HomeStreet, Inc. — Form 10-Q Summary
Registrant discrepancy: The request identifies Mechanics Bancorp, but the supplied filing is for HomeStreet, Inc. This summary covers HomeStreet’s unaudited quarter ended March 31, 2018, compared primarily with the three months ended March 31, 2017 and, for balance-sheet items, December 31, 2017.
Business context and reporting period
HomeStreet is a Seattle-based financial services company operating commercial and consumer banking and mortgage banking businesses, primarily in the western United States. Its mortgage banking segment originates and services residential loans; its banking segment gathers deposits and makes consumer and commercial loans.
Financial performance and position
| Metric | Q1 2018 | Comparable / change |
|---|---|---|
| Net interest income | $48.5 million | $45.7 million in Q1 2017; up 6.2% |
| Net interest margin | 3.25% | 3.23% in Q1 2017 |
| Noninterest income | $60.8 million | $74.5 million in Q1 2017; down 18.3% |
| Noninterest expense | $100.8 million | $106.9 million in Q1 2017; down 5.7% |
| Provision for credit losses | $0.75 million | None in Q1 2017 |
| Income before taxes | $7.8 million | $13.2 million in Q1 2017 |
| Net income / diluted EPS | $5.9 million / $0.22 | $9.0 million / $0.33 in Q1 2017 |
| Return on average assets / equity | 0.35% / 3.27% | 0.57% / 5.53% in Q1 2017 |
Balance sheet at March 31: Assets were $6.92 billion, up 2.7% from year-end; loans held for investment, net, were $4.76 billion, up 5.6%; deposits were $5.05 billion, up 6.1%; and shareholders’ equity was $701.0 million, down from $704.4 million. Cash and cash equivalents were $66.3 million. FHLB advances totaled $851.7 million, federal funds purchased and repurchase-agreement borrowings were $25.0 million, and long-term debt was $125.3 million.
Cash flow and liquidity: Operating activities provided $107.3 million; investing activities used $303.9 million; and financing activities provided $190.3 million. Cash, cash equivalents and restricted cash decreased $6.4 million. The Bank’s primary liquidity ratio was 21.5%, versus 18.1% at year-end. Available borrowing capacity was $308.8 million from the FHLB and $344.3 million from the Federal Reserve Bank.
Credit and capital: Nonperforming assets were $11.2 million, or 0.16% of assets, versus $15.7 million, or 0.23%, at year-end. Nonaccrual loans were $10.9 million; the allowance for loan losses was $39.1 million, or 0.81% of loans held for investment. The Bank’s Tier 1 leverage and total risk-based capital ratios were 9.58% and 13.09%; the Company’s were 9.08% and 10.97%. Management said both remained above applicable “well-capitalized” levels.
Material changes versus the prior comparable period
- Net income fell 34.7%, primarily as mortgage loan origination and sale gains declined $12.0 million and servicing income declined $1.7 million. Management attributed pressure to limited housing inventory, higher rates reducing refinancing, and stronger competition compressing mortgage margins.
- Mortgage Banking reported a $4.3 million net loss, compared with a $0.3 million loss in Q1 2017. Lower mortgage revenue more than offset reduced segment expenses.
- Commercial and Consumer Banking net income rose to $10.2 million from $9.3 million, supported by higher net interest income and a lower effective tax rate, partly offset by higher expenses and a credit-loss provision.
- Average interest-earning assets increased 5.4%; interest expense rose 37.3%, reflecting higher rates on deposits and FHLB advances. The effective tax rate declined to 24.5% from 32.1%, largely following federal tax reform.
- Unrealized losses on available-for-sale securities drove a $10.2 million other comprehensive loss, reducing equity. The filing attributes the securities’ market-value declines primarily to interest-rate changes and says it identified no expected credit losses on the debt securities.
Outlook, commentary, risks and unusual items
- Outlook and cost actions: No formal earnings or revenue guidance is provided. Management expects a slower growth rate than in prior periods and intends to pursue measured banking growth while optimizing mortgage operations. In April 2018, after quarter-end, HomeStreet reduced headcount by 86 and cut other costs; it expects annualized pretax expense savings of $12.4 million and anticipated additional severance charges in Q2.
- Mortgage and interest-rate exposure: Management cited constrained housing supply, higher mortgage rates, intense competition, and margin pressure. MSR valuations and hedge results are sensitive to rates, prepayments, assumptions and model inputs. Q1 MSR fair-value gains were substantially offset by losses on economic hedges; management also cited a flattening yield curve and negative convexity as factors weighing on servicing risk-management results.
- Funding and growth risks: Deposits grew, but brokered deposits increased to $489.7 million from $345.5 million at year-end. The filing warns that higher funding costs may rise faster than asset yields and that reliance on wholesale or brokered funding could increase liquidity risk.
- Credit, concentration and contingencies: Lending is concentrated in real estate and western U.S. markets. The company reported $72.7 million of TDR loans and $737.7 million of undistributed construction commitments. It reported no material legal claims considered probable or reasonably possible of a material loss, and no significant subsequent event affecting the financial statements.
- Other developments: An activist investor pursued a proxy contest; a Washington court upheld the company’s rejection of a deficient nomination notice, and the activist filed a definitive proxy statement on April 25. A vendor notified HomeStreet that its independent auditors had found the vendor’s internal controls inadequate; HomeStreet said it did not believe that issue affected it because of its own controls. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
- Accounting: HomeStreet expects the new expected-credit-loss standard, effective for it in 2020, may increase the loan-loss allowance; the potential amount was not yet clear. The company said adoption of the revenue-recognition standard had no material financial impact.
Important facts for investors to verify
- Confirm that HomeStreet, rather than Mechanics Bancorp, is the intended issuer for this review.
- Track whether the April 2018 $12.4 million annualized savings target is achieved, and the amount and timing of related severance or restructuring costs.
- Monitor mortgage origination volumes, secondary-market margins, servicing and hedge results, and sensitivity of MSR values to rates and prepayments.
- Assess deposit pricing and composition—including brokered deposits—alongside liquidity, borrowing availability and the cost of FHLB funding.
- Follow loan growth, construction and real-estate concentrations, delinquencies, TDR performance, allowance levels and the eventual impact of the expected-credit-loss standard.
- Review changes in capital ratios and any effect of regulatory rules on mortgage servicing assets, and monitor the proxy contest and vendor-control issue for subsequent developments.