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Good morning, ladies and gentlemen, and welcome to the Mechanics Bancorp Second Quarter 2026 Earnings Conference Call. As a reminder, this conference call is being recorded. I would now like to turn the call over to Nathan Duda, Chief Financial Officer of Mechanics Bancorp. Please go ahead.
Thank you, operator, and good morning, everyone. We appreciate you joining our earnings conference call. With me here today are C.J. Johnson, our President and Chief Executive Officer; and Carl Webb, our Executive Chairman. The related earnings press release and earnings presentation are available on the News and Events section of our Investor Relations website. Before we begin, I'd like to remind everyone that any forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those anticipated future results. Please see our safe harbor statements in our earnings press release and in our earnings presentation. All comments expressed or implied made during today's call are subject to those safe harbor statements. Any forward-looking statements made during this call are made only as of today's date, and we do not undertake any duty to update such forward-looking statements, except as required by law. Additionally, during today's call, we may discuss certain non-GAAP financial measures, which we believe are useful in evaluating our performance. A reconciliation of these non-GAAP financial measures to the most comparable GAAP financial measures can also be found in our earnings release and in the earnings presentation. C.J., let me hand it over to you.
Thank you, Nathan, and good morning. We appreciate everyone joining our call and for your interest in Mechanics Bancorp. I'll start today by summarizing the highlights of our second quarter performance. I'll also provide another strategic update on the bank before handing things off to Nathan to review our financials in more detail. Carl, Nathan and I will then open up the call for your questions. With that, let's turn to Slide 4. We had a nice second quarter reporting $57.7 million in net income. On a fully diluted basis, we earned $0.25 per share, and our tangible book value per share increased to $7.56. This quarter, we paid a large dividend of $0.70 per share with the major driver being the successful closure of our DUS business line sale to Fifth Third in early May. Q2 did have a few noncore items, which I'll walk you through quickly. We had three one-time noninterest income adjustments, including a $1.8 million MSR valuation gain, a final true-up of $900,000 related to the DUS sale, and a $600,000 loss on a sale of an old branch property that's been closed for a while. We also incurred $5.9 million of merger expenses, primarily severance as we finished up our HomeStreet integration and had a significant amount of headcount reduction as a result. We also had a negative provision of $2.8 million, which we backed out of our core results. When you adjust for these items, we earned $59 million of core net income for the quarter, representing a core ROAA of 1.1% and a core ROATCE of 14.7%. Our total assets are now $21.2 billion with total gross loans of $13.6 billion, total deposits of $18.1 billion and tangible shareholders' equity of $1.75 billion. Our deposits decreased $153 million this quarter with $199 million of the decline from high-cost CD balances and with the pace of CD decline down substantially from Q1. Non-maturity balances grew $46 million, but we did see some mix shift into money market accounts from noninterest-bearing accounts. We expect CDs to continue declining modestly in the third quarter. But overall, we think total deposits should begin to grow from here on out. Notably, intangibles decreased $107 million in Q2, driven by the DUS business line sale. Our capital ratios remain robust with a 14.4% CET1 ratio and an 8.7% Tier 1 leverage ratio. Net charge-offs for the quarter were minimal again with only 0.6 basis points or $220,000 of non-auto net charge-offs. Also, our runoff auto loans continue to perform in line with expectations, with net charge-offs continuing to drop each quarter as the auto portfolio seasons. Our ACL dropped one basis point to 1.12% of loans driven by the modest negative provision I mentioned a bit ago. Our allowance remains a very robust 2.57x our total nonperforming assets as of 6/30. Our cost of deposits was 1.25% in the second quarter, down 3 basis points from Q1, but our spot cost of deposits at 6/30 was back to 1.28%, primarily due to mix shift and swift deposit competition. Our NIM was 3.62% for the quarter, up 1 basis point and our CRE concentration ratio dropped to 342% from 348% in Q1 and is only 97% if you exclude lower-risk multifamily loans. Turning to Slide 5. I'd like to provide you with an update on some of the key strategic initiatives happening at the bank. We have now substantially completed our HomeStreet integration, and it's good to get back to business as usual. By any measure, the merger with HomeStreet was a financial and strategic success, but it certainly was a heavy lift operationally, and I want to once again thank our dedicated employees for a job well done. As I mentioned previously, we had $5.9 million of one-time merger charges in the quarter, which was mostly severance as our FTE went from 1,890 to 1,756 quarter-over-quarter. A lot of that expense reduction benefit will show up in our Q3 noninterest expense figures. We remain on track to deliver on our budgeted cost synergies from the merger and reiterate our prior guidance of achieving an annual run rate noninterest expense, excluding CDI amortization, of