loans, we consider the same factors with regard to the borrower and the guarantors. In addition, we evaluate liquidity, net worth, leverage, other outstanding indebtedness of the borrower, an analysis of cash expected to flow through the borrower (including the outflow to other lenders) and prior experience with the borrower. We use this information to assess financial capacity, profitability and experience. Ultimate repayment of these loans is sensitive to interest rate changes, general economic conditions, liquidity and availability of long-term financing.

Additional considerations for commercial permanent loans secured by real estate:

Our underwriting standards for commercial permanent loans generally require that the loan-to-value ratio for these loans not exceed 75% of appraised value or discounted cash flow value, as appropriate, and that commercial properties attain debt coverage ratios (net operating income divided by annual debt servicing) of 1.25 or better.

Our underwriting standards for multifamily residential permanent loans generally require that the loan-to-value ratio for these loans not exceed 80% of appraised value, cost, or discounted cash flow value, as appropriate, and that multifamily residential properties attain debt coverage ratios of 1.2 or better. However, underwriting standards can be influenced by competition and other factors. We endeavor to maintain the highest practical underwriting standards while balancing the need to remain competitive in our lending practices.

Additional considerations for commercial construction loans secured by real estate:

We originate a variety of real estate construction loans. Underwriting guidelines for these loans vary by loan type but include loan-to-value limits, term limits, loan advance limits and pre-leasing requirements, as applicable.

Our underwriting guidelines for commercial real estate construction loans generally require that the loan-to-value ratio not exceed 75% and stabilized debt coverage ratios of 1.25 or better.

Our underwriting guidelines for multifamily residential construction loans generally require that the loan-to-value ratio not exceed 80% and stabilized debt coverage ratios of 1.2 or better.

Our underwriting guidelines for single family residential construction loans to builders generally require that the loan-to-value ratio not exceed 85%.

As noted above, underwriting standards can be influenced by competition and other factors. However, we endeavor to maintain the highest practical underwriting standards while balancing the need to remain competitive in our lending practices.

Asset Quality and Nonperforming Assets

Nonperforming assets ("NPAs") were $39.0$30.4 million, and $53.8 million or 0.87% of total assets at September 30, 2013 and December 31, 20122014, respectively. NPAs at September 30, 2013 represented 1.37% of total assets compared to 2.05%$38.6 million, or 1.26% of total assets at December 31, 20122013. Nonaccrual loans of $26.8$19.9 million,, or 1.74%1.00% of total loans at September 30, 20132014, decreased$3.1 $5.8 million, or 22.6%, from $25.7 million, or 10.5% from $29.9 million, or 2.24%1.36% of total loans at December 31, 20122013. OREO balances of $12.3$10.5 million at September 30, 2013declined$11.7 million2014, decreased $2.4 million, or 48.8%18.8%, from $23.9$12.9 million at December 31, 20122013. Net charge-offscharge-

79


offs during the three and nine months ended September 30, 20132014 were $1.5 million$57 thousand and $3.8 million,$478 thousand, respectively, compared with $5.0$1.5 million and $22.7$3.8 million during the three and nine months ended September 30, 2012,2013, respectively.

At September 30, 20132014, our loans held for investment portfolio, excluding the allowance for loan losses, was $1.53$1.99 billion,, an increase of $198.3$90.9 million from December 31, 20122013, while the. The allowance for loan losses decreased to $24.7$21.8 million,, or 1.61%1.10% of loans held for investment, compared to $27.6$23.9 million,, or 2.06%1.26% of loans held for investment at December 31, 20122013, reflecting the improved credit quality of the Company's loan portfolio..

ImprovedIn recognition of our improving credit quality of the Company's loan portfolio resulted in a $1.5 million reversal to thetrends and lower charge-offs, we recorded no provision for credit losses in the third quarter of 20132014, compared to a reversal of provision of $5.5$1.5 million in the third quarter of 20122013. Our provision for credit losses forFor the nine months ended September 30, 20132014 was $900, we recorded a reversal of provision of $1.5 million, compared to a provision of $900 thousand. For during the three and nine months ended September 30, 2012, our provision for credit losses was $5.5 million and $7.5 million, respectively. Net charge-offs in the quarter totaled $1.5 million, down from $5.0 million of net charge-offs in the third quarter of 2012. Of the $1.5 million in net charge-offs during the quarter, $967 thousand had been specifically reserved as of June 30, 2013.2013.

72



The following tables present the recorded investment, unpaid principal balance and related allowance for impaired loans, broken down by those with and those without a specific reserve.
 
At September 30, 2013At September 30, 2014
(in thousands)
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
          
Impaired loans:          
Loans with no related allowance recorded$74,169
 $88,951
 $—
$81,770
 $97,567
 $—
Loans with an allowance recorded40,798
 41,163
 2,958
39,321
 39,581
 2,636
Total$114,967
 $130,114
 $2,958
$121,091
(1) 
$137,148
 $2,636
At December 31, 2012At December 31, 2013
(in thousands)
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
          
Impaired loans:          
Loans with no related allowance recorded$53,615
 $67,262
 $—
$81,301
 $112,795
 $—
Loans with an allowance recorded70,350
 72,220
 6,368
38,568
 38,959
 2,571
Total$123,965
 $139,482
 $6,368
$119,869
(1) 
$151,754
 $2,571
(1)
Includes $70.0 million and $70.3 million in single family performing troubled debt restructurings ("TDRs") at September 30, 2014 and December 31, 2013, respectively.

The Company had 190247 impaired loans totaling $115.0121.1 million at September 30, 20132014 and 167216 impaired loans totaling $124.0119.9 million at December 31, 20122013. The average recorded investment in these loans for the three and nine months ended September 30, 20132014 was $122.2$119.1 million and $123.5$119.0 million, respectively, compared with $130.8$122.2 million and $154.7$123.5 million for the three and nine months ended September 30, 2012.2013, respectively. Impaired loans of $40.8$39.3 million at September 30, 2013 and $38.6 million had a valuation allowance of $2.6 million and $2.6 million at $3.0 millionSeptember 30, 2014. At and December 31, 20122013, impaired loans of $70.4 million had a valuation allowance of $6.4 million.respectively.

The allowance for credit losses represents management’s estimate of the incurred credit losses inherent within our loan portfolio. For further discussion related to credit policies and estimates see Critical Accounting Policies and Estimates — Allowance for Loan Losses within Part II, Item 7 Management's Discussion and Analysis in our 20122013 Annual Report on Form 10-K.


80


The following table presents the allowance for credit losses, including reserves for unfunded commitments, by loan class.

At September 30, 2013 At December 31, 2012At September 30, 2014 At December 31, 2013
(in thousands)Amount 
Percent of
Allowance
to Total
Allowance
 
Loan Category
as a % of
Total Loans
 Amount 
Percent of
Allowance
to Total
Allowance
 
Loan Category
as a % of
Total Loans
Amount 
Percent of
Allowance
to Total
Allowance
 
Loan Category
as a % of
Total Loans
 Amount 
Percent of
Allowance
to Total
Allowance
 
Loan Category
as a % of
Total Loans
                      
Consumer loans                      
Single family$12,132
 48.7% 53.2% $13,388
 48.2% 50.3%$8,878
 40.2% 39.6% $11,990
 49.8% 47.7%
Home equity4,636
 18.6% 8.4% 4,648
 16.7% 10.2%3,563
 16.1
 6.9
 3,987
 16.6
 7.1
16,768
 67.3% 61.6% 18,036
 64.9% 60.5%12,441
 56.3
 46.5
 15,977
 66.4
 54.8
Commercial loans                      
Commercial real estate4,468
 17.9% 26.0% 5,312
 19.1% 27.0%3,981
 18.0
 26.6
 4,012
 16.7
 25.2
Multifamily770
 3.1% 2.7% 622
 2.2% 1.3%713
 3.2
 3.1
 942
 3.9
 4.2
Construction/land development1,392
 5.6% 5.2% 1,580
 5.7% 5.3%2,687
 12.2
 15.0
 1,414
 5.9
 6.9
Commercial business1,496
 6.1% 4.5% 2,201
 8.1% 5.9%2,289
 10.3
 8.8
 1,744
 7.1
 8.9
8,126
 32.7% 38.4% 9,715
 35.1% 39.5%9,670
 43.7
 53.5
 8,112
 33.6
 45.2
Total allowance for credit losses$24,894
 100.0% 100.0% $27,751
 100.0% 100.0%$22,111
 100.0% 100.0% $24,089
 100.0% 100.0%



7381


The following table presents activity in our allowance for credit losses, which includes reserves for unfunded commitments.
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2013 2012 2013 20122014 2013 2014 2013
              
Allowance at the beginning of period$27,858
 $27,125
 $27,751
 $42,800
$22,168
 $27,858
 $24,089
 $27,751
(Reversal of) provision for loan losses(1,500) 5,500
 900
 7,500
Provision for loan losses—
 (1,500) (1,500) 900
Recoveries:              
Consumer              
Single family179
 22
 425
 455
65
 179
 106
 425
Home equity273
 121
 526
 398
94
 273
 420
 526
452
 143
 951
 853
159
 452
 526
 951
Commercial              
Commercial real estate—
 130
 —
 258
275
 —
 431
 —
Construction/land development348
 193
 699
 835
123
 348
 185
 699
Commercial business25
 631
 173
 717
51
 25
 198
 173
373
 954
 872
 1,810
449
 373
 814
 872
Total recoveries825
 1,097
 1,823
 2,663
608
 825
 1,340
 1,823
Charge-offs:              
Consumer              
Single family(606) (1,363) (2,468) (3,889)(226) (606) (509) (2,468)
Home equity(377) (1,078) (1,515) (3,577)(135) (377) (694) (1,515)
(983) (2,441) (3,983) (7,466)(361) (983) (1,203) (3,983)
Commercial              
Commercial real estate(1,306) (1,757) (1,449) (3,474)—
 (1,306) (23) (1,449)
Construction/land development—
 (1,823) (148) (13,858)—
 —
 —
 (148)
Commercial business—
 (74) —
 (538)(304) —
 (592) —
(1,306) (3,654) (1,597) (17,870)(304) (1,306) (615) (1,597)
Total charge-offs(2,289) (6,095) (5,580) (25,336)(665) (2,289) (1,818) (5,580)
(Charge-offs), net of recoveries(1,464) (4,998) (3,757) (22,673)(57) (1,464) (478) (3,757)
Balance at end of period$24,894
 $27,627
 $24,894
 $27,627
$22,111
 $24,894
 $22,111
 $24,894




7482


The following table presents the composition of TDRs by accrual and nonaccrual status.
 
At September 30, 2013At September 30, 2014
(in thousands)Accrual Nonaccrual TotalAccrual Nonaccrual Total
          
Consumer          
Single family (1)
$71,686
 $4,819
 $76,505
$72,663
 $1,379
 $74,042
Home equity2,426
 132
 2,558
2,501
 20
 2,521
74,112
 4,951
 79,063
75,164
 1,399
 76,563
Commercial          
Commercial real estate20,385
 —
 20,385
23,964
 1,182
 25,146
Multifamily3,190
 —
 3,190
3,101
 —
 3,101
Construction/land development3,122
 3,544
 6,666
5,693
 —
 5,693
Commercial business120
 —
 120
658
 9
 667
26,817
 3,544
 30,361
33,416
 1,191
 34,607
$100,929
 $8,495
 $109,424
$108,580
 $2,590
 $111,170
 
At December 31, 2012At December 31, 2013
(in thousands)Accrual Nonaccrual TotalAccrual Nonaccrual Total
          
Consumer          
Single family (1)
$67,483
 $3,931
 $71,414
$70,304
 $4,017
 $74,321
Home equity2,288
 465
 2,753
2,558
 86
 2,644
69,771
 4,396
 74,167
72,862
 4,103
 76,965
Commercial          
Commercial real estate21,071
 770
 21,841
19,620
 628
 20,248
Multifamily3,221
 —
 3,221
3,163
 —
 3,163
Construction/land development6,365
 5,042
 11,407
6,148
 —
 6,148
Commercial business147
 —
 147
112
 —
 112
30,804
 5,812
 36,616
29,043
 628
 29,671
$100,575
 $10,208
 $110,783
$101,905
 $4,731
 $106,636

(1)
Includes loan balances insured by the FHA or guaranteed by the VA of $24.6 million and $17.8 million, at $17.6 millionSeptember 30, 2014 and $13.1 million, at September 30, 2013 and December 31, 2012,2013, respectively.



75


The followingCompany had 231 loan relationships classified as troubled debt restructurings (“TDRs”) totaling $111.2 million at September 30, 2014 with related unfunded commitments of $55 thousand. The Company had 204 loan relationships classified as TDRs totaling $106.6 million at December 31, 2013 with related unfunded commitments of $47 thousand. TDR loans within the loans held for investment portfolio and the related reserves are included in the impaired loan tables present information about TDRs by loan portfolio segment and loan class.
 At September 30, 2013
(dollars in thousands)Concession type 
Number of loan
relationships
 
Recorded
investment
 Related cumulative charge-offs
        
Consumer loans       
Single family (1)
       
 Interest rate reduction 151
 $75,155
 $3,504
 Payment restructure 8
 1,350
 —
   159
 $76,505
 $3,504
Home equity       
 Interest rate reduction 20
 $2,384
 $25
 Payment restructure 5
 174
 —
   25
 $2,558
 $25
Total consumer       
 Interest rate reduction 171
 $77,539
 $3,529
 Payment restructure 13
 1,524
 —
   184
 $79,063
 $3,529
Commercial loans       
Commercial real estate       
 Interest rate reduction 2
 $5,779
 $1,884
 Forgiveness of principal 1
 14,606
 1,000
   3
 $20,385
 $2,884
Multifamily       
 Interest rate reduction 2
 $3,190
 $—
   2
 $3,190
 $—
Construction/land development       
 Interest rate reduction 3
 $6,254
 $7,063
 Forgiveness of principal 1
 412
 49
   4
 $6,666
 $7,112
Commercial business       
 Payment restructure 1
 120
 68
   1
 $120
 $68
Total commercial       
 Interest rate reduction 7
 $15,223
 $8,947
 Payment restructure 1
 120
 68
 Forgiveness of principal 2
 15,018
 1,049
   10
 $30,361
 $10,064
Total loans       
 Interest rate reduction 178
 $92,762
 $12,476
 Payment restructure 14
 1,644
 68
 Forgiveness of principal 2
 15,018
 1,049
   194
 $109,424
 $13,593

(1)above.
Includes loan balances insured by the FHA or guaranteed by the VA of $17.6 million at September 30, 2013.


7683


 At December 31, 2012
(dollars in thousands)Concession type 
Number of loan
relationships
 
Recorded
investment
 Related cumulative charge-offs
        
Consumer loans       
Single family (1)
       
 Interest rate reduction 118 $70,042
 $3,647
 Payment restructure 8 1,372
 —
   126 $71,414
 $3,647
Home equity       
 Interest rate reduction 19 $2,577
 $176
 Payment restructure 5 176
 —
   24 $2,753
 $176
Total consumer       
 Interest rate reduction 137 $72,619
 $3,823
 Payment restructure 13 1,548
 —
   150 $74,167
 $3,823
Commercial loans       
Commercial real estate       
 Interest rate reduction 2 $6,071
 $1,884
 Payment restructure 1 15,770
 —
   3 $21,841
 $1,884
Multifamily       
 Interest rate reduction 2 $3,221
 $—
   2 $3,221
 $—
Construction/land development       
 Interest rate reduction 4 $10,753
 $7,065
 Forgiveness of principal 2 654
 43
   6 $11,407
 $7,108
Commercial business       
 Payment restructure 1 $147
 $68
   1 $147
 $68
Total commercial       
 Interest rate reduction 8 $20,045
 $8,949
 Payment restructure 2 15,917
 68
 Forgiveness of principal 2 654
 43
   12 $36,616
 $9,060
Total loans       
 Interest rate reduction 145 $92,664
 $12,772
 Payment restructure 15 17,465
 68
 Forgiveness of principal 2 654
 43
   162 $110,783
 $12,883

(1)
Includes loan balances insured by the FHA or guaranteed by the VA of $13.1 million at December 31, 2012.


