Mechanics Bancorp quarterly report, Q2 FY2013

HomeStreet, Inc. — Form 10-Q Summary

Entity note: The supplied filing is for HomeStreet, Inc., not Mechanics Bancorp. It covers the quarter and six months ended June 30, 2013; the interim financial statements are unaudited.

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 Pacific Northwest, California, and Hawaii. The company reorganized its reporting segments into Mortgage Banking and Commercial and Consumer Banking beginning in the second quarter of 2013.

Financial results and condition

Metric	Q2 2013	Q2 2012	Six months 2013	Six months 2012
Net interest income	$17.4 million	$14.8 million	$32.7 million	$27.6 million
Noninterest income	$57.6 million	$56.9 million	$116.5 million	$97.0 million
Noninterest expense	$56.7 million	$47.0 million	$112.5 million	$81.7 million
Net income	$12.1 million	$18.7 million	$23.0 million	$38.6 million
Diluted EPS	$0.82	$1.26	$1.56	$3.03

• Q2 net interest margin was 3.10%, versus 2.85% a year earlier. Six-month margin was 2.96%, versus 2.68%; excluding a $1.4 million prior-period interest-expense correction recorded in Q1, six-month margin was 3.08%.
• At June 30, total assets were $2.78 billion, loans held for investment net of allowance were $1.42 billion, deposits were $1.96 billion, and shareholders’ equity was $268.3 million. Cash and cash equivalents were $21.6 million.
• FHLB advances were $409.5 million and long-term debt was $61.9 million. Deposits declined $13.7 million from year-end, while FHLB advances increased $150.4 million.
• For the first six months, operating activities provided $115.1 million; investing activities used $256.3 million; financing activities provided $137.6 million. Cash decreased $3.6 million to $21.6 million.
• The Bank reported Tier 1 leverage capital of 11.89%, Tier 1 risk-based capital of 17.89%, and total risk-based capital of 19.15%, and was categorized as well-capitalized. The primary liquidity ratio was 39.7%, down from 43.9% at year-end.

Material changes versus comparable periods

• Q2 net income fell 35% year over year despite net revenue rising about 5%; for the first six months, net income declined 40% as revenue rose about 20% and expenses rose about 38%.
• Mortgage origination and sale gains increased to $52.4 million in Q2 from $46.8 million; six-month gains rose to $106.4 million from $76.3 million. Single-family closed loan production was up 22% in Q2 and 40% for the first half.
• Mortgage servicing income declined to $2.2 million in Q2 from $7.1 million and to $5.3 million for the first half from $15.0 million, primarily reflecting lower net gains from MSR risk management.
• Higher staffing, commissions, and growth-related costs contributed to the expense increase. Salaries and related costs rose 37% in Q2 and 49% in the first half year over year.
• Credit indicators improved in several respects: nonperforming assets were $41.7 million, or 1.50% of assets, versus $73.7 million, or 3.04%, a year earlier; Q2 net charge-offs were $1.1 million versus $10.3 million. Nonaccrual loans were $29.7 million, or 2.06% of loans.
• Available-for-sale securities grew to $538.2 million from $416.3 million at year-end. Rising market rates contributed to a $17.7 million six-month other comprehensive loss, moving accumulated other comprehensive income from $9.2 million to a loss of $8.5 million.

Outlook, commentary, risks, and unusual items

• Management described a mortgage market shifting from refinancing toward purchase lending after mortgage rates rose sharply late in Q2. It intended to pursue purchase-market share through pricing, marketing relationships, and producer hiring; no quantified earnings or revenue guidance was provided.
• Management attributed improved net interest margin partly to lower funding costs from reducing higher-cost certificates of deposit. Certificate balances fell $251.8 million from year-end, while transaction and savings deposits increased $284.3 million.
• In Q1, the company recorded $1.4 million of interest expense to correct prior-period under-accrual of interest on deferred Trust Preferred Securities. This reduced reported first-half margin; management’s adjusted six-month margin was 3.08%.
• Rate changes create material risks to mortgage production, securities values, and MSR valuations and hedging. The single-family MSR fair value was $128.1 million; management disclosed sensitivity to prepayment and discount-rate assumptions. The securities portfolio had $17.4 million of gross unrealized losses, which the company attributed to rate changes and considered temporary.
• Credit risks include real-estate concentration, loan delinquencies, TDRs, mortgage repurchase and indemnification obligations, and Fannie Mae/Freddie Mac program exposure. TDRs totaled $111.1 million across 182 relationships. The mortgage repurchase liability was $1.8 million; no legal claims were assessed as probable or reasonably possible of resulting in loss at quarter-end.
• The company disclosed risks related to a critical technology vendor’s control and remediation issues, cyber threats, regulatory changes, and costs of expansion. It stated that disclosure controls were effective and that no material quarterly change in internal control over financial reporting occurred.
• Subsequent events: HomeStreet agreed to acquire two AmericanWest branches, with about $36.5 million in deposits and $2.15 million in loans, and announced agreements to acquire Fortune Bank for about $27.0 million and Yakima National Bank for about $10.3 million. The transactions were subject to approvals and were expected to close in Q4 2013. The board also approved a special $0.11-per-share cash dividend payable August 15, 2013.
• The company and Bank had regulatory cease-and-desist/MOU restrictions terminated by March 2013 and December 2012, respectively. New Basel III-related capital rules were adopted in July 2013, with general compliance beginning in 2015; management believed current capital levels met the standards, including the conservation buffer.

Important facts for investors to verify

• Whether the announced acquisitions received required approvals, closed on schedule, and delivered expected strategic and financial benefits.
• Whether mortgage volumes and margins held up after the late-quarter rate increase, and how the purchase-versus-refinance mix evolved.
• Whether MSR assumptions, valuation changes, and hedge performance remain reliable amid changing rates and prepayment behavior.
• Whether improving credit trends persist, including nonaccrual loans, TDR performance, charge-offs, and adequacy of the loan-loss allowance.
• How unrealized securities losses, liquidity metrics, FHLB funding, deposit composition, and Basel III capital requirements affect flexibility and shareholder distributions.
• Whether the technology vendor remediated identified control weaknesses and whether mortgage repurchase, indemnification, and other contingent exposures change materially.