HomeStreet's CEO Discusses Q4 2013 Results - Earnings Call Transcript

| About: HomeStreet, Inc. (HMST)
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HomeStreet, Inc. (NASDAQ:HMST) Q4 2013 Earnings Conference Call January 28, 2014 1:00 PM ET


Mark Mason - President and CEO


Tim Coffey - FIG Partners


Good day and welcome to the HomeStreet Incorporated Fourth Quarter and Year-end 2013 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, President and CEO. Please go ahead.

Mark Mason

Hello and thank you for joining us for our fourth 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 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 different actions 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 report on Form 10-Q for the third quarter and our annual report on 10-K for 2012 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, update 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.

The mortgage market continues to be [theoretically] different from where it was a year ago, with the magnitude of the decrease in mortgage volume exceeding in our expectations. While home demand continues to rise, home sale activities still subdued driven impart by low levels of new and existing homes for sale.

New home sales dropped by 7% nationally in December from prior month levels, though they were up nearly 23% from the Puget Sound Region, a trend we expect to see continue given the favorable economic climate. Additionally even though new home construction rose in 2013 with housing starts up 18% nationally and 14.5% in our core market area in Puget Sound is still below the long-term levels necessary to provide for recovering demand.

However shop rise in permits of the second half of 2013 in Puget Sound is expected to be reflected in a corresponding rise in housing starts in the first half of this year. Supporting that growth is employment and wage growth in Puget Sound. Employment grew by 2.8% in 2013 almost double the national average of 1.6% and average salaries rose 4.1% through the first three quarters of last year compared to 3.2% nationally. Regional economy is expected to continue to outpace the national economy in employment and wage growth this year.

The Mortgage Bankers Association is forecasting total loan origination volume for the industry to be $293 billion for the fourth quarter, a decrease of 27% from the third quarter and it declined to roughly 50% from the fourth quarter of 2012. Our primary markets experienced more significant decreases in volume with Pacific Northwest volume dropping 33% and Puget Sound 36% from the third quarter. The mix of purchase to refinance volume in the fourth quarter is expected to be 47% purchase and 53% refinance nationally, but substantially lower purchase share than volume experienced at HomeStreet and somewhat below our markets as a whole.

In the fourth quarter our closed loan volume was comprised of 76% purchases compared to 52% for the Pacific Northwest. In January, total loan origination activity has increased as we expect at this time of year. The Mortgages Bankers Association reported last week that mortgage applications have gone up for three straight weeks as key interest rates reached their lowest levels in nearly three months. Our monthly data application volume is up 18% over the last month and interest rate lock commitments were up 10% so far.

HomeStreet’s net income for the fourth quarter was strongly impacted by the changes in the mortgage market. Our strategy of continuing to grow the ranks of our production staff and expand our market share and footprint has mitigated what would have been more significant reductions in earnings than the industry volume decrease. We have made substantial progress in the fourth quarter; toward our goal of business diversifications. We experienced strong growth in earning assets, increasing loans held for investment through acquisitions and strong organic growth and successfully closed three quality bank and deposit branch acquisitions, adding six retail deposits branches. And teams have accomplished commercial lenders and customer service professionals. We grew our net interest income, increased mortgage servicing income and reduced salaries and related costs increasing our efficiency.

Now a little about our fourth quarter and full year results. HomeStreet successfully closed the acquisitions of Fortune Bank and Yakima National Bank and completed the addition of two retail deposit branches we purchased from American West Bank in the fourth quarter.

Net income for the year was $23.8 million or $1.61 per diluted share. Excluding acquisition-related costs, net income for the quarter was $1.8 million or $0.12 per diluted share compared to $2 million or $0.13 per diluted share in the prior quarter. Including acquisition related costs we had a net loss of $861,000 or $0.06 per diluted share for the quarter.

Net interest income was $21.4 million in the fourth quarter, an increase of $1 million or 4.8% from the prior quarter and an increase of $4.8 million or 28.9% from the fourth quarter of 2012. Our net interest margin decreased by 7 basis points in the quarter to 3.34% compared to 3.41% in the third quarter and 3.06% in the fourth quarter of 2012. Our net interest margin was lower primarily due to lower securities yields caused by unanticipated accelerated bond premium amortization as a result of increases in expected pre-payments fees.