77


Delinquent loans and other real estate owned by loan type consisted of the following.
 
At September 30, 2013At September 30, 2014
(in thousands)
30-59 Days
Past Due
 
60-89 Days
Past Due
 90 Days or More Past Due and Not Accruing 
90 Days or 
More Past Due and Still Accruing(1)
 
Total
Past Due
Loans
 
Other
Real Estate
Owned
30-59 Days
Past Due
 
60-89 Days
Past Due
 90 Days or More Past Due and Not Accruing 
90 Days or 
More Past Due and Still Accruing
 
Total
Past Due
Loans
 
Other
Real Estate
Owned
                      
Consumer loans                      
Single family$10,359
 $5,170
 $12,648
 $43,762
 $71,939
 $5,494
$2,406
 $1,535
 $8,350
 $31,480
(1) 
$43,771
 $2,818
Home equity554
 100
 2,295
 —
 2,949
 —
461
 109
 1,700
 —
 2,270
 —
10,913
 5,270
 14,943
 43,762
 74,888
 5,494
2,867
 1,644
 10,050
 31,480
 46,041
 2,818
Commercial loans                      
Commercial real estate—
 —
 6,861
 —
 6,861
 —
—
 —
 7,058
 —
 7,058
 1,822
Multifamily—
 —
 —
 —
 —
 —
Construction/land development—
 —
 3,544
 —
 3,544
 5,815
—
 —
 —
 —
 —
 5,838
Commercial business—
 —
 1,405
 —
 1,405
 957
44
 —
 2,798
 —
 2,842
 —
—
 —
 11,810
 —
 11,810
 6,772
44
 —
 9,856
 —
 9,900
 7,660
Total$10,913
 $5,270
 $26,753
 $43,762
 $86,698
 $12,266
$2,911
 $1,644
 $19,906
 $31,480
 $55,941
 $10,478
 
(1)FHA-insured and VA-guaranteed single family loans that are 90 days or more past due are maintained on accrual status if they are determined to have little to no risk of loss.

At December 31, 2012At December 31, 2013
(in thousands)
30-59 Days
Past Due
 
60-89 Days
Past Due
 90 Days or More Past Due and Not Accruing 
90 Days or 
More Past Due and Still Accruing(1)
 
Total
Past Due
Loans
 
Other
Real Estate
Owned
30-59 Days
Past Due
 
60-89 Days
Past Due
 90 Days or More Past Due and Not Accruing 
90 Days or 
More Past Due and Still Accruing(1)
 
Total
Past Due
Loans
 
Other
Real Estate
Owned
                      
Consumer loans                      
Single family$11,916
 $4,732
 $13,304
 $40,658
 $70,610
 $4,071
$6,466
 $4,901
 $8,861
 $46,811
(1) 
$67,039
 $5,246
Home equity787
 242
 2,970
 —
 3,999
 —
375
 75
 1,846
 —
 2,296
 —
12,703
 4,974
 16,274
 40,658
 74,609
 4,071
6,841
 4,976
 10,707
 46,811
 69,335
 5,246
Commercial loans                      
Commercial real estate—
 —
 6,403
 —
 6,403
 10,283
—
 —
 12,257
 —
 12,257
 1,688
Construction/land development—
 —
 5,042
 —
 5,042
 9,587
—
 —
 —
 —
 —
 5,977
Commercial business—
 —
 2,173
 —
 2,173
 —
—
 —
 2,743
 —
 2,743
 —
—
 —
 13,618
 —
 13,618
 19,870
—
 —
 15,000
 —
 15,000
 7,665
Total$12,703
 $4,974
 $29,892
 $40,658
 $88,227
 $23,941
$6,841
 $4,976
 $25,707
 $46,811
 $84,335
 $12,911
 
(1)FHA-insured and VA-guaranteed single family loans that are 90 days or more past due are maintained on accrual status as they have little to no risk of loss.

Liquidity and Capital ManagementResources

Liquidity risk management is primarily intended to ensure we are able to maintain cash flows adequate to fund operations and meet our obligations, including demands offrom depositors, funding loan commitments, draws on lines of credit and paying any creditors, on a timely and cost-effective basis, in various market conditions. Our liquidity profile is influenced by changes in market conditions, the composition of the balance sheet and risk tolerance levels. HomeStreet, Inc., HomeStreet Capital ("HSC") and HomeStreetthe Bank
have established liquidity guidelines and operating practicesplans that involve the assessment ofdetail the sources and uses of cash as well as collateral maintained at the Federal Reserve Bank and FHLB. The overall liquidity position is projected on a short-term and long-term basis to manage liquidity risk. Furthermore, the projected liquidity position is analyzed and reviewed using stress scenarios on a semi-annual basis to identify potential adverse impacts to off-balance sheet capacity and to ensure operational preparedness.liquidity.


84


HomeStreet, Inc., HomeStreet Capital and the Bank have different funding needs and sources of liquidity and separate regulatory capital requirements.

78



HomeStreet, Inc.

The main source of liquidity for the CompanyHomeStreet, Inc. is proceeds from dividends from the Bank and HomeStreet Capital Corporation.Capital. In the past, we have raised longer-term funds through the issuance of senior debt and TruPS. Historically, the main cash outflows were distributions to shareholders, interest and principal payments to creditors and operating expenses. The Company’sHomeStreet, Inc.’s ability to pay dividends to shareholders depends substantially on dividends received from the Bank.

HomeStreet Capital

HomeStreet Capital generates positive cash flow from its servicing fee income on the DUS portfolio, net of its costs to service the portfolio. Offsetting this are HomeStreet Capital's costs to purchase the servicing rights on new production from the Bank. Liquidity management and reporting requirements for DUS lenders such as HomeStreet Capital are set by Fannie Mae. HomeStreet Capital's liquidity management therefore consists of meeting Fannie Mae requirements and its own operational needs.

HomeStreet Bank

The Bank’s primary short-term sources of funds include deposits, advances from the FHLB, repayments and prepayments of loans, proceeds from the sale of loans and investment securities and interest from our loans and investment securities. We have also raised short-term funds through the sale of securities under agreements to repurchase. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit inflows and outflows and loan prepayments are greatly influenced by interest rates, economic conditions and competition. The primary liquidity ratio is defined as net cash, short-term investments and other marketable assets as a percent of net deposits and short-term borrowings. At September 30, 20132014, our primary liquidity ratio was 36.8%36.1% compared to 43.9%26.9% at December 31, 20122013.

At September 30, 20132014 and December 31, 20122013, the Bank had available borrowing capacity of $91.4113.8 million and $55.7228.5 million, respectively, from the FHLB, and $382.8390.6 million and $124.3332.7 million, respectively, from the Federal Reserve Bank of San Francisco, respectively.Francisco.

Our lending agreement with the FHLB permits it to refuse to make advances during periods in which an “event of default” (as defined in that agreement) exists. An event of default occurs when the FHLB gives notice to the Bank of an intention to take any of a list of permissible actions following the occurrence of specified events or conditions affecting the Bank. The Bank is not aware of any potential event of default at the present time.

Cash ManagementFlows

For the nine months ended September 30, 20132014, cash and cash equivalents increased $12.6 million779 thousand, compared to a decreasean increase of $241.312.6 million for the nine months ended September 30, 20122013. The following discussion highlights the major activities and transactions that affected our cash flows during these periods.

Cash flows from operating activities

The Company's operating assets and liabilities are used to support our lending activities, including the origination and sale of mortgage loans. For the nine months ended September 30, 20132014, net cash of $258.2352.6 million was provided byused in operating activities, as cash used to fund loans held for sale production exceeded proceeds from the sale of loans held for sale were largely offset by cash used to fund the production of loans held for sale.loans. We believe that cash flows from operations, available cash balances and our ability to generate cash through short-term debt are sufficient to fund our operating liquidity needs. For the nine months ended September 30, 20122013, net cash of $336.1261.4 million was used inprovided by operating activities, primarilyas proceeds from the sale of loans held for sale were largely offset by cash used to fund the production of loans held for sale.

Cash flows from investing activities

The Company's investing activities primarily include available-for-sale securities and loans originated andas held for investment. For the nine months ended September 30, 2014, net cash of $24.2 million was used in investing activities, as the Company increased the balances of its loans held for investment portfolio, primarily offset by the sale of loans originated as held for investment and the sale of investment securities. The Company elected to sell single family mortgage loans during the second quarter of 2014 to provide additional liquidity to support the commercial loan portfolio growth and to reduce the concentration of single family mortgage loans in the portfolio. For the nine months ended September 30, 2013, net cash of $447.7 million was used in investing activities, as the Company increased the balances of its investment securities portfolio and its loans held for investment portfolio. For the nine months ended September 30, 2012, net cash of $39.0 million was used in investing activities, as we used the proceeds from our stock issuance to purchase available-for-sale securities. Net purchases in our investment securities portfolio were $232.6 million during that period, reflecting management's decision during the quarter to increase this component of the overall asset mix.


85


Cash flows from financing activities

The Company's financing activities are primarily related to customer deposits and net proceeds from the FHLB. For the nine months ended September 30, 2014, net cash of $377.6 million was provided by financing activities, primarily resulting from a $214.6 million growth in deposits and net proceeds of $152.0 million of FHLB advances. For the nine months ended September 30, 2013, net cash of $202.1199.0 million was provided by financing activities. We had net proceeds of $79.6$79.6 million of FHLB advances as the Company grew its investment securities portfolio by $157.3$157.3 million and its loans held for investment portfolio by $201.2$201.2 million,, both of which requirerequired additional wholesale funding. The decline of customer deposits due to the maturity of certificates of deposit was partially offset by increased transaction and savings deposits. For the nine months ended September 30, 2012, net cash of $133.9 million was provided by financing activities as the Company had

79


net proceeds of $87.8 million from the issuance of common stock, mostly through our initial public offering, which we used to purchase available-for-sale investment securities.

Capital Management

Federally insured depository institutions, such as the Bank, are required to maintain a minimum level of regulatory capital. The FDIC regulations recognize two types, or tiers, of capital: “core capital,” or Tier 1 capital, and “supplementary capital,” or Tier 2 capital. The FDIC currently measures a bank’s capital using (1) Tier 1 leverage ratio, (2) Tier 1 risk-based capital ratio and (3) Total risk-based capital ratio. In order to qualify as “well capitalized,” a bank must have a Tier 1 leverage ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least 6.0% and a Total risk-based capital ratio of at least 10.0%. In order to be deemed “adequately capitalized,” a bank generally must have a Tier 1 leverage ratio of at least 4.0%, a Tier 1 risk-based capital ratio of at least 4.0% and a Total risk-based capital ratio of at least 8.0%. The FDIC retains the right to require a depository institution to maintain a higher capital level based on its particular risk profile.

At September 30, 20132014, the Bank wasBank's capital ratios continued to meet the regulatory capital category of “well capitalized” underas defined by the FDIC regulatory requirements.FDIC’s prompt corrective action rules.

The following tables present the Bank’s capital amounts and ratios.
At September 30, 2013At September 30, 2014
Actual 
For Minimum Capital
Adequacy Purposes
 
To Be Categorized As
“Well Capitalized” Under
Prompt Corrective
Action Provisions
Actual 
For Minimum Capital
Adequacy Purposes
 
To Be Categorized As
“Well Capitalized” Under
Prompt Corrective
Action Provisions
(in thousands)Amount Ratio Amount Ratio Amount RatioAmount Ratio Amount Ratio Amount Ratio
                      
Tier 1 leverage capital
(to average assets)		$302,959
 10.85% $111,691
 4.0% $139,614
 5.0%$312,141
 9.63% $129,613
 4.0% $162,016
 5.0%
Tier 1 risk-based capital
(to risk-weighted assets)
302,959
 17.19% 70,505
 4.0% 105,757
 6.0%312,141
 13.03% 95,808
 4.0% 143,713
 6.0%
Total risk-based capital
(to risk-weighted assets)		325,027
 18.44% 141,010
 8.0% 176,262
 10.0%$334,251
 13.96% $191,617
 8.0% $239,521
 10.0%

At December 31, 2012At December 31, 2013
Actual For Minimum Capital
Adequacy Purposes		 To Be Categorized As
“Well Capitalized” Under
Prompt Corrective
Action Provisions		Actual For Minimum Capital
Adequacy Purposes		 To Be Categorized As
“Well Capitalized” Under
Prompt Corrective
Action Provisions
(in thousands)Amount Ratio Amount Ratio Amount RatioAmount Ratio Amount Ratio Amount Ratio
                      
Tier 1 leverage capital
(to average assets)		$286,963
 11.78% $97,466
 4.0% $121,833
 5.0%$291,673
 9.96% $117,182
 4.0% $146,478
 5.0%
Tier 1 risk-based capital
(to risk-weighted assets)		286,963
 18.05% 63,596
 4.0% 95,394
 6.0%291,673
 14.12% 81,708
 4.0% 122,562
 6.0%
Total risk-based capital
(to risk-weighted assets)		306,934
 19.31% 127,192
 8.0% 158,991
 10.0%$315,762
 15.28% $163,415
 8.0% $204,269
 10.0%


Basel III
86


New Capital Regulations

In July 2013, federal banking regulators (including the FDIC and the FRB) adopted new capital rules (the “Rules”). The Rules apply to both depository institutions (such as the Bank) and their holding companies (such as the Company). The Rules reflect, in part, certain standards initially adopted by the Basel Committee on Banking Supervision in December 2010 (which standards are commonly referred to as “Basel III”) as well as requirements contemplated by the Dodd-Frank Act.

Under the Rules, both the Company and the Bank will be required to meet certain minimum capital requirements. The Rules implement a new capital ratio of common equity Tier 1 capital to risk-based assets. Common equity Tier 1 capital generally consists of retained earnings and common stock instruments (subject to certain adjustments), as well as accumulated other comprehensive income (“AOCI”) except to the extent that the Company and the Bank exercise a one-time irrevocable option to exclude certain components of AOCI. Both the Company and the Bank expect to elect this one-time option to exclude certain components of AOCI. Both the Company and the Bank are required to have a common equity Tier 1 capital ratio of at least 4.5%. In addition, both the Company and the Bank are required to have a Tier 1 leverage ratio of 4.0%, a Tier 1 risk-based ratio of at least 6.0%

80


and a total risk-based ratio of at least 8.0%. BothIn addition to the preceding requirements, both the Company and the Bank are required to establish a “conservation buffer”, consisting of common equity Tier 1 capital, equal towhich is at least 2.5%. above each of the preceding common equity Tier 1 capital ratios, the Tier 1 risk-based ratio and the total risk based ratio. An institution that does not meet the conservation buffer will be subject to restrictions on certain activities including payment of dividends, stock repurchases and discretionary bonuses to executive officers.