approximately $430 million by the fourth quarter of this year. Strong earnings deleveraging of the balance sheet post-merger and the successful DUS business line sale generated substantial capital in the first half of 2026 with $255 million or $1.10 per Class A share in dividends paid to investors so far this year. That on its own implies a dividend yield of roughly 7% year-to-date. In addition, we continue to have approximately $100 million of excess capital above our 8.25% Tier 1 leverage ratio target at 6/30. We expect to pay a $56 million dividend or $0.25 per Class A share in Q3 and then another larger $75 million to $100 million dividend in Q4, subject to board and regulatory approval. We can also efficiently use our excess capital generated by a smaller, less risky balance sheet to enhance future earnings and expect to execute a modest restructuring of our remaining low-yielding AFS securities in Q3. The highlights of our planned restructuring include selling approximately $310 million of 1.78% yielding AFS securities and reinvesting in mortgage-backed securities at current market rates close to 5.5%, which will result in a $25 million after-tax loss that will be earned back in four to five years. The AFS restructuring will improve our near-term NIM, but we expect that benefit to be somewhat offset over time by increased deposit pricing pressure and auto runoff. Our modeling assumptions continue to assume a flat forward curve with no short-term rate hikes or cuts. We will also evaluate a sale of the remaining auto loans in the coming quarters. And if we decide to sell, it will be at a modest loss. We also could decide to continue servicing the auto loans out through maturity. We continue to expect a 17% to 18% ROATCE and a 1.3% to 1.4% ROAA in 2027 and beyond. Let's flip to Slide 6, which shows an overview of Mechanics Bancorp today. We have $21.2 billion in assets with 166 branches and great deposit market share across the West Coast with a branch map spanning from Mexico to Canada and out to Hawaii. Our key stats compare very favorably to all publicly traded banks with $10 billion to $100 billion in assets. But the ones I like to focus on the most are our risk-weighted assets to total assets of 58%, which ranks second. And a new one this quarter, our expected 2027 dividend yield of approximately 7%, which assumes cash dividends next year of $250 million. Our 7% expected dividend yield ranks first by a wide margin despite taking very little risk with either our funding base or our earning assets. Stopping briefly on Slide 7. We continue to be the fourth largest West Coast and California bank by deposits when measuring community banks with less than $250 billion in assets. Our unique franchise has been built over many years and without a doubt has tremendous scarcity value. It's been a few quarters since we included Slide 8, but I wanted to refresh new investors on our market share breakdown in many highly attractive West Coast MSAs, including top 10 ranks in San Francisco, Seattle and all across the Central Coast of California. California is an economically vibrant state that has the fifth largest GDP in the world if it were its own country. And Seattle is one of the fastest-growing large cities in the United States. We really like our market positioning post merger, and are looking forward to focusing on core deposit growth now that the integration is behind us. Slide 9 is a detailed look at the evolution of our unique deposit base, which we believe is one of the most attractive on the West Coast. Our average deposit size is only $43,000 per account with an average relationship tenure of 19 years. We also have a highly diversified customer base with 49% consumer accounts by business counts and 8% public funds with no broker deposits. Our focus is on profitably growing core relationships. The top right chart shows that prior to the merger with HomeStreet, we grew core deposits over $600 million since the third quarter of 2019, despite closing 32 branches after our acquisition of Rabobank's California franchise. After merging with HomeStreet, we deliberately let noncore hot CDs leave the bank as we prioritized capital efficiency and looked to minimize risk. The two charts on the bottom left and the bottom right highlight the strong relative position of our deposit base versus the broader U.S. banking industry. Slide 10 looks back over the past decade on the exceptional credit quality of our commercial loan portfolio. Since 2016, we've had no losses on construction or multifamily loans and only a few minor charge-offs on acquired commercial loans from both Rabobank and HomeStreet. Our credit team has a tremendous amount of experience managing through economic cycles, and we fully expect to continue our strong credit performance in the coming years. I've reworked Slide 11 a bit, but this really is key to our investment thesis: the strength of our deposits and the efficiency with which we operate our bank from both an expense and a capital management standpoint allow us to post great returns despite having one of the lowest risk mixes of assets in the country. In turn, our strong financial performance allows us to pay a market-leading dividend yield of approximately 7%. The point I will continue to emphasize is that we will pay these significant dividends despite a very conservative balance sheet and credit profile relative to our banking peers. Over time, we hope to earn a premium earnings multiple given the superior risk-adjusted returns and the lower-risk cash flows we generate for our investors. To wrap up my section, let's turn to Slide 12, which