HomeStreet Inc
NASDAQ:HMST
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HomeStreet Inc
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Good afternoon. Thank you for attending today’s Second Quarter 2023 Analyst Earnings Call for HomeStreet Bank. Joining us on this call is Mark Mason, CEO, President, and Chairman of the Board.
I would now like to pass the conference over to our host, Mark Mason. Please go ahead.
Hello and thank you for joining us for our second quarter 2023 analyst earnings call. Before we begin, I’d like to remind you that our detailed earnings release and an accompanying investor presentation were filed with the SEC on Form 8-K on Friday and is available on our website at ir.homestreet.com under the News & Events link.
In addition, a recording and a transcript of this call will be available at the same address following our call. Please note that during our call today, we will make certain predictive statements that reflect our current views, the expectations and uncertainties about the company’s performance and the financial results. These are likely forward-looking statements that are made subject to the Safe Harbor statements included in Friday's earnings release, our investor deck, and the risk factors disclosed in our other public filings. Additionally, reconciliations to non-GAAP measures referred to on our call today can be found in our earnings release and investor deck available.
Joining me today is our Chief Financial Officer, John Michel. John will briefly discuss our financial results, and then I’d like to give you an update on our results of operations and our outlook going forward. We will then respond to questions from our analysts.
Thank you, Mark. Good morning everyone, and thank you for joining us. In the second quarter of 2023 we recorded a net loss of $31.4 million or $1.67 per share due to a $39.9 million goodwill impairment charge. Our core earnings in the second quarter which excludes the impact of the goodwill impairment charge was $3.2 million or $0.17 per share as compared to net income of $5.1 million or $0.27 per share in the first quarter of 2023.
We made a determination based primarily on the significant decline in our stock price during the second quarter that our $39.9 million of goodwill was impaired. This write-off of goodwill is a noncash charge and has no impact on our core earnings, cash flows or liquidity position, nor does it impact our tangible capital or regulatory capital. The elimination of our goodwill will provide cost savings moving forward as we will no longer incur cost related to third party evaluations of our goodwill or the costs incurred by our external accounts and auditing goodwill.
In the second quarter of 2023, our annualized return on average tangible equity was 2.9%. Our core earnings annualized return on average assets was 13 basis points, and our efficiency ratio was 93.7%. These results reflect the continuing adverse impact, the significant increase in short-term interest rates has had on our business.
Our net interest income in the second quarter of 2023 was $5.9 million lower than the first quarter of 2023 due to a decrease in our net interest margin from 2.23% to 1.93%. The decrease in our net interest margin was due to a 44 basis point increase in the cost of interest bearing liabilities, which was partially offset by a 10 basis point increase in the yield on interest earning assets. Yields on interest earning assets increased as yields on adjustable rate loans increased due to increases in the indices on which their rates are based.
The increase in the cost of interest bearing liabilities was due to overall higher deposit and borrowing costs. Our cost of deposits increased 37 basis points in the second quarter while the cost of borrowings increase only 5 basis points due to actions we took in prior quarters the fixed the rates on the majority of our borrowing.
Our effective tax rate of 14.2% for the second quarter of 2023 was significantly impacted by the goodwill impairment charge, a portion of which was not deductible for tax purposes. Our core earnings effective tax rate for the quarter and six months ending June 30, 2023 was 1.6% and 15.2% respectively. The core earnings effective tax rate is lower than our statutory tax rate, primarily due to the higher proportion of tax exempt revenues in comparison to our overall earnings.
A $0.4 million negative provision for credit losses was recorded during the second quarter of 2023 compared to a $0.6 million provision for credit losses in the first quarter of 2023. The negative provision for the second quarter of 2023 reflects the decrease in our reserve for unfunded commitments as our allowance for credit losses remained unchanged at $41.5 million and our net charge-offs realized in the quarter were nominal. As a percentage of investments held for investment loan portfolio, which decreased by $50 million during the second quarter, the allowance for credit losses increased to 57 basis points.
Going forward, we expect the ratio of our allowance for credit losses to our held for investment loan portfolio to remain relatively stable and provisioning in future periods to generally reflect changes in the balance of our loans held for investment, assuming our history of minimal charge off continues.
Our ratio of non-performing assets to total assets increased from 15 basis points at March 31, 2023 to 44 basis points at June 30, 2023, primarily due to loans related to one customer relationship being designated as non-accrual in the second quarter. Non-interest income in the second quarter of 2023 was consistent with the first quarter as a 10% increase in single family lending rate lock was offset by a slight decrease in the rate lock margin.
The $38.3 million increase in non-interest expenses in the second quarter of 2023 as compared to the first quarter of 2023 was due to the $39.9 million goodwill impairment charge, which was partially offset by a $1.5 million decrease in compensation and benefit costs as seasonally higher benefit costs recorded in the first quarter, primarily employer taxes and 401 (k) employer matches decreased in the second quarter.
Our common equity Tier 1 and total risk-based capital ratios have improved significantly during the current year. As of June 30, 2023 the company's common equity Tier 1 and total risk-based capital ratios were 9.14% and 12.16% respectively while the bank's common equity Tier 1 and total risk-based capital ratios were 12.78% and 13.49% respectively.
I will now turn the call over to Mark.
Thank you, John. As John stated earlier, our operating results for the quarter reflect the continuing adverse impact of the historically record velocity and magnitude of increases in short-term interest rates. Our core earnings were $3.2 million and as expected, our net interest margin decreased in the second quarter to 1.93% due to decreases in balances of lower cost transaction and savings deposits and overall higher funding costs.
To mitigate the impact of a lower net interest margin, we have continued to reduce non-essential expenses while being mindful to sustain and protect our high quality lending lines of business, preserving our ability to grow once the interest rate environment stabilizes and loan pricing and volumes normalize.
Additionally, we have reduced our new loan originations and the size of our loan and securities portfolios, raised new deposits through promotional products and reduced the level of uninsured deposits to just 7% of total deposits, primarily through products which provide complete FDIC deposit insurance coverage.
The deposit outflows we experienced in the second quarter were primarily due to depositors seeking higher yields or due to seasonal tax payments or other remittances. In June and July, our deposits have stabilized to a greater extent with non-interest bearing deposits increasing and very limited loss of interest bearing deposits due to yield competition. Overall, our deposit outflows have slowed substantially. While we may experience some continued repricing of low cost deposits, we believe that continued growth in our promotional certificate of deposit balances and our successful business development efforts, which have continued to attract new customers this year will replace any runoff.
With non-interest bearing and low cost deposits seeking higher yields we have pursued a strategy to attract new deposits and retain existing deposits through promotional certificates of deposit accounts and retain core deposits through promotional money market accounts. This strategy affords us the opportunity to retain deposits without repricing all of our existing low cost core deposits.
While our promotional certificate of deposit accounts are priced competitively to attract new customers, our promotional money market accounts are used as a defensive measure and are not priced at the top of the market. Once short-term market rates stabilize and then begin to decrease, we anticipate that we will begin to see growth in our deposit balances again.
Additionally, in this cycle, we have not experienced material identifiable deposit loss related to concerns about deposit security. Over time, of course, customers in our non-promotional deposit products are expected to migrate somewhat to the better yielding and promotional products, though this migration has been slow. However, this ongoing migration is part of the continuing increase in our overall deposit costs.
This competitive rate environment has resulted in reductions in our net interest margin, which are expected to continue somewhat until rates stabilize in later fall. Today based on commentary from the Federal Reserve, that time appears to run through 2023. We expect rate-based competition for deposits to continue until the Federal Reserve stops raising rates and ultimately reduces them.
We utilize both broker deposits and borrowings to meet our wholesale funding needs. Our choice of funding is primarily based on the lowest cost alternative. Historically, the lowest cost alternative between broker deposits and borrowings has varied based on market rates and conditions.
Since the beginning of this year, the Federal Home Loan Bank and the Federal Reserve Bank Term funding program have generally been at lower costs than broker deposits, and as a result, our borrowing balances have been increasing and our broker deposit balances have been decreasing. While this may affect some metrics such as our loan to deposit ratio, we believe this is the best choice today as it minimizes our funding costs, and we continue to have substantial borrowing availability well beyond our usage today.
On a positive note, the deposit levels at the three retail deposit branches we acquired in Southern California in the first quarter have stabilized post-acquisition, and our weighted average cost of deposits at these branches has remained low at just 38 basis points as of June 30, 2023.
We are continuing to experience the cyclical downturn in single family mortgage loan volume as higher rates and spreads dampen the demand for new loans. Volumes in the second quarter increased slightly from their low levels in the first quarter, and we expect volumes to continue to increase once rates and spreads stabilize.
Home prices have been stable or rising and are primarily West Coast markets, and the demand for new homes is on the rise. In our residential construction business, our builders have recently increased their land acquisition and new project development accordingly. This change in activity augers well for coming quarters as sales and payoffs have exceeded new starts recently.
At quarter end our cash and security balances of $1.6 billion were 17% of total assets, and our contingent funding availabilities was $5.6 billion equal to 84% of total deposits. Our loan portfolio remains well diversified with our highest concentration in Western States’ multifamily loans, historically one of the lowest risk loan types. Our loan delinquencies remained historically low and our net charge-offs during the second quarter were only $0.1 million.
Our portfolio is conservatively underwritten with a very low expected loss potential. Credit quality remains solid, and we currently do not see any meaningful credit challenges on the horizon. The increase in non-performing assets was primarily due to the designation of one customer relationship as collateral dependent and non-performing in the second quarter. This relationship consists of $27 million of loans secured by properties targeted for redevelopment that are current in their payments and over collateralized. These loans were adversely classified due to primarily diminished cash flows being experienced by the guarantor. Based on current appraised values, we do not anticipate any credit losses from this relationship.
We are continuing to limit our loan portfolio growth, focusing on loan origination activity of floating rate products such as commercial loans, residential construction loans, and home equity loans. We are generally not making any new multi-family loans today, with the exception of Fannie Mae DUS loans, which we sell. We're focused today on working with our existing borrowers to create prepayments or modify existing loans to advance more proceeds where appropriate or extend fixed rate periods in exchange for increasing the interest rate on these loans.
Over time, we expect these efforts to make a meaningful improvement in both the size and yield of our multifamily portfolio. Our efforts to reduce the size of our loan portfolio today are impacted by prepayment speeds, which continue at historically low levels, particularly for multifamily loans. Accordingly, we are anticipating that our overall loan portfolio will remain stable through the second half of this year.
At June 30, 2023, our accumulated and other comprehensive income balance, which is a component of our shareholder's equity, was a negative $101 million. While this represents a $5.37 reduction to our tangible book value per share, it is not a permanent impairment in the value of our equity and it has no impact on our regulatory capital levels.
Given our available liquidity, earnings and cash flow, we don't anticipate a need to sell any of these securities to meet our cash needs, so we don't anticipate realizing these temporary write-downs. In the near-term, we anticipate a decline in our loans held for investment, stable deposits, a slight decrease in our net interest margin, increasing non-interest income, and slightly increasing non-interest expenses.
In May, we held our annual meeting at which time all of our directors received 95% or more of the votes cast and our say on pay proposal was approved by 95% of the votes cast. Additionally, last week the Board of Directors approved a $0.10 per share dividend payable on August the 23rd, 2023. This dividend amount was unchanged from the prior quarter. While our current lower level of profitability has been materially driven by the exogenous interest rate environment, these conditions will change when interest rates stabilize and the performance of our rate sensitive businesses improve.
We look forward to what an environment of stable rates can provide for improved financial performance for our Bank. Until that time, we are doing all we can to limit balance sheet growth, maintain liquidity, defer or reduce expenses, and reduce staffing to required levels without damaging our businesses.
At HomeStreet Bank, we have consistently maintained strong capital well above the regulatory requirements for being considered well-capitalized, and we have a track record of strong credit quality. Over the past 10 years, our charge-offs have been minimal and our ratio of non-performing assets to total assets is still historically low relative to others.
HomeStreet has been conservatively managed for the benefit of our customers for over 100 years. We are a middle market community bank focused on small-to-medium sized businesses, families and individuals who need basic financial products and sound financial advice. We don't offer deposit or lending products, which we believe are not appropriate or valuable for our customers. We also avoid businesses and industries which we believe are of higher risk to the bank. We are navigating through these challenging times, confident that we will become an even stronger institution with a continuing commitment to provide excellent service to our customers.
With that, this concludes our prepared comments today. We thank you for your attention. John and I will be happy to answer analyst questions at this time. Investors are welcome to reach out to John or I after the call if they have questions that are not covered during this Q&A. Operator?
Absolutely. Our first question today comes from Matthew Clark with Piper Sandler. Please proceed.
Hi, good morning.
Good morning, Matt.
Good morning, Matt.
First one from me, just on the margin. Do you have the spot rate on deposits at the end of June and the average margin in the month of June?
We do, Matt, but we don't disclose those type of discreet numbers.
Actually the deposit as of June, 30th will be in the Q. I don't have that handy right in my hand. We usually disclose the balance end of period number in the Q.
Oh in the Q?
Yes.
Oh. So I stand corrected, but we don't have it for you this morning.
Okay. I'm just trying to get some better visibility into the margin for the upcoming quarter.
Sure.
It looks like your borrowings came down a decent amount at quarter end. It would suggest at least, again using numbers without having spot rates that your margin might actually expand in the upcoming quarter, but again not having enough visibility on kind of spot rates, it's tough to conclude that, but it does seem like your guidance calls for additional some modest margin pressure?
Yes. In terms of the balances of the borrowings and they're going down, we borrowed at the end of March because of the situation we're in and pumped up our cash balance at the end of March. And so during the second quarter, we paid that down. That was one of the big reasons for the decrease in our borrowing balances from that perspective.
So when we give guidance, Matt, we also consider conservatively what we expect to happen with deposit flows and loan originations and conservatively, we are assuming some additional slight deposit runoff. That may not occur. Obviously, with my comments about June and July, we feel much better about the stability of our deposits. So our guidance does reflect some conservatism on that front.
Okay, understood. And then just on expenses, I know headcount is down year-over-year. Our expense-to-average asset ratio is, call it, 214 [ph] which might suggest there's a little bit more room to extract some savings. But just anything you can do on the expense run rate? I mean, you have modest margin pressure and slightly higher expense guide that would suggest it's going to be tough to remain profitable.
Yes, we expect to remain profitable. I hope when you did that calculation, you excluded the goodwill charge.
Of course.
And seasonally, in the first quarter, obviously, we have more employee-related expenses, for 1K expenses and the like. Our expenses we think are going to be relatively stable.
Yes. I think the only change, we're just trying to account for the fact that we're anticipating some increases in our single-family lock volume and obviously, that would increase our cost a little bit. That's the only impact, we think, in terms of costs if you read the rest of the comments, we think everything else is going be pretty much stable or decreasing.
Right. So that variable expense comes with revenue to be really explicit. To the extent that volume doesn't occur, our expenses will be lower.
Okay. And then just last one from me. What's your willingness to consider selling your dust license that you have, which I would think is very marketable and use those proceeds to restructure your balance sheet?
We get that question from time to time. We are generally uninterested in selling that license. It's a very integrated part of our multifamily business. In the past, we have spoken to folks who had an interest in potentially buying that asset. There the value they placed on that asset of that business was typically only slightly greater than the value of the servicing, which does not make for an attractive transaction to consider and I think that's still true today. It's much more valuable to us.
Got it. Thank you.
Thank you for your question. Our next question comes from Woody Lay with KBW. Please proceed.
Hey, good morning guys.
Good morning.
I wanted to sort of start off on deposits. And just as you look at the loan-to-deposit ratio, it was up in the quarter. Is there sort of a maximum level that you all would be willing to take it up to sort of in the near-term?
We don't expect it to change much from here. I mean, if you think about it, it's a ratio that we could manage if we found that to be a priority. Again, subject to my comments -- my prepared comments earlier, we have been choosing to utilize borrowings as opposed to broker deposits because of their cost. If we wanted to move that ratio up significantly, we could, but it would hurt our margin. And so we are comfortable operating at these levels without making that a priority. We manage liquidity and our net interest margin primarily and during this period of time, things like our loan-to-deposit ratio takes a back seat, if you will, to those more significant priorities.
Right, that makes sense. And then looking at the CD portfolio, do you know how much of that portfolio is sort of set to mature over the next six months?
We do obviously. I don't have that number in front of me. But if you think about the tenors that we have originated these CDs at, the primary tenors when we first started last year, we really focused on 18 months and 13 months. As we have gone through the last several quarters, we've shortened up the highest rate tenor. Today, you can get either a seven-month or an 11-month CD for the same rate and customers are generally choosing seven months.
So not only have we shortened our emphasis, but our customers are also short in there. I think we see the future different. I think customers are expecting rates to rise, and of course, we're expecting rates to fall next year. So I would think that one of us is obviously going to be right. I just got a note here that over the next six months a little less than $600 million is going to roll and we roll most of these. We haven't asked that question yet, but our roll rate is the vast majority, lease and it will be as long as we stay competitive.
Right. And did you say those will [Audio Gap] similar rates or are you expecting a sort of lift in rates on that portion?
Actually, technically, if they don't come in and make a decision about where they would like the money to go at maturity, they roll into our rack rates CDs at the same tenor. And when they [Audio Gap] first 30 days, we'll excuse that and put them in whatever product they want. Usually, it's, of course, the promotional CD product. But we generally expect them to roll in the similar tenor, right? I mean, around that somewhere in the six to 11 months, but more recently, I guess, seven months. That's where we've been seeing the majority of interest in.
Got it. That's helpful. And then last, I know there are several dynamics impacting the tax rate, but is there sort of a tax rate you expect going forward?
It's a little confusing. It will be pretty low because just the level of the tax exempt investments. So I normally have provided guidance in the past. A reasonable number would be about 15%, Matthew, but it may vary just as a percentage. Absolutely, dollars are not going to be very big but it may, I’m sorry.
Okay, all right. That's helpful. Thanks guys.
All right. And then to follow up on a question from Matthew, are at the end of the quarter, weighted average cost of deposits is approximately 2%.
Thanks.
Sorry, I didn't know we disclosed it.
Thank you for your question. Our next question comes from Tim Coffey with Janney. Please proceed.
Great, thanks. Good morning gentlemen.
Good morning, Tim. How are you doing?
I’m good. Thanks. Mark, as you start looking to controlling nonessential expenses, I'm wondering what is in that category of nonessential expenses.
I’ll take a long time to answer right? I'm sorry, essential expenses could take a long time. Nonessential, think of expenses like advertising and marketing, I call it nonessential, but basically, it means you could stop them tomorrow, but you have to make a decision about how far down you're going to cut those expenses. You don't want to be completely out of the public view, but you can cut them down materially for a period of time without losing brand awareness and so on.
Most of our expenses in that category actually recently are advertising for promotional deposit products and we are cut back substantially on marketing other lines of business that don't have a lot of demand right now and branding marketing. Things like holiday parties and conferences and things that maybe is calling them nonessential is the wrong word, but expenses that in the short run can be managed down.
Okay. Okay. Now, that's very helpful. Thank you. And then, John, apologies if I missed this, but what is the monthly or quarterly cash flow coming off the securities portfolio?
Boy, that's let me check. I think it's about $40 million to $50 million, if I remember correctly, roughly that. Durations, I think a lot about a little over four years.
Okay. And that's $40 million to $50 million on a quarterly basis, right?
Monthly basis.
Monthly, okay.
Yes. Sorry.
Okay. No, I wanted to make sure I got that right. And then on the borrowings, what's the maturity schedule there?
So we have couple of different things. We have a portion of it that's basically overnight. That's the smallest portion. We have about $600 million with the bank term funding program, which is about -- which is a year out. We've had that. But we have an ability under that program to reestablish those just before it expires to extend down another year, and so we'll be evaluating that and see if it makes sense at that time. And the other is about $1 billion we did in staggered ladders in three, four and five-year tranches, and we did that last November.
Okay. Okay. And just -- I don't know if you have this, but what the cost is on the bank term funding program?
That's a good question. We refinanced it once and then took down a little more. One second, you might be able to.
I think it looks like it's falling up right now. It looks like at the end of the quarter, it was 4.66…
4.66.
Again, another key disclosure. So…
Okay. Those are my questions. I appreciate the time. Thank you.
Thank you, Tim.
Thank you.
Thank you for your questions. [Operator Instructions] Our next question is a follow-up from Woody Lay with KBW. Please proceed.
Hey guys. I just had a quick follow-up on credit. You called out the jump in or I mean the slight jump in NPAs from the one relationship. Just was hoping to get a little extra color on sort of what property that involves? And maybe just you called out the reserve outlook as being stable; sort of what your maybe macroeconomic assumptions are for that reserve outlook?
Sure. Let me take the first part of that first. The $27 million relationship really relates to two different projects. One is a project to redevelop a retail property into a mixed-use primarily multifamily property. The other is a collection of both multifamily and small office buildings into what was anticipated to be an office project but ultimately, we'll probably be, again, a multifamily mixed-use project, so both of them are projects under development.
So there's some cash flow associated with the properties but from an underwriting standpoint, we are placing a lot of reliance on the guarantor, who is a substantial company with substantial income property holdings in the City of Seattle. And given the challenges that guarantor is facing we felt it appropriate to designate these as collateral dependent.
We have agreed to extend the loans on these properties for between 18 months and two years with some additional collateral with funded interest reserves and accordingly, we're in good position over collateralized assurance of current interest and essentially putting these properties to bed until there's a change in the environment.
Second question on macro assumptions, I mean we utilize like a lot of folks, Moody's and their economic forecast as a baseline for our ACL. That baseline has not changed dramatically. John, do you think?
No, it is not.
And so, our macroeconomic expectations, at least vis-à-vis our ACL been fairly consistent for the last several quarters.
And then just -- and one of the things we do is we take the baseline and then we actually adjust it down in our qualitative factors for basically anticipating some deep decrease and the economic conditions, even though Moody's has kind of had pretty stable economic conditions, we actually assume a downgrade for purposes of our qualitative factors. And that's our biggest component non-taxable loss reserve loss. Yes.
Got it. Thanks for taking my follow up.
Thank you.
Thank you all for your questions. There are no questions waiting at this time, so I will pass the conference back to the management team for any further remarks.
Thank you again for attending our call. We appreciate our analysts attendance and their questions. Look forward to speaking with you next quarter. That concludes our call.
That will conclude the conference call. Thank you all for your participation. You may now disconnect your line.