HomeStreet, Inc. (NASDAQ:HMST)
Q1 2014 Results Earnings Conference Call
April 29, 2014 01:00 PM ET
Mark Mason - Chief Executive Officer
Cory Stewart - EVP, In-Charge of Finance and Accounting
Paul Miller - FBR
Tim Coffey - FIG Partners
Good day and welcome to the HomeStreet Incorporated First 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 Mr. Mark Mason, CEO. Please go ahead.
Hello and thank you for joining us for our first 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.
For those of you who read our earnings release on any news wire services, may have noticed for the first time we published a summary press release with the short description of the results of the first quarter and we referenced to the full detailed description of our results of operations and financial condition filed as a part of our Form 8-K on the subject. We made this change to save the expense and time involved in wiring a longer press release. We expect to announce earnings in this manner going forward.
On today’s call, we will make some forward-looking statements. Any statement that is in 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 than those that 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 2013 as well as our various other SEC reports.
Additional information on 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 share a few thoughts about current market conditions, updating you on our progress and executing our strategy and highlight key financial results. Please refer to our earnings release for a more detailed discussion of our financial condition and results of operations.
In the first quarter, HomeStreet became the number one lender for purchase mortgages in the three-state Pacific Northwest region for the first time in our history. This accomplishment is a result of our strategy to continue to grow our franchise during this portion of the mortgage banking cycle. While many other lenders are pursuing a similar strategy, large regional or national lenders are consolidating their businesses. We believe our strategy is the right one for HomeStreet. While not unique, HomeStreet's platform remains attractive to high quality loan originators giving us the opportunity to grow the ranks of our originators in communities, we believe will be perpetually strong housing markets.
For the industry as a whole, purchasers accounted for 51% originations nationally and 53% in the Pacific Northwest in the first quarter. By contrast HomeStreet's purchases as a percentage of total rate lock commitments were 78% for the quarter. And month to date in April purchases accounted for 80% of total locks.
We are growing market share, both in our traditional Pacific Northwest markets and in new markets, most significantly California. California interest rate lock commitments comprised approximately 13% of total interest rate lock commitments in the first quarter.
Despite this success, consistently lower than anticipated loan volume continues to challenge our mortgage banking profitability in recent quarters. In most markets the inventory of homes for sale remains low, potential move up buyers are afraid to put their homes on the market for fear of not finding their next home. Many homeowners refinanced their homes with mortgages in the low 3% range and are reluctant to re-price their mortgages to change homes. And cash sales are higher than average. On a national basis, the MBA has reported that existing home sales are running at the slowest pace since late 2012 and that new home sales dropped at March after two months of growth. The latest industry data shows that refinancing demand is at its lowest level in 14 years.
For the first quarter the MBA is anticipating a 23% decrease in total loan production from the fourth quarter. The Northwest region felt slightly better with a decrease of 21% about over this period. HomeStreet’s closed loans by comparison were down only 13% quarter-over-quarter.
We do not expect any time soon to get help from any significant growth in new home inventories. Housing permits continue to recover slowly. The pace of permitting is higher in the Northwest than the U.S. as a whole even though it is still 10% to 20% below the long run average.
The multifamily share of housing permits has steadily gained ground during the economic recovery, but this activity also is beginning to slow as single family housing permits are expected to trend up over the next several years. Our core market region of Puget Sound is home to 1.2% of the national’s population. However the region represents 1.6% of the home building activity today.
While our first quarter lending volume is lower than we anticipated our loan application and interest rate loss volumes have increased steadily since February. This is an expected result of traditional home buying seasonality, which is more significant in the Northwest and the ramp up of loan volume from the hiring of loan originators throughout our network over the past several quarters.
Now a little about our first quarter results, net income in the quarter was $2.3 million or $0.15 per diluted share compared to a net loss of $861,000 or $0.06 per share for the fourth quarter. Excluding acquisition-related expenses, net income for the quarter was $2.8 million or $0.19 per diluted share compared to net income of $1.8 million or $0.12 per share in the prior quarter.