summarizes the investment highlights of Mechanics Bancorp. First and foremost, we have fantastic market share across the West Coast with a branch footprint and customer mix that's nearly impossible to replicate. We are also very profitable due to our top-notch deposits and simple, efficient business model despite taking relatively little risk. We are a core-funded bank with an exceptional track record of credit outperformance, and we are also very well capitalized with a liquid balance sheet. We are prudent with our capital, and we'll continue to pay out substantial dividends with a market-leading dividend yield. There's also a complete alignment between our public and private investors as Ford Financial Fund owns 74% of the company. Finally, we have an experienced management team with strong operating and M&A track records. With that, let me turn the call over to Nathan to dig into more detail on our second quarter results. We've also added a few new pages this quarter, which I think you will find helpful.
Thank you, C.J. Starting on Slide 14. For the second quarter, net interest income declined $1.9 million or 1% to $177.2 million compared to the linked quarter. Average interest-earning assets declined approximately $468 million during the quarter, driven primarily by lower loan balances. Our net interest margin increased 1 basis point to 3.62% and was driven by lower funding costs as the total cost of deposits declined to 1.25% from 1.28% in the first quarter. The improvement was primarily attributable to the continued runoff and repricing of higher-cost legacy HomeStreet certificates of deposit, which declined approximately $199 million during the quarter. Second quarter interest income included $13.2 million of discount accretion on loans acquired in the HomeStreet transaction compared to $12.7 million in the first quarter. As of June 30, 2026, we had approximately $136 million of remaining discount on those acquired loans. Lastly, earning asset mix remained relatively stable during the quarter, with a modest reduction in cash balances, partially offset by additional investment securities purchases. Turning to Slide 15. This slide highlights one of the most important drivers of our future earnings growth. As we've discussed previously, the legacy Mechanics balance sheet contains approximately $4.8 billion of lower-yielding assets with a weighted average yield of 3.12%, comprised primarily of multifamily loans, single-family residential loans and held-to-maturity securities. Over time, these assets will mature, pay down or otherwise reprice and can be reinvested at current market rates. More than half of this portfolio, or approximately $2.8 billion, is expected to turn over within the next five years. If reinvested at current market rates, that represents approximately 260 basis points of potential yield pickup relative to the existing portfolio. Importantly, this opportunity is already embedded within our balance sheet and does not require balance sheet growth or a change in our conservative risk profile. As these assets continue to reprice over time, we expect them to provide a meaningful tailwind to future net interest income and margin expansion. Turning to Slide 16. We put together this illustrative example of the potential impact of short-term rate changes by comparing our variable assets to our rate-sensitive deposits, which include our time deposits, and estimating the NII impact of those rate changes. As you can see, we expect a meaningful reduction in NII for any rate hikes in the short term and would benefit from any rate cuts. I would note that the actual impact of rate hikes will diminish over time as more of the bank's fixed-rate loans amortize, mature or pay off and the bank reinvests those proceeds at market rates. Turning to Slide 17. Noninterest income increased $2.8 million or 13% to $23.8 million as compared to the first quarter. The increase was primarily driven by approximately $2.2 million of nonrecurring income items, which are highlighted on the slide. Excluding these items, underlying noninterest income increased modestly from the prior quarter as trust fees increased approximately $0.4 million and bank card royalty income increased approximately $0.5 million, partially offset by a $0.3 million decline in loan servicing income. Turning to Slide 18. Noninterest expense decreased $6 million or 4.6% to $124.5 million compared to $130.4 million in the first quarter. Merger-related expenses totaled $5.9 million during the quarter compared to $4.8 million in the prior quarter and were primarily comprised of severance costs associated with the final phase of our HomeStreet integration. Excluding these merger-related expenses, noninterest expense declined $7.1 million from the linked quarter, driven primarily by lower salaries and employee benefits expense reflecting headcount reductions and the realization of core conversion synergies following the successful HomeStreet conversion. As a result, our efficiency ratio improved to 58.4% compared to 61.6% in the first quarter. Excluding CDI amortization, annualized core noninterest expense was approximately $445 million during the quarter and we remain on track to achieve our previously communicated run rate noninterest expense target of approximately $430 million by the fourth quarter of 2026. Turning to Slide 19. Loan interest income declined $3 million or 1.7% to $178.2 million compared to the first quarter. Loan yields declined 3 basis points to 5.2%, driven primarily by modestly lower contractual yields and changes in portfolio mix as residential and consumer balances grew as a