Mechanics Bancorp quarterly report, Q2 FY2018

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SEC filing summary

Registrant identity: The supplied filing is HomeStreet, Inc.’s Form 10-Q, not a filing identified as Mechanics Bancorp. The summary below reflects HomeStreet’s filing.

Business context and reporting period

Unaudited results cover the quarter and six months ended June 30, 2018; balance-sheet comparisons are to December 31, 2017, and income-statement comparisons are to the corresponding 2017 periods. HomeStreet is a Seattle-based financial services company operating primarily in the western United States and Hawaii, with Commercial and Consumer Banking and Mortgage Banking segments.

Financial performance and condition

  • Second-quarter results: Net income was $7.1 million, down 36.7% year over year; diluted EPS was $0.26 versus $0.41. Total net revenue was $120.4 million, down 6%.
  • First-half results: Net income was $13.0 million, down 35.8%; diluted EPS was $0.48 versus $0.75. Total net revenue was $229.7 million, down 7%.
  • Interest income and margins: Second-quarter net interest income was $51.0 million; on a tax-equivalent basis it was $51.7 million, up 7.7%. Net interest margin was 3.25%, compared with 3.29% a year earlier. Management attributed margin pressure to funding costs rising faster than yields on assets.
  • Expenses and returns: Second-quarter noninterest expense was $110.6 million, roughly flat year over year, and included $6.9 million of restructuring charges. Return on average assets was 0.40% and return on average equity was 3.78%, versus 0.70% and 6.71%, respectively, a year earlier.
  • Balance sheet at June 30: Total assets were $7.16 billion; net loans held for investment were $4.88 billion; deposits were $5.12 billion; shareholders’ equity was $706.5 million. Assets increased 6% and deposits 7.5% from year-end 2017.
  • Funding and debt: Deposits were $5.12 billion, FHLB advances $1.01 billion, other borrowings $30.0 million, and long-term debt $125.4 million. Brokered deposits rose to $607.8 million, or 11.9% of deposits, from $345.5 million, or 7.3%, at year-end. The $30 million line-of-credit draw was described as an annual test draw and was repaid in July.
  • Liquidity and capital: Cash and cash equivalents were $176.2 million, up from $72.7 million at year-end. The Bank’s primary liquidity ratio was 23.6%, versus 18.1% at year-end; reported available borrowing capacity was $335.8 million at the FHLB and $322.9 million at the Federal Reserve. The Bank’s Tier 1 leverage, common equity Tier 1, and total risk-based capital ratios were 9.72%, 12.69%, and 13.52%; management said the Bank remained well capitalized.
  • Cash flows, first half: Operating activities provided $35.8 million; investing activities used $350.1 million; financing activities provided $417.2 million. Cash, cash equivalents and restricted cash increased $102.9 million.
  • Credit quality: Nonaccrual loans were $9.6 million, or 0.20% of loans, and nonperforming assets were $10.4 million, or 0.14% of assets. The allowance for loan losses was $39.5 million, or 0.80% of loans; the provision for credit losses was $1.0 million for the quarter and $1.8 million for the half year.

Material changes versus comparable periods

  • Mortgage Banking weakened: second-quarter segment net loss was $4.8 million, versus $1.8 million net income in 2017; first-half segment net loss was $9.1 million, versus $1.5 million net income. Lower production, lower servicing income and restructuring charges contributed.
  • Single-family mortgage rate-lock commitments declined 14% in the quarter and 9% in the first half; closed volume declined 13% and 12%, respectively. Management cited higher rates, constrained housing inventory and stronger competition.
  • Commercial and Consumer Banking improved: second-quarter net income rose 26% to $11.9 million; first-half net income rose 18% to $22.1 million, supported by higher net interest income and loan growth.
  • Interest expense rose sharply: 64% in the quarter and 51% in the first half, reflecting higher rates on deposits and FHLB advances. First-half net interest margin was slightly lower year over year.
  • Nonperforming assets fell from $15.7 million at year-end to $10.4 million. Available-for-sale securities had $27.9 million of gross unrealized losses at June 30, versus $14.0 million at year-end; the filing attributes the declines to market interest-rate changes and reports no identified expected credit losses.

Outlook, commentary, risks and unusual items

  • Management is targeting measured growth in commercial and consumer banking and a more efficient mortgage operation; it did not provide earnings or revenue guidance. It expects mortgage originations to remain pressured by higher rates, limited housing supply and competition.
  • In June, the company announced closure or consolidation of 20 home-lending centers, primarily in California and Arizona, with a reduction of 110 full-time equivalents. It expects $11.4 million in annualized pre-tax savings and estimated total restructuring costs of $9.7 million, including $6.9 million recorded in Q2 and approximately $1.7 million expected in Q3.
  • On June 29, HomeStreet completed a sale of servicing rights on approximately $4.90 billion of single-family mortgage principal balance. The sale generated $65.3 million in cash proceeds during the first half and a reported $573,000 pre-tax gain; servicing transfers were expected to be completed by August 16, 2018.
  • Management modified the Fannie Mae DUS loss-sharing arrangement, reducing consolidated risk-weighted assets and improving reported capital ratios. Under the described arrangement, HomeStreet shares losses with Fannie Mae and is responsible for up to one-third of principal losses on covered loans.
  • Interest-rate risk remains significant. Management reported that a modeled parallel 200-basis-point rate increase would reduce one-year net interest income by 3.1% and net portfolio value by 12.2%; results depend on assumptions and do not reflect possible management actions. MSR values are sensitive to prepayment and discount-rate assumptions, and hedging results can vary.
  • Other risks include real-estate and geographic concentration in the western United States, reliance on brokered and wholesale funding, mortgage repurchase and indemnification obligations, regulatory requirements, and execution risk around restructuring and projected savings. The filing reports no material legal claims considered probable or reasonably possible of a material loss and no material subsequent events. Management concluded disclosure controls were effective at quarter-end.

Important facts for investors to verify

  • Confirm the registrant: the source is HomeStreet, Inc., despite the request metadata naming Mechanics Bancorp.
  • Track mortgage production, servicing income, hedge performance and MSR valuation, including the servicing-rights sale and transfer.
  • Assess whether the announced restructuring delivers the expected $11.4 million annualized savings and whether further charges or cuts arise.
  • Monitor deposit pricing, brokered-deposit reliance, borrowing capacity and the effect of rising funding costs on net interest margin and liquidity.
  • Review loan growth and credit quality, including construction and real-estate exposures, TDRs, allowance adequacy and mortgage repurchase liabilities.
  • Reconcile capital-ratio changes with the DUS agreement modification and confirm the company’s capacity to fund growth while maintaining regulatory buffers.