Net interest income was $22.7 million for the quarter, an increase of $1.3 million or 6.2% from the prior quarter. Our net interest margin increased by 17 basis points to 3.51% compared to 3.34% in the fourth quarter.
Total interest earning assets increased to net $30 million or 1.1% compared to the fourth quarter of 2013 as growth in loan balances is partially offset by lower balances in our investment securities portfolio.
Non-interest income was $34.7 million, down $1.4 million from the fourth quarter as a result of $1.1 million decrease in gain on sale of investment securities offset impart by $1 million increase in net gain on single family mortgage loan origination and sale activities.
Non-interest expense was $56.1 million in the first quarter, a decrease of 4.7% from $58.9 million for the fourth quarter. Non-interest expense in the first quarter included $823,000 of acquisition-related expenses. Net interest expense in the fourth quarter of 2013 includes $4.1 million of acquisition related expenses.
On March 31st, the Bank’s Tier 1everage ratio was 9.94% and the total risk-based capital ratio was 15.04%.
Additionally in the first quarter, we successfully completed the integrations of Fortune Bank and the Yakima National Bank, institutions we acquired in the fourth quarter last year. I’m happy to report that our team did a fantastic job. We do not experience any systems integration issues or customer service issues of significant and we are operating today as one team which is producing strong deposit growth and lending volume. Furthermore, we have not experienced any material loss with customers or employees.
I’d like to speak now about our commercial and consumer banking business results. We again made substantial progress in the first quarter toward our goal of business diversification. Segment net income was $3.3 million, an increase $3.1 million over the fourth quarter. Excluding acquisition related expenses, segment net income was $3.9 million, an increase of $972,000 over the fourth quarter.
Net interest income was $20.2 million for the quarter, an increase of $2.1 million or 11.4% over the prior quarter. We continued to experience strong commercial and consumer loan demand. With over $290 million in new commitments in the quarter, quarterly organic net growth in our loan portfolio was over 5% even after an usually high $111 million in pay downs in the quarter. Net loans held for investment decreased overall to $1.66 billion as we sold $56 million of single family portfolio mortgages in March and transferred another approximately $254 million of single family mortgage loans out of the portfolio into loans held for sale.
We elected to sell single family mortgages at this time out of the portfolio to provide additional liquidity to support growth in our commercial loan portfolio, to reduce our concentration of single family mortgages in the portfolio and to take advantage of low industry originations and high secondary market demand which has produced premium valuations on these sales.
While this significant sale has reduced our progress in growing interest earning assets for the quarter, we believe the premium valuation of the sales, the additional liquidity and the acceleration of portfolio diversification warranted this decision. As a consequence of the transfer of single family mortgage loans from our held for investment portfolio to our held for sale portfolio, we released $1.5 million of the loan loss reserves during the quarter.
New loan commitments totaled $290.8 million comprised of $109 million of commercial real estate; $29 million of commercial and industrial loans; and $59 million of residential construction loans. In addition, we originated $94 million of single family residential loans for the portfolio. Balances on new originations and advances on existing loans and lines of credit totaled $213 million in the quarter.
Additionally in the quarter, we added two residential construction lending teams, one in Utah and one in California, marking our entrance into these markets with this line of business. Segment non-interest expense was $18.7 million for the quarter compared to $20.8 million in the fourth quarter. Excluding acquisition related expenses, segment non-interest expense for the first quarter was $17.8 million compared to $16.7 million for the fourth quarter.
We also had strong deposit growth in the quarter. Deposit balance of $2.37 billion increased 7.3% in the quarter with transaction in the savings deposits grown by 5.7% from year-end and non-interest bearing transaction accounts increasing almost 10% in the quarter to $220 million or 9.3% of total deposits. Our growth of non-interest bearing accounts has been phenomenal over the past year. Non-interest bearing accounts have grown steadily since the end of the first quarter of last year with such accounts total only $83.2 million and represented only 4.3% of our total deposits at that time.
