HomeStreet, Inc. 2016 Q3 Form 10-Q Summary
Entity note: The filing provided is for HomeStreet, Inc., not Mechanics Bancorp. It covers the quarter and nine months ended September 30, 2016; financial amounts below are in U.S. dollars.
Business context and reporting period
HomeStreet is a Seattle-based financial services company focused on mortgage banking and commercial and consumer banking, primarily in the western United States. During 2016 it expanded through the February acquisition of Orange County Business Bank and an August acquisition of two Bank of Oswego branches. Management said a separate acquisition of two Southern California branches from Boston Private was expected to close in November 2016, subject to conditions.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $46.8 million | $39.6 million | $132.0 million | $108.6 million |
| Noninterest income | $111.7 million | $67.5 million | $285.9 million | $215.8 million |
| Net revenue | $158.5 million | $107.1 million | $417.9 million | $324.4 million |
| Net income | $27.7 million | $10.0 million | $55.9 million | $32.6 million |
| Diluted earnings per share | $1.11 | $0.45 | $2.27 | $1.58 |
| Net interest margin | 3.34% | 3.67% | 3.46% | 3.63% |
| Efficiency ratio | 72.15% | 85.92% | 78.20% | 84.41% |
At September 30, 2016, total assets were $6.23 billion, loans held for investment net of allowance were $3.76 billion, deposits were $4.50 billion, and shareholders’ equity was $586.0 million. Compared with December 31, 2015, assets rose 27%, loans held for investment rose 18%, and deposits rose 39%.
Mortgage banking drove much of the earnings improvement: Q3 mortgage origination and sale gains were $92.6 million, up 60%, and mortgage servicing income was $14.5 million, up 205%. Single-family mortgage loan sales reached $2.49 billion in Q3, up 27%. Expenses also increased: noninterest expense rose 24% in Q3 and 19% for the first nine months, reflecting higher staffing, commissions, expansion costs, and regulatory requirements.
Credit quality and capital: provision for credit losses was $1.3 million in Q3 and $3.8 million year to date. Nonaccrual loans increased to $25.9 million, or 0.68% of total loans, from $17.2 million, or 0.53%, at year-end. Nonperforming assets were $32.4 million, or 0.52% of assets. The allowance for loan losses was $34.0 million, or 0.89% of loans held for investment. The Bank’s Tier 1 leverage and total risk-based capital ratios were 9.91% and 14.41%; management reported the Company and Bank above applicable well-capitalized minimums.
Liquidity and funding: cash and cash equivalents were $56.0 million. The Bank’s primary liquidity ratio was 32.4%, versus 25.4% at year-end, and available borrowing capacity was $311.1 million at the FHLB and $433.2 million at the Federal Reserve. FHLB advances declined to $858.9 million from $1.02 billion. Long-term debt was $125.1 million, including $65 million of 6.50% senior notes due 2026 and $61.9 million of trust-preferred-related debt.
For the first nine months, operating cash flow was negative $181.3 million, investing cash flow was negative $791.5 million, and financing cash flow was positive $996.1 million; cash increased $23.3 million to $56.0 million. Operating and investing outflows reflected mortgage loan production, portfolio lending, and securities purchases, partly funded by deposit growth and borrowing activity.
Material changes versus comparable periods
- Q3 net income increased 178% year over year; nine-month net income increased 71%.
- Net interest income grew with higher average loan and securities balances, but net interest margin contracted, primarily due to asset mix and higher funding costs.
- Mortgage production and servicing revenue rose substantially, supported by higher rate-lock commitments and a larger servicing portfolio. Loans serviced for others reached $19.32 billion, up from $16.35 billion at year-end 2015.
- Balance-sheet growth reflected acquisitions, organic lending and deposit growth, and investment of senior-note proceeds in securities pending future loan growth.
- Nonaccrual loans and nonperforming assets increased in dollars; net charge-offs remained low, with net recoveries of $0.8 million for the first nine months.
- Common shares outstanding increased to 24.8 million from 22.1 million at year-end 2015, mainly reflecting shares issued for the OCBB acquisition.
Outlook, commentary, risks and unusual items
- Management described continued growth in mortgage and commercial banking, branch and lending-center expansion, and strategic acquisitions. The filing provides no quantified earnings or revenue guidance.
- The pending Boston Private branch acquisition was expected to close in November 2016, subject to closing conditions and other factors; completion was not assured.
- Management cited mortgage-volume sensitivity to interest rates and housing conditions, margin pressure from funding costs, real-estate and geographic concentration, acquisition integration and growth execution, and the risk of increased credit losses.
- Mortgage servicing rights are materially sensitive to prepayment and discount-rate assumptions. The filing’s sensitivity analysis estimates a $19.0 million MSR fair-value decrease from a 25-basis-point adverse change in prepayment assumptions.
- Mortgage repurchase and indemnification exposure remained: $18.27 billion of servicing-retained loans were subject to representations and warranties, with a recorded repurchase liability of $3.6 million. The company also had a $1.7 million reserve for loss-sharing obligations on $1.06 billion of Fannie Mae DUS loans.
- Management reported no material legal claims considered probable or reasonably possible of loss, but disclosed it was cooperating with an ongoing SEC Division of Enforcement inquiry concerning prior fair-value hedge-accounting analysis. Management believed no enforcement action was warranted and did not expect a material financial impact, while noting the outcome could not be assured.
- Adoption of the new expected-credit-loss standard (CECL) was expected to have a material impact on the financial statements; the company was still evaluating the effect. Management said no significant subsequent event had a material impact before filing.
Important facts for investors to verify
- Confirm the filing’s registrant: the supplied 10-Q is HomeStreet, Inc., not Mechanics Bancorp.
- Track whether mortgage production, servicing income, and earnings remain resilient if interest rates or refinance activity change.
- Monitor net interest margin, deposit costs, brokered-deposit growth, and reliance on FHLB and other wholesale funding.
- Review the trend in nonaccrual loans, nonperforming assets, allowance coverage, and real-estate concentrations, including acquired loan portfolios.
- Check the outcome of the SEC inquiry and any developments in mortgage repurchase, indemnification, or other contingencies.
- Verify completion and integration of the pending branch acquisition, and assess the cost and dilution implications of further growth.