Business context and reporting period
Entity discrepancy: The request identifies Mechanics Bancorp, but the supplied Form 10-Q is for HomeStreet, Inc. and subsidiaries. This summary reflects the filing provided, not a filing identified as Mechanics Bancorp.
The unaudited report covers the quarter and nine months ended September 30, 2014; it was signed November 12, 2014. HomeStreet is a Seattle-based financial services company focused on mortgage banking and commercial and consumer banking, principally in the Pacific Northwest, California and Hawaii.
Financial performance and condition
Amounts below are in millions of dollars except per-share data and ratios.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net interest income | $25.3 | $20.4 | $71.2 | $53.1 |
| Noninterest income | $45.8 | $38.2 | $134.2 | $154.7 |
| Noninterest expense | $64.2 | $58.1 | $183.2 | $170.6 |
| Net income | $5.0 | $1.7 | $16.6 | $24.7 |
| Diluted earnings per share | $0.33 | $0.11 | $1.11 | $1.67 |
| Net interest margin | 3.50% | 3.41% | 3.50% | 3.12% |
| Efficiency ratio | 90.21% | 99.20% | 89.23% | 82.14% |
At September 30, 2014, total assets were $3.47 billion, loans held for investment net of allowance were $1.96 billion, loans held for sale were $698.1 million, deposits were $2.43 billion and shareholders’ equity was $294.6 million. Cash and cash equivalents were $34.7 million.
For the first nine months, operating activities used $352.6 million of cash, investing activities used $24.2 million, and financing activities provided $377.6 million; cash increased $0.8 million. Management attributed operating cash use largely to mortgage-loan production exceeding proceeds from loan sales.
At quarter-end, Federal Home Loan Bank advances were $598.6 million, repurchase-agreement borrowings were $14.2 million and long-term debt was $61.9 million. The Bank’s primary liquidity ratio was 36.1%; disclosed available borrowing capacity was $113.8 million from the FHLB and $390.6 million from the Federal Reserve Bank of San Francisco. Bank capital ratios were 9.63% Tier 1 leverage, 13.03% Tier 1 risk-based and 13.96% total risk-based; the Bank remained well-capitalized under then-current standards.
Credit indicators improved: nonaccrual loans were $19.9 million, or 1.00% of loans; nonperforming assets were $30.4 million, or 0.87% of assets; and nine-month net charge-offs were $0.5 million. The allowance for loan losses was $21.8 million, or 1.10% of loans held for investment. Management recorded no Q3 provision and a $1.5 million nine-month reversal of provision.
Material changes versus comparable periods
- Q3 net income increased 199% year over year, reflecting higher net interest income and mortgage-related income. Nine-month net income fell 32.6%, primarily because mortgage origination and sale gains declined.
- Q3 net interest income rose 24%; average loans held for investment increased 30% year over year. The nine-month margin comparison is affected by a $1.4 million prior-period interest-expense correction in 2013; excluding it, the 2013 nine-month margin was 3.21%.
- Nine-month mortgage loan origination and sale gains fell to $104.9 million from $139.9 million. Single-family closed-loan production declined 17% for the nine-month period, although Q3 interest-rate lock commitments rose 49% year over year.
- Expenses increased 10% in Q3 and 7% for the nine-month period, reflecting acquisitions, expanded operations and higher staffing-related and occupancy costs. The nine-month efficiency ratio worsened to 89.23% from 82.14%.
- Assets grew 13% from December 31, 2013. Deposits rose 9.7%; FHLB advances rose 34%. Construction and land-development loans increased to $297.8 million from $130.5 million.
- The company sold servicing rights on $2.96 billion of Fannie Mae loans in June 2014, reducing MSRs to $124.6 million from $162.5 million at year-end. The sale generated $4.7 million of pretax income and was described as supporting capital preparation and balance-sheet management.
Outlook, risks and unusual items
- No specific earnings or revenue guidance is provided. Management said limited housing inventory was restraining mortgage volumes and increasing costs, and noted that competitive pricing was reducing secondary-market margins.
- HomeStreet announced a proposed stock-for-stock acquisition of Simplicity Bancorp, expected to close in the first half of 2015 subject to shareholder and regulatory approvals. The filing gives differing pro forma figures in different sections; the combined-company estimates should be verified.
- Basel III capital standards were scheduled to begin applying January 1, 2015. Management expected to elect to exclude certain accumulated other comprehensive income components and said it believed current capital levels would meet the new standards, while identifying MSR deductions and capital constraints as relevant risks.
- A putative Simplicity shareholder class action filed in October 2014 seeks, among other things, to enjoin the merger and obtain damages. HomeStreet said it considered the claims without merit and intended to defend itself. Management reported no legal claims considered probable or reasonably possible of loss as of September 30.
- Management disclosed a material weakness in internal accounting controls concerning hedge-effectiveness analysis for fair-value hedges on 14 commercial loans and related swaps. The identified errors were deemed immaterial to reported periods, but management concluded that the potential maximum error could have been material and that internal controls over financial reporting were ineffective as of quarter-end. Remediation was planned for Q4 2014.
- Key risks include interest-rate and mortgage-market volatility, housing supply, MSR valuation and prepayment assumptions, real-estate credit concentration, acquisition integration, regulatory changes, and mortgage-loan repurchase or indemnity claims. The company paid $1.6 million of dividends in the first quarter but declared no Q3 dividend.
Most important facts for investors to verify
- Confirm the intended company: the supplied filing is HomeStreet, Inc., not Mechanics Bancorp.
- Track remediation and subsequent testing of the hedge-accounting material weakness, including whether controls are later deemed effective.
- Verify Simplicity merger approvals, litigation status, expected timing and consistent pro forma financial figures.
- Assess mortgage production, secondary-market margins, servicing income and sensitivity of MSR fair values to prepayment and interest-rate assumptions.
- Monitor Basel III capital compliance, liquidity and wholesale funding levels, and whether credit quality improvements continue as the loan portfolio grows.