This growth in deposits is the result of our commercial and consumer marketing and retail deposit branch additions prior to it that time. Over the remainder of this year, we're scheduled to open four additional new retail deposit branches in our core Seattle market. With the first two scheduled to open later in the second quarter. Upon completion of these openings, we will have substantially achieved our goal of branching to every community of deposit concentration in Seattle.
An important part of our banking strategy is to become the community bank of choice for Seattle. And while achievement of this goal will take some time of branching strategy is an important step. Credit performance is strong in the quarter with classified assets ending the quarter at 1.5% of total assets compared to 1.65% last quarter and non-performing assets decreased to 1.12% of total assets compared to 1.26% as of the end of the year. We also saw meaningful reductions in non-accruals and delinquencies.
Now, let's talk about our mortgage banking results. We continue to execute on our strategy to build the multi-state retail mortgage origination franchise by opportunistically recruiting teams of top producers in major Western regional markets.
As I discussed before, our strategy is to mitigate the impact of declining profit margins and lower industry loan volume by relevering our fixed cost base and continuing to hire high quality, high volume mortgage producers in our existing and new markets.
This quarter, as expected we saw seasonal ramp up in applications and interest rate lock commitments while applications and locks increased this activity in loan closings were substantially below numbers that we had previously anticipated.
And as a consequence our production costs continue to be hired than plans. Today, we project continued growth in origination activity through the summer followed by a flattening of volume through the end of the year as we expect our continued growth and personal to mitigate the seasonal declines in loans for originator later this year.
Overall, assuming we continue to higher at the current pace and macroeconomic forces remain stable we currently expect total originations in 2014 to exceed those of last year. In the first quarter, our mortgage banking business segment recorded a net loss of $1 million compared to a net loss of $1.1 million in the prior quarter. Interest rate lock commitments total $803 million an increase of 21% over the fourth quarter, month of April locks are 11% over the March level which is consistent with the seasonal recovery we have experienced since year-end. January locks increased 26% over December, February locks increased 15% over January and March locks increased 22% over the fourth quarter. We expect this pattern to generally continue through midsummer, slow during the vacation season and rise again in the fall until the holidays.
Closed loan volume designated for sale was $676 million for the quarter, a decrease of 12.6% in the fourth quarter. Net gain on single-family mortgage loan origination in sale activities was $24.3 million in the quarter, an increase of $1 million or 4.3% for the prior quarter. This was primary due to higher rate lock volume offset by lower closed loan volume and slightly lower composite profit margin.
The composite profit margin was 323 basis points in the quarter compared to 350 basis points in the prior quarter. Margin softened overall during the quarter, but the softening was primarily in non-performing jumbo loan production, which comprised approximately 12% of interest rate lock volume in the quarter, up from only 3% in the prior quarter.
Jumbo market is under pressure today by large balance sheet lenders that our lending at below secondary market losses. We have decided to decrease our concentration of single-family mortgages in our portfolio and as such we've change our products to conform to secondary market requirements.
Today HomeStreet and other lenders selling these loans in the secondary market are originating these loans at or near breakeven margins. This market condition is driven by widening of spread for mortgage-backed securitization market. And until those spreads narrow, this pricing condition will continue.
Housing price appreciation has exacerbated the impact of this condition on lenders as a greater proportion of total originations are now non-conforming loans. On a positive note, loan prepayments continue to slow. The annualized constant prepayment rate or CPR of our portfolio of loan service for others was only 6.2% for the first quarter.
As a consequence of slow prepayments in the originations, our servicing portfolio increased to $12.2 billion at quarter-end, up 3.4% from December 31st. Single-family mortgage service and income of $7.5 million in the quarter increased from $7.4 million in the fourth quarter of last year.
Segment non-interest expense of $37.4 million decreased $618,000 or 1.6% from the fourth quarter of 2013. This decrease was primarily attributable to a 15% decrease in loan commissions and incentives as closed loan volumes declined 13% from the fourth quarter. However, our loan application volume has risen substantially, growing 48% from the fourth quarter of last year.