The prompt corrective action rules, which apply to the Bank but not the Company, are modified to include a common equity Tier 1 risk-based ratio and to increase certain other capital requirements for the various thresholds. For example, the requirements for the Bank to be considered well-capitalized under the Rules are a 5.0% Tier 1 leverage ratio, a 6.5% common equity Tier 1 risk-based ratio, an 8.0% Tier 1 risk-based capital ratio and a 10.0% total risk-based capital ratio. To be adequately capitalized, those ratios are 4.0%, 4.5%, 6.0% and 8.0%, respectively.

The Rules modify the manner in which certain capital elements are determined, including but not limited to, requiring certain deductions related to mortgage servicing rights and deferred tax assets. When the federal banking regulators initially proposed new capital rules in 2012, the rules would have phased out trust preferred securities as a component of Tier 1 capital. As finally adopted, however, the Rules permit holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes the Company) to continue to include trust preferred securities issued prior to May 19, 2010 in Tier 1 capital, generally up to 25% of other Tier 1 capital.

As a result, the Company will not be required to exclude our outstanding trust preferred securities from our Tier 1 capital calculations.
The Rules make changes in the methods of calculating certain risk-based assets, which in turn affects the calculation of risk-basedrisk- based ratios. Higher or more sensitive risk weights are assigned to various categories of assets, among which are commercial real estate, credit facilities that finance the acquisition, development or construction of real property, certain exposures or credit that are 90 days past due or are nonaccrual, foreign exposures, certain corporate exposures, securitization exposures, equity exposures and in certain cases mortgage servicing rights and deferred tax assets.

The Company and the Bank are generally required to begin compliance with the Rules on January 1, 2015. The conservation buffer will be phased in beginning in 2016 and will take full effect on January 1, 2019. Certain calculations under the Rules will also have phase-in periods. We believe that the current capital levels of the Company and the Bank are in compliance with the standards under the Rules including the conservation buffer.

buffer as of the effective date, and we have taken additional steps, including the sale of MSRs in the quarter ended June 30, 2014, to increase our capital to prepare for compliance with these new standards.
Accounting Developments

See the Consolidated Financial Statements—Note 1, Summary of Significant Accounting Policies for a discussion of Accounting Developments.

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ITEM 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk Management

For a discussion of the quantitative and qualitative disclosures about market risk, see Part II,I, Item 7A3 Quantitative and Qualitative Disclosures About Market Risk, Market Risk Management in our Quarterly Report on Form 10-Q for the period ended June 30, 2014, which discussion highlights developments since December 31, 2013 and should be read in conjunction with the 2012MarketRisk Management discussion within Part II, Item 7A Quantitative and Qualitative Disclosures About Market Risk in our 2013 Annual Report on Form 10-K.

During the six months ending June 30, 2014, the Company undertook certain actions in order to adjust the interest rate risk sensitivity of its balance sheet. Specifically, the Company reduced the interest rate sensitivity of its available-for-sale investment securities and held-for-investment loan portfolios and extended the maturity of a portion of its FHLB borrowings. As a result of these combined actions, the estimated sensitivity of net interest income is positively correlated with changes in interest rates, meaning an increase (decrease) in interest rates would result in an increase (decrease) in net interest income.

There have been no material changes in the Company���s market risk management since June 30, 2014. Since December 31, 2013, there have been no material changes in the types of risk management instruments we use or in our hedging strategies.

ITEM 4CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The CompanyRegistrant carried out an evaluation, with the participation of our management, and under the supervision of our Chief Executive Officer and Chief Accounting Officer, of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of the end of the period covered by this report.
After the closing of the Registrant’s books for the quarter ended September 30, 2014 and during the preparation of the Registrant’s financial statements as of and for the three and nine month periods then ended, management discovered errors in the Registrant’s analysis of hedge effectiveness related to fair value hedge accounting for fourteen commercial loans and related swap or derivative instruments designed to hedge against benchmark interest rate risk (“Hedge Effectiveness Errors”). The loans and related swaps had been originated between 2006 and 2008. Management determined that the loans and related swaps had not been evaluated in accordance with the appropriate fair value hedging methodology. The Hedge Effectiveness Errors resulted in inaccurate calculations of changes in the loan fair values related to changes in the benchmark interest rate. Management further determined that management of the hedging effectiveness analysis and loan valuation by the Treasury Department had been ineffective and that there was insufficient oversight provided by the Accounting Department to ensure adherence to the relevant accounting principles and to provide for an effective system of internal controls relating to these assets and liabilities.
Following the discovery of the Hedge Effectiveness Errors, management determined that the circumstances reflected a deficiency in the Registrant’s internal accounting controls. Management then evaluated the materiality of the Hedge Effectiveness Errors to the current and prior accounting periods and determined the Hedge Effectiveness Errors were immaterial to all relevant periods. Management also evaluated the deficiency in its accounting controls based upon the potential maximum errors that could have resulted from the deficiency. Based upon that evaluation, our Chief Executive Officermanagement determined that the Registrant had experienced a material weakness in its internal accounting controls as of September 30, 2014.
Based on Management’s assessment of the Hedge Effectiveness Errors and Chiefrelated internal accounting control weakness, management determined that certain changes in the Registrant’s internal accounting controls and other actions will be implemented during the fourth quarter of 2014, including:
enhanced oversight by the Accounting OfficerDepartment of complex accounting for financial instruments within the Registrant’s Treasury Department;
termination of the swaps related to affected loans during the fourth quarter of 2014, an action that is expected to have no material impact upon the Registrant’s results of operations or financial condition;
terminating any remaining fair value hedge accounting relationships; and
amortizing the previously recorded changes in value of the affected loans over the remaining life of those loans, an amount that in the aggregate is immaterial to the Registrant’s results of operations and financial condition.

88


In addition, the Registrant had ceased the lending and hedging practices from 2008 that gave rise to these errors and management has no plans to reestablish any similar practices or products.
Management has concluded that, our disclosure controls and procedures were effective as of September 30, 2013.

2014, the Registrant’s internal controls over financial reporting were not effective for the reasons set forth above.
Internal Control Over Financial Reporting

There were no changes to our internal control over financial reporting that occurred during the quarter ended September 30, 20132014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


8289


PART II – OTHER INFORMATION
 
ITEM 1LEGAL PROCEEDINGS

On or about October 10, 2014, a putative class action lawsuit related to the merger of Simplicity Bancorp with and into HomeStreet, captioned Bushansky vs. Simplicity Bancorp, Inc., et al. (Cause No. BC560508), was filed in the Superior Court of California, Los Angeles County, against Simplicity, each of Simplicity’s directors and HomeStreet, Inc. The action, brought by a purported shareholder of Simplicity, seeks certification of a class of all holders of Simplicity common stock (except the defendants and their affiliates) and alleges, among other things, that Simplicity’s directors breached their fiduciary duties by putting their personal interests ahead of those of Simplicity’s shareholders and failing to take adequate measures to protect the interests of Simplicity’s shareholders, and further alleges that HomeStreet aided and abetted such alleged breaches. The action seeks, among other things, an injunction against the merger and damages, as well as recovery of the costs of the action, including attorneys’ and experts’ fees. HomeStreet believes the claims alleged against it in the actions to be without merit and intends to defend against them vigorously. In addition, Simplicity has informed the Company that it also believes the allegations against it in the actions to be without merit, and that it intends to defend against the claims vigorously.

Because the nature of our business involves the collection of numerous accounts, the validity of liens and compliance with various state and federal lending laws, we are subject to various legal proceedings in the ordinary course of our business related to foreclosures, bankruptcies, condemnation and quiet title actions and alleged statutory and regulatory violations. We are also subject to legal proceedings in the ordinary course of business related to employment matters. We do not expect that these proceedings, taken as a whole, will have a material adverse effect on our business, financial position or our results of operations. There are currently no matters that, in the opinion of management, would have a material adverse effect on our consolidated financial position, results of operation or liquidity, or for which there would be a reasonable possibility of such a material adverse effectloss based on information known at this time.

ITEM 1ARISK FACTORS
An investment
This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced by us described below and elsewhere in this report.

We are growing rapidly, and we may be unable to manage our growth properly.

In 2012, HomeStreet completed its initial public offering of common stock. At that time HomeStreet had been operating under regulatory orders that had been imposed during the financial crisis of 2007 through 2010 as a result of HomeStreet Bank having experienced operating losses, capital impairment, asset quality deterioration and a number of related operational and management issues. In early 2010 we began recruiting a new management team, and the recapitalization brought about by our initial public offering, together with aggressive management strategies, helped us substantially improve all aspects of our operations and financial condition. As a result of a combination of these factors, our regulators removed all extraordinary restrictions on our operations by early 2013. In November 2013 we completed the simultaneous acquisitions by merger of Fortune Bank, headquartered in Seattle, and Yakima National Bank, headquartered in Yakima, Washington. In December 2013 we completed the acquisition of two Seattle branches from AmericanWest Bank. In September 2014, we announced the pending acquisition by merger of Simplicity Bancorp and the merger of Simplicity Bank with HomeStreet Bank ("Simplicity Merger"). That pending merger represents our third whole-bank acquisition in less than two years. Simultaneously, we have grown our mortgage origination operations opportunistically but quickly, opening new offices in the Company is speculativeSan Francisco Bay and involvesLos Angeles areas of California in 2013 and 2014 while also continuing to grow those operations in our Pacific Northwest offices, and in October 2014 we announced plans to further expand our mortgage origination operations into Arizona beginning in the fourth quarter of 2014.

At the time we completed our IPO, and after giving effect to the $77.6 million in net proceeds from that offering, based on December 31, 2011 balances, we had total assets of approximately $2.4 billion, total deposits of approximately $2.0 billion, and total loans of approximately $1.5 billion, and we had approximately 600 employees. At September 30, 2014, we had total assets of approximately $3.5 billion, total deposits of $2.4 billion, total loans of approximately $2.7 billion, and approximately 1,600 employees. On a high degreeproforma basis giving effect to the Simplicity Merger, as of risk. September 30, 2014, the combined company would have had total assets of approximately $4.1 billion, total deposits of $3.07 billion, and total loans of approximately $3.07 billion. Further, unlike the Fortune Bank and Yakima National Bank acquisitions, which together resulted in only modest geographic expansion, the Simplicity Merger represents a substantial geographic expansion of our commercial and consumer

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banking operations. We have plans to continue growing strategically, and we may also grow opportunistically from time to time. Growth can present substantial demands on management personnel, line employees, and other aspects of a bank’s operations, and those challenges are particularly pronounced when growth occurs rapidly. We may face difficulties in managing that growth, and we may experience a variety of adverse consequences, including:

loss of or damage to key customer relationships;
distraction of management from ordinary course operations;
loss of key employees or significant numbers of employees;
the potential of litigation from prior employers relating to the portability of their employees;
costs associated with opening new offices to accommodate our growth in employees;
increased costs related to hiring, training and providing initial compensation to new employees, which may not be recouped if those employees do not remain with us long enough to be profitable;
challenges in complying with legal and regulatory requirements in new jurisdictions;
inadequacies in our computer systems, accounting policies and procedures, and management personnel (some of which may be difficult to detect until other problems become manifest);
challenges integrating different systems, practices, and customer relationships;
an inability to attract and retain personnel whose experience and (in certain circumstances) business relationships promote the achievement of our strategic goals; and
increasing volatility in our operating results as we progress through these initiatives.

The pending acquisition of Simplicity and any future acquisitions could consume significant resources, present significant challenges in integration and may not be successful.

In the fourth quarter of 2013 we completed our acquisitions of Fortune Bank, Yakima National Bank and the two retail branches of AmericanWest Bank and in September 2014 we announced the Simplicity Merger. While we consider our 2013 acquisitions to be substantially integrated, we expect to close the Simplicity acquisition in the first half of 2015 and we may seek out other acquisitions in the near future as we look for ways to continue to grow our business and our market share. The Simplicity acquisition and any future acquisition we may undertake may involve numerous risks described below represent somerelated to the investigation and consideration of the materialpotential acquisition, the costs of undertaking such a transaction and, if we are successful in closing such transaction, the risks you should carefully consider before making an investment decision. Ifinherent in the integration of the acquired assets or entity into HomeStreet or HomeStreet Bank, including risks that arise after the transaction is completed. These risks include:

Diversion of management's attention from normal daily operations of the business;
Costs incurred in the process of vetting potential acquisition candidates which may not be recouped by the Company;
Difficulties in integrating the operations, technologies, and personnel of the acquired companies;
Difficulties in implementing, upgrading and maintaining our internal controls over financial reporting and our disclosure controls and procedures;
Inability to maintain the key business relationships and the reputations of acquired businesses;
Entry into markets in which we have limited or no prior experience and in which competitors have stronger market positions;
Potential responsibility for the liabilities of acquired businesses;
Inability to maintain our internal standards, controls, procedures and policies at the acquired companies or businesses; and
Potential loss of key employees of the acquired companies.

Difficulties in pursuing or integrating any of these risks occur,new acquisitions may increase our business, capital, liquidity, financial condition and results of operations could be materiallycosts and adversely affected, in which case the price ofimpact our common stock could decline significantly and you could lose all or a part of your investment. The risk factors described below are not the only risks that may affect us. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, may also become important factors that materially and adversely affect our business, capital, liquidity, financial condition and results of operations. You should carefully considerFurther, even if we successfully address these factors and are successful in closing the following risk factors,transaction and integrating the systems together, withwe may nonetheless experience customer losses, or we may fail to grow the other information contained in this Report and other documentsacquired businesses as we file with the SEC, before making an investment decision about the Company.intend.

Fluctuations in interest rates could adversely affect the value of our assets and reduce our net interest income and noninterest income, thereby adversely affecting our earnings and profitability.

Interest rates may be affected by many factors beyond our control, including general and economic conditions and the monetary and fiscal policies of various governmental and regulatory authorities. ChangesIncreases in interest rates may reducein early 2014 reduced our mortgage revenues in large part by drastically reducing the market for refinancings, which wouldhas negatively impactimpacted our noninterest income and, to a lesser extent, our net interest income, and may impactas well as demand for our residential loan products and the revenue realized on the sale of loans. Our earnings are also dependent on the difference between the interest earned on loans and investments and the interest paid on deposits and borrowings. Changes in market interest rates impact the rates earned on

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loans and investment securities and the rates paid on deposits and borrowings and may negatively impact our ability to attract deposits, make loans and achieve satisfactory interest rate spreads, which could adversely affect our financial condition or results of operations. In addition, changes to market interest rates may impact the level of loans, deposits and investments and the credit quality of existing loans.

OurIn addition, our securities portfolio includes securities that are insured or guaranteed by U.S. government agencies or government-sponsored enterprises and other securities that are sensitive to interest rate fluctuations. The unrealized gains or losses in our available-for-sale portfolio are reported as a separate component of shareholders' equity until realized upon sale. As a result, futureFuture interest rate fluctuations may impact the value of these securities and as a result, shareholders' equity, causing material fluctuations from quarter to quarter. Failure to hold our securities until maturity or until market conditions are favorable for a sale could adversely affect our financial condition.

A significant portion of our noninterest income is derived from originating residential mortgage loans and selling them into the secondary market. That business has benefited from a long period of historically low interest rates. To the extent interest rates continue to rise, particularly if they rise substantially, we may experience a further reduction in mortgage financing and refinancing of new home purchases.purchases and refinancing. These factors have and may in the future further negatively affectaffected our mortgage loan origination volume and our noninterest income in the past and may do so again in the future.

