2023-08-02 05:43:20 ET
Summary
- HomeStreet, Inc. has reported core earnings of $3.2 million in Q2 through optimized operational expenses and cautious loan origination.
- The company has implemented strategic measures to combat the impact of contracted net interest margins, including reducing loan origination and increasing deposit base.
- HomeStreet's stock price has significantly declined, underperforming the S&P 500, and its earnings growth rate is negative, raising concerns about its future performance.
Thesis
In this article, I explore HomeStreet, Inc.'s (HMST) Q2 earnings report , focusing on key trends and strategic decisions in response to an unfavorable interest rate environment. While the company has managed to report core earnings of $3.2 million through optimized operational expenses and cautious loan origination, its long-term performance, in comparison with the S&P 500, and negative earnings growth rate depict a concerning picture. A comprehensive analysis of the company's performance, valuation, risks, and headwinds is provided, underscoring why HomeStreet, amidst persisting challenges and uncertain future prospects, might be considered a high-risk investment.
Company Overview
HomeStreet, Inc., established in 1921 as Continental Mortgage and Loan Company, is based in Seattle, Washington and has a diverse business portfolio as the holding company for HomeStreet Bank, primarily serving the Western United States. Their comprehensive suite of offerings spans commercial, mortgage, and consumer/retail banking services. They offer an assortment of products ranging from basic checking and savings accounts, interest-bearing and money market accounts, credit cards and insurance to loan portfolios that include commercial real estate loans such as multifamily, construction land development loans, owner-occupied real estate loans, commercial business loans and home equity loans among many others.
HomeStreet's Q2 Earnings Highlights
The latest quarterly earnings report from HomeStreet is indicative of several potentially advantageous trends. Despite headwinds (more on those below in "Risks & Headwinds") from an unfavorable interest rate environment that poses a challenge for many in the banking sector, HomeStreet has been able to keep its head above water, reporting core earnings of $3.2 million.
To combat the inevitable erosion of the net interest margin, a critical profitability indicator in the banking industry, HomeStreet has deployed strategic measures aimed at optimizing operational expenses. Particularly, according to management, the company claims to have trimmed down on non-essential expenditures.
A key part of HomeStreet's strategy to lessen the adverse impact of contracted net interest margins involves, I would say, a "cautious" approach to loan origination. They have chosen to decrease new loan origination while also shrinking the size of their loan and securities portfolios. Simultaneously, HomeStreet has bolstered its deposit base through an array of promotional products. This twofold tactic appears to have helped balance the impact of a lower net interest margin but has also successfully reduced the portion of uninsured deposits to a mere 7% of total deposits.
Even as HomeStreet grappled with deposit outflows in the second quarter, they've managed to achieve a state of equilibrium in June and July. The stabilization can be largely attributed to their strategic efforts focused on both attracting new deposits and fortifying existing ones through competitively structured promotional products.
In a noteworthy strategic shift, HomeStreet has opted for funding through the Federal Home Loan Bank and the Federal Reserve Bank Term funding program. The switch was primarily driven by the more attractive cost structure of these programs when juxtaposed with broker deposits. The good news is that as a direct outcome of this strategic move, the company has noted an uptick in its borrowing balances and a simultaneous reduction in its broker deposit balances.
Also, HomeStreet's recent expansion into Southern California through the acquisition of three retail deposit branches has started to bear fruit. Deposit levels at these branches have successfully steadied post-acquisition, and even more promising is the low average cost of deposits. According to management, assuming that the interest rate environment stabilizes, HomeStreet anticipates a resurgence in the single-family mortgage loan volume and heightened activity in the homebuilding sector.
Performance
Within the medium term, HomeStreet's stock price has experienced a significant decline from the beginning of 2016 till July 2023, dropping from USD 21.71 to USD 9.20. Such a drastic reduction, an approximate -10.71% annualized rate of return without dividends, raises eyebrows on the company's overall health and performance.
Comparing HomeStreet's performance to the S&P500 Index benchmark is a sobering reminder of how much HomeStreet's investors have lost out on potential gains. The S&P has delivered a strong annualized return of 11.26% without dividends, and a whopping 12.53% with dividends, significantly outperforming HomeStreet on both fronts.
Valuation
HomeStreet's earnings growth rate stands at -2.38% (see chart below). In my view, this figure is downright worrisome. A negative growth rate typically suggests declining profitability, indicating the company may be struggling to maintain its operational efficiency or to generate sufficient sales.
Now, let's talk about valuation multiples: HomeStreet's blended P/E is 7.15x, significantly lower than the so-called "fair" P/E of 15x and the company's historical normal P/E ratio of 11.94x. Lower P/E ratios can sometimes be a sign of undervaluation, but coupled with a negative growth rate, it's more likely painting a picture of a company with a cloudy future.
Risks & Headwinds
Seeking Alpha's indicators suggest that HMST is on a collision course for underperformance. That is, this stock has been flashing negative EPS revisions and showing declining growth, a double blow compared to the broader Financials sector. Historically speaking, stocks with Sell ratings have a consistent track record of lagging behind the S&P 500. It's a pattern that doesn't bode well for HomeStreet.
The EPS Revisions Grade for HMST, sitting at an 'F', is basically a neon sign saying 'proceed with caution'. We're seeing zero upward revisions in the last 90 days, which is a stark contrast to the sector median of 1. The Financials sector is not typically a high-flying growth sector, but HMST is trailing the pack even there.
Then there's the ROE Growth. A forward-looking ROE Growth of -36.37% seems downright bad, especially when compared to the sector's median of -3.67%.
Now let's examine the Growth Grades. An 'F' in virtually every category is the kind of report card that makes investors shudder. Whether you're looking at Dividend Per Share Growth, EPS Diluted Growth, EBIT Growth, or Revenue Growth (all forward-looking), HMST is underperforming.
The year-over-year metrics don't offer any solace either. Revenue Growth is down by over 22%, EPS Diluted Growth is dropping faster than a lead balloon at over 46%, and ROE Growth is shrinking by nearly 46%. All these numbers paint a very gloomy picture for HMST when compared to the respective sector medians.
And while HomeStreet's Q2 financial results exhibit certain positive dynamics, the report also unearths a few disquieting trends that merit attention. First and foremost, the company is feeling the effects of an unprecedented spike in short-term interest rates, an event which has placed considerable strain on its operating results. One indicator is a decline in net interest margin that decreased to 1.93%. The dip can largely be attributed to a dual dynamic of diminishing transaction and savings deposits coupled with the escalating cost of funding.
Moreover, HomeStreet faced the headwind of deposit outflows during the second quarter. The outflows were primarily driven by depositors pursuing avenues offering higher yields or making routine tax payments, reflecting the cyclicality of banking operations. While the company has managed to stabilize the outflow, the potential for further repricing of low-cost deposits remains, casting a degree of uncertainty over future deposit dynamics.
HomeStreet has also found itself caught in the current of a competitive rate environment. This fierce competition has further chipped away at the company's net interest margin, a trend expected to persist until the rates stabilize. HomeStreet's management anticipates that this rate-based tug-of-war for deposits will continue until the Federal Reserve halts its rate-raising regimen, contributing to an environment of persisting uncertainty.
Lastly, a striking aspect of the financials is the negative balance of $101 million in the accumulated and other comprehensive income as of June 30, 2023. This represents a considerable reduction in the tangible book value per share, amounting to $5.37. Despite the company's assurance that this is not indicative of a permanent impairment, it undoubtedly raises potential concerns among investors, adding a layer of complexity to HomeStreet's financial health and future prospects.
Final Takeaway
Based on the data, I would rate HomeStreet's stock as a "sell." The company has been facing persistent challenges from an unfavorable interest rate environment and competitive rate market, reflecting in the declining net interest margin and negative growth rate. Furthermore, its dismal performance compared to the S&P 500, negative EPS revisions, low ROE growth, and a substantial decrease in its tangible book value per share all point towards a high-risk investment with uncertain future prospects.
For further details see:
HomeStreet: Q2 Earnings Report, Proceed With Caution