Additionally, prequalification applications continue to outnumber applications for borrowers with properties under contracted purchase. All of these applications must be fully underwritten. As such, we are today underwriting approximately twice the number of applications necessary to close the loans we originate. This condition continues to negatively affect our production cost efficiency.
In the quarter, on a voluntary and involuntary basis, we reduced the ranks of production personnel by 49 people and operations personnel by 47 to upgrade production performance and improve operating efficiency. These reductions have prepared us for improved efficiency going forward and we continue to spend on network of mortgage loan production offices. Today we have 49 standalone home loan centers.
I'd now like to make a few closing comments. For the past four quarters, the company has paid the special cash dividend. As a consequence of lower earnings in recent quarters and to preserve capital for future growth, our Board of Directors and management believe it's appropriate to discontinue special dividend at this time.
Assuming the stabilization of our mortgage banking business and the continued growth of our commercial and consumer banking business, we hope to adapt to a regular quarterly dividend sometime in the future.
Additionally today we filed on Form S-3 shelf registration statement provided for the potential issuance of up to $125 million of equity and debt securities. We filed it this time since it is most efficient to file a shelf registration soon after the annual filing of Form 10-K.
We have no current plan to issue securities under this shelf. We have filed this registration statement to provide ourselves flexibility in the event we need to issue securities and support of an acquisition or to provide capital for growth in the future.
As a part of our preparation for the effective date for HomeStreet of the new Basel III based regulatory capital standards, we are considering a sale of a portion of our portfolio mortgage servicing rights. We feel this action is necessary and appropriate in conjunction with other actions we may take in the future to optimize our capital utilization. We anticipate remaining as a sub-servicer of such loans so that we could maintain that important contact with our customers.
While the ultimate size of such sales are uncertain at this juncture, we are planning an initial marketing of approximately 25% of our portfolio of loan service for others. We hope to complete the sale of servicing rights sometime in the second quarter.
We remain committed to growing our mortgage banking share and continuing to build our traditional banking business, strengthening our lending capabilities and growing our balance sheet organically and potentially for future acquisitions.
With improving loan volume and assuming stable profit margins, we expect to return to mortgage origination profitability in the second quarter and beyond. We appreciate your attention today. We like to answer any questions you have at this time.
Thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from Paul Miller with FBR. Please go ahead.
Paul Miller - FBR
Hey, thanks a lot. Hey Mark, can you talk a little bit about the margin, the margin I think came up in that mid 3 level. Have we seen most of the improvement or can we still see some improvement with lower NPAs?
We believe we're still going to experience some improvement, though not on the funding side. We expect our funding costs are going to remain pretty stable to slightly down as we draw our non-interest deposits. Most of the changes are likely to come on the loan yield side over the next several quarters.
Having said that, we think that the opportunity to expand the margins substantially and quickly, really isn’t there for most of us in this market. We may get expansion by next year of perhaps 10 basis points to 15 basis points, but that will be dependent upon relatively stable interest rates.
Paul Miller - FBR
And then you've grown, in your loan portfolio one of the areas has grown very nicely that construction land development. Can you add some color to that, that's growing at a very fast clip; it's really the main driver of the loan growth especially in the commercial loan book?
Sure. Most of that is commercial real estate today. Our residential construction has been a little slower than we booked to-date. We in Seattle are experiencing an explosion in apartment growth. So we’ve done a fair amount of apartment construction lending and mini-perm lending. But we have also lent on the line of other property types, we have two new retail projects down in the Portland area and some other mixed use projects as well. Those balances, the commitments of course have grown faster than balances and those projects are going to be built over the next 18 to 30 months.
We have a growing opportunity in residential construction. We complain about the lack of housing inventory as it relates to our mortgage business, well that’s also true in the residential construction business, housing starts have been slower than we expect. And we're rebuilding that part of our business, a much safer business than it was during the recession. So I would expect to see continued growth in these line items in our portfolio as in our region both of these businesses are growing faster than the nation as a whole.