Non-interest income was $36.1 million, down $2.1 million from the third quarter due to lower mortgage loan origination and sale revenue offset impart by an increase of $3.8 million in mortgage servicing income.

Non-interest expense excluding acquisition related costs declined $2.9 million from the third quarter. Competition related expenses decreased by $3.6 million or 9% primarily due to lower commissions in management incentives resulting from lower single family close loan volume. Including acquisition expenses, non-interest expense increased by 1.3% or $752,000 from the third quarter.

Our employee headcount was 1,530 at year-end, a net increase of 105 from the end of the third quarter and 432 above the prior year. In the fourth quarter, we added 74 employees from bank and deposit branch acquisitions and 142 mortgage producers and operations personnel primarily in the new markets. These additions were offset by the reduction of 5 mortgage production and 24 mortgage operations positions in response to the slowdown in mortgage activity; and five commercial lending and administration positions, which were eliminated through improved efficiency and performance.

The bank acquisitions completed in the quarter allowed us to reorganize our commercial lending management structure, an increase to cost savings anticipated. We also notified another 21 employees primarily in mortgage operations personnel of terminations that will take effect early in the first quarter of 2014. Additionally some employees related to the acquisitions are being retained through the transition and integration period and these positions will be eliminated after the successful completion of those integrations.

We recently completed our periodic compliance examination on our annual safety and soundness examination. We are very satisfied with the results of those exams including our unbroken strength of outstanding CRA ratings. As an active mortgage lender to low and moderate income borrowers, HomeStreet has had an outstanding CRA ratings since the enactment of the Community Reinvestment Act. Continuing the strong partnership with our regulators is one of our primary goals and we appreciate their service and help in improving our company.

And on January the 23rd our Board of Directors approved a special common stock dividend of $0.11 per share, payable on February the 24th to shareholders of record as of February the 3rd.

I would like to go into a little more detail now on our commercial and consumer banking business. Segment net income was $2.9 million before acquisition related costs of $4.1 million compared to net income of $4.1 million in the third quarter. The variance from the prior quarter was largely due to a $1.5 million recovery of loan loss provision in the third quarter.

Net income for the year excluding the acquisition related cost was $5.6 million in the segment compared to a net loss of $14.5 million for 2012. Loans held for investment totaled $1.9 billion at year end, an increase of 24% from the third quarter. Organic growth of 11% in the quarter comprised of new originations of $276.7 million offset by $113.4 million of loan prepayments and maturities.

Total new loan commitments in the quarter were $379 million, compared to $242 million in the prior quarter, an increase of 56%. We had significant originations and commitments in each lending area with the strongest growth coming with a multifamily construction in C&I lending.

Deposit balances of $2.2 billion, increased 5% in the fourth quarter. The transaction and savings deposits balances growing by nearly 8%. This growth was primarily the result of deposits added from the acquisitions. Credit performance was strong in the quarter, both non-performing assets decreasing to 1.26% of total assets compared to 1.37% at September the 30th. Classified assets decreased to 1.65% of total assets, down from 1.9% at September the 30th. We also saw significant reductions in non-accruals and delinquencies.

Excluding acquired loans our allowances for credit losses was 1.4% of total loans at year end, compared to 1.61% of total loans at the end of the third quarter reflecting continued improvement in the credit quality of our portfolio.

To mitigate the impact of lower mortgage revenue and acquisition related costs in the quarter and to increase our liquidity to provide funding for the substantial levels of new landing, we sold $67 million of securities in the quarter realizing the gain of $1.8 million. And at the end of 2013, the bank’s tier 1 leverage ratio stood at 9.99% and the total risk based capital ratio was 15.51%. The decline from the prior quarter was due to the acquisitions as well as the net loss for the quarter.