Current economic conditions continue to pose significant challenges for us and could adversely affect our noninterest income.financial condition and results of operations.

Our mortgage servicing rights carry interest rate risk because the total amount of servicing fees earned, as well as changes in fair-market value, fluctuate based on expected loan prepayments (affecting the expected average life of a portfolio of residential mortgage servicing rights). The rate of prepayment of residential mortgage loans may be influenced by changing national and regional economic trends, such as recessions or depressed real estate markets, as well as the difference between interest rates on existing residential mortgage loans relative to prevailing residential mortgage rates. Changes in prepayment rates are therefore difficult for us to predict. An increaseDespite recent improvements in the general level of interest rates may adversely affect the ability of some borrowers to pay the interesteconomy and principal of their obligations. During periods of declining interest rates, many residential borrowers

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refinance their mortgage loans. The loan administration fee income related to the residential mortgage loan servicing rights corresponding to a mortgage loan deceases as mortgage loans are prepaid. Consequently, the fair value of portfolios of residential mortgage loan servicing rights tend to decrease during periods of declining interest rates, because greater prepayments can be expected and, as a result, the amount of loan administration income received also decreases.

A change in federal monetary policy could adversely impact our mortgage banking revenues.

The Federal Reserve System or Federal Reserve is responsible for regulating the supply of money in the United States, and as a result its monetary policies strongly influence our costs of funds for lending and investing as well as the rate of return we are able to earn on those loans and investments, both of which impact our net interest income and net interest margin. The Federal Reserve Board's interest rate policies can also materially affect the value of financial instruments we hold, including debt securities and mortgage servicing rights, or MSRs. These monetary policies can also negatively impact our borrowers, which in turn may increase the risk that they will be unable to pay their loans according to the terms or at all. We have no control over the monetary policies of the Federal Reserve Board and cannot predict when changes are expected or what the magnitude of such changes may be.

As a result of the Federal Reserve Board's concerns regarding continued slow economic growth, the Federal Reserve Board's Open Market Committee expanded its standing monetary policy, known as “quantitative easing,” in September 2012 to provide for a purchases by the Federal Reserve of up to $40 billion per month of mortgage-backed securities in the secondary market and up to $45 billion per month of longer-term United States Treasury securities. This program, which is intended to bolster the U.S. economy by retaining relatively low interest rates to promote increased spending, was adopted in 2008 and originally provided for the repurchase of only treasury securities. The inclusion of mortgage-backed securities was intended to have the effect of maintaining historically low mortgage interest rates. Because a substantial portion of our revenues and our net income historically have been, and in the foreseeable future are expected to be, derived from gain on the origination and sale of mortgage loans and on the continuing servicing of those loans, the Federal Reserve Board's policy may have had, and for so long as the program continues, may continue to have, the effect of supporting higher revenues than might otherwise be available. Contrarily, a reduction in or termination of this policy, absent a significant rebound in employment and real wages, would likely reduce mortgage originations throughout the United States, including ours. Recent speculation regarding potential changes in this policy has led to volatility in the financial markets and may have been a factor in increasing mortgage interest rates, reducing the overall demand in the market for mortgage loan origination. An actual reduction or termination of the quantitative easing program would likely further raise interest rates, which could reduce our mortgage origination revenues and in turn have a material adverse impact upon our business.

We may incur significant losses as a result of ineffective hedging of interest rate risk related to our loans sold with a reservation of servicing rights.

Both the value our single family mortgage servicing rights, or MSRs, and the value of our single family loans held for sale changes with fluctuations in interest rates, among other things, reflecting the changing expectations of mortgage prepayment activity. To mitigate potential losses of fair value of single family loans held for sale and MSRs related to changesincreases in interest rates, we actively hedge this risk with financial derivative instruments. Hedging is a complex process, requiring sophisticated models, experiencedare continuing to operate in an uncertain economic environment, including sluggish national and skilled personnelglobal conditions, accompanied by high unemployment and continual monitoring. Changesvery low interest rates. Financial institutions continue to be affected by changing conditions in the value of our hedging instrumentsreal estate and financial markets, along with an arduous and changing regulatory climate in which regulations passed in response to conditions and events during the economic downturn continue to be implemented. Recent improvements in the housing market may not correlate with changescontinue, and a return to a recessionary economy could result in the value offinancial stress on our single family loans held for sale and MSRs, and we could incur a net valuation loss as aborrowers that may result of our hedging activities. Following the expansion of our single family mortgage operations in early 2012 through the addition of a significant number of single family mortgage origination personnel, the volume of our single family loans held for sale and MSRs has increased. The increase in volume in turn increases our exposure to the risks associated with the impact of interest rate fluctuations on single family loans held for sale and MSRs.

A substantial portion of our revenue is derived from residential mortgage lending which is a market sector that has significant volatility and is facing significant regulatory changes which take effect in January 2014.

A substantial portion of our consolidated net revenues (net interest income plus noninterest income) are derived from originating and selling residential mortgages. Residential mortgage lending in general has experienced substantial volatility in recent periods. Moreover, ahome prices, increased foreclosures and significant increase in interest rates,write-downs of asset values, all of which we experienced in the second quarter of 2013, may materially andwould adversely affect our future loan origination volume, margins,financial condition and the valueresults of the collateral securing our outstanding loans, may increase rates of borrower default, and may otherwise adversely affect our business.


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Difficult market conditions have adversely affected and may continue to have an adverse effect on our business.

During the period from early 2008 through most of 2011, the United States economy in general, and the financial institutions sector in particular, experienced a severe downturn owing to a number of factors that affected virtually every aspect of our business. While these conditions have moderated, uncertainty continues to affect our business, and thus raises risk as to our ability to maintain profitability at current levels.operations.

In particular, we may face risks related to market conditions that may negatively impact our business opportunities and plans, such as:
uncertainty relatedMarket developments may affect consumer confidence levels and may cause adverse changes in payment patterns, resulting in increased delinquencies and default rates on loans and other credit facilities;
Regulatory scrutiny of the industry could further increase, leading to increasedharsh regulation of our industry that could lead to a higher cost of compliance, limit our ability to pursue business opportunities and aggressive governmental enforcement inincrease our exposure to the financial sector generallyjudicial system and the mortgage banking business specifically, including increased costs of compliance;plaintiff’s bar;
theThe models we use to assess the creditworthiness of our customers may prove less reliable than we had anticipated in predicting future behaviors which may impair our ability to make good underwriting decisions;
If our forecasts of economic conditions and other economic predictions are not accurate, we may face challenges in accurately estimating the ability of our borrowers to repay their loans if our forecastsloans;
Further erosion in the fiscal condition of economic conditionsthe U.S. Treasury may lead to new taxes limiting the ability of the Company to pursue growth and other economic predictions are not accurate;
increases in FDIC insurance premiums duereturn profits to depletion of that agency's insurance funds;
restrictions in our ability to engage in routine funding transactions due to the commercial soundness of other financial institutions and government sponsored entities ("GSEs");shareholders; and
uncertainty regarding futureFuture political developments and fiscal policy.policy decisions may create uncertainty in the marketplace.

If recovery from the economic recession slows or if we experience another recessionary dip, our ability to access capital and our business, financial condition and results of operations may be adversely impacted.

The proposed restructuring or replacement of Fannie Mae and Freddie Mac and changes in existing government-sponsored and federal mortgage programs could adversely affect our business.

We have been rapidly increasingoriginate and purchase, sell and thereafter service single family and multifamily mortgages under the growth of our mortgage banking business through hiring of additional loan officersFannie Mae, and support personnel,to a lesser extent the Freddie Mac single family purchase programs and the costs associated withFannie Mae multifamily DUS program. Since the nationwide downturn in residential mortgage lending that growth may not keep pacebegan in 2007 and the placement of Fannie Mae and Freddie Mac into conservatorship, Congress and various executive branch agencies have offered a wide range of proposals aimed at restructuring these agencies. The Obama administration has called for scaling back the role of the U.S. government in, and promoting the return of private capital to, the mortgage markets and the reduction of the role of Fannie Mae and Freddie Mac in the mortgage markets by, among other things, reducing conforming loan limits, increasing guarantee fees and requiring larger down payments by borrowers with the anticipated increaseultimate goal of winding down Fannie Mae and Freddie Mac. As recently as January

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2014, the White House reaffirmed the view that housing finance reform should include ending Fannie Mae and Freddie Mac’s business model.

Notwithstanding the White House’s reaffirmed position, in May 2014 FHFA released a strategic plan relating to the conservatorships of Fannie Mae and Freddie Mac which no longer involves specific steps to contract Fannie Mae’s and Freddie Mac’s market presence, but retains a goal focused on ways to bring additional private capital into the system in order to reduce taxpayer risk. However, Congress has recently considered several bills to reform the housing finance system, including bills that, among other things, would require Fannie Mae and Freddie Mac to be wound down after a period of time and place certain restrictions on Fannie Mae’s and Freddie Mac’s activities prior to being wound down. We expect that Congress will continue to hold hearings and consider legislation on the future status of Fannie Mae and Freddie Mac, including proposals that would result in Fannie Mae’s liquidation or dissolution.

We cannot be certain if or when Fannie Mae and Freddie Mac ultimately will be restructured or wound down, if or when additional reform of the housing finance market will be implemented or what the future role of the U.S. government will be in the mortgage market, and, accordingly, we will not be able to determine the impact that any such reform may have on us until a definitive reform plan is adopted. However, any restructuring or replacement of Fannie Mae and Freddie Mac that restricts the current loan purchase programs of those entities may have a material adverse effect on our revenues.
Beginning in Februarybusiness and results of 2012,operations. Moreover, we have hired a substantial numberrecorded on our balance sheet an intangible asset (mortgage servicing rights, or MSRs) relating to our right to service single and multifamily loans sold to Fannie Mae and Freddie Mac. That MSR asset was valued at $124.6 million at September 30, 2014. Changes in the policies and operations of mortgage loan personnel, including large groups of employees previously affiliated with MetLife Home Loans.In additionFannie Mae and Freddie Mac or any replacement for or successor to increasing our exposure to a more volatile segment of our business, the rapid expansion ofthose entities that adversely affect our single family residential loan and DUS mortgage loan operations through hiring a large number of additional employees in our traditional markets and in additional Western states involves significant expense and exposesservicing assets may require us to potential additional risks, including:record impairment charges to the value of these assets, and significant impairment charges could be material and adversely affect our business.
Expenses related
In addition, our ability to hiringgenerate income through mortgage sales to institutional investors depends in part on programs sponsored by Fannie Mae, Freddie Mac and trainingGinnie Mae, which facilitate the issuance of mortgage-backed securities in the secondary market. Any discontinuation of, or significant reduction in, the operation of those programs could have a large numbermaterial adverse effect on our loan origination and mortgage sales as well as our results of operations. Also, any significant adverse change in the level of activity in the secondary market or the underwriting criteria of these entities could negatively impact our results of business, operations and cash flows.

We may need to increase our capital to be prepared to comply with more stringent capital requirements under Basel III beginning on January 1, 2015.

In July 2013, the U.S. federal banking regulators (including the Federal Reserve and FDIC) jointly announced the adoption of new employees;rules relating to capital standards requirements, including requirements contemplated by Section 171 of the Dodd-Frank Act as well as certain standards initially adopted by the Basel Committee on Banking Supervision, which standards are commonly referred to as Basel III. A substantial portion of these rules will apply to both the Company and the Bank beginning in January 2015. As part of these new rules, both the Company and the Bank will be required to have a common equity Tier 1 capital ratio of 4.5%, have a Tier 1 leverage ratio of 4.0%, a Tier 1 risk-based ratio of 6.0% and a total risk-based ratio of 8.0%. In addition, both the Company and the Bank will be required to establish a “conservation buffer”, consisting of common equity Tier 1 capital, equal to 2.5%, which means in effect that in order to prevent certain regulatory restrictions, the common equity Tier 1 capital ratio requirement will be 7.0%, the Tier 1 risk-based ratio requirement will be 8.5% and the total risk-based ratio requirement will be 10.5%. In this regard, any institution that does not meet the conservation buffer will be subject to restrictions on certain activities including payment of dividends, stock repurchases and discretionary bonuses to executive officers. The requirement for a conservation buffer will be phased in beginning in 2016 and will take full effect on January 1, 2019.
Higher compensation costs relative
Additional prompt corrective action rules will apply to productionthe Bank, including higher ratio requirements for the Bank to be considered well-capitalized. The new rules also modify the manner for determining when certain capital elements are included in the initial monthsratio calculations. Under current capital standards, the effects of accumulated other comprehensive income items included in capital are excluded for the purposes of determining regulatory capital ratios. Under Basel III, the effects of certain accumulated other comprehensive items are not excluded; however, banking organizations that are not required to use advanced approaches, including the Company and the Bank, may make a one-time permanent election to continue to exclude these items. The Company and Bank expect to make this election in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of the Company's securities portfolio.

In addition, deductions include, for example, the requirement that mortgage servicing rights, certain deferred tax assets not dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from the

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new common equity Tier 1 capital to the extent that any one such category exceeds 10% of new employment;common equity Tier 1 capital, or all such categories in the aggregate exceed 15% of new common equity Tier 1 capital. Maintaining higher capital levels may result in lower profits for the Company as we will not be able to grow our lending as quickly as we might otherwise be able to do if we were to maintain lower capital levels. See “Regulation and Supervision of Home Street Bank - Capital and Prompt Corrective Action Requirements - New Capital Regulations” in Item 1 of our Form 10-K for the year ended December 31, 2013 previously filed with the SEC.
Increased compliance costs;
Costs associatedThe sale of approximately 24% of our MSR portfolio in the second quarter of 2014 was consummated in part to facilitate balance sheet and capital management in preparation for Basel III. The application of more stringent capital requirements could, among other things, result in lower returns on invested capital and result in regulatory actions if we were to be unable to comply with opening new officessuch requirements.

We are subject to extensive regulation that may be neededrestrict our activities, including declaring cash dividends or capital distributions, and imposes financial requirements or limitations on the conduct of our business.

Our operations are subject to provide forextensive regulation by federal, state and local governmental authorities, including the new employees;
New stateFDIC, the Washington Department of Financial Institutions and the Federal Reserve, and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Because our business is highly regulated, the laws, rules and regulations to which we have not been previously subject;
Diversion of management's attention fromare subject are evolving and change frequently. Changes to those laws, rules and regulations are also sometimes retroactively applied. Examination findings by the daily operations of other aspects of the business;
The potential of litigation related from prior employers relatedregulatory agencies may result in adverse consequences to the portability of their employees;
The potential loss of other key employees.

Company or the Bank. We cannot give assurance that these costs and other risks will be fully offset or mitigated by increased revenue generated by the expansion in this business linehave, in the near future, or at all.
Effortspast, been subject to integrate future acquisitions could consume significant resources.

In addition to our recently announced acquisitions of Fortune Bank, Yakima National Bank and agreements to acquire two retail branches of AmericanWest Bank, which are expected to close in the fourth quarter of 2013, we may seek out other acquisitions in the near future as we look for ways to continue to growspecific regulatory orders that constrained our business and our market share. These acquisitionsrequired us to take measures that investors may have deemed undesirable, and pending acquisitions and any other future acquisition we may undertake involve numerous risks relatedagain in the future be subject to such orders if banking regulators were to determine that our operations require such restrictions. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the integrationauthority to restrict our operations, adversely reclassify our assets, determine the level of deposit premiums assessed and require us to increase our allowance for loan losses.

