Mechanics Bancorp annual report, FY2017

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Business context and reporting period

Source/identity note: The supplied filing is HomeStreet, Inc.’s Form 10-K for the fiscal year ended December 31, 2017—not a filing identified as Mechanics Bancorp. The summary below reflects HomeStreet’s filing. The filing also provides unaudited fourth-quarter results.

HomeStreet is a Seattle-based financial services company with Commercial and Consumer Banking and Mortgage Banking segments, operating mainly in the western United States. Its businesses include banking, commercial and residential lending, mortgage origination and servicing, and insurance.

Financial performance and condition

  • Full-year earnings: Net income was $68.9 million, up 18.6% from $58.2 million; diluted EPS was $2.54 versus $2.34. Results included a one-time, noncash $23.3 million tax benefit from revaluing deferred taxes under the Tax Cuts and Jobs Act.
  • Revenue and margin: Total net revenue was $506.6 million, down 6.0% from $539.2 million. Net interest income rose 8.0% to $194.4 million, while noninterest income fell 13.1% to $312.2 million. Net interest margin declined to 3.31% from 3.45%; the efficiency ratio worsened to 86.79% from 82.40%.
  • Segment results: Commercial and Consumer Banking net income increased to $42.1 million from $30.8 million. Mortgage Banking net income was $26.9 million, slightly below $27.4 million, and included a $27.9 million tax benefit.
  • Fourth quarter: Net income was $34.9 million, or $1.29 diluted EPS, versus $2.3 million, or $0.09 diluted EPS, in Q4 2016. The marked increase was substantially affected by the tax benefit; pretax income was $17.0 million versus $3.4 million.
  • Cash flow: Operating activities provided $160.6 million in 2017, investing activities used $556.2 million, and financing activities provided $414.4 million. Cash and cash equivalents increased $18.8 million to $72.7 million.
  • Balance sheet and funding: Total assets were $6.74 billion, up $498.3 million; net loans held for investment were $4.51 billion, deposits $4.76 billion, and shareholders’ equity $704.4 million. FHLB advances totaled $979.2 million and long-term debt $125.3 million, including $65.0 million principal of 6.5% senior notes due 2026.
  • Liquidity and capital: The Bank’s primary liquidity ratio fell to 18.1% from 31.2%. Available FHLB borrowing capacity was $579.2 million and Federal Reserve borrowing capacity $331.5 million. The Bank’s Tier 1 leverage and total risk-based capital ratios were 9.67% and 14.02%, respectively; the Bank remained well capitalized.
  • Credit quality: Provision for credit losses declined to $0.75 million from $4.1 million; net recoveries were $3.1 million. Nonaccrual loans fell to $15.0 million from $20.5 million, and nonperforming assets to $15.7 million from $25.8 million. The allowance for loan losses was 0.83% of loans held for investment.

Material changes versus prior year

  • Mortgage rate-lock commitments declined 19% to $6.98 billion; single-family closed loan volume fell 16% to $7.55 billion. The filing attributes weaker production to higher rates reducing refinancing and limited housing inventory constraining purchase lending.
  • Mortgage Banking noninterest income fell 16.6% to $269.8 million. The segment reduced staffing by 13.1%, closed three production offices, consolidated six offices into three, and recorded $3.7 million of restructuring charges.
  • Commercial and Consumer Banking continued expanding: loans held for investment rose 18.0%, deposits rose 7.5%, and four retail branches were added. This growth contributed to higher net interest income and operating costs.
  • Interest expense increased 46.7% to $43.2 million, reflecting higher deposit and FHLB funding costs and the 2016 senior-note issuance. Investment securities declined 13.4% to $904.3 million.

Outlook, commentary, risks and unusual items

  • Management expects a 2018 effective tax rate of 21%–22%, before discrete items. The filing does not provide quantified earnings or revenue guidance.
  • Management plans measured growth in Commercial and Consumer Banking and continued mortgage cost control, process improvements, and automation. Further adjustments to mortgage staffing and offices may be considered as market conditions change.
  • Management expected proposed regulatory capital-rule changes, if adopted substantially as proposed, to reduce capital required for mortgage servicing assets beginning in 2018; final rules were not yet published.
  • Key risks include interest-rate and yield-curve movements, mortgage-market volatility and constrained housing supply, real-estate and geographic concentration, MSR valuation and hedging mismatches, deposit/funding costs, credit losses, regulatory compliance costs, and execution of restructuring and growth plans.
  • Other notable matters: an activist investor announced an intent to nominate directors for the 2018 annual meeting; HomeStreet disclosed a vendor’s auditor had identified inadequate internal controls, while management said it did not expect an impact based on HomeStreet’s controls. The company reported no material legal claims expected to adversely affect its financial position, results, or liquidity. Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting.

Important facts for investors to verify

  1. Confirm the issuer: the supplied text is HomeStreet, Inc. (NASDAQ: HMST), not Mechanics Bancorp.
  2. Separate recurring earnings from the $23.3 million tax benefit, including the segment-level tax effects; assess normalized 2017 and Q4 earnings.
  3. Track mortgage origination volumes, margins, servicing income, restructuring savings, and sensitivity of the $258.6 million single-family MSR fair value to rates and prepayments.
  4. Monitor net interest margin, deposit pricing, FHLB borrowing costs and maturities, and the decline in the primary liquidity ratio.
  5. Review loan growth and concentrations, construction commitments, allowance adequacy, nonperforming assets, and the effect of the expected-credit-loss standard (CECL), which the filing says could materially affect statements.
  6. Verify final Basel capital rules, compliance costs as assets approach $10 billion, the activist campaign’s outcome, and whether announced operational changes deliver expected benefits.