percentage of the portfolio. Multifamily and single-family residential yields declined 8 and 11 basis points, respectively, reflecting lower discount accretion and modest pressure on contractual yields. During the quarter, C&I yields increased due primarily to approximately $1 million of discount accretion recognized on a small subset of loans. The CRE concentration ratio improved to 342% at quarter end from 348% at March 31. During the quarter, we originated approximately $756 million of loan commitments predominantly in construction, single-family residential and other consumer categories and sold approximately $32 million of loans, primarily multifamily debt and single-family residential loans. Turning to Slide 20. Our commercial real estate portfolio remains well diversified and continues to reflect our long-standing focus on lower-risk multifamily lending. Multifamily represents approximately 71% of the total CRE portfolio with an average loan size of $4 million, an average LTV of 56% and an average debt coverage ratio of 1.55x. The remainder of the CRE portfolio is broadly distributed across retail, office, industrial, hotel and mixed-use categories, each with relatively modest exposure and conservative credit characteristics. At quarter end, our CRE concentration ratio was 342% or 96% excluding multifamily loans. We continue to make progress reducing higher-risk segments inherited through the HomeStreet merger. Legacy HomeStreet syndicated loan balances declined from approximately $142 million at September 30, 2025, to approximately $69 million at June 30, 2026. In addition, construction and owner-occupied CRE balances continued to decline during the quarter, reflecting our disciplined approach to balance sheet risk management. Importantly, we continue to have no exposure to nondepository financial institutions. Technology-related exposure represents less than 1% of our C&I portfolio and office exposure remains modest at approximately 8% of total CRE with conservative average LTVs and debt coverage ratios. Turning to Slide 21. You can see both legacy Mechanics' strong historical asset quality trends and the impact of the HomeStreet merger. Mechanics has consistently maintained excellent credit quality with minimal non-auto charge-offs and a low level of nonperforming assets. As shown on the slide, the majority of our historical charge-offs have been auto-related, and that portfolio continues to perform better than our original expectations as it runs off. Non-auto net charge-offs were just 1 basis point annualized during the second quarter. At June 30, nonperforming assets represented 0.28% of total assets compared to 0.25% on March 31. The increase was primarily driven by a modest increase in nonperforming loans, including certain single-family home equity and multifamily relationships, partially offset by the sale of foreclosed assets during the quarter. Our allowance for credit losses totaled 1.12% of total loans at quarter end compared to 1.13% in the prior quarter. During the second quarter, we recorded a $2.8 million reversal of provision expense, primarily reflecting the elimination of qualitative factor adjustments established in the first quarter and a reduction in the reserves for unfunded commitments. Our ACL remains robust at approximately 2.6x nonperforming assets. Turning to Slide 22. Securities interest income was essentially unchanged at $53.1 million during the second quarter compared to the linked quarter. Securities yields also remained stable at 3.97% during the quarter. The securities portfolio increased approximately $156 million at quarter end, primarily driven by additional purchases of agency mortgage-backed securities. Securities available for sale increased approximately $186 million, while held-to-maturity securities declined modestly due to normal paydowns. Overall, the portfolio continues to provide stable earnings and liquidity while maintaining a conservative risk profile. Turning to Slide 23. Total deposits declined $153 million during the quarter, driven by a $199 million reduction in the higher-cost time deposits, partially offset by growth in non-maturity deposits. This contributed to a $1.8 million or 3% decline in deposit interest expense compared to the prior quarter. Total cost of deposits improved to 1.25%, down 3 basis points from the first quarter, driven primarily by the continued runoff of higher-cost legacy HomeStreet time deposits. The average cost of our time deposits was down to 2.45% for the second quarter. I would note that the spot cost of deposits at June 30 was 1.28%, which reflects some competitive pressures that we are seeing in our markets. Lastly, noninterest-bearing deposits represented 35% of total deposits at quarter end. Turning to capital and liquidity on Slide 25. We remain very well capitalized with a 14.4% CET1 ratio and an 8.7% Tier 1 leverage ratio at June 30. Available liquidity totaled approximately $15.9 billion at quarter end. Book value per share was $12.15 at quarter end, while tangible book value per share increased to $7.56. During the second quarter, we paid dividends totaling $0.70 per Class A share bringing year-to-date dividends to $1.10 per share. As C.J. discussed earlier, our strong capital position continues to support significant capital returns to shareholders, subject to board and regulatory approval. We currently expect to pay a dividend of approximately $0.25 per Class A share in the third quarter, followed by an approximately $75 million to $100 million dividend in the fourth quarter. That concludes our prepared remarks. We will now open the line for questions.