The Dodd-Frank Act is expected to increase our costs of operations and may have a material negative effect on us.

The Dodd-Frank Act significantly changed the laws as they apply to financial institutions and revised and expanded the rulemaking, supervisory and enforcement authority of federal banking regulators. It is also expected to have a material impact on our relationships with current and future customers.

Some of these changes were effective immediately, though many are being phased in gradually. In addition, the statute in many instances calls for regulatory rulemaking to implement its provisions. While some provisions are now being implemented, such
as the Basel III capital standards which take effect beginning on January 1, 2015, not all of the acquired assetsregulations called for by
Dodd-Frank have been completed or entity into HomeStreet or HomeStreet Bank, including risks that arise afterare in effect, so the transaction is completed. These risks include:
difficulties in integrating the operations, technologies, and personnelprecise contours of the acquired companies;
difficulties in implementing internal controls over financial reporting;
diversion of management's attention from normal daily operationslaw and its effects on us cannot yet be fully understood. The provisions of the business;
inability to maintain the key business relationshipsDodd-Frank Act and the reputationssubsequent exercise by regulators of acquired businesses;their revised and expanded powers thereunder could materially and negatively impact the profitability of our business, the value of assets we hold or the collateral available for our loans, require changes to business practices or force us to discontinue businesses and expose us to additional costs, taxes, liabilities, enforcement actions and reputational risk. For example, the Dodd-Frank Act imposes a requirement that private securitizers of mortgage and other asset backed securities retain, subject to certain exemptions, not less than five percent of the credit risk of the mortgages or other assets backing the securities. The regulatory agencies released the final Risk Retention rules on October 22, 2014 to be effective in one year for residential mortgage-backed securitizations and in two years for all other securitization types. See “Regulation and Supervision” in Item 1 of our Form 10-K for the year ended December 31, 2013 previously filed with the SEC.

New federal and state legislation, case law or regulatory action may negatively impact our business.

Enacted legislation, including the Dodd-Frank Act, as well as future federal and state legislation, case law and regulations could require us to revise our operations and change certain business practices, impose additional costs, reduce our revenue and earnings and otherwise adversely impact our business, financial condition and results of operations. For instance,

Recent legislation and court decisions with precedential value could allow judges to modify the terms of residential mortgages in bankruptcy proceedings and could hinder our ability to foreclose promptly on defaulted mortgage loans or expand assignee liability for certain violations in the mortgage loan origination process, any or all of which could adversely affect our business or result in our being held responsible for violations in the mortgage loan origination process.

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entry into marketsCongress and various regulatory authorities have proposed programs that would require a reduction in principal balances of “underwater” residential mortgages, which if implemented would tend to reduce loan servicing income and which might adversely affect the carrying values of portfolio loans.
The Washington state supreme court has ruled that Mortgage Electronic Registration System, Inc. (“MERS”) does not meet the definition of “beneficiary” under Washington’s deed of trust act, requiring additional steps to be taken to appoint a successor trustee prior to initiating a non-judicial foreclosure in that state or necessitating a judicial foreclosure process for MERS-related mortgages. Court cases in Oregon have brought similar challenges regarding MERS under Oregon state law.  While the Oregon Supreme Court has ruled on the appeal of several lower-court MERS cases, enough ambiguity exists in the ruling that we and other servicers of MERS-related loans have elected to foreclose primarily through judicial procedures in Oregon, resulting in increased foreclosure costs, longer foreclosure timelines and additional delays.   If state courts in  Washington or other states where we do significant business issue similar decisions in the cases pending before them, our foreclosure costs and foreclosure timelines may continue to increase, which in turn, could increase our single family loan delinquencies, servicing costs, and adversely affect our cost of doing business and results of operations.

These or other judicial decisions or legislative actions, if upheld or implemented, may limit our ability to take actions that may be essential to preserve the value of the mortgage loans we service or hold for investment. Any restriction on our ability to foreclose on a loan, any requirement that we forego a portion of the amount otherwise due on a loan or any requirement that we modify any original loan terms may require us to advance principal, interest, tax and insurance payments, which would negatively impact our business, financial condition, liquidity and results of operations. Given the relatively high percentage of our business that derives from originating residential mortgages, any such actions are likely to have a significant impact on our business, and the effects we experience will likely be disproportionately high in comparison to financial institutions whose residential mortgage lending is more attenuated.

In addition, while these legislative and regulatory proposals and courts decisions generally have focused primarily, if not exclusively, on residential mortgage origination and servicing, other laws and regulations may be enacted that affect the manner in which we do business and the products and services that we provide, restrict our ability to grow through acquisition, restrict our ability to compete in our current business or expand into any new business, and impose additional fees, assessments or taxes on us or increase our regulatory oversight.

Termination of the merger agreement could adversely impact our financial results and stock price.

On September 27, 2014, we entered into a merger agreement pursuant to which we have limited or no prior experienceagreed to acquire Simplicity Bancorp. We expect to close that transaction in the first half of 2015, but it remains subject to certain closing conditions, including regulatory approvals and certain shareholder approvals. In addition, Simplicity has the ability to terminate the merger agreement in certain circumstances, including in order to pursue a superior offer. If the merger agreement is terminated, there may be various consequences. For example, HomeStreet’s businesses may be impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the merger. HomeStreet has incurred substantial costs in connection with the merger agreement, including legal and accounting fees, investment banking fees, printing charges and filing fees. If the merger agreement is terminated, HomeStreet will be required to recognize an operating expense in the amount of such costs in the period in which competitorsthe merger agreement is terminated, and unless a termination fee is due from Simplicity in connection with the closing, HomeStreet will not receive any reimbursement for those expenses. Additionally, if the merger agreement is terminated, the market price of our common stock could decline to the extent that the current market prices reflect a market assumption that the merger will be completed.

Pending litigation against Simplicity and HomeStreet could result in an injunction preventing the effective time or a judgment resulting in the payment of damages.

In connection with the merger, purported Simplicity stockholders have strongerfiled at least one putative shareholder class action lawsuit against Simplicity, the members of the Simplicity board of directors and HomeStreet. Among other remedies, the plaintiffs seek to enjoin the merger. If the pending case and any similar cases are not resolved, these lawsuits could prevent or delay completion of the merger and result in substantial costs to HomeStreet and Simplicity, including any costs associated with the indemnification of directors and officers. Plaintiffs may file additional lawsuits against HomeStreet, Simplicity and/or the directors and officers of either company in connection with the merger. The defense or settlement of any lawsuit or claim that remains unresolved at the time the merger is completed may adversely affect HomeStreet’s business, financial condition, results of operations and cash flows.


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New CFPB regulations which took effect in January 2014 may negatively impact our residential mortgage loan business and compliance risk.

Our consumer business, including our mortgage, credit card, and other consumer lending and non-lending businesses, may be adversely affected by the policies enacted or regulations adopted by the Consumer Financial Protection Bureau (CFPB) which has broad rulemaking authority over consumer financial products and services. In January 2014 new federal regulations promulgated by the CFPB took effect which impact how we originate and service residential mortgage loans. The new regulations, among other things, require mortgage lenders to assess and document a borrower’s ability to repay their mortgage loan. The regulations provide borrowers the ability to challenge foreclosures and sue for damages based on allegations that the lender failed to meet the standard for determining the borrower’s ability to repay their loan. While the regulations include presumptions in favor of the lender based on certain loan underwriting criteria, it is uncertain how these presumptions will be construed and applied by courts in the event of litigation. The ultimate impact of these new regulations on the lender’s enforcement of its loan documents in the event of a loan default, and the cost and expense of doing so, is uncertain, but may be significant. In addition, the secondary market positions;demand for loans that do not fall within the presumptively safest category of a “qualified mortgage” as defined by the CFPB is uncertain.
responsibility for the liabilities of acquired businesses;
inabilityThe new regulations also require changes to maintain our internal standards, controls,certain loan servicing procedures and policies atpractices. The new servicing rules will, among other things, result in increased foreclosure costs and longer foreclosure timelines in the acquired companies or businesses;event of loan default, and failure to comply with the new servicing rules may result in additional litigation and compliance risk.
potential loss
The CFPB recently proposed additional rules under the Home Mortgage Disclosure Act (“HMDA”) that are intended to improve information reported about the residential mortgage market and increase disclosure about consumer access to mortgage credit. As drafted, the proposed updates to the HMDA increase the types of key employeesdwelling-secured loans that would be subject to the disclosure requirements of the acquired companies.rule and expands the categories of information that financial institutions such as the Bank would be required to report with respect to such loans and such borrowers, including potentially sensitive customer information. If implemented, these changes would increase our compliance costs due to the need for additional resources to meet the enhanced disclosure requirements, including additional personnel and training costs as well as informational systems to allow the Bank to properly capture and report the additional mandated information. In addition, because of the anticipated volume of new data that would be required to be reported under the updated rules, the Bank would face an increased risk of errors in the information. More importantly, because of the sensitive nature of some of the additional customer information to be included in such reports, the Bank would face a higher potential for a security breach resulting in the disclosure of sensitive customer information in the event the HMDA reporting files were obtained by an unauthorized party. The comment period for these proposed rules closed on October 29, 2014 and the final rules have not yet been released.
Difficulties in integrating any or all
While the full impact of these acquisitionsCFPB's activities on our business is still unknown, we anticipate that the proposed rule change under the HMDA and other CFPB actions that may follow may increase our compliance costs and require changes in our business practices as a result of new regulations and requirements and could limit the products and services we are able to provide to customers. We are unable to predict whether U.S. federal, state or local authorities, or other pertinent bodies, will enact legislation, laws, rules, regulations, handbooks, guidelines or similar provisions that will affect our business or require changes in our practices in the future, and any such changes could adversely impactaffect our cost of doing business and profitability. See “Regulation and Supervision - Regulation and Supervision” in Item 1 of our Form 10-K for the year ended December 31, 2013 previously filed with the SEC.

Our accounting policies and methods are fundamental to how we report our financial condition and results of operations, and we use estimates in determining the fair value of certain of our assets, which estimates may prove to be imprecise and result in significant changes in valuation.

A portion of our assets are carried on the balance sheet at fair value, including investment securities available for sale, mortgage servicing rights related to single family loans and single family loans held for sale. Generally, for assets that are reported at fair value, we use quoted market prices or internal valuation models that utilize observable market data inputs to estimate their fair value. In certain cases, observable market prices and data may not be readily available or their availability may be diminished due to market conditions. We use financial models to value certain of these assets. These models are complex and use asset-specific collateral data and market inputs for interest rates. Although we have processes and procedures in place governing internal valuation models and their testing and calibration, such assumptions are complex as we must make judgments about the effect of matters that are inherently uncertain. Different assumptions could result in significant changes in valuation, which in turn could affect earnings or result in significant changes in the dollar amount of assets reported on the balance sheet.


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If we fail to maintain effective systems of internal and disclosure control, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our securities.

Effective internal and disclosure controls are necessary for us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. As part of our ongoing monitoring of internal control we may from time to time discover deficiencies in our internal control as defined under standards adopted by the Public Company Accounting Oversight Board, or PCAOB, that require remediation. Under the PCAOB standards, a “material weakness” is a significant deficiency or combination of significant deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. A “significant deficiency” is a control deficiency or combination of control deficiencies, that adversely affect a company’s ability to initiate, authorize, record, process, or report financial data reliably in accordance with generally accepted accounting principles such that there is a more than remote likelihood that a misstatement of a company’s annual or interim financial statements that is more than inconsequential will not be prevented or detected.

Following the closing of our books for the third quarter of 2014, management discovered a deficiency in our internal control over financial reporting relating to the evaluation of certain hedging instruments. Management investigated this deficiency in light of the extent to which misstatements had resulted in our prior period reports, and determined that the amount of actual misstatements was immaterial for each of the prior periods and in the aggregate. However, we also examined the deficiencies in light of the maximum possible error that could have resulted from the deficiencies, and determined that such an amount could have been material. As a result, this Quarterly Report on Form 10-Q identifies and discusses a deficiency in our disclosure controls and procedures, and notes that we intend to take certain remedial measures to improve our internal control over financial reporting. However, we cannot offer assurances that these remedial measures will completely resolve the deficiencies that we have identified, or that we do not have other undiscovered deficiencies in our disclosure controls and procedures or our internal control over financial reporting.

If we discover additional deficiencies in our internal controls, we may also identify defects in our disclosure controls and procedures that require remediation. If we discover additional deficiencies, we will take affirmative steps to improve our internal and disclosure controls. However, there is no assurance that we will be successful. Any failure to maintain effective controls or timely effect any necessary improvement of our internal and disclosure controls could harm operating results or cause us to fail to meet our reporting obligations. Ineffective internal and disclosure controls, including the deficiencies identified in this report, could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our securities.

HomeStreet, Inc. primarily relies on dividends from the Bank and payment of dividends by the Bank may be limited by applicable laws and regulations.

HomeStreet, Inc. is a separate legal entity from the Bank, and although we may receive some dividends from HomeStreet Capital Corporation, the primary source of our funds from which we service our debt, pay dividends to our shareholders and otherwise satisfy our obligations is dividends from the Bank. The availability of dividends from the Bank is limited by various statutes and regulations, as well as by our policy of retaining a significant portion of our earnings to support the Bank's operations. New capital rules will also impose more stringent capital requirements to maintain “well capitalized” status which may additionally impact the Bank’s ability to pay dividends to the Company. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Management – New Capital Regulations” as well as “Regulation of Home Street Bank - Capital and Prompt Corrective Action Requirements - New Capital Rules” in Item 1 of our Form 10-K for the year ended December 31, 2013 previously filed with the SEC. If the Bank cannot pay dividends to us, we may be limited in our ability to service our debts, fund the Company's operations and acquisition plans and pay dividends to the Company's shareholders. While the Company has made special dividend distributions to its public shareholders in prior quarters, the Company has not adopted a dividend policy and the board of directors determined that it is in the best interests of the shareholders not to declare a dividend to be paid in the third quarter of 2014. As such, our dividends are not regular and are subject to restriction due to cash flow limitations, capital requirements, capital needs of the business or other factors.


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We cannot assure you that we will remain profitable.

We have sustained significant losses in the past and our profitability has declined in recent quarters. We cannot guarantee that we will remain profitable or be able to maintain the level of profit we are currently experiencing. Many factors determine whether or not we will be profitable, in a given quarter, and our ability to remain profitable is threatened by a myriad of issues, including:
Increased costs from growth through acquisition of new loan officers, originators and servicing personnel as well as the acquisition of other entities such as Fortune and Yakima National Bank could exceed the income growth anticipated from these opportunities, especially
Further increases in the short term as these new hires and new acquisitions are integrated into our business;
Changes in the interest rate environmentrates may continue to limit our ability to make loans, decrease our net interest income and noninterest income, reduce demand for loans, increase the cost of deposits and otherwise negatively impact our financial situation;
Volatility in mortgage markets, which is driven by factors outside of our control such as interest rate changes, housing inventory and general economic conditions, may negatively impact our ability to originate loans and change the fair value of our existing loans;loans and servicing rights;
Changes in governmental sponsored entitiesregulations that impact the Company or the Bank and may limit our ability to offer certain products or services or may increase our costs of compliance;
Increased costs from growth through acquisition could exceed the income growth anticipated from these opportunities, especially in the short term as these acquisitions are integrated into our business;
Changes in government-sponsored enterprises and their ability to insure or to buy our loans in the secondary market may haveresult in significant changes in our ability to recognize income on sale of our loans to third parties;
Competition in the mortgage market industry may drive down the interest rates we are able to offer while at the same time changeson our mortgages, which will negatively impact our net interest income;
Changes in the cost structures and fees of governmental sponsored entitiesgovernment-sponsored enterprises to whom we sell many of these loans may compress our margins and reduce our net income and profitability; and
Our hedging strategies to offset risks related to interest rate changes may not prove to be successful and may result in unanticipated losses for the Company.