Paul Miller - FBR
What the -- I know you’ve hired some teams out in California, is this loan growth coming in footprint or is some of this coming out some of the areas in California?
On the commercial side, substantially all of our loan growth is in Puget Sound area. We’re just now starting to look at business in California and in Utah, and I wouldn’t expect that to be significant for some time.
Paul Miller - FBR
Okay. And Mark, thanks a lot.
Thank you, Paul.
(Operator Instructions). And our next question comes from Tim Coffey of FIG Partners. Please go ahead.
Tim Coffey - FIG Partners
Hey good, morning Mark.
Tim Coffey - FIG Partners
As far as on one of your comments about capital, are you concerned at all about the level of capital you have given the aggressive organic growth rate that you envision for the company?
Well, we are likely to be challenged, not this year but after this year if we grow at the current pace and we don’t reduce our level of mortgage servicing rights. The Basel III related capital requirements are effective for HomeStreet January 1 of next year. And given the level of mortgage servicing rights we carry today and other currently off balance sheet items like our Fannie Mae delegated underwriter and servicing portfolio which is a recourse portfolio, what have you bought back on balance sheet for capital purposes. And so those two changes reduce our regulatory capital in a meaningful way. And so we have to be more careful about planning for the effectiveness of that change. And so, we are seeking to mitigate that through balance sheet management and sales and servicing. And hopefully between those two items and the recovery of earnings, we will be able avoid capital raising. If we begin growing faster and we are profitable enough to support the capital raising, we might consider a capital raising next year but it would have to be supported by a strong earnings pace.
Tim Coffey - FIG Partners
Okay. You mentioned the 823 in M&A expenses this quarter, anything anticipated in forward quarters from these…
No, nothing material. And in fact what we didn’t mention is we have the number of personnel that we kept only through the conversion dates of the systems during the quarter. We have few those folks love to transition out here in April and then all of the cost savings from a personnel standpoint will also be completed. So our efficiency related to those acquisitions is going to go up very significantly in the second quarter and then going forward.
Tim Coffey - FIG Partners
Okay. And then you mentioned briefly in the press release, could you walk me through the tax rate for the quarter?
It's artificially low in the quarter, as a consequence of an adoption of new accounting guidance for really geographically where you recognize aspects of municipal bond interest. Maybe I better have Cory Stewart, our Executive Vice President In-Charge of Finance and Accounting speak to that one. (inaudible)?
Hey, Jim. So yes, I mean the biggest difference between the rate for the quarter and the fully effective rate of approximately 33% relates to the adoption of the new accounting for the low income housing tax credits. And so the difference between what we had amortized on those investments under the previous method and what we would amortize under the new method as related to prior periods, flow through our income taxes as a discrete item. So as a result of that four hundred and some odd thousand dollars of discrete tax expense or tax benefit, excuse me, they resulted in a quarterly rate of 18.6%. But what you would expect going forward is closer to the approximately 33%.
So subsequence to this quarter for the remainder of the year, you should assume something approximately 33% effectively.
Tim Coffey - FIG Partners
Okay, that’s helpful. And do you have any plans for additional loan sales out of the single family residential portfolio held for investment?
No, not at this time. We do expect to close that portion of those loans which are in held for sale at the end of the quarter here in April and early part of May, most of those sales have been closed to-date. And there will be little bit of fall out as always are from these sales and will likely to transfer some minority amount of those loans back to the held for investment portfolio, and that has been concluded.
Tim Coffey - FIG Partners
Okay. Well, thanks. Those were all my questions.
(Operator Instructions). At this time, I see no questions. So this will conclude our question and answer session. I would now like to turn the conference back over to Mr. Mark Mason for any closing remarks.
Again we appreciate you joining our call and patiently listening to our remarks. And during the call, we appreciate your question today, look forward to talking to you next quarter. Thank you, operator.
Thank you. The conference has now concluded. Thank you again for attending today’s presentation. You may now disconnect your phones.
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