分析師問答
Your first question comes from the line of Woody Lay with KBW.
I wanted to start on the deposit trends that you saw in the quarter. And as you highlighted, there was a little bit of mix shift and the spot cost is a little bit higher than where we were on average. So I was just interested to know your thoughts on how you think that mix shift trends over the back half of the year? And it sounds like there could be a little more pressure on the deposit cost front over the back half of the year?
Yes, I'll start, and I'll see if Carl and Nathan want to add anything. It's a good question. Obviously, in the second quarter we saw rates move back up. I think we've seen—and we've priced up a bit on some of our CDs and some of our money markets as we've seen rate competition increase in the market. We also had, at the end of March, a lower spot rate, and April is tax season. So there's a little bit of noise there as a data point. In the month of June, our deposit costs rose slightly, by less than one basis point, and we saw a pickup really in May. The deposit costs slowed down in June. We do expect, Woody, that mix shift will continue through the rest of the year. We are seeing some continued mix shift into money market accounts. Our CDs will continue to decline a bit. So we expect deposit cost to increase modestly through the rest of the year. Overall, we're very encouraged by general pipelines and the refocus that we have on growing the core business. Obviously, it's very competitive out there, but our deposit base is very low cost to begin with. When we have these elevated rates and a lot of competition in markets, it creates a bit of pressure, but overall, we still feel solid about our deposit base. Nathan or Carl, do you want to add anything to that?
I'd just note that we've seen a consistent pickup in our CD renewal rate in the second quarter. Obviously, the acquisition CDs were intentionally managed down; they were relatively high. But in the second quarter, we saw renewal rates pick up to historical levels and our renewal rate overall in the entire CD portfolio is still relatively low, as noted by our cost of CDs being lower than our money market accounts at the end of the second quarter. So we feel that's a positive trend. But yes, there certainly has been additional pressure in the second quarter with elevated rates.
Yes. I'd also say all deposits are core in our view. Our CD costs are very solid core client relationships. There's still some pressure—there's a lot of competition there. But we've mostly gotten through what we wanted to do, which was manage out high-rate seekers and noncore relationships. You've actually seen our average tenure go from 17 years to 19 years, and that's also a function of some of these rate-seeking CDs moving on, which also creates a lot of excess capital for us.
That's really helpful color. And then maybe just as my follow-up on the loans or on the asset side, and I appreciate Slide 15. It's super helpful color that you provided and it's pretty interesting to see the rate on multifamily loans is only 30 basis points higher than new securities. So given a pretty tight spread there, how does that impact your thoughts on where you see asset growth as you get some of these cash flows from both the bond and the loan side?
Yes, that's a good question. Carl, Nathan and I talk about it a lot. There's not a lot of incremental spread between where we're seeing commercial real estate multifamily lending and where we can reinvest in similar-duration securities. We put a lot of effort into being prudent about where we're lending and who we're lending to. We want to lend to core client relationships; many of the multifamily relationships we've had go back decades. It's an allocation decision, and I think you'll continue to see us manage our commercial real estate down modestly, and we'll eventually get below that 300% level. We've made good progress on that, and it will continue. As some of that low-yielding CRE rolls off, the reinvestment rate on securities is pretty competitive, and it's also a lot lower risk. That's a trade we've been willing to make, and I think we'll continue to see some of that.