These and other factors may limit our ability to generate revenue in excess of our costs, in any given quarter, which in turn may result in a lower rate of profitability or even substantial losses for the Company.
HomeStreet, Inc. primarily relies on dividends from the Bank
Federal, state and payment of dividends by the Banklocal consumer protection laws may be limited by applicable laws and regulations.

HomeStreet, Inc. is a separate legal entity from the Bank, and although we do receive some dividends from HomeStreet Capital Corporation, the primary source of our funds from which we service our debt, pay dividends to our shareholders and otherwise satisfy our obligations is dividends from the Bank. The availability of dividends from the Bank is limited by various statutes and regulations, as well as by our policy of retaining a significant portion of our earnings to support the Bank's operations. If the Bank cannot pay dividends to us, we may be limited inrestrict our ability to serviceoffer and/ or increase our debts, fundrisk of liability with respect to certain products and services and could increase our cost of doing business.

Federal, state and local laws have been adopted that are intended to eliminate certain practices considered “predatory” or “unfair and deceptive”. These laws prohibit practices such as steering borrowers away from more affordable products, failing to disclose key features, limitations, or costs related to products and services, selling unnecessary insurance to borrowers, repeatedly refinancing loans, imposing excessive fees for overdrafts, and making loans without a reasonable expectation that the Company's operationsborrowers will be able to repay the loans irrespective of the value of the underlying property. It is our policy not to make predatory loans or engage in deceptive practices, but these laws and pay dividendsregulations create the potential for liability with respect to our lending, servicing, loan investment and deposit taking activities. As we offer products and services to customers in additional states, we may become subject to additional state and local laws designed to protect consumers. The additional laws and regulations may increase our cost of doing business, and ultimately may prevent us from making certain loans, offering certain products, and may cause us to reduce the Company's shareholders.average percentage rate or the points and fees on loans and other products and services that we do provide.

The significant concentration of real estate secured loans in our portfolio has had and may continue to have a negative impact on our asset quality and profitability.

Substantially all of our loans are secured by real property. Our real estate secured lending is generally sensitive to national, regional and local economic conditions, making loss levels difficult to predict. Declines in real estate sales and prices, significant increases in interest rates, and a degeneration in prevailing economic conditions may result in higher than expected loan delinquencies, foreclosures, problem loans, OREO, net charge-offs and provisions for credit and OREO losses. Although real estate prices have recently increasedare stable in the markets in which we operate, if market values were to decline, again, the collateral for our loans may provide less security and our ability to recover the principal, interest and costs due on defaulted loans by selling the underlying real estate will be diminished, leaving us more likely to suffer additional losses on defaulted loans. Such declines may have a greater effect on our earnings and capital than on the earnings and capital of financial institutions whose loan portfolios are more geographically diversified.


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Worsening conditions in the real estate market and higher than normal delinquency and default rates on loans could cause other adverse consequences for us, including:
the
The reduction of cash flows and capital resources, as we are required to make cash advances to meet contractual obligations to investors, process foreclosures, and maintain, repair and market foreclosed properties;
decliningDeclining mortgage servicing fee revenues;revenues because we recognize these revenues only upon collection;
increasingIncreasing loan servicing costs;
decliningDeclining fair value on our mortgage servicing rights; and
decliningDeclining fair values and liquidity of securities held in our investment portfolio that are collateralized by mortgage obligations.

Our allowance for loan losses may prove inadequate or we may be negatively affected by credit risk exposures. Future additions to our allowance for loan losses will reduce our earnings.

Our business depends on the creditworthiness of our customers. As with most financial institutions, we maintain an allowance for loan losses to provide for defaults and nonperformance, which represents management's best estimate of probable incurred losses inherent in the loan portfolio. Management's estimate is the result of our continuing evaluation of specific credit risks and loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions, industry concentrations and other factors that may indicate future loan losses. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and judgment and requires us to make estimates of current credit risks and future trends, all of which may undergo material changes. Generally, our nonperforming loans and OREO reflect operating difficulties of individual borrowers and weaknesses in the economies of the markets we serve. This allowance may not be adequate to cover actual losses, and future provisions for losses could materially and adversely affect our financial condition, results of operations and cash flows.

In addition, we are currently pursuingas a strategyresult of growth through acquisition, including theour acquisitions of Fortune Bank, Yakima National Bank and the pending acquisitions of two branches of AmericanWest Bank. UponBank in the closingsecond half of those acquisitions,2013, we have added and will be addingthe loans previously held by the acquired companycompanies or branchrelated to the acquired branches to our books. The pending acquisition of Simplicity and any future acquisitions we may make will have a similar result. Although we review loan quality as part of our due diligence in considering any acquisition, the addition of such loans may increase our credit risk exposure, requiring an increase in our allowance for loan losses or we may experience adverse effects to our financial condition, results of operations and cash flows stemming from losses on those additional loans.

If we breach any of the representations or warranties we make to a purchaser when we sell mortgage loans, we may be liable to the purchaser for unpaid principal and interest on the loan.

When we sell mortgage loans in the ordinary course of business, we are required to make certain representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. Our loan sale agreements require us to repurchase mortgage loans if we have breached any of these representations or warranties, in which case we may be required to repurchase such loan and record a loss upon repurchase and/or bear any subsequent loss on the loan. We may not have any remedies available to us against a third party for such losses, or the remedies available to us may not be as broad as the remedies available to the purchaser of the mortgage loan against us. In addition, if there are remedies against a third party available to us, we face further risk that such third party may not have the financial capacity to perform remedies that otherwise may be available to us. Therefore, if a purchaser enforces remedies against us, we may not be able to recover our losses from a third party and may be required to bear the full amount of the related loss. If repurchase and indemnity demands increase, our liquidity, results of operations and financial condition will be adversely affected.

If we breach any representations and warranties or fail to follow guidelines when originating a FHA/HUD-insured loan or a VA-guaranteed loan, we may lose the insurance or guarantee on the loan and suffer losses and/or pay penalties.

We originate and purchase, sell and thereafter service single family loans that are insured by FHA/HUD or guaranteed by the VA. We certify to the FHA/HUD and the VA that the loans meet their requirements and guidelines. The FHA/HUD and VA audit loans that are insured or guaranteed under their programs, including audits of our processes and procedures as well as individual loan documentation. Violations of guidelines can result in monetary penalties or require us to provide indemnifications against loss or loans declared ineligible for their programs. In the past, monetary penalties and losses from indemnifications have not created material losses to the Bank. As a result of the housing crisis, the FHA/HUD has stepped up enforcement initiatives. In addition to regular FHA/HUD audits, HUD's Inspector General has become active in enforcing FHA regulations with respect to individual loans and has partnered with the Department of Justice ("DOJ") in filing lawsuits against lenders for systemic violations. The penalties resulting from such lawsuits can be much more severe, since systemic violations

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can be applied to groups of loans and penalties may be subject to treble damages. The DOJ has used the Federal False Claims Act in prosecuting these lawsuits. Because of our significant origination of FHA/HUD insured and VA guaranteed loans, if the DOJ were to find potential violations by the Bank, we could be subject to material monetary penalties and/or losses, and may even be subject to lawsuits alleging systemic violations which could result in treble damages.

Changes in fee structures by third party loan purchasers and mortgage insurers may decrease the margin we can recognize on conforming home loans and may adversely impact our results of operations.
Recently, certain third party loan purchasers have revised their fee structures and increased the costs of doing business with them. For example, certain purchasers of conforming loans, including Fannie Mae and Freddie Mac, raised costs for guarantor fees and other required fees and payments. Additionally, the FHA raised costs for premiums and and extended the period for which private mortgage insurance is required on a loan purchased by them. These changes increased the cost of selling conforming loans to third party loan purchasers which in turn decreases our margin and negatively impacts our profitability. Additional changes in the future from third party loan purchasers may have a negative impact on our ability to originate loans to be sold because of the increased costs of such loans and may decrease our profitability with respect to loans held for sale. In addition, any significant adverse change in the level of activity in the secondary market or the underwriting criteria of these third party loan purchasers could negatively impact our results of business, operations and cash flows.
We may face risk of loss if we purchase loans from a seller that fails to satisfy its indemnification obligations.

We generally receive representations and warranties from the originators and sellers from whom we purchase loans and servicing rights such that if a loan defaults and there has been a breach of such representations and warranties, we may be able to pursue a remedy against the seller of the loan for the unpaid principal and interest on the defaulted loan. However, if the originator and/or seller breach such representations and warranties and does not have the financial capacity to pay the related damages, we may be subject to the risk of loss for such loan as the originator or seller may not be able to pay such damages or repurchase loans when called upon by us to do so. Currently, we only purchase loans from Windermere Mortgage Services Series LLC, an affiliated business arrangement with certain Windermere real estate brokerage franchise owners.

The proposed restructuring or elimination of Fannie Mae and Freddie Mac could negatively affect our business.

We originate and purchase, sell and thereafter service single family and multifamily mortgages under the Fannie Mae, and to a lesser extent the Freddie Mac single family purchase programs and the Fannie Mae multifamily DUS program. Since the nationwide downturn in residential mortgage lending that began in 2007 and the placement of Fannie Mae and Freddie Mac into conservatorship, Congress and various executive branch agencies have offered a wide range of proposals aimed at restructuring these agencies.

In August 2012, the Treasury Department entered into amendments to its senior preferred stock purchase agreements with each of Fannie Mae and Freddie Mac that require those agencies to reduce the amount of mortgage assets they hold, setting a cap of $650 billion for December 31, 2012 and requiring a decrease of at least 15% per year for each year thereafter, to a minimum of $250 billion, as a step toward winding down those agencies. Most recently, the House Financial Services Committee recommended legislation that would wind down Fannie Mae and Freddie Mac with the expectation that a private market would emerge to purchase, bundle and resell conforming loans into the secondary market in their stead, subject to oversight and regulation from the federal government.

Whether or not such a private market would emerge is unknown. We cannot predict whether or not this or any other proposed legislation will pass, when or if a dismantling of Fannie Mae and Freddie Mac may occur, what the future of the mortgage market might be as a following a dismantling of Fannie Mae and Freddie Mac, or how such legislation or any alternative legislation that may be proposed might impact our business. Moreover, we cannot predict what regulation may apply to private third party loan purchasers following a move away from government sponsored entities as the largest entities that purchase, bundle and securitize loans, although the Dodd-Frank Act already imposes a requirement that private securitizers of mortgage and other asset backed securities retain, subject to certain exemptions, not less than five percent of the credit risk of the mortgages or other assets backing the securities.

While there is no clarity on what will ultimately happen to Fannie Mae and Freddie Mac, any dismantling of those entities, or any other legislation that calls for the restructuring of Fannie those entities in such a way that restricts their loan purchase programs, may have a material adverse effect on our ability to originate loans and sell those loans to third party purchasers, which in turn would have a material adverse effect on our business and results of operations. Moreover, we have recorded on our balance sheet an intangible asset (mortgage servicing rights, or MSRs) relating to our right to service single and multifamily loans sold to Fannie Mae and Freddie Mac. That MSR asset was valued at $146.3 million at September 30, 2013

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and $95.5 million at December 31, 2012. Changes in Fannie Mae's and Freddie Mac's policies and operations that adversely affect our single family residential loan and DUS mortgage servicing assets may require us to record impairment charges to the value of these assets, and significant impairment charges could be material and adversely affect our business.

Through our wholly owned subsidiary HomeStreet Capital Corporation, we participate as a lender in the DUS program. Fannie Mae delegates responsibility for originating, underwriting and servicing mortgages, and we assume a limited portion of the risk of loss during the remaining term on each commercial mortgage loan that we sell to Fannie Mae.

We are subject to extensive regulation that has restricted and could further restrict our activities, including capital distributions, and impose financial requirements or limitations on the conduct of our business.

Our operations are subject to extensive regulation by federal, state and local governmental authorities, including the FDIC, the Washington Department of Financial Institutions and the Federal Reserve, and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Because our business is highly regulated, the laws, rules and regulations to which we are subject are evolving and change frequently. Changes to those laws, rules and regulations are also sometimes retroactively applied. Furthermore, the on-site examination cycle for an institution in our circumstances is frequent and extensive. Examination findings by the regulatory agencies may result in adverse consequences to the Company or the Bank. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the authority to restrict our operations, adversely reclassify our assets, determine the level of deposit premiums assessed and require us to increase our allowance for loan losses.

The Dodd-Frank Act is expected to increase our costs of operations, increase our regulatory and legal risks and may have a material negative effect on us.

The Dodd-Frank Act significantly changes the laws as they apply to financial institutions and revises and expands the rulemaking, supervisory and enforcement authority of federal banking regulators. It is also expected to have a material impact on our relationships with current and future customers.

Some of these changes are effective immediately, though many are being phased in gradually. In addition, the statute in many instances calls for regulatory rulemaking to implement its provisions, not all of which have been completed, so the precise contours of the law and its effects on us cannot yet be fully understood. The provisions of the Dodd-Frank Act and the subsequent exercise by regulators of their revised and expanded powers thereunder could materially and negatively impact the profitability of our business, the value of assets we hold or the collateral available for our loans, require changes to business practices or force us to discontinue businesses and expose us to additional costs, taxes, liabilities, enforcement actions and reputational risk. See “Regulation and Supervision” in Part I - Item 1 of our Annual Report on Form 10-K for the year ended December 31, 2012.

We will be subject to more stringent capital requirements.

On July 2, 2013, the U.S. federal banking regulators (including the Federal Reserve and FDIC) jointly announced the adoption of new rules relating to capital standards requirements, including requirements contemplated by the Dodd-Frank Act as well as certain standards initially adopted by the Basel Committee on Banking Supervision, which standards are commonly referred to as Basel III. A substantial portion of these rules will apply to both the Company and the Bank beginning in January 2015. As part of these new rules, both the Company and the Bank will be required to have a common equity Tier 1 capital ratio of 4.5%, have a Tier 1 leverage ratio of 4.0%, a Tier 1 risk-based ratio of 6.0% and a total risk-based ratio of 8.0%. In addition, both the Company and the Bank will be required to establish a “conservation buffer”, consisting of common equity Tier 1 capital, equal to 2.5%, which in effect brings the common equity Tier 1 capital ratio requirement to 7% to preclude regulatory restrictions on specified operations. In this regard, any institution that does not meet the conservation buffer will be subject to restrictions on certain activities including payment of dividends, stock repurchases and discretionary bonuses to executive officers. Additional prompt corrective action rules will apply to the Bank, including higher ratio requirements for the Bank to be considered well-capitalized. The new rules also modify the manner for determining when certain capital elements are included in the ration calculations. Maintaining higher capital levels may result in lower profits for the Company as we will not be able to grow our lending as quickly as we might otherwise be able to do if we were to maintain lower capital levels.

We have in the past and may again in the future be subject to certain specific regulatory constraints on the activities of the Bank and the Company, which could result in us not being as profitable as banks that are not subject to such conditions.