Now let's talk about our mortgage-banking results. We continue to execute our strategy of building a substantial multi-state retail mortgage origination franchise by opportunistically recruiting teams with top producers in major Western markets. At the beginning of 2013, we had 24 standalone home loan centers in four states. Today we have 48 home loan centers in five states, including 11 offices in California.

As I’ve discussed previously, our strategy is to mitigate the impact of declining profit margins and lower industry loan volume by continuing to hire high quality, high volume mortgage producers in our existing and new markets, leveraging our fixed cost and realizing our opportunity to continue to grow our franchise during this most recent way of industry consolidation.

In California, our newest market, originators contributed 10% of closed loan volume in the fourth quarter and almost 12% in December. We feel that despite the greater than anticipated decreases in industry and regional originations over the last two quarters, our strategy is sound and should result in growing profitability this year.

In the fourth quarter, our mortgage banking business segment recorded a net loss of $1.1 million compared to a net loss of $2.1 million in the third quarter. Total net income for 2013 for the segment was $21.2 million, a 78% decrease from 2012. The $1 million improvement over the third quarter was due to higher mortgage servicing income and lower compensation-related expenses, offset by a decrease in net gain on loan origination sale activities.

Interest rate lock commitment volume was $662 million in the fourth quarter, a $124 million or 16% below the third quarter. Closed loan volume designated for sale was $773 million for the quarter compared to $1.2 billion in the third quarter, a decrease of 35%. For the full year, closed loan volume was $4.46 billion compared to $4.67 billion in 2012.

Though the imbalance in closed loans to locks was not as extreme as in the third quarter, closed loans were 17% greater in the quarter than interest rate lock commitments, negatively affecting earnings since the majority of our mortgage revenue was recognized at the time of interest rate lock, all majority of origination costs including commissions are recognized upon closing.

If rate lock commitments during the fourth quarter had been the same level as closed loans, our segment net income would have been approximately $2 million higher due to higher gain on loan origination sale revenue. Conversely, if closed loan volume had been the same as interest rate lock commitments, segment net income would have been approximately $800,000 higher, primarily as a result of lower variable costs such as commissions and incentives.

Net gain on single-family mortgage loan origination on sale activities was $23 million in the quarter, a decrease of $8.1 million or 26% from the third quarter and $44 million or 65% lower than the fourth quarter of 2012. The change was primarily due to the lower level of interest rate lock commitments.

The composite margin was 350 basis points in the quarter compared to 375 basis points in the third quarter. While margins declined somewhat this quarter, the decline was less than we anticipated.

Single-family mortgage servicing income was $7.4 million in the fourth quarter, just over double that of the prior quarter. This increase was due to higher mortgage servicing rights values as a result of lower expected prepayments, as well as an increase of $700,000 in single-family servicing fees collected in the quarter, as a portfolio of loans service for others grew by 4.5% in the quarter to $11.8 billion.

Mortgage banking non-interest expense decreased $6.3 million or 14% from the third quarter; this was primarily due to lower commission expenses loan volumes declined. And we redeemed our overall number two market share ranking for refinance and purchase mortgage loans in Puget Sound and the Pacific Northwest region of Washington, Oregon and Idaho, based on the combined results of HomeStreet and our affiliate Windermere Mortgage Services.

In conclusion, I’d like to make a few comments about future results and our strategy. As we’ve discussed, we’re focused on diversifying our business and strengthening our lending capability, growing our balance sheet organically and potentially from further acquisitions and increasing mortgage origination footprint and market share.

Sharply declining loan volume in the mortgage market has made our mortgage banking strategy more challenging in the last few quarters. We believe the personnel we've hired and offices we've opened will provide substantial value going forward. We’re committed to growing this business in a controlled fashion and minimizing to the extent possible the impact on earnings and customer service.

We believe the recent changes in the industry brought on by rising rates have only increased our opportunities and significant unfulfilled home demand in our market should translate into more significant growth and purchase loan volume into the nation as a whole. We’re very pleased with our progress in growing our commercial and consumer banking business. Our bank and deposit branch acquisitions are exceeding our expectations and our lending businesses are now beginning to realize the potential with significant organic loan growth last quarter and strong pipelines to start this year.

Please note that we anticipate additional non-recurring acquisition costs related to our acquisitions of approximately $700,000 in the first quarter and substantially all of the steps necessary to achieve our anticipated operating cost savings related to these acquisitions will be completed in the first quarter.

Our near-term goal for our commercial and consumer banking business is to achieve 6% to 8% quarter-over-quarter growth in earnings assets through next year, while managing growth in segment non-interest expense to only 1% to 2% growth per quarter over that same period. We believe that investments we have made in personnel and new branches and our recent acquisitions will allow us to achieve these goals. Additionally, we continue to look for quality acquisitions to accelerate this growth.

We appreciate your attention today. We’d be happy to take your questions at this time.

Question-and-Answer Session


We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Tim Coffey of FIG Partners. Please go ahead.

Tim Coffey - FIG Partners

Good morning, Mark. How are you doing?

Mark Mason

Good Tim, how are you?

Tim Coffey - FIG Partners

I am good, thanks. So the mortgage market; I mean given the headwind that you are facing in your own Puget Sound region, do you anticipate ‘14 to kind of be a reflection of what we saw in the second half of 2013?

Mark Mason

Well for us, the question of mortgage loan volume is in part what’s going on in the industry and you think about that in terms of loans producer or loan officer. And then that number has declined from a peak of 7 loans to 8 loans per loan officer per month to just below 3 loans per loan officer per month in the fourth quarter. Now given this, the more significant seasonality in our Pacific Northwest market that number can vary pretty substantially during the year and in middle of the year, the second and third quarters, that number will rise above 4 to perhaps 4.5 loans per loan officer per month and then back down to maybe its current level, absent any macroeconomic changes; greater pace of home sales, a greater pace of new home construction things like that that could impact the purchase market. But we also have to consider the impact of hiring. So, as our number of producers rises and gets through the ramp up period to full productivity, which is about four months, our originations are anticipated to rise notwithstanding those macroeconomic issues.

So, our forecast indicates, notwithstanding any changes in the market that our originations will grow pretty substantially, seasonally during the second and third quarters, but also as the consequence of continued hiring. And we've hired a substantial number of people even in the fourth quarter of last year who are finishing their ramp up periods in the first quarter and will contribute pretty substantially in the middle part to the end of this year. And so, our origination expectations next year exceed last year, notwithstanding the change in the market.

Tim Coffey - FIG Partners

Okay. And how many producers do you have at year-end?

Mark Mason

Total producers were approximately 365.

Tim Coffey - FIG Partners

Do you anticipate additional sales of the securities to (inaudible) liquidity?

Mark Mason

We may, I think it’s more likely that we allow the securities portfolio to pay down amortization and not to grow commensurable balance sheet growth.

Tim Coffey - FIG Partners

Okay. The estimates or the expectations you gave for your balance sheet growth, specifically the average earning assets, do you anticipate loan growth to be faster than that?

Mark Mason

We hope that it will be; we do. I mean we have very substantial loan origination capability today across all of our commercial and consumer product lines, including single family loans that we retain on our balance sheet. We have far more capacity than that 6% to 8% quarterly would suggest. Our challenge going forward we believe is going to be balance sheet capacity and may be selling more of our even commercial originations into the secondary market.

Tim Coffey - FIG Partners

Any interest in purchasing loans?

Mark Mason

Well, given our capacity challenges, no, not at this juncture.

Tim Coffey - FIG Partners

Okay. And then within the good organic loan growth this quarter, within multi-family, there is more of commercial loans, what are you seeing from competitors in terms of pricing and underwriting?

Mark Mason

Well, the pricing is very competitive, let me start with that. Having said that, our originations in the fourth quarter for multi-family and other commercial real estate types averaged interest rates of 4.55%, which feel stronger than my last comments. That’s what permanent loans; construction though somewhat lower than that, averaging 3.2%. Now, those are much shorter duration loans. They are floaters, so there is no interest rate risk, but the competition in construction and the multi-family end of that is still pretty significant.

Tim Coffey - FIG Partners

Okay. Well, those were my questions. I appreciate your time.


(Operator Instructions). As there are no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mark Mason for any closing remarks.

Mark Mason

I think we’ll wait and pull in more time for questions. And I’m going to take this opportunity to correct the couple of numbers in my prior comments. It came to my attention that we had a couple of typos. When we were talking about our employee headcount this year and the number of additions, the numbers we cited for reductions were misstated. We actually reduced mortgage production personnel by 42 employees, mortgage operations personnel by 32 and commercial lending and administration by 37 positions; my apologies for the typos in my prepared comments. Could we pull a little more time for question operator?


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

Tim Coffey - FIG Partners

Hello again, Mark.

Mark Mason

Hi Tim.

Tim Coffey - FIG Partners

Well, as we look towards the earn-back on the goodwill from these acquisitions, have your estimates changed at all?

Mark Mason

Well, our internal estimates have obviously changed with additional income from the acquisitions. I think that our expectations for our acquisitions have increased since the [daily] announcement, their lending activity, I feel fairly comfortable it’s going to exceed our expectations right away as an example. In their first two months of activity, we closed those at the beginning of the second month of the quarter; they originated correctly $24 million of commercial loans. That would be substantially greater than the pace of originations and greater than our expectations. So I think our expectations are increasing.

Tim Coffey - FIG Partners

And then these discussions, kind of M&A discussions, no need to go in the detail, but the tone maybe the depth of the discussions, have they changed at all in the last, say six months?

Mark Mason

I think that those bills -- there continue to be changes in the M&A market. Last year was a good year from a source perspective for valuations, right. Valuations came up on average 20% to 30%, I would say, in terms of book value multiples. We don’t expect that to continue this year because we don’t see the same opportunity for target earnings increases or better cost savings.

From our standpoint given where our stock is currently trading, it’s a little bit harder for us to do high premium to book value transactions because of the additional dilution that that would create. Doesn’t mean we are out of the market though and transactions that might take less stock and a little more cash is still possible, smaller transactions. And we believe that our stock value will hopefully recover this year as our earnings recover from a consequence that everything that we put in place over the last year and so we will be better positioned to have those conversations.

We hope to do more transactions this year. We have been concentrating on completing our acquisitions in a quality way, improving our efficiency as a consequence and we will see what the market brings. And I think the valuation comments are consistent with what others are saying. I think there will be transactions this year. I am not sure we will have the magnitude or the number of transactions as we had last year. As we said in the Pacific Northwest, we will have to see.

Tim Coffey - FIG Partners

Good. And I see you are pretty committed to paying a cash dividend right now. What would it take for you to consider stock repurchase program?

Mark Mason

That would be tough to consider. If you look at the pace of our balance sheet growth, we feel we have a need for all of that capital. If you extrapolate those growth -- the growth potential from those earning assets number, growth numbers, you're going to need that capital. So, we don't anticipate stock buybacks in any near-term.

Tim Coffey - FIG Partners


Mark Mason

Beyond that, let me make one more comment regarding regulator expectations; and I think you will hear this from most folks in the industry though, particularly from people like us with more aggressive growth plans and exposure to businesses like mortgage banking. Our regulators expect us to carry higher levels of capital than we might previously have expected. We believe that based upon our conversations with our regulators that maintaining a Tier 1 leverage ratio in the approximately 9% range is a number that they are going to be comfortable with. Could we get below that? Sure. But we're targeting maintenance of those kind of numbers for the near-term.

Tim Coffey - FIG Partners

All right. Well, that’s a good story. Thank you very much.

Mark Mason

Great. Thanks Tim.


(Operator Instructions). Mr. Mason, I'm showing no further questions. Would you like to have any closing remarks?

Mark Mason

Sure. I want to just thank you again to everyone who participated today for your patience and questions. I can't leave the call without wishing well our Seattle Seahawks. This weekend HomeStreet Bank is the bank of the Seahawks and we're pretty excited up here in the Pacific Northwest. Thank you all for being on the call today.


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

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