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HomeStreet (NASDAQ:HMST)
Q3 2021 Earnings Call
Oct 26, 2021, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good day, and welcome to HomeStreet's third-quarter 2021 earnings call. [Operator instructions] Please note that this event is being recorded. Now I'd like to turn the call over to Mr. Mark Mason, chairman and CEO.

Please go ahead.

Mark Mason -- Chairman and Chief Executive Officer

Hello, and thank you for joining us for our third-quarter 2021 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 yesterday and are 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 may make certain predictive statements that reflect our current views and expectations about the company's performance and financial results.

These are likely forward-looking statements that are made subject to the safe harbor statements included in yesterday'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 on our website. Joining me today is our chief financial officer, John Michel. John will briefly discuss our financial results, and then I'd like to give an update on our results of operations and our outlook going forward.

John?

John Michel -- Chief Financial Officer

Thank you, Mark. Good morning, everyone, and thank you for joining us. In the third quarter of 2021, our net income was $27 million or $1.31 per share, as compared to net income of $29 million or $1.37 per share in the second quarter of 2021. Our annualized return on tangible common equity for the third quarter was 15.6%.

Our annualized return on average assets was 1.48%, and our efficiency ratio was 62.8%. Our net interest income in the third quarter was slightly lower than the second quarter due to a $1.7 million decrease in interest income derived from PPP loans which was partially offset by higher levels of non-PPP loans. PPP loans caused our net interest margin to be higher by 11 basis points. Excluding the impact of PPP loans, our net interest margin in the third quarter of 2021 was consistent with our net interest margin in the second quarter of 2021.

As of September 30th, 2021, outstanding PPP loans were $77 million with deferred fees of $2.4 million. As a result of the continued favorable performance of our loan portfolio, and the improving outlook of the impact of COVID-19 on our loan portfolio, we recorded a $5 million recovery of our allowance for credit losses in the third quarter of 2021. As we continue to have more clarity of the minimal impact COVID is having on our loan portfolio and with projected improvements in our economies, we expect to recover additional amounts of our allowance for credit losses in future periods. Our ratio of nonperforming assets to total assets improved to 26 basis points.

Our ratio of ACL to total loans was 1.06%. The $3.8 million decrease in net gain on loan origination and sale activities in the third quarter of 2021 as compared to the second quarter of 2021 and was due primarily to a lower volume of single-family mortgage rate locks and lower levels of CRE loans sold in the third quarter. The $0.9 million decrease in noninterest expense in the third quarter as compared to the second quarter was primarily due to lower compensation costs, which were partially offset by higher general administrative and other expenses. The $3.2 million decrease in compensation costs was primarily due to reduced commissions resulting from lower levels of loans closed in our single-family mortgage operations, and lower benefit costs due to third-quarter seasonality.

General, administrative and other costs increased due to a $1.9 million reimbursement of legal costs received from our insurance carrier in the second quarter of 2021 and higher marketing costs. During the third quarter of 2021, we repurchased 2% of our outstanding common stock at an average price of $40.26 per share and declared and paid a dividend of $0.25 per share. Since the beginning of 2021, we have repurchased 7% of our outstanding common stock. This is in addition to the 12% and 9% repurchase in 2019 and 2020, respectively.

I will now turn the call over to Mark.

Mark Mason -- Chairman and Chief Executive Officer

Thank you, John. HomeStreet's results for the third quarter continued our outstanding results for the year. Our results reflect our diversified business model the benefits of our conservative credit culture and continuing focus on operating efficiency. Our loan origination levels remained strong with $804 million of originations.

And excluding the impact of PPP loans and despite continuing high levels of prepayments, our total loans grew at an annualized rate of 19% during the quarter and 9% year to date. As expected, our single-family mortgage loan volume and profit margins decreased from second-quarter levels, and our revenue has now declined to near-normal levels. The credit quality of our loan portfolio continued its strong performance. As John mentioned, greater clarity on the impact of COVID on our portfolio allowed us to recover $5 million of our ACL.

For the second consecutive quarter, our mortgage banking revenue comprised only 17% of total revenue and less than 8% of our net income. We continue to anticipate a slight decrease in our origination and gain on sales activities over the next few quarters. Due to increasing revenues from other operations, we expect the revenue contributions from our single-family mortgage banking business to represent an even smaller share of total company revenue going forward. We expect our overall net interest margin to continue to benefit in the fourth quarter of 2021 from the forgiveness of PPP loans.