Between 2009 and 2013, both the Bank and the Company operated under specific regulatory restrictions on their operations. These restrictions were intended to preserve and strengthen the Bank's capital adequacy and improve its asset quality, among other things,

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and limited our ability to pay cash dividends or to renew or incur debt. The Bank operated under a cease and desist order from May 8, 2009 until March 26, 2012, when that order was replaced with a memorandum of understanding (“MOU”). On December 27, 2012, the FDIC determined that the MOU was no longer necessary and, as a result, terminated the MOU. Additionally, the Company, which was subject to a cease and desist order since May 8, 2009, had such order terminated effective March 26, 2013. However, we cannot offer assurances that we can avoid the adverse conditions that caused us to fall below desirable performance levels, and if that were to happen, we may again become subject to more stringent regulatory orders and other regulatory enforcement actions.

New federal and state legislation, case law or regulatory action may negatively impact our business.

Enacted legislation, including the Dodd-Frank Act, as well as future federal and state legislation, case law and regulations could require us to revise our operations and change certain business practices, impose additional costs, reduce our revenue and earnings and otherwise adversely impact our business, financial condition and results of operations. For instance,

Recent legislation and court decisions with precedential value could allow judges to modify the terms of residential mortgages in bankruptcy proceedings and could hinder our ability to foreclose promptly on defaulted mortgage loans or expand assignee liability for certain violations in the mortgage loan origination process, any or all of which could adversely affect our business or result in our being held responsible for violations in the mortgage loan origination process.
Congress and various regulatory authorities have proposed programs that would require a reduction in principal balances of “underwater” residential mortgages, which if implemented would tend to reduce loan servicing income and which might adversely affect the carrying values of portfolio loans.
Recent court cases in Oregon and Washington have challenged whether Mortgage Electronic Registration Systems, Inc. (“MERS”) meets the statutory definition of deed of trust beneficiary under applicable state laws. Based on decisions handed down by courts in Oregon, we and other servicers of MERS related loans have elected to foreclose through judicial procedures in Oregon, resulting in increased foreclosure costs, longer foreclosure timelines and additional delays. If the Oregon case law is upheld on appeal, and/or if the Washington courts issue a similar decision in the cases pending before them, our foreclosure costs and foreclosure timelines may continue to increase, which in turn, could increase our single family loan delinquencies and adversely affect our cost of doing business and results of operations

We cannot offer assurances as to which, if any, of these initiatives may be adopted or, if adopted, to what extent they would affect our business. Any such initiatives may limit our ability to take actions that may be essential to preserve the value of the mortgage loans we service or hold for investment. Any restriction on our ability to foreclose on a loan, any requirement that we forego a portion of the amount otherwise due on a loan or any requirement that we modify any original loan terms may require us to advance principal, interest, tax and insurance payments, which would negatively impact our business, financial condition, liquidity and results of operations. Given the relatively high percentage of our business that derives from originating residential mortgages, any such actions are likely to have a significant impact on our business, and the effects we experience will likely be disproportionately high in comparison to financial institutions whose residential mortgage lending is more attenuated.

In addition, while these legislative and regulatory proposals generally have focused primarily, if not exclusively, on residential mortgage origination, other laws and regulations may be enacted that affect the manner in which we do business and the products and services that we provide, restrict our ability to growth through acquisition, restrict our ability to compete in our current business or expand into any new business, and impose additional fees, assessments or taxes on us or increase our regulatory oversight. For example, our consumer business, including our mortgage, credit card, and other consumer lending and non-lending businesses, may be adversely affected by the policies enacted by the Consumer Financial Protection Bureau (CFPB) which has broad rulemaking authority over consumer financial products and services. The full impact of CFPB's activities on our business is still unknown, however, we anticipate that CFPB actions may increase our compliance costs and require changes in our business practices as a result of new regulations and requirements and could limit the products and services we are able to provide to customers. We are unable to predict whether U.S. federal, state or local authorities, or other pertinent bodies, will enact legislation, laws, rules, regulations, handbooks, guidelines or similar provisions that will affect our business or require changes in our practices in the future, and any such changes could adversely affect our cost of doing business and profitability. See “Regulation and Supervision - Regulation and Supervision” in Part I- Item 1 of our Annual Report on Form 10-K for the year ended December 31, 2012.

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An important information technology systems provider was previously identified as having internal control deficiencies, and the persistence or recurrence of such issues could give rise to significant risks to the Bank and the Company.

In the first quarter of 2012 and again in the second quarter of 2013, we were notified that the provider of one of the Bank's critical information technology and transaction processing systems was identified as posing a significant risk to banking operations for that vendor's clients. That vendor encountered a significant cyber-attack and related computer fraud, and there have been indications that in the absence of a prompt remediation of known and unknown deficiencies, that vendor's systems may create enhanced risk for users.
The Bank does not use this system that was the subject of the cyber-attack; however, the Bank uses this vendor for a wide variety of important functions, and given their progress in remediating these issues, and subject to the vendor's continued progress, we have plans to increase our reliance on this vendor and its products and services. Our Board of Directors, as well as the Bank's Board of Directors, were briefed on this development and are provided quarterly updates on the vendor's remediation efforts. Although the vendor believed all of the outstanding actions had been completed by March 31, 2013, a subsequent assessment found those remediation activities had not been wholly effective. If these concerns are not addressed effectively, the Bank could experience a number of potentially materially adverse consequences, including:
greater than normal exposure to compliance problems, which could lead to adverse regulatory actions, including potential enforcement actions;
the need to replace one or more of our information systems providers, which could lead to increased costs, disruptions in our relationships with one or more customers, management distractions, and other difficulties;
potential claims by customers, including class action claims, resulting from actual or alleged compromises of consumer or business financial information;
difficulties in maintaining an adequate system of internal controls and procedures and internal control over financial reporting;
the loss of confidence of one or more of our customers, or reputational harm associated with the use of these systems, particularly if our customers experience actual difficulties, losses or attacks; and
a dispute with this vendor over the adequacy of the products and services for which we contracted, potentially including increases in legal fees and other litigation costs.

A failure in or breach of our security systems or infrastructure, or those of our third party vendors and other service providers, resulting from cyber-attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses.

Information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. Those parties also may attempt to fraudulently induce employees, customers, or other users of our systems to disclose confidential information in order to gain access to our data or that of our customers. Our operations rely on the secure processing, transmission and storage of confidential information in our computer systems and networks, either managed directly by us or through our data processing vendors. In addition, to access our products and services, our customers may use personal smartphones, tablet PC's, and other mobile devices that are beyond our control systems. Although we believe we have robust information security procedures and controls, our technologies, systems, networks, and our customers' devices may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of Company or our customers' confidential, proprietary and other information, or otherwise disrupt the Company's or its customers' or other third parties' business operations.

Third parties with which we do business or that facilitate our business activities, including exchanges, clearing houses, financial intermediaries or vendors that provide services or security solutions for our operations, could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.

To date we have not experienced any material losses relating to cyber-attacks or other information security breaches, but there can be no assurance that we will not suffer such attacks and losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, our plans to continue to implement our Internet banking and mobile banking channel, our expanding operations and the outsourcing of a significant portion of our business operations. As a result, cyber-security and the continued development and enhancement of our controls, processes and practices designed to protect customer information, our systems, computers, software, data and networks from attack, damage

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or unauthorized access remain a priority for the Company. As cyber threats continue to evolve, we may be required to expend significant additional resources to insure, to continue to modify or enhance our protective measures or to investigate and remediate important information security vulnerabilities.

Disruptions or failures in the physical infrastructure or operating systems that support our businesses and customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in customer attrition, financial losses, the inability of our customers to transact business with us, violations of applicable privacy and other laws, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially and adversely affect our results of operations or financial condition.

The network and computer systems on which we depend could fail or experience security breaches.

Our computer systems could be vulnerable to unforeseen problems. Because we conduct a part of our business over the Internet and outsource several critical functions to third parties, operations will depend on our ability, as well as the ability of third-party service providers, to protect computer systems and network infrastructure against damage from fire, power loss, telecommunications failure, physical break-ins or similar catastrophic events. Any damage or failure that causes interruptions in operations could have a material adverse effect on our business, financial condition and results of operations.

In addition, a significant barrier to online financial transactions is the secure transmission of confidential information over public networks. Our Internet banking system relies on encryption and authentication technology to provide the security and authentication necessary to effect secure transmission of confidential information. Advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms our third-party service providers use to protect customer transaction data. If any such compromise of security were to occur, it could have a material adverse effect on our business, financial condition and results of operations.

Our real estate lending also exposes us to environmental liabilities.

In the course of our business, it is necessary to foreclose and take title to real estate, which could subject us to environmental liabilities with respect to these properties. Hazardous substances or waste, contaminants, pollutants or sources thereof may be discovered on properties during our ownership or after a sale to a third party. We could be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances or chemical releases at such properties. The costs associated with investigation or remediation activities could be substantial and could substantially exceed the value of the real property. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. We may be unable to recover costs from any third party. These occurrences may materially reduce the value of the affected property, and we may find it difficult or impossible to use or sell the property prior to or following any environmental remediation. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected.

We may be required to recognize impairment with respect to investment securities, includingA failure in or breach of our security systems or infrastructure, or those of our third party vendors and other service providers, resulting from cyber-attacks, could disrupt our businesses, result in the FHLB stock we hold.disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses.

Information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. Those parties also may attempt to fraudulently induce employees, customers, or other users of our systems to disclose confidential information in order to gain access to our data or that of our customers. Our securities portfolio currently includes securities with unrecognized losses. We may continue to observe declinesoperations rely on the secure processing, transmission and storage of confidential information in the fair market value of these securities. We evaluate the securities portfolio for any other than temporary impairment each reporting period.our computer systems and networks, either managed directly by us or through our data processing vendors. In addition, as a condition of membership in the FHLB, we are required to purchaseaccess our products and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB. Our FHLB stock is carried at cost and is subject to recoverability testing under applicable accounting standards. Future negative changes to the financial condition of the FHLBservices, our customers may require us to recognize an impairment charge with respect to such holdings. The FHLB is currently subject to a Consent Order issued by its primary regulator, the Federal Housing Finance Agency.

use personal

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The strengthsmartphones, tablet PCs, and stabilityother mobile devices that are beyond our control systems. Although we believe we have robust information security procedures and controls, we are heavily reliant on our third party vendors, and our vendors’ or our own technologies, systems, networks and our customers' devices may become the target of cyber-attacks, computer viruses, malicious code, unauthorized access, hackers or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of Company or our customers' confidential, proprietary and other financial institutions may adversely affect our business.information, or otherwise disrupt the Company's or its customers' or other third parties' business operations.

Our counterparty risk exposure is affected by the actions and creditworthiness of other financial institutionsThird parties with which we do business. Negative impactsbusiness or that facilitate our business activities, including exchanges, clearing houses, financial intermediaries or vendors that provide services or security solutions for our operations, could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints. In addition, some of our counterpartyprimary third party service providers may be subject to enhanced regulatory scrutiny due to regulatory findings during examinations of such service provider(s) conducted by federal regulators. While we have and will subject such vendor(s) to higher scrutiny and monitor any corrective measures that the vendor(s) are or would undertake, we are not able to fully mitigate any risk which could result from a breach or other operational failure caused by this, or any other vendor’s breach.

To date we are not aware of any material losses relating to cyber-attacks or other information security breaches, but there can be no assurance that we will not suffer such attacks and losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, our plans to continue to implement our Internet banking and mobile banking channel, our expanding operations and the outsourcing of a significant portion of our business operations. As a result, cybersecurity and the continued development and enhancement of our controls, processes and practices designed to protect customer information, our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for the Company. As cyber threats continue to evolve, we may be required to expend significant additional resources to insure, to continue to modify or enhance our protective measures or to investigate and remediate important information security vulnerabilities, however, our measures may be insufficient to prevent physical .and electronic break-ins, denial of service and other cyber-attacks or security breaches.

Disruptions or failures in the physical infrastructure or operating systems that support our businesses and customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in customer attrition, financial institutionslosses, the inability of our customers to transact business with us, violations of applicable privacy and other laws, regulatory fines, penalties or intervention, additional regulatory scrutiny, reputational damage, litigation, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially and adversely affect our results of operations or financial condition.

The network and computer systems on which we depend could fail or experience security breaches.

Our computer systems could be vulnerable to unforeseen problems. Because we conduct a part of our business over the Internet and outsource several critical functions to third parties, operations will depend on our ability, as well as the ability of third-party service providers, to protect computer systems and network infrastructure against damage from fire, power loss, telecommunications failure, physical break-ins or similar catastrophic events. Any damage or failure that causes interruptions in operations may compromise our ability to engageperform critical functions in routine funding transactions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. Many of these types of transactions can expose us to credit risk in the event of default by a direct or indirect counterparty or client.

If other financial institutions in our markets dispose of real estate collateral at below-market or distressed prices, such actions may increase our lossestimely manner and could have a material adverse effect on our business, financial condition and results of operations as well as our reputation and customer or vendor relationships.

In addition, a significant barrier to online financial transactions is the secure transmission of confidential information over public networks. Our Internet banking system relies on encryption and authentication technology to provide the security and authentication necessary to effect secure transmission of confidential information. Advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms our third-party service providers use to protect customer transaction data. If any such compromise of security were to occur, it could have a material adverse effect on our business, financial condition and results of operations.

Our accounting policiesThe failure to protect our customers’ confidential information and methodsprivacy could adversely affect our business.

We are fundamentalsubject to howstate and federal privacy regulations and confidentiality obligations that, among other things restrict the use and dissemination of, and access to, the information that we reportproduce, store or maintain in the course of our business. We also have contractual obligations to protect certain confidential information we obtain from our existing vendors and customers. These obligations generally include protecting such confidential information in the same manner and to the same extent as we protect our own confidential information, and in some instances may impose indemnity obligations on us relating to unlawful or unauthorized disclosure of any such information.

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The actions we may take in order to promote compliance with these obligations vary by business segment and may change over time, but may include, among other things:
training and educating our employees and independent contractors regarding our obligations relating to confidential information;
monitoring changes in state or federal privacy and compliance requirements;
drafting and enforcing appropriate contractual provisions into any contract that raises proprietary and confidentiality issues;
maintaining secure storage facilities and protocols for tangible records;
physically and technologically securing access to electronic information; and
in the event of a security breach, providing credit monitoring or other services to affected customers.
If we do not properly comply with privacy regulations and protect confidential information, we could experience adverse consequences, including regulatory sanctions, penalties or fines, increase compliance costs, litigation and damage to our reputation, which in turn could result in decreased revenues and loss of customers, all of which would have a material adverse effect on our business, financial condition and results of operations, and we use estimates in determining the fair value of certain of our assets, which estimates may prove to be imprecise and result in significant changes in valuation.