Our next question comes from the line of Tim Mitchell with Raymond James.
This is Tim on for David. To follow up on Woody's question and just talk about the outlook for the margin. All the details you gave on Slide 15 are great. You have a lot of tailwinds just from back-book repricing, the bond restructure, some continued runoff of the CD book. You also noted some potential pressure on the deposit cost side given the competitive backdrop. Could you help us unpack some of the puts and takes for the margin and where you think the core margin can shake out over the next few quarters?
Sure. I'm happy to go first. There are a couple of moving pieces. We added the two new slides to give investors additional insights into our near-term sensitivity to changes in Fed funds. We are modestly liability sensitive, as you can see on Page 16, where we have a greater amount of rate-sensitive deposits than floating-rate assets. So rates down near term is good for us; rates up near term would be a modest drag. Long run, we feel positive that there will be margin expansion given the repricing we have on a lot of these very low-yielding $4.8 billion at 3.12% that are cash flowing and those cash flows should pick up. On top of that, we are planning to execute an AFS restructuring to sell the remaining $310 million of low-yielding securities in the AFS portfolio. We expect a four- to five-year earn-back and that will be a modest bump to margin near term and into next year. You raised a good point that deposit costs may increase modestly from here, which will offset some of the benefit. So we expect modest NIM improvement in a flat rate environment. If we get rate hikes, that would cut into the improvement.
That's super helpful. And then just on the size of the balance sheet overall. It's obviously declined in the past couple of quarters. There are a lot of moving parts here as you continue to optimize it post merger. But if you could walk us through some of the puts and takes around when we could see the size of the balance sheet stabilize and start to grow a little bit. Loan originations were up nicely this quarter, but I also understand there may be some work to be done on the auto book and maybe some multifamily portfolios.
From a balance sheet size standpoint, it's going to be driven really by our deposits, and I think we have reached the bottom of our deposits decline. We expect to grow modestly—I'd say modestly, in the 1% to 2% range moving forward on deposits. There will be some continued mix shift and a bit of pressure on costs, but that should stabilize. On the asset side, there will be continued remixing. We are growing single-family and HELOC modestly and our partnership with Inclined Lending against the cash surrender value of whole life policies is growing nicely. We will continue to be prudent on commercial real estate, construction lending and C&I; we're selectively looking at all of our relationships and making sure they are priced appropriately on a risk-adjusted basis. Carl, do you want to add anything?
No, I think that says it well. It's very competitive out there. Deposits largely dictate the size of the balance sheet, and some credit pricing in the market is irrational today. We're not going to give away credit at this bank. We've always been disciplined in our extension of credit. To the point earlier, you have a 30 basis point spread between securities and multifamily lending, and so I don't see us pressing hard to grow loans that we cannot underwrite well and price appropriately. We won't always be able to meet the competition. So those are my thoughts on the balance sheet side. I think roughly $1.2 billion is a good level to look for us going forward.
And then since I took the question cap off, I'll ask one more just on capital. Obviously, the ratios continue to build and the HomeStreet integration is moving into the rearview mirror. I'm curious about your updated thoughts around M&A. There's been some deals in your footprint recently. Could you give us an update on your attitude, what conversations are like and your overall thoughts there?
I'll make a couple of quick comments and then C.J. and Nathan can certainly join in. Over the past 40 years Ford Financial has been extremely acquisitive, but we've never done a transaction just to get bigger. It always has to meet the first test of making us better. We've always defined better as it relates to franchise value, namely liabilities and deposit costs. When you've got top-decile deposits and a strong deposit franchise, it makes it very difficult when screening M&A opportunities, particularly in our West Coast footprint. We're just coming off an extremely successful deal and still have some digestion and assimilation work after HomeStreet. I tend to think our biggest bang for our resources is to focus internally. Although the integration and conversion to the Mechanics platform is going very well, I don't see anything on the horizon right now because it has to meet this deposit test. That's a high bar. We're not going to do anything just for the sake of getting larger; it has to help our deposit franchise, and that's hard to find.
