2023-11-05 00:50:15 ET
Summary
- HomeStreet Bank has experienced a 90% loss in value in less than two years due to rising interest rates.
- The bank's loan portfolio has remained stagnant and demand for credit has shrunk.
- The net interest margin has dramatically decreased, and the bank's high loan-to-deposit ratio limits its operations.
HomeStreet ( HMST ) is experiencing one of the most difficult times in its history. Since the Fed began in early 2022 to raise interest rates, an interminable ordeal has begun that has led this bank to lose more than 90% in less than two years. In the last few days there has been a 10% rebound, but beware: recovery is not necessarily underway. Several times during the last few quarters the slump seemed to be at the end of the line but it was not.
On October 30, Q3 2023 was released and although EPS beat estimates , $0.12 actual versus $0.04 expected, the issues from previous months continue to be there.
Highlights Q3 2023
HomeStreet, Inc. (HMST) Q3 2023 Earnings Call
The loan portfolio is worth $7.44 billion and multifamily loans have a weight of as much as 53%. Compared to the previous three quarters, the loan portfolio has remained virtually unchanged, and this is one of the first problems facing this bank. Demand for credit has shrunk and it is no longer as easy to grow as in the past. In addition, on the yield front, the situation is not improving.
HomeStreet, Inc. (HMST) Q3 2023 Earnings Call
Interest-earning assets have an average yield of 4.46%, only 1 basis point higher than the previous quarter. Overall, compared to last year the improvement was 51 basis points: too little given how fast the Fed Funds Rate has risen.
Instead, what has increased quickly are interest-bearing liabilities.
HomeStreet, Inc. (HMST) Q3 2023 Earnings Call
The average cost of interest-bearing liabilities reached 3.33%, up 25 basis points from the previous quarter. On an annual basis, the increase was 211 basis points: basically four times as much as the yield on interest-earning assets. So, it is not surprising that the net interest margin has plummeted dramatically over the past year.
HomeStreet, Inc. (HMST) Q3 2023 Earnings Call
In Q3 2022 it was 3.00%, today only 1.74%, and this collapse is continuing with some intensity. This is a very bad result and far below 3.27% , which is the average net interest margin of banks with assets between 5-49 billion. But how long will this ordeal continue?
According to CFO John Michel's statements , HomeStreet may have bottomed out this quarter, which is probably why the market is reacting positively these days.
In terms of projecting forward, what our activity is we're anticipating that the Fed will raise rates one more time in the fourth quarter and then keep them stable through the -- pretty much through the end of 2024. We believe when they say higher longer that they're going to do that. So based on that looking at our mixes and our funding and our future activity, we feel that the margin has stabilized at the current time. And we expect it to -- if interest rates stabilize, we'll start seeing some benefits as our loans reprice.
In practice, assuming there is another hike and rates remain stable until the end of 2024, the margin will finally start to improve. This is actually good news, but my doubts remain about the feasibility of this scenario since the market expects a totally different Fed Funds Rate at the end of 2024. In particular, it is discounting at least 2-3 cuts.
In addition, another aspect that caught my attention during the conference call is that CEO Mark Mason is focused on variable-rate lending, which I find rather counterintuitive since rates have probably peaked, or nearly peaked.
We've lowered our loan originations substantially but not eliminated originations, because it's beneficial to originate variable rate loans today, particularly high quality.
Personally, I believe that in the current economic environment it is convenient to lock in rates since they are very high compared to recent history. My view is that I don't think the Fed can keep rates that high until the end of 2024, so lending at floating rates could prove to be a mistake especially in the event of a recession in 2024. In short, my doubt is mainly about HomeStreet's view on the course of monetary policy, but certainly I could be wrong.
Let us now turn to total deposits.
HomeStreet, Inc. (HMST) Q3 2023 Earnings Call
Total deposits reached $6.75 billion, up $80 million from the previous quarter. The positive aspect here is that non-interest bearing deposits remained unchanged, but time deposits continue to increase dangerously: they reached a weight of 44% of total deposits.
Relating total loans to total deposits, the result is an LTD ratio of 110%, so very high. Well, this I think is another problem for this bank. Such a high LTD ratio implies a certain rigidity in the financial structure and thus limits HomeStreet's operations. In any case, CEO Mark Mason does not seem at all concerned about this.
Look, over the long term if you look at our history, we've run roughly 95% loan-to-deposits. And so we've always run somewhat higher loan-to-deposit ratio than our peers, because we've never struggled to originate loans, right? We would rather be operating back at around 95%. But we're working with what we have at this juncture. And why are we struggling with that ratio, primarily prepayment speeds, right? We've lowered our loan originations substantially but not eliminated originations, because it's beneficial to originate variable rate loans today, particularly high quality.
We have not had the anywhere near normal levels of prepayment speeds because of the loan extension that you experience in a very low rate period like this. So we've accepted the reality that we're going to run a loan-to-deposit ratio higher than what we would consider a normalized level for us. We don't think it represents an excess risk today given our strong on-balance sheet liquidity, strong borrowing capacity and so on.
In short, HomeStreet would like to return to having an LTD ratio of 95%, but at present this is not possible mainly because of prepayment speeds. In any case, even if it fails to ease this ratio, it would not be a problem given the large amount of liquidity on the balance sheet.
Personally, again, I remain quite doubtful about HomeStreet's vision. Liquidity represents 13% of the balance sheet, but the weakness in terms of the cost of deposits remains: reducing LTD without making profitability even worse will not be easy. Also, let's not forget that we are talking about a bank that has lost over 90% of its value in two years, so we cannot rule out a future panic situation where depositors will withdraw en masse. At that point the unrealized losses of AFS securities could be realized.
Finally, as a final food for thought, there is the dividend. After the panic triggered by SVB's bankruptcy, the dividend was cut to $0.10 per share and has not yet returned to previous levels. Typically this is the first sign of a distressed bank.
Conclusion
After a 90% collapse, there are not many scenarios for HomeStreet: either it is the deal of a lifetime or it is a risk not worth taking. Personally, based on my risk aversion, I would avoid this bank.
Interest-bearing liabilities continue to increase more than yield on assets, the LTD of 110% limits operations, and finally, I do not agree with the macroeconomic scenario expected by management in 2024. In short, this quarterly report has not resolved the doubts I had already expressed in the past, which is why my opinion of this bank remains negative. I prefer to avoid distressed banks that are not systemically important.
For further details see:
HomeStreet Q3 Earnings: Still Too Many Difficulties For This Bank