A portion of our assets are carried on the balance sheet at fair value, including investment securities available for sale, mortgage servicing rights related to single family loans and single family loans held for sale. Generally, for assets that are reported at fair value, we use quoted market prices or internal valuation models that utilize observable market data inputs to estimate their fair value. In certain cases, observable market prices and data may not be readily available or their availability may be diminished due to market conditions. We use financial models to value certain of these assets. These models are complex and use asset-specific collateral data and market inputs for interest rates. Although we have processes and procedures in place governing internal valuation models and their testing and calibration, such assumptions are complex as we must make judgments about the effect of matters that are inherently uncertain. Different assumptions could result in significant changes in valuation, which in turn could affect earnings or result in significant changes in the dollar amount of assets reported on the balance sheet.

operations.
Our operations could be interrupted if our third-party service and technology providers experience difficulty, terminate their services or fail to comply with banking regulations

We depend, and will continue to depend, to a significant extent, on a number of relationships with third-party service and technology providers. Specifically, we receive core systems processing, essential web hosting and other Internet systems and deposit and other processing services from third-party service providers. If these third-party service providers, or if any parties to whom our third party service providers have subcontracted services, experience difficulties or terminate their services and we are unable to replace them with other service providers, our operations could be interrupted and our operating expenses may be materially increased. If an interruption were to continue for a significant period of time, our business financial condition and results of operations could be materially adversely affected.

We continually encounter technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements.

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands for convenience, as well as to create additional efficiencies in our operations. Many national vendors provide turn-key services to community banks, such as internetInternet banking and remote deposit capture that allow smaller banks to compete with institutions that have substantially greater resources to invest in technological improvements. We may not be able, however, to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.

We may be required to recognize impairment with respect to investment securities, including the FHLB stock we hold.

Our securities portfolio currently includes securities with unrecognized losses. We may continue to observe declines in the fair market value of these securities. We evaluate the securities portfolio for any other than temporary impairment each reporting period. In addition, becauseas a condition of membership in the FHLB, we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB. Our FHLB stock is carried at cost and is subject to recoverability testing under applicable accounting standards. Future negative changes to the financial condition of the demandFHLB may require us to recognize an impairment charge with respect to such holdings. The FHLB is currently subject to a Consent Order issued by its primary regulator, the Federal Housing Finance Agency.

A change in federal monetary policy could adversely impact our mortgage banking revenues.

The Federal Reserve is responsible for technology-driven products, banksregulating the supply of money in the United States, and as a result its monetary policies strongly influence our costs of funds for lending and investing as well as the rate of return we are increasingly contracting with third party vendorsable to provide data processingearn on those loans and core banking functions.investments, both of which impact our net interest income and net interest margin. The useFederal Reserve Board's interest rate policies can also materially affect the value of technology-related products, services, delivery channelsfinancial instruments we hold, including debt securities and processes exposes a bank to various risks, particularly transaction, strategic, reputation and compliance risks. Theremortgage servicing rights, or MSRs. These monetary policies can be no assurancealso negatively impact our borrowers, which in turn may increase the risk that wethey will be ableunable to successfully managepay their loans according to the risks associated with our increased dependency on technology.

terms or be unable to pay their loans at all. We have no control

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over the monetary policies of the Federal stateReserve Board and local consumercannot predict when changes are expected or what the magnitude of such changes may be.

As a result of the Federal Reserve Board's concerns regarding continued slow economic growth, the Federal Reserve Board, in 2008 implemented its standing monetary policy known as “quantitative easing,” a program involving the purchase of mortgage backed securities and United States Treasury securities, the volume of which has been aligned with specific economic targets or measures intended to bolster the U.S. economy. As the Federal Reserve Board, through the Federal Open Market Committee (the “Committee”), monitors economic performance, the volume of the quantitative easing program continues to be incrementally reduced. The Committee has stated that if incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. However, asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.

Because a substantial portion of our revenues and our net income historically have been, and in the foreseeable future are expected to be, derived from gain on the origination and sale of mortgage loans and on the continuing servicing of those loans, the Federal Reserve Board's monetary policies may have had, and for so long as the program continues, may continue to have, the effect of supporting higher revenues than might otherwise be available. Contrarily, a reduction in or termination of this policy, absent a significant rebound in employment and real wages, would likely reduce mortgage originations throughout the United States, including ours. Continued reduction or termination of the quantitative easing program may likely further raise interest rates, which could reduce our mortgage origination revenues and in turn have a material adverse impact upon our business.

A substantial portion of our revenue is derived from residential mortgage lending lawswhich is a market sector that experiences significant volatility.

A substantial portion of our consolidated net revenues (net interest income plus noninterest income) are derived from originating and selling residential mortgages. Residential mortgage lending in general has experienced substantial volatility in recent periods. An increase in interest rates in the second quarter of 2013 resulted in a significant adverse impact on our business and financial results due primarily to a related decrease in volume of loan originations, especially refinancings. Any future additional increase in interest rates may restrictfurther materially and adversely affect our future loan origination volume, margins, and the value of the collateral securing our outstanding loans, may increase rates of borrower default, and may otherwise adversely affect our business. Additionally, in recent periods we have experienced very low levels of homes available for sale in many of the markets in which we operate. The lack of housing inventory has had a downward impact on the volume of mortgage loans that we originate.  Further, it has resulted in elevated costs, as a significant amount of loan processing and underwriting that we perform are to qualifying borrowers for mortgage loan transactions that never materialize. The lack of inventory of homes for sale may continue to have an adverse impact on mortgage loan volumes into the foreseeable future.

We may incur losses due to changes in prepayment rates.

Our mortgage servicing rights carry interest rate risk because the total amount of servicing fees earned, as well as changes in fair-market value, fluctuate based on expected loan prepayments (affecting the expected average life of a portfolio of residential mortgage servicing rights). The rate of prepayment of residential mortgage loans may be influenced by changing national and regional economic trends, such as recessions or depressed real estate markets, as well as the difference between interest rates on existing residential mortgage loans relative to prevailing residential mortgage rates. Changes in prepayment rates are therefore difficult for us to predict. An increase in the general level of interest rates may adversely affect the ability of some borrowers to pay the interest and principal of their obligations. During periods of declining interest rates, many residential borrowers refinance their mortgage loans. The loan administration fee income (related to the residential mortgage loan servicing rights corresponding to a mortgage loan) decreases as mortgage loans are prepaid. Consequently, the fair value of portfolios of residential mortgage loan servicing rights tend to decrease during periods of declining interest rates, because greater prepayments can be expected and, as a result, the amount of loan administration income received also decreases.

We may incur significant losses as a result of ineffective hedging of interest rate risk related to our loans sold with a reservation of servicing rights.

Both the value our single family mortgage servicing rights, or MSRs, and the value of our single family loans held for sale changes with fluctuations in interest rates, among other things, reflecting the changing expectations of mortgage prepayment activity. To mitigate potential losses of fair value of single family loans held for sale and MSRs related to changes in interest rates, we actively hedge this risk with financial derivative instruments. Hedging is a complex process, requiring sophisticated

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models, experienced and skilled personnel and continual monitoring. Changes in the value of our hedging instruments may not correlate with changes in the value of our single family loans held for sale and MSRs, and we could incur a net valuation loss as a result of our hedging activities. Following the expansion of our single family mortgage operations in early 2012 through the addition of a significant number of single family mortgage origination personnel, the volume of our single family loans held for sale and MSRs has increased. The increase in volume in turn increases our exposure to the risks associated with the impact of interest rate fluctuations on single family loans held for sale and MSRs.

Changes in fee structures by third party loan purchasers and mortgage insurers may decrease our loan production volume and the margin we can recognize on conforming home loans, and may adversely impact our results of operations.

Certain third party loan purchasers revised their fee structures in the third quarter of 2013 and increased the costs of doing business with them. For example, certain purchasers of conforming loans, including Fannie Mae and Freddie Mac, raised costs of guarantee fees and other required fees and payments. These changes increased the cost of mortgages to consumers and the cost of selling conforming loans to third party loan purchasers which in turn decreased our margin and negatively impacted our profitability. Additionally, the FHA raised costs for premiums and extended the period for which private mortgage insurance is required on a loan purchased by them. Additional changes in the future from third party loan purchasers may have a negative impact on our ability to originate or increaseloans to be sold because of the increased costs of such loans and may decrease our risk of liabilityprofitability with respect to loans held for sale. In addition, any significant adverse change in the level of activity in the secondary market or the underwriting criteria of these third party loan purchasers could negatively impact our results of business, operations and cash flows.

If we breach any of the representations or warranties we make to a purchaser or securitizer of our mortgage loans or MSRs, we may be liable to the purchaser or securitizer for certain costs and damages.

When we sell or securitize mortgage loans in the ordinary course of business, we are required to make certain representations and warranties to the purchaser about the mortgage loans and could increase our costthe manner in which they were originated. Our agreements require us to repurchase mortgage loans if we have breached any of doing business.

Federal, statethese representations or warranties, in which case we may be required to repurchase such loan and local lawsrecord a loss upon repurchase and/or bear any subsequent loss on the loan. We may not have been adoptedany remedies available to us against a third party for such losses, or the remedies available to us may not be as broad as the remedies available to the purchaser of the mortgage loan against us. In addition, if there are remedies against a third party available to us, we face further risk that are intendedsuch third party may not have the financial capacity to eliminate certain lending practices considered “predatory” or “unfair and deceptive practices.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insuranceperform remedies that otherwise may be available to borrowers, repeatedly refinancing loans, and making loans withoutus. Therefore, if a reasonable expectation that the borrowers willpurchaser enforces remedies against us, we may not be able to repayrecover our losses from a third party and may be required to bear the full amount of the related loss.

In addition, in connection with the sale of a significant amount of our MSRs to SunTrust Mortgage, Inc., we agreed to indemnify SunTrust Mortgage, Inc. for prepayment of a certain amount of those loans. In the event the holders of such loans prepay the loans, irrespectivewe may be required to reimburse SunTrust Mortgage, Inc. for a certain portion of the anticipated MSR value of the underlying property. It is our policy not to make predatorythat loan.

If repurchase and indemnity demands increase on loans or engageMSRs that we sell from our portfolios, our liquidity, results of operations and financial condition will be adversely affected.

If we breach any representations or warranties or fail to follow guidelines when originating a FHA/HUD-insured loan or a VA-guaranteed loan, we may lose the insurance or guarantee on the loan and suffer losses, pay penalties, and/or be subjected to litigation from the federal government.

We originate and purchase, sell and thereafter service single family loans that are insured by FHA/HUD or guaranteed by the VA. We certify to the FHA/HUD and the VA that the loans meet their requirements and guidelines. The FHA/HUD and VA audit loans that are insured or guaranteed under their programs, including audits of our processes and procedures as well as individual loan documentation. Violations of guidelines can result in deceptive practices, but these laws createmonetary penalties or require us to provide indemnifications against loss or loans declared ineligible for their programs. In the potential for liabilitypast, monetary penalties and losses from indemnifications have not created material losses to the Bank. As a result of the housing crisis, the FHA/HUD has stepped up enforcement initiatives. In addition to regular FHA/HUD audits, HUD's Inspector General has become active in enforcing FHA regulations with respect to our lending, servicing, loan investment and deposit taking activities. They increase our cost of doing business, and ultimately may prevent us from making certainindividual loans and causehas partnered with the Department of Justice ("DOJ") in filing lawsuits against lenders for systemic violations. The penalties resulting from such lawsuits can be much more severe, since systemic violations can be applied to groups of loans and penalties may be subject to treble damages. The DOJ has used the Federal False Claims Act and other federal laws and regulations in prosecuting these lawsuits. Because of our significant origination of FHA/HUD insured and VA guaranteed loans, if the DOJ were to find potential violations by the Bank, we could be subject to material

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monetary penalties and/or losses, and may even be subject to lawsuits alleging systemic violations which could result in treble damages.

We may face risk of loss if we purchase loans from a seller that fails to satisfy its indemnification obligations.

We generally receive representations and warranties from the originators and sellers from whom we purchase loans and servicing rights such that if a loan defaults and there has been a breach of such representations and warranties, we may be able to pursue a remedy against the seller of the loan for the unpaid principal and interest on the defaulted loan. However, if the originator and/or seller breach such representations and warranties and does not have the financial capacity to pay the related damages, we may be subject to the risk of loss for such loan as the originator or seller may not be able to pay such damages or repurchase loans when called upon by us to reduce the average percentage rate or the points and fees ondo so. Currently, we only purchase loans that we do make.from WMS Series LLC, an affiliated business arrangement with certain Windermere real estate brokerage franchise owners.

Some provisions of our articles of incorporation and bylaws and certain provisions of Washington law may deter takeover attempts, which may limit the opportunity of our shareholders to sell their shares at a favorable price.

Some provisions of our articles of incorporation and bylaws may have the effect of deterring or delaying attempts by our shareholders to remove or replace management, to commence proxy contests, or to effect changes in control. These provisions include:
a classified board of directors so that only approximately one third of our board of directors is elected each year;
elimination of cumulative voting in the election of directors;
procedures for advance notification of shareholder nominations and proposals;
the ability of our board of directors to amend our bylaws without shareholder approval; and
the ability of our board of directors to issue shares of preferred stock without shareholder approval upon the terms and conditions and with the rights, privileges and preferences as the board of directors may determine.

In addition, as a Washington corporation, we are subject to Washington law which imposes restrictions on some transactions between a corporation and certain significant shareholders. These provisions, alone or together, could have the effect of deterring or delaying changes in incumbent management, proxy contests or changes in control.




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ITEM 2UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4MINE SAFETY DISCLOSURE

Not applicable.

ITEM 5OTHER INFORMATION

Not applicable.


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ITEM 6EXHIBITS

EXHIBIT INDEX
 
Exhibit  
Number  Description
   
2.1
Agreement and Plan of Merger between HomeStreet, Inc. and Simplicity Bancorp, Inc. dated as of September 27, 2014. (1)
31.1  
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(1)(2)
   
31.2 
Certification of Chief Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(1)(2)
   
32  
Certification of Periodic Financial Report by Principal Executive Officer and Principal Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and 18 U.S.C. § 1350.(2)(3)
   
101.INS  
XBRL Instance Document(3)(4)(5)
   
101.SCH  
XBRL Taxonomy Extension Schema Document(3)(4)
   
101.CAL  
XBRL Taxonomy Extension Calculation Linkbase Document(3)(4)
   
101.DEF  
XBRL Taxonomy Extension Label Linkbase Document(3)(4)
   
101.LAB  
XBRL Taxonomy Extension Presentation Linkbase Document(3)(4)
   
101.PRE  
XBRL Taxonomy Extension Definitions Linkbase Document(3)(4)
 
(1)Previously filed as an exhibit to the registrant's Current Report on Form 8-K dated September 29, 2014.
(2)Filed herewith.
(2)(3)This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that Section. Such exhibit shall not be deemed incorporated into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
(3)(4)As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for purposes of Section 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to liability under those sections.
(4)(5)
Pursuant to Rule 405 of Regulation S-T, includes the following financial information included in the Firm’s Quarterly Report on Form 10-Q for the quarter ended September 30, 20132014, formatted in XBRL (eXtensible Business Reporting Language) interactive data files: (i) the Consolidated Statements of Operations for the three and nine months ended September 30, 20132014 and 20122013, (ii) the Consolidated Statements of Financial Condition as of September 30, 20132014, and December 31, 20122013, (iii) the Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the three and nine months ended September 30, 20132014 and 20122013, (iv) the Consolidated Statements of Cash Flows for the nine months ended September 30, 20132014 and 20122013, and (v) the Notes to Consolidated Financial Statements.


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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, State of Washington, on November 7, 201312, 2014.
 
 HomeStreet, Inc.
   
 By:/s/ Mark K. Mason
  Mark K. Mason
  President and Chief Executive Officer



 HomeStreet, Inc.
   
 By:/s/ Cory D. Stewart
  Cory D. Stewart
  
Executive Vice President and
Chief Accounting Officer
  


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