Yes. I don't really have anything to add to that.
Your next question comes from the line of David Rochester with Cantor.
I just wanted to touch on the guidance I think you had last quarter for 2027 GAAP net income in the $275 million to $300 million range. I realize it's a long way off and a lot happens between now and then, but I still want to get your updated thoughts on that range just given the results, your comments on deposit pricing and on the loan front as well.
Sure, Dave. I'll take that. I think our guidance is very consistent with what it was last time. We want to focus on the ROATCE target, and I think when you take the 17% ROATCE for '27, it should fall right in that same net income range. It's hard to forecast into '27—there are moving pieces—but we have a significant amount of confidence in an increasing ROATCE. It's about 15% today; I think that's going to be up next quarter. We have tailwinds heading into '27 on repricing and on becoming more efficient. I feel very good about our expense guidance, credit and increasingly positive about deposits bottoming out and growing moving forward. So that's my thought on that.
Okay. Great. And you mentioned the expense guidance and getting a lot of those cost saves hitting in the third quarter. Are you expecting to get pretty close to that $430 million run rate in the third quarter and then kind of leveling out in the fourth quarter?
Yes. The core conversion was completed at the end of March. There were a lot of layoffs as part of the merger, and this quarter our headcount was down over 130. So a lot of reductions happened later in the quarter. I think you'll see a pretty substantial reduction in our noninterest expense in the third quarter, and some of that will continue into the fourth quarter. So I feel pretty confident about that. We should also see a significant reduction in the one-time charges related to the merger. There'll still be a couple of items, some leases here or there, but we're basically through it.
Okay. And maybe one on capital. You mentioned having $100 million in excess at the end of June. How much cushion would you guys target to have at the end of 4Q after something like a cleanup dividend, which is kind of implied by that range you gave, the $75 million to $100 million, which is above our estimate and consensus at this point. Just trying to get a sense for how you think about that going forward.
We're managing to an 8% leverage ratio in arrears, which effectively puts us around an 8.5% leverage ratio target in practice. The bank is generating a lot of capital and our risk-weighted assets continue to drop. We're now at a 14.4% CET1. Peers might be around 11% to 12% CET1 on average, so we have a lot of capital flexibility which creates optionality. We are going to continue to pay substantial dividends. We feel confident in the $250 million dividend guide for next year that we mentioned. The main thing is we're still running with capital above peers, and that gives us flexibility.
Just one last one on the margin. You talked a lot about this already. With the restructuring you mentioned and the deposit cost comments, it seems like you're looking for maybe a little bump in the third quarter, then stabilize and grind higher. You mentioned NIM may increase modestly in this rate backdrop which would assume rates continue to hold. Is that how you're thinking about it?
Yes. Looking at this quarter's results and the continued generation of capital, we've adjusted some of our assumptions around deposit growth, betas and mix shift that would be negative to earnings. The AFS restructure where we redeploy capital to add earnings moving forward helps offset that. That's why we think our guidance is relatively consistent with last quarter due to those competing factors. Over the long run, our margin should increase. In the short run, it's going to be pretty dependent on what the Fed does. Either way, it's not going to be a huge needle mover to our NIM, which we expect to remain pretty strong.
There are no further questions at this time. I will now turn the call back to C.J. Johnson for closing remarks.
Thank you, operator, and to all who joined us today. As we closed out the quarter, we believe Mechanics Bancorp is exceptionally well positioned. The HomeStreet integration is substantially complete, expenses continue to trend favorably, credit quality remains strong, and we maintain capital levels that are among the strongest in our peer group. We also believe the earnings power of the franchise continues to improve. We have meaningful embedded asset repricing opportunities, significant flexibility to optimize our balance sheet and the ability to deploy excess capital in ways that enhance shareholder value. Perhaps most importantly, we continue to offer shareholders a unique combination of low-risk earnings, a strong and granular deposit franchise, substantial excess capital and what we believe is one of the most attractive dividend yields in the banking industry. We are proud of the progress we made since closing the HomeStreet acquisition, confident in the opportunities ahead and focused on delivering attractive long-term returns for our shareholders. Thanks for your time today. We look forward to speaking with you next quarter.
This concludes today's call. Thank you for attending. You may now disconnect.