Looking forward, with the Federal Reserve indicating that short-term interest rates will remain low for the foreseeable future, we expect our net interest margin, excluding the impact of PPP loans to remain level as the benefit of our deposits continuing to reprice downward, is expected to offset any decline in the yields on our portfolio loans. As I have mentioned previously, we continue to increase our commercial real estate loan originations, primarily multifamily, both for sale and for our portfolio. The strong fundamentals and demand in our markets and our successful platform have supported this initiative. These continuing high levels of loan production are expected to result in 10 to 15% growth in our loan portfolio next year and beyond with a commensurate increase in net interest income.

Our efficiency ratio in the third quarter was consistent with the prior quarter at 62.8%. While the expected decline in mortgage banking profitability is likely to result in upward pressure on our efficiency ratio through mid-next year. We anticipate that as a result of loan portfolio growth and related increases in net interest income, and our ability to leverage our existing operating infrastructure, we have the opportunity to improve our efficiency ratio to approximately 60% in the second half of next year. And ultimately, to the mid-to-high 50% range beyond that.

Based upon our continuing strong financial results and positive outlook, we repurchased $15 million of our common stock during the quarter and paid a $0.25 per share dividend, which today equates to a yield of approximately 2.3% on the market value of our common stock. We anticipate continuing to efficiently retain capital for growth while returning excess capital to shareholders. In that regard, and subject to our board of directors' review and approval and the non-objection of our regulators, we plan on repurchasing $20 million of our outstanding shares in the fourth quarter. Additionally, given our consistently strong performance, the board of directors anticipates discussing an increase in our dividend in the first quarter of next year.

Of course, future declarations of the current or higher levels of dividends are subject to our financial condition and future outlook at that time as well as corporate governance, legal and regulatory requirements. Last quarter, we disclosed that we were evaluating the use of securitizations as a tool to enable us to originate multifamily permanent loans to our full potential, to uncap individual borrower lending limits, and to improve our capital efficiency and retain the servicing on these loans and that we planned on completing our first securitization this year. While we continue to evaluate the use of securitization, we have instead agreed to execute a whole loan sale in the fourth quarter due to extremely favorable prices available in the secondary market today. Looking forward to 2022, we expect lower levels of portfolio loan sales, either through whole loan sales or securitization as we plan to retain loans in our portfolio to generate increasing levels of net interest income.

Since going public in 2012, HomeStreet has been executing a strategy to convert from a legacy thrift to a full-service commercial and consumer bank. This conversion focused on the development of commercial lending and deposit product lines and more recently, reducing the size of our single-family mortgage banking business. S&P has recently recognized our successful conversion, and HomeStreet's global industry classification standard code will be changed from a thrift and mortgage finance institution to a regional bank effective as of November 1st of this year. This change may qualify HomeStreet for inclusion in certain regional bank indexes that currently exclude us.

To reiterate my comments from last quarter, the investments that we have made and the improvements in our efficiency and profitability have provided us with the operating leverage that will enable us the opportunity to grow revenue and return earnings without commensurate additions to personnel or other operating expenses. And while quarter-to-quarter earnings may show some degree of volatility, excluding recoveries of our allowance for credit losses and excluding nonrecurring items, such as PPP loans and expense recoveries and, of course, subject to any unforeseen changes in the economy in our business, we believe we have the opportunity to continue to grow year-over-year earnings per share over the next few years. Specifically, we believe that current estimates understate our possible earnings per share over the next few years. Given our performance in relation to peers and their forward-looking comments today, I believe our stock is significantly undervalued.

Today, we trade at a meaningful discount to our peers on a price to earnings or tangible book value basis. Specifically, based upon multiples of 2022 consensus earnings estimates, today, the median of our peers trade at over 30% higher than HomeStreet. Historically, this discount was largely attributed to high levels of mortgage banking revenues and earnings and its associated volatility. Historically, this was accurate with mortgage banking revenues exceeding 50% of total revenues.

However, even at the height of last year's mortgage refinancing, our mortgage banking revenues never exceeded 32% of total revenues. And the last two quarters of mortgage banking revenue represented only 17% of revenues and less than 8% of the bottom line. Today, any meaningful discount associated with mortgage banking volatility is unwarranted. And I believe our shares represent a tremendous opportunity for investors.

The best way for me to describe the current state of affairs at HomeStreet is that, while we are pleased to have achieved strong operating results and total shareholder returns over the prior decade, this is not the same HomeStreet of 10 years ago, nor is it the same HomeStreet of even three years ago. What we have been able to accomplish with our effective reorganization is to have brought the company to a place where we can expect to achieve lower earnings volatility, higher operational profitability, and stronger earnings growth, all of which we believe should compare very favorably to our regional banking peers going forward. With that -- this concludes our prepared comments today. We appreciate your attention.

And John and I would be happy to answer any questions you have at this time.

Questions & Answers:


Operator

[Operator instructions] First question comes from Jeff Rulis from D.A. Davidson. Please go ahead.

Jeff Rulis -- DA Davidson & Co. -- Analyst

Good morning.

Mark Mason -- Chairman and Chief Executive Officer

Hey, Jeff.

John Michel -- Chief Financial Officer

Hey, Jeff.

Jeff Rulis -- DA Davidson & Co. -- Analyst

Question on the gain on sale projections in '22. You've got sort of flattish fee income expectations, just trying to see what that line item year over year. Maybe you could just detail a little bit more what you see with the gain on sale item.

Mark Mason -- Chairman and Chief Executive Officer

Obviously, we expect gain on sales of single-family mortgage loans to decline from this year, right? I mean earlier this year, we still had much more meaningful levels of refinancing activity. So absent a meaningful decline in mortgage rates, we are expecting the revenues next year in the single-family mortgage banking area to look a lot more like the second half of this year. So you can see there would be a noticeable decline in those revenues. Additionally, given my earlier statements, that we are planning to sell less multifamily loans next year, either by whole loan sale or securitization, those revenues are expected to decline also.

We are expecting to continue to grow our multifamily Fannie Mae U.S. business. And of course, those are all loan sales securitizations. We're expecting those related revenues to rise that mitigates those declines somewhat.

But you could foresee these revenues declining if you sort of mix up all those comments by 25% to say, a third of this year's gain on sale value.

John Michel -- Chief Financial Officer

For this year, yeah. So just to add, the third quarter revenue numbers probably are pretty consistent from a single-family perspective in terms of going forward, and looking on a go-forward basis should not be substantially different, either up or down from that. The other thing I want to point out is as we go through in this mortgage banking revenues, as the prepayment speeds decline, we would expect some uptick in our loan servicing revenue on the single-family mortgage side.

Mark Mason -- Chairman and Chief Executive Officer

It's countercyclical. I know, Jeff, you've looked at our results for a long time and seen that our servicing results have been pretty poor, and they always are during falling rates, right? High levels of prepayment speeds, which create high levels of decay or amortization of servicing rights. Also, when looking at these third-quarter results, we didn't have a multifamily loan sale, right? So you really need to look at both third and fourth quarters to get a realistic run rate going forward. And as we mentioned, we've agreed to have a whole loan sale of multifamily loans in the fourth quarter at premiums that were sufficient to keep us from securitizing.

So we're expecting that to be a strong loan sale.

Jeff Rulis -- DA Davidson & Co. -- Analyst

Gotcha. And just a housekeeping item, maybe John, what were the PPP balances at quarter end?

John Michel -- Chief Financial Officer

We're at $77 million, and the deferred fees were about $2.5 million. Our expectations are is that through the fourth quarter, there'll be continued some forgiveness activity and then we don't expect anything materially to be affecting next year's results on the PPP side, be small benefit.

Jeff Rulis -- DA Davidson & Co. -- Analyst

Gotcha. And the -- go ahead.

Mark Mason -- Chairman and Chief Executive Officer

Also just kind of beyond the revenue question, we believe that revenue loss is going to be made up by other revenue increases, primarily greater net interest income. And all of these things together, we believe, along with continuing repurchases that we are not going to see a diminution in earnings per share next year despite the broad estimates that exist today.

John Michel -- Chief Financial Officer

Yeah. If you look at our numbers, our expectation is because of the declining balances this year due to PPP loans, is not only do we expect our year-over-year balances to increase by 10 to 15%, but we expect our average balance of loans to increase by a similar level next year also.

Jeff Rulis -- DA Davidson & Co. -- Analyst

And that 10 to 15% includes the loans held for sale?

John Michel -- Chief Financial Officer

The 10 to 15%, the loans held for sale tend to -- it would not include that from the perspective of going forward. The loans held for sale will kind of be more fluctuating. And historically, we've been pretty consistent because we have a loan sale on a quarterly basis. In the future, that will be more fluctuating because we aren't going to necessarily do one on a quarterly basis going forward.

Mark Mason -- Chairman and Chief Executive Officer

So right, the 10 to 15% is just loans held for investment.

Jeff Rulis -- DA Davidson & Co. -- Analyst

OK. Got it. And the 19% annualized loan growth in the quarter, did you include the held-for-sale piece.

John Michel -- Chief Financial Officer

That we did include. Yeah, we did. If you look at the held for sale between the second quarter and the third quarter, there was a big jump because of reclassification. So to get that annualized number, we did include all the loans.

That's why we also included the loans for the whole year, and that run rate was 9%. That's why I want to make sure we're clarifying everybody what the growth is. But we have strong growth when you pull back the PPP loans in terms of our overall portfolio.

Jeff Rulis -- DA Davidson & Co. -- Analyst

Gotcha. Thanks for clarifying. I'll step back. Thank you.

John Michel -- Chief Financial Officer

Thanks, Jeff.

Mark Mason -- Chairman and Chief Executive Officer

Thanks, Jeff.

Operator

[Operator instructions] Next question is from Steve Moss, B. Riley Securities. Go ahead, please.

Steve Moss -- B. Riley FBR Inc. -- Analyst

Hi. Good morning.

Mark Mason -- Chairman and Chief Executive Officer

Good morning, Steve.

Steve Moss -- B. Riley FBR Inc. -- Analyst

Maybe just following up on the loan pipeline being strong here. I hear you guys on multi-family originations, obviously. But kind of curious, you saw some growth here in the quarter in construction and even other spots, just kind of how you're thinking about the mix in terms of the growth going forward?

Mark Mason -- Chairman and Chief Executive Officer

We have a very strong pipeline, particularly in the commercial real estate area, the multifamily area. Obviously, in the single-family mortgage area, we're coming into the seasonally lower volume period, and the fourth quarter tends to be a period seasonally where you're drawing down the pipeline. So we will exit the fourth quarter at least in the single-family area with a smaller pipeline than we enter. That may not be true in the commercial area.

It sort of remains to be seen. Obviously, loan rates continue to be attractive. And in some areas like the Panama Des area, recent changes in the lending caps for Fannie Mae and Freddie Mac in the multifamily area have spurred great originations there. The change in administration has been good for the agencies with respect to multifamily lending caps.

Those caps were increased about 10% from the 2021 cap. And the agencies have become much more competitive since those announcements. So we're expecting a much stronger agency lending through the end of the year and at least next year.

John Michel -- Chief Financial Officer

Yeah. And one other thing, too, is our single-family loans originated for portfolio have been strong this year, and we continue to have pretty strong results next year. Just the level of prepayments have been so high this last year and a half that it's been hard to keep pace with it. We expect with prepayments going down next year that we expect our single-family portfolio to continue to actually just start growing next year.

Mark Mason -- Chairman and Chief Executive Officer

And it's been writing off since we downsized the business.

John Michel -- Chief Financial Officer

Right.

Mark Mason -- Chairman and Chief Executive Officer

Right.

Steve Moss -- B. Riley FBR Inc. -- Analyst

Exactly. OK. That's helpful. And then in terms of just loan pricing, kind of curious as to where rates are in terms of what's coming on the books these days versus what the rate of what is going off?

Mark Mason -- Chairman and Chief Executive Officer

Well, I mean that's still -- that condition hasn't changed, right? I mean loans that are prepaying or prepaid for a reason, right? And so let me see if I can give you some runoff note rates. In the aggregate, in the third quarter --

John Michel -- Chief Financial Officer

That's what we originated at.

Mark Mason -- Chairman and Chief Executive Officer

Right. I'm looking for the runoff.

John Michel -- Chief Financial Officer

The runoff is here.

Mark Mason -- Chairman and Chief Executive Officer

We ran loans off. Actually, it appears balanced, but it's not really. In total, we ran off loans at about a 3.38% spread and replace them to 3.39%, but that's not true by category, right? If you look at, for example, single-family loans, the loans that prepaid were 3.93%, and the loans we add over 3.36%, right? I mean that puts a perspective what happens with runoff.

John Michel -- Chief Financial Officer

The one thing that's affecting us too is the PPP loans or some of the runoff we have. And so those loan rates were low at 1%.

Mark Mason -- Chairman and Chief Executive Officer

Right. That's what makes the aggregate loan.

John Michel -- Chief Financial Officer

Yep.

Mark Mason -- Chairman and Chief Executive Officer

But in the ongoing portfolios, the multifamily perm portfolio plus the nonresidential CRE perm portfolio. We ran off at 4.21% and we added a 3.22, right? So these trends continue. This is the same experience all of our peers are having Fortunately, our funding costs continue to fall. And in the aggregate, where we believe we're able to maintain our core net interest margin.

Steve Moss -- B. Riley FBR Inc. -- Analyst

OK. That's helpful. And then in terms of -- Mark, you talked about capital deployment going up to 20 million here, likely on the buyback. Just kind of I take that to be you're signaling sustained profitability closer to this quarter's current level.

Just kind of curious on how you guys are thinking about it, especially as we think about 2022?

Mark Mason -- Chairman and Chief Executive Officer

Well, that's a great question. We have been fