HomeStreet Inc (HMST) 2012 Q2 法說會逐字稿

Good afternoon, and welcome to the HomeStreet's second-quarter 2012 earnings conference call. All participants will be in listen-only mode.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Mark Mason, President and Chief Executive Officer. Please go ahead.

Hello, and thank you for joining us today for our second-quarter 2012 earnings call. I'll begin with a few highlights from the quarter, followed by a more detailed discussion of our results. I'll then talk briefly about the condition of the economy in our markets, after which I'd be happy to take your questions. Before we begin, I'd like to remind you that our second-quarter earnings release is available on our website at ir.HomeStreet.com.

I'd like to caution you that I may make forward-looking statements during today's call that are subject to many risks and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings, including our 2011 annual report on Form 10-K, our proxy statement, and the Form 8-K filed today containing our earnings release. Additionally, information on any non-GAAP financial measures referenced in today's call, including a reconciliation of those measures to GAAP measures, may also be found in our SEC filings, and in the earnings release available on our website.

Now let's get started. The second quarter marked HomeStreet's first full quarter of operations following our successful IPO and recapitalization. The quarter was characterized by record performance in mortgage banking, growth in our net interest margin, and significant improvement in asset quality. I'd like to share a few highlights from the quarter. HomeStreet reported net income of $18 million or $2.43 per diluted share for the second quarter, compared to net income of $19.1 million or $3.55 per diluted share for the first quarter. Diluted earnings per share for the second quarter reflect IPO shares issued in February, as outstanding for the entire quarter. Whereas the first-quarter earnings per share reflect these shares outstanding for only approximately one-half of the quarter.

Our year-to-date net income of $37 million marks a record in the Company's 91-year history for full-year earnings. And our pretax income of $21.4 million increased 23% from the prior quarter, driven by higher mortgage loan origination and sales revenue, which was up $17 million or 60% from the prior quarter. As anticipated, we continued to grow our net interest margin, which increased 30 basis points to 2.83% in the second quarter. This increase was driven in large part by improvement in our cost of funds, which decreased to 1.11%, down from 1.33% in the prior quarter. Single-family closed loan production was $1.1 billion for the quarter, the highest quarterly production in our Company's history. In the second quarter, HomeStreet became the number two lender by volume in the five County Puget Sound area of Washington, as well as in Clark and Spokane counties, based upon our combined production with Windermere Mortgage Services.

In recognition of the Company's strong earning performance and the expected future realization of the Company's net deferred tax assets, the effective income tax rate for the second quarter and the remainder of this year reflects the full reversal of the valuation allowance remaining at the end of the first quarter. Non-performing assets declined to $73.7 million, or 3% of total assets, down from 4.5% at the end of the first quarter. Regulatory capital ratios for the Bank continued to increase. Our Tier 1 leverage ratio was 10.1%, and our total risk-based capital ratio was 17% at the end of the quarter.

On July 27, it was my pleasure to announce the appointments of Cory Stewart and Darrell van Amen to the executive management team. Cory joined us earlier in the year, and he will be named the Executive Vice President and Chief Accounting Officer. Darrell joined HomeStreet in 2003, and he will be named Executive Vice President and Chief Investment Officer. We have chosen to separate the traditional functions of the office of Chief Financial Officer, assigning these responsibilities to the two executive positions. We are extremely fortunate to have in Cory and Darrell two very experienced and highly capable professionals who are ready to take on the additional responsibilities. And I am confident that they will be successful in their new positions. I will continue to act as interim CFO until regulatory approval of the two appointments has been received.

I would like to discuss our results for the quarter in more detail. Strong performance in our mortgage banking business continues to drive our earnings. This is driven by growth in volume through growing our origination personnel, and strong secondary market margins, as a result of ongoing consolidation in the mortgage industry and industry capacity constraints. Single-family closed loan production designated for sale totaled $1.07 billion for the quarter, an increase of $356 million or 50% over the first quarter of this year, and up 230% year-over-year. Single-family mortgage interest rate lock commitments totaled just over $1.2 billion for the quarter, up $307 million or 33% from the first quarter, and an increase of $882 million or 256% from the second quarter of last year. Our origination personnel, who were previously with MetLife home loans, originated approximately 32% of our single family mortgage production during the quarter. And we continued to grow in our production capacity, increasing our mortgage origination support staff by 14% in the second quarter.

Purchase mortgage activity picked up in the second quarter as well, representing 35% of single-family closed loans in the quarter, compared to 32% in the first quarter. Our results also reflect strong secondary market profit margins. Net gain on mortgage loan origination and sales activities was $45.5 million for the quarter, an increase of $17 million, or 60%, over the prior quarter, and almost 400% over this period last year. Growth in our gain on mortgage loan origination sales activities reflects continuing strong demand for both purchase and refinanced loans in our markets, driven by historically low mortgage rates and the HARP 2 refinancing program. And strong secondary market profit margins, which began to increase in the third quarter of last year, HARP 2 refinances represented 15% of originations in the quarter. Mortgage servicing income of $7.1 million decreased slightly from the prior quarter, due to an overall lower net gain from valuation changes in our mortgage servicing rights, and related hedge instruments.

Our balance of loans serviced for others increased to $8.3 billion at quarter end, compared to $7.8 billion at the end of the first quarter. By quarter-end, the value of our single family mortgage servicing rights represented 95 basis points, on the outstanding principal balance of single-family loans serviced for others, and 2.8 times the weighted average portfolio of servicing fee, of 34 basis points. The fair value of our mortgage servicing rights continues to be somewhat higher than peers, due to a number of factors, most significant of which is our high average servicing fee, as a result of higher government loan composition, and our low loan delinquency rate of 2.03% for the portfolio at year-end -- quarter-end, I'm sorry, which is among the lowest in the industry, and our low average loan interest rate, which was 4.69%, at the end of the quarter.

We continue to make significant progress in improving our credit risk profile. Non-performing assets declined to $74 million or 3% of assets, down from 4.5% of total assets at the end of the first quarter. This was primarily the result of greater than 50% decline in non-accrual loans during the quarter. Other real estate owned increased to $40.6 million in the second quarter, an increase of $9 million. This increase was due in part to the transfer to REO of an $18.8 million residential construction property, that had collateralized the Company's largest non-performing loan. This increase was partially offset by property sales of nearly $10 million in the quarter. As of July 27, approximately 59% of the quarter-end REO balance was under contract for sale, or had been sold since quarter end. Loan delinquencies declined to $84 million, representing a little over 6.5% of total loans, down from 11% in the prior quarter.

And as a consequence of these improvements in our credit quality, and a charge off of pre-existing specific reserves, the allowance for credit losses decreased somewhat to $27 million, or approximately 2% of total loans. Additionally, we recorded a provision for credit losses of $2 million in the second quarter, compared with no provision in the prior quarter. We continued to improve the composition of our deposits, and reduce our cost of funds. Our efforts are focused on increasing our middle market consumer and business customer base through superior local customer service, state-of-the-art business cash management services, and competitive pricing and product structures. Deposits totaled $1.9 billion at quarter-end, down from $96 million or 5% from the first quarter, and down $89 million or 4% from the end of the second quarter of last year. Transaction savings and money market accounts increased $91 million, or 11% in the quarter, and are up 40% from one year ago. These core deposits now make up 50% of our total deposits. Certificates of deposit decreased $135 million or 15% from the prior quarter, down 36% from the second quarter of last year.

We continue to grow our net interest income. Net interest income was $14.7 million for the second quarter, increasing 14% over the first quarter, and 23% over the year-ago quarter. Total average interest earning assets increased modestly from the prior quarter, as higher mortgage production volumes resulted from a higher average balance of loans held for sale. This increase was partially offset by a decrease in cash and cash equivalents, which was redeployed for loans held for sale production and purchases of investment securities. And as I mentioned earlier, the net interest margin increased to 2.83% from 2.53% in the first quarter. We anticipate that our net interest margin will continue to improve as we continue to re-price, roll-off, or convert scheduled maturities of time deposits at lower current rates, re-price adjustable rate loans to current market rates upon maturity, extension, or restructuring, and continue to optimize the composition of our securities portfolio.

Non-interest income was $55.5 million in the quarter, a 42% increase over the first quarter, and up nearly 200% from the year-ago quarter. The most significant driver continues to be our mortgage banking activities, where we added a $17 million increase in net gain on mortgage loan and sale activities. Non-interest expense was $47 million in the quarter, up $12 million or 35% from the first quarter, and up 74% from the year-ago quarter. This increase from the prior quarter was primarily the result of a $7 million increase in salary and related costs, reflecting higher incentive compensation due to higher single family loan production volume, as well as an 11% increase in the Company's headcount in the quarter. Additionally, our expenses and losses related to REO were $3.5 million higher for the quarter.

As a consequence of our stock price performance in the second quarter, all three tranches of the restricted stock grants to management at the completion of the IPO vested upon stock price appreciation of 25%, 40% and 50% over the IPO price. As a result, additional compensation cost of $1.7 million was recorded in the quarter. Going forward, our non-interest expense will continue to fluctuate with levels of mortgage loan production, as well as changes in headcount. Effective beginning in the second quarter, the FDIC deposit insurance premium was reduced to 14 basis points from 23 basis points previously, which is anticipated to result in an annual reduction of about $2 million in premiums at today's deposit balances.

Our income tax expense for the second quarter was $3.4 million, as compared to a tax benefit of $1.7 million in the first quarter. The year-to-date net income tax expense includes a benefit related to the full release of the remaining valuation allowance with respect to the Company's net deferred tax assets. The reversal of the valuation allowance was based upon the Company's assessment, with respect to its ability to realize deferred tax assets in the future. Our annual effective tax rate differs from the federal statutory rate of 35%, due to state income taxes on income in Oregon, Hawaii and Idaho, tax exempt interest on income -- on interest income, and the reversal of the Company's remaining valuation allowance.

I'd now like to make a few brief comments on the local economy. Regional labor and housing markets continued to improve as a whole, with Puget Sound as one of the economically healthier regions of the country. We have experienced steady job growth, slowly declining unemployment rates, and positive trends in our housing market, and are generally pretty upbeat about the regional economy. Having said that, the recovery is inconsistent.

The monthly Puget Sound Index of leading economic indicators declined slightly in April and May, after rising the prior two months. With four components weakening, manufacturing hours, help-wanted ads, housing permits, and the interest rate spread, and three components improving -- first-time filings for unemployment; real durable goods spending; and the Boeing backlog delivery ratio. We expect a fair amount of volatility from month-to-month going forward, and the modest decline is most likely indicative of a slower recovery, rather than the beginnings of a regional recession. We're fortunate to have some big employment powerhouses in the region, which is helping to drive our local economy forward. The region's employment growth has been double that of the nation over the last year, led by hiring in aerospace, construction, and professional and business services. Recent figures from the US Bureau of Labor Statistics show Seattle as having the ninth highest addition of non-farm jobs in the country between April 2011 and April 2012.

Wages in Washington grew by 3.6% last year, with much of the increase led by the rise in the number of workers earning more than $75,000, reflecting the influence of major local employers such as Microsoft, Boeing, and Amazon. Housing market trends continue to be positive for the region, though there's a great deal of variation between counties and metropolitan markets. The strongest advocates are in King County, the population center of the state, and HomeStreet's headquarters, and its Snohomish County, site of the Boeing 787 production, and related economic activity. Lack of housing inventory continues to be a constraint. New listings in the second quarter for single-family homes dropped an average of 39.5%, for the three-county region of King, Pierce, and Snohomish counties, compared to a year ago. At the same time, pending sales rose an average of 18% year-over-year, though the increase for June was several percentage points below that of April and May.

Closed sales grew by an average of 13% for the three-month period over this period last year, with the greatest increase in King and Snohomish counties, while existing home sales fell nationally in June, compared to May. The three-county Puget Sound region experienced a slight increase of just over 1%. Median home prices rose month by month throughout the quarter in several of the areas where we have mortgage lending operations. The three-county Puget Sound area median home price has gone up for four consecutive months, with the exception of a small dip in Snohomish County in April, and was 5% higher in June than a year ago. The median home price in Portland rose almost 9% between this April and last, giving Portland the sixth largest median price gain by percentage in the nation. In fact, Oregon's economy, which was hard hit by the recession, was recently cited as the second-fastest growing economy in the nation.

On Oahu, where we have a strong mortgage presence, single family home sales had a 12.5% gain in volume and a 10% gain in price in June compared to a year earlier. And home prices rose on Maui by more than 30% in June on a modest increase in the number of sales. Home builder confidence rose in July, marking the largest monthly increase recorded by the National Association of Homebuilders in close to a decade, with the greatest gains recognized in the West. Demand for commercial real estate in the Puget Sound market has been on the rise, with vacancies declining. The local office market is among the strongest in the nation, with the technology sector driving the demand for space and the industrial market is benefiting from increasing poor activity, and demand for new development.

Vacancies decreased to approximately 6% for retail, 11% for office, and 6% for industrial properties at the end of the second quarter, several percentage points below the national average for each category. In the multi-family market, job growth and tighter housing inventory is expected to sustain a strong demand for rental units, continuing to drive vacancies down and rents up. And in Portland, apartment vacancies are expected to reach historic lows this year, as the employment picture improves at the same time that new units are in short supply. In summary, we feel good about our market areas, and the signs of recovery. Especially in our core markets, and we see great opportunities for HomeStreet going forward.

I'd like to thank you for your attention and patience during my remarks, and I'd be happy to take your questions at this time.

(Operator Instructions)

Paul Miller, FBR.

Good quarter, Mark. Going back to the -- on your origination side, I think you said 65% purchased, 45% refi, was that correct?

That's correct. 35% purchase.

35% purchased, and historically where does that run with your company?

Historically, 70% purchases. The Company has historically enjoyed a higher than industry average of purchase money mortgages as a consequence, one, of our joint venture with Windermere Mortgage Services, which of course is a point-of-sale purchase business, and as a result of our retail focus on servicing the residential brokerage market.

And when we're doing these models, you reported two numbers. $1 billion on originations and $1.3 billion of interest rate locks. Is the interest rate locks, is that the number we should have in our models for your gain on sale to come up with your overall revenue from mortgage banking?

It's the primary driver because we marked to fair value, the derivatives represented by interest rate lock commitments, the value that is represented, or the additional value by secondary market gains, and the value of originated mortgage servicing that will be created when we sell the loans. That value, which is about two-thirds of the gain, is recognized at the data block, net of our estimated fallout. The remainder of our revenue, that represented by origination funding fees is recognized at the date of the closing of the loans.

So I guess they're both important numbers, but is the $1.3 million the more important number?

I think it is because, one, it generates most of the gain. And it's a view of what the run rate is for the Company. As you think about the lag between application and closing, the real activity in the quarter, which will be closed in the following quarter, to the extent it wasn't closed yet, are lock commitments. So that really shows our run rate. And it's a better barometer of total volume.

And then you said the tenure act probably the volatility on the downside here, have you seen any let up at all in demand over the last month or so, or is it pretty strong both on gain on sale and volumes?

It continues strong. June from an application volume standpoint, was slightly below May. Relatively. But we think that part of that is seasonal, the people do take vacations in the summer. And we think that has slightly affected the level of activity. Having said that, because we continue to add origination capacity, not only in the form of loan officers, but in fulfillment personnel, our volume for the following quarter, we don't expect to be less than the second quarter.

And then can you talk a little bit about your desk license? Where are we in ramping that up to a higher potential that we talked about when we recapped you, back in February?

Well, that business, like many of the lending businesses is a personnel business. And we are in the process of hiring additional personnel and discussing the potential for corresponding in joint venture relationships with third parties. That is going to be a little slower-developing than the growth in clearly our single family mortgage business, but we are as excited about the prospects for our commercial mortgage banking business, which would be, in large part the Fannie Mae desk business going forward. It's just going to take a little bit longer to develop.

And when you say little longer, is that a couple quarters or another year or -- what's the road map, here?

I think you'll see it grow over the next year.

Over the next year? Thank you very much, Mark.

(Operator Instructions)

The next question comes from Tucker Andersen of Above All Advisors.

Could you talk a little bit about the continued growth of the municipal securities on your balance sheet? Is that driven by your deposit gathering strategy, or is that because of the fact that your tax position has changed? And could you also talk about the composition of that area of your balance sheet?

Sure. Prior to the IPO, we had managed our securities portfolio, really on the basis of the risk weighting of the securities, given that we were in a position of trying to maintain and grow on a capital ratios. Post-IPO, post-recapitalization, we can now move the composition of that portfolio to reflect the portfolios of other institutions that have more diversified, better-performing portfolios. So we are at about our target composition, of about 30% of our securities portfolio in municipal bonds. We think that is the right diversification, and an appropriate inclusion in a bank securities portfolio, not only as a consequence of the favorable tax treatment, but the favorable tax-affected yield on those securities. Now, having said that we don't believe almost mint municipal securities are appropriate for bank balance sheets. And we will generally only invest in general obligation or revenue based bonds of highly-rated investment grade issuers.

And are those primarily in your larger geographic area or are those diversified across the country?

Diversified across the country. Again, we seek to mitigate event risk by having diversity of location and issuer as well.

Thank you.

(Operator Instructions)

The next question comes from Mark Patterson of NWQ Investment Management.

Might have missed it, but when you were talking about the effective tax rate, did you comment on the second half of 2012 being similar to Q2 based on a similar type of income mix, I understand that it changes because of the munies and so forth, but if you had somewhat of a similar type of pretax number, you would be about at a 15% effective?

Yes. Actually it's going to be a little higher effective rate. An easier way to think about it is to look at the full-year. For the full year, if you applied the federal tax rate, the federal rate of 35% to the pretax earnings, and reduced that amount by the beginning of the year valuation allowance, which was a little in excess of $14 million, and also reduced it for about $1 million of permanent differences, book tax differences that decrease our taxable income, that number, less the tax expense or credits for income taxes is recognized in the first two quarters, you could understand what the tax expense would be for the remaining two quarters of the year.

So our actual effective rate will be dependent on what we earn for the rest of the year. We had to base this quarter's effective rate on a forecast of earnings for the remainder of the year. And that will, of course be subject to adjustment based on actual results. So the effective rate that we utilized in our calculations for the full year this year is approximately 20.7%.

Okay. Great.

After consideration of all of those things.

Thank you. One other question on the gain on sale margin environment right now, what you saw in Q2 and kind of where you feel you are at as we are book our way into Q3 already?

The margins in the second quarter were higher than the first. Our gross revenue on direct originations from the bank was in excess of 400 basis points. And our net profit margin on a direct business was in excess of 200 basis points. That is up from the first quarter. The first quarter direct revenue was just short of 400 basis points. And the net on direct business was about 140 basis points.

Our margins on our business through Windermere are running fairly consistent. Somewhat above 200 basis point net revenue to us. And a little over 200 basis points net profit margins. So we're seeing margins that are up approximately 20% in gross revenue on direct business. We do not expect that to continue. Though it may continue somewhat into the third quarter. They are extraordinarily high. Depending on how much they'll decrease, frankly.

Right. But as it stands right now, just early into the Q3 and what was locked, you don't see much of a change from Q2 at this point?

We don't yet. Yes. Okay. Great. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Mason for any closing remarks.

Well, thank you again for your attention and patience. We appreciate your interest in the Company. Thank you for attending our call today.

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