HomeStreet, Inc.
Q3 2014 Earnings Call Transcript

Published: 28 Oct 2014

[Operator:]

Good day and welcome to the HomeStreet Third Quarter 2014 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Mark Mason, President and CEO. Please go ahead.

[Mark Mason:]

Thank you. Hello and thank you for joining us for our third quarter earnings call. Before we begin, I’d like to remind you that our earnings release was furnished this morning with the SEC on Form 8-K and is available on our website at ir.homestreet.com. In addition, a recording of this call will be available today at the same address. On today’s call, we will make some forward-looking statements. Any statement that isn’t a description of historical fact is probably forward-looking and these statements are subject to many risks and uncertainties. Our actual performance may fall short of our expectations or we may take actions different from those we currently anticipate. Factors that may cause actual results to differ from expectations or that may cause us to deviate from our current plans are detailed in our SEC filings, including our quarterly reports on Form 10-Q and our annual report on Form 10-K for 2013 as well as our various other SEC reports. Additionally, any non-GAAP financial measures referenced in today’s call, including a reconciliation of those measures to GAAP measures may be found in our SEC filings and in the earnings release available on our website. Today I’d like to update you on recent events, talk about our progress and executing our business strategy and highlight key financial results. I’ll also share a few thoughts about current market conditions. Please refer to our earnings release for a more detailed discussion of our financial condition and results of operations. In the third quarter, we took important steps to execute our strategy to grow our business and diversify earnings. We have our best quarter yet for new loan commitments and our loans held for investment portfolio, an increase of 19% from the second quarter. We are very pleased with the strong growth of our average earning assets over 8% in the quarter. Our single family mortgage close loan volume was up almost 18% in the second quarter despite ongoing lower industry loan volume. And on September 29, we announced our plans to acquire Simplicity Bancorp, a seven branch, $879 million asset retail franchise in Southern California. This acquisition will provide us with a retail deposit branch network in the largest market in the Western United States. We already have a growing mortgage origination presence. This merger supports our recent additions of residential construction and commercial real estate lending in the Southern California market. And it provides an end market platform to which we will add full commercial banking services including SBA lending. We expect to complete this acquisition in the first quarter of 2015 after obtaining the approval of the shareholders of each company and the necessary regulatory approvals. Mortgage bankers association recently revised its 2015 forecast upward and expects total originations to be 7% higher than 2014 previously. The increase is based on stronger economic growth overall, job gains and decline in unemployment. Purchased mortgages are expected to increase 15% in 2015 while refinances are expected to drop approximately 3% next year. That being said, lenders are currently seeing an increase in refinanced applications with mortgage interest rates for fixed 30-year loans dipping under 4% for the first time in 16 months. We’re expecting to see our October rate lock commitments come in about 25% over September and October with a jump in refinancing which has been ticking up all quarter to approximately 40% of total interest rate lock commitments. If 30-year fixed interest rates on mortgages stay below 4%, this could serve as a welcome catalyst for move up buyers and for people sitting on the fence waiting to enter mortgage market. The MBA has estimated the third quarter 2014 mortgage originations increased 1% over the second quarter. By contrast our originations continue to be significantly higher than the nation overall increasing almost 18% in the quarter. We are still on track to meet last year’s origination volume. Nationally, purchased share increased 3% to 62% of total originations in the third quarter in the Pacific North West, the percentage of purchased mortgage decreased by 4% and that is slightly below the national average at 60% of total originations. HomeStreet’s purchased share however amounted to 78% of our close loans in the quarter. Home inventory continues to be a significant constraining issue on the housing recovery. U.S. housing starts are continuing to recovery but are still well short of the long-run average. The Pacific Northwest is expected to continue to grow more quickly than the rest of the country consistent for the past six months. The Puget Sound in Portland, Vancouver markets are forecasted to be above the long range average in 2015. Currently multifamily makes up just over half the housing starts in the largest Pacific Northwest markets and 20% to 30% of starts elsewhere around the region. Employment growth continues to be above the national average in Puget Sound and many of the regions in which we have branches and lending centers. I’d now like to share some key metrics from the quarter. Our third quarter net income was $5 million or $0.33 per diluted share compared to $9.4 million or $0.63 per diluted share for the second quarter. Excluding acquisition related expenses of $722,000 in the third quarter net income was $5.4 million or $0.36 per diluted share. Tangible book value per share increased to $18.86 as of September 30th compared to $18.42 per share at June 30th. Our year-to-date return on average tangible equity is 8.22%. Net interest income increased $2.2 million or 9% to $25.3 million compared to $23.1 million in the prior quarter. The increase was primarily due to growth in average interest earning assets which grew organically by 8.4% in the quarter. The growth came from all lending units’ particularly commercial real estate, commercial construction and residential construction. Our net interest margin was 3.50% on a tax equivalent basis an increase of two basis points from the second quarter. Non-interest income was $45.8 million down $7.8 million from the second quarter. Included in the second quarter non-interest income was a pre-tax gain of $3.9 million from the sale of approximately $211 million of mortgage loans that were formally in our held for investment portfolio. And pre-tax servicing income was $4.7 million higher than the second quarter as a result of our sale of mortgage servicing rights last quarter. Non-interest expense was $64.2 million for the quarter compared to $63 million in the second quarter, this increase was related to increase headcount and increase commissions on higher closed mortgage loan volume. At September 30th the Bank’s tier 1 leverage ratio was 9.63% and the total risk based capital ratio was 13.95%. I’d like to speak now about our commercial and consumer banking business segment results. Our commercial and consumer banking business continues to expand with strong segment core deposit growth, loan production and loan portfolio growth. We continue to target net growth in our loans held for investment portfolio of 5% or more per quarter subject to liquidity and capital constraints. Segment net income was $3.5 million in the quarter compared to $3.8 million in the second quarter. The second quarter income included $3.9 million pre-tax gain on the sale of portfolio of mortgage loans in the quarter. Excluding acquisition related expenses incurred in both periods net income decrease $144,000 in the quarter compared to the prior quarter. Excluding acquisition related expenses and the $3.9 million gain on sale portfolio loans in the prior quarter, net income increased $2.4 million. Our loans held for investment portfolio grew 8.4% in the quarter while new commitments totaled $324 million. Non-performing assets decreased to only 0.87% of total assets at September 30th compared to approximately 1% of total assets at the end of June. Classified assets also declined in the quarter to 1.09% of total assets compared to 1.24% at June 30th. Due to continued improvement in credit quality and minimal charge-offs we did not record a loan loss provision in the third quarter. While total deposits grew less than 1% over the quarter we continue to grow core deposits and reduce balances of higher cost in time deposits. Non-interest earning transaction deposits grew to 11.2% of total deposits from 9.8% at June 30th. Total transaction in savings deposits rose approximately 2.8% and now comprises 73% total deposits. We reduce certificates of deposit balances by 20% this quarter; these accounts now make up only 15% of total deposits. And during the quarter we opened two retail deposit branches and strong neighborhood in our core Seattle market. Now let’s talk about our mortgage banking business segment results. As I’ve discussed previously, our mortgage banking strategy is to build mortgage volume market share, end market share to mitigate the impact of decline in profit margins and lower industry loan volume. Through the third quarter, national mortgage volume has declined 44% from the prior year. Our year-to-date held for sale loan volume has decreased only 17% as a result of this growth strategy. Despite our volume decreasing less than the industry these declines in volume and profit margins have been challenging for us. Recently interest rates have declined and our refinancing loan originations have increased. This recent improvement will improve our October results and if these rates continue through the fourth quarter our fourth quarter expectations for this segment will improve. October interest rate lock activity we now know will be the highest for HomeStreet since 2013. Additionally as a result of our continued hiring of high quality and loan producers we are expecting our loan volume not to decline in the fourth quarter as we would normally expect given historic seasonality in purchase mortgage volume. Mortgage banking segment net income for the quarter was $1.4 million compared to $5.6 million in the second quarter the decrease in quarter-over-quarter income was primarily due to the $4.7 million pretax gain on sale of servicing that we have recognized in the second quarter, as well as higher commission expense in the third quarter as a result of higher closed loan volume. Closed loan volume designated for sale was $1.29 billion in the quarter, an increase of nearly 18% from the prior quarter. The combined pipeline of locks and closed loans held for sale was $974 million at September 30 compared to $953 million at June 30. Interest rate lock commitments totaled $1.17 billion for the quarter, a decrease of $34 million from the second quarter. The volume of closed loans designated for sale surpassed interest rate lock activity commitments by 11% this quarter. This differential negatively affects accounts earnings. As a majority of our mortgage revenue is recognized at the time of interest rate lock or a majority of origination cost including commissions are recognized upon closing. If rate lock commitments during the third quarter would have been the same as closings at $1.3 billion it would have resulted in approximately $3.3 million higher gain on loan origination in sale revenue. Conversely of closed loan volume had been the same as the $1.2 billion in interest rate lock commitment pretax income would have been approximately $1.4 million higher as a result of lower variable cost such as commissions and incentives. Net gain on single family mortgage loan origination sale activities was $37 million in the quarter essentially flat from the second quarter. We continue to experience some pressure on profit margins due primarily to lower profit margins on non-conforming jumbo mortgage loans which comprised 19% registered lock commitments in the quarter. The deposit profit margin was 316 basis points compared to 321 basis points in the prior quarter. Single family mortgage servicing income was $5.3 million in the quarter compared to $9.6 million in the second quarter. The decline in servicing income again was related to the second quarter gain on sale of servicing of $4.7 million. Additionally, fee income from servicing decreased $1 million from the second quarter primarily from lower balances in the servicing portfolio as a result of this sale of servicing. Segment non-interest expense was $45.2 million, an increase of $2.7 million or just over 6% from the second quarter. This was primarily due to higher commissions related higher closed loan production. We continue to focus on improving production efficiency in the quarter and as a result our direct cost originated loan decreased by about three basis points. And we are expecting further improvement in this area in the coming quarters. In the quarter we added a net of 23 production and operations personnel in mortgage banking. And as part of our efforts to gain mortgage market share in new and existing market we opened five new home loan centers in Washington, California and Hawaii. And in November, we will open our first home loan production office in Phoenix, Arizona and we expect to open several offices in Arizona before year-end. I would now like to make a few closing comments. We continue to make solid progress on our plan to grow and diversify our business. Our recent results are showing the benefits of our strategy. Our commercial and consumer banking segment loan portfolio deposit growth have been substantial and far outpace industry and peer averages over those periods. Growth in segment net interest income and net income reflect this progress. And our pending acquisition of Simplicity Bank will accelerate our goal of increasing commercial and consumer banking segment income to consistently more than 50% of our total bottom-line. While the mortgage industry continues to produce substantially lower than historical loan volumes and confound forecasting we have returned the segment to profitability and we are on our way to relevering [ph] our system and returning to expected levels of profitability. Towards our goal, we continue to hire high quality personnel and expand our franchise in strong Western markets. We’re looking forward to closing out 2014 in a very strong manner and we’re very excited about the prospects of 2015. Thank you for your attention today. I’d be happy to answer any questions you have at this time. Operator?

[Operator:]

We will now begin the question-and-answer session. (Operator Instructions) First question comes from Paul Miller of FBR Capital Markets. Please go ahead.

[Unidentified Analyst:]

Hey Mark, it’s Jessica in for Paul, how are you?

[Mark Mason:]

Good Jessica.

[Unidentified Analyst:]

We have one question, how can we think about capital management going forward given your capital levels adjusted for the Simplicity merger and just maybe -- dividend or a buyback or even saving that capital for more acquisitions?

[Mark Mason:]

Thanks for the question. Important benefit of the Simplicity acquisition is the additional free capital. Today, Simplicity has extra capital that they have been utilizing to buy back stock over recent periods. We will utilize that additional capital to mitigate any potential need to raise additional capital in the near term. That opportunity is limited not simply to any calculable excess capital on their balance sheet today but we may restructure components of their loan portfolio to provide additional lending room that would not require additional capital and so we’re pretty happy with the opportunity to take off the table any considerations of capital raise in the near term. The other aspect of the Simplicity acquisition for us what’s important is being able to build a significant amount of our earnings in basic spread earnings, basic net interest income that should allow some time we hope next year after we have completed the acquisition and stabilized the consolidated group post-acquisition to contemplate the adoption of a regular quarterly dividend because we will have a very significant base of durable spread income and so we would hope to have that conversation internally sometime in the second half of next year with the hope for expectation of initiating regular quarterly dividends.

[Operator:]

(Operator Instructions) The next question comes from Tim Coffey of FIG Partners. Please go ahead.

[Tim Coffey:]

Hey, can you give us an idea of kind of what the pipeline of – on the commercial banking side going into 4Q?

[Mark Mason:]

That’s a good question. I don’t have the pipeline numbers in front of me though I would say on balance we expect to close more in terms of dollars in the fourth quarter than this quarter both in the loan portfolio and with respect to our Fannie Mae DUS business. We have as you seen from the commitment detail over the last several quarters a building portfolio of unfunded construction loans which are funding up plus permit loan closings that are anticipated for the fourth quarter. So, as a directional statement I think we expected to be higher than the third quarter as a consequence of not just prior activity and existing commitments but other loans scheduled close in the quarter.

[Tim Coffey:]

Okay, and what is that – how should we read into that in regards to the provision expense because for the first three quarters of the year is almost nothing, what we see for the fourth quarter into ’15?

[Mark Mason:]

Well, we’ve been fortunate that notwithstanding our loan growth our improvement in credit quality and much lower than expected charge offs has prevented the need for a provision so far this year. We expect that to change in the fourth quarter for us to settle it coverage ratios, similar to those at the end of the third quarter and so to the extent that our loan portfolio grows and/or we experience charge offs that would create a need for provisioning and we think that fourth quarter is going to be the time that we the first time we experience that in the recent past. So if you’re thinking about the coverage levels today with some levels of anticipated charge-offs in the quarter. You can probably calculate the expected provision for the quarter and similarly next year if you think about a level of charge-offs is probably still smaller than current year despite current year charge-offs hasn’t come down quite a bit.

[Tim Coffey:]

Okay. And as I hear your comments say that loan fee margin on the mortgage side of the business you see those going up?

[Mark Mason:]

No, I think one comment that the margins have deteriorated a little bit on our composite margin a few basis points this quarter. I don’t think I commented on our forward look but I can’t. We are being conservative in our internal forecasting about the forward margin. We’re expecting growth in our loan volume to mitigate that next year, but we expect to still see some softening in margins. We said that last year about this and frankly margins have been much higher this year that we had forecast them coming into this year. I think the probability of a significant decline in our composite margin is probably not great. When you consider the number of companies that are breaking even for losing money on mortgage origination today what that reflect is the cost of production for everyone has grown dramatically over the last several years with increasing credit in underwriting requirements and very substantial increases in data and file quality requirements by the agencies and even in securitization. And so the cost of production must be near the revenue today if people breaking even a losing money. So we think the probability of people being interested in even greater price competition from here is probably less likely than it was a year ago.

[Tim Coffey:]

Okay. Great, thanks, that’s good color. And then turning to Simplicity, do you have any updates on the quarter?

[Mark Mason:]

They have not yet released earnings I think they’re schedule to release early in November in the first week of November. So I can’t comment on that yet. I would ask that question to Simplicity management.

[Tim Coffey:]

Okay. And then as relates to deal cost on the Simplicity deal, do you still -- putting those between 1Q and 2Q provided the closes the timeline how do you think you have got those into one quarter?

[Mark Mason:]

We estimate the total deal cost just over $19 million, some of that we’ve already taken in this quarter of approximately $570,000 of merger related expenses in the quarter and 700,000 a little over or about 570 some related to Simplicity merger. So those are already been incurred. We’re going to incur maybe another 400,000 in the fourth quarter. So that’s going to leave us approximately $18 million of cost that we have estimated yet to incur. To the extent that the transaction closes in the first quarter and the system conversions occur subsequent to that say in the second quarter. We would expect to incur somewhere around $10 million in the first quarter and $8 million in the second quarter for total of 18. To the extent that the systems conversions might occur concurrent with the legal closing that would shift quite a bit of that $8 million into first quarter and that would be great right, because we want to get pass those expenses as quickly as possible and start pretty clean quarters. But it’s going to rely on the timing of closing and the timing of those conversions.

[Tim Coffey:]

And any updates on regulatory approvals or conversions like that?

[Mark Mason:]

No early promises other than to-date we have not run into any hurdles or any concerns from any of the agencies. So at this junction we don’t have reason to believe that our estimated first quarter closing is in danger though we have yet to file the proxy, the joint proxy that we’ll be filing for the two related shareholder votes. And of course there has been a couple of lawsuits now filed which is common unfortunately in the transaction. I don’t know if it’s two or one, actually is kind of confusing we have notices if you look in the Press Release of all these law firms they look like two lawsuits they maybe actually the same suit but there is at least one lawsuit which has become common unfortunately and transactions today, they appear to act at the end of the day as transaction tax because at least today the history of these pieces of litigation has been a settlement that didn’t impair the intended closing date of the transaction. Too early to give an opinion on the status of that litigation, though I am very comfortable in saying that we do not see anything that is transpired in the marketing of Simplicity nor the negotiation of the proposed merger that we think is actionable on any basis and we think all these parties have acted in the best interest of the respective companies. So I expect this litigation to conclude in the same manner as others.

[Operator:]

(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to Mark Mason for any closing remarks. Actually sir a question is just coming from Tim O’Brein from Sandler O’Neil. Please go ahead.

[Tim O’Brein:]

Hey could you talk a little bit more about the Arizona expansion?

[Mark Mason:]

Sure. Our basic strategy is to expand our mortgage market share in existing markets wherever possible, and do expand to other major mortgage markets in the Western United States to subsequently grow a meaningful mortgage market share, and then follow that with full service banking probably through acquisitions. We have done this opportunistically today that is to say that in hiring teams and we generally don’t hire individuals in new markets, we hire teams of high performing individuals. We first find teams that we think would be added into our system and then open offices in their markets. We don’t choose a market and then go look for a team other than knowing there are major markets we generally like to be in. So we recently got an opportunity to hire teams of significant successful track record in Arizona. And since this a market that is on our list markets that we would ultimately like to operate in we are opening offices for them. This is the same exercise that predated our entry into Northern California and Southern California, similarly in Idaho and in other markets in Oregon and Washington. And the fact that it’s in Arizona this time is only significant and that we’re yet in the state of Arizona physically but we have been originating loans in Arizona for some period of time related to borrowers who may have second homes or loan officers who may have existing relationships in the state of Arizona.

[Tim O’Brein:]

So you said several more branches by the end of the year did you say by end of 2015?

[Mark Mason:]

We are hoping to add several more by the end of this year, end of fourth quarter of 2014.

[Tim O’Brein:]

And what markets are we talking about besides Phoenix if any Tucson?

[Mark Mason:]

I really shouldn’t say yet. I think you know the major market.

[Tim O’Brein:]

Sure, thanks for the color.

[Mark Mason:]

Thank you Tim. Operator would you pull for questions one more time.

[Operator:]

Certainly. (Operator Instructions) Seeing that there are no questions, I will turn the call back over to you, Mark Mason for any closing remarks sir.

[Mark Mason:]

Again we appreciate your patience and listening to our prepared remarks and the great questions from analysts following our company. Thank you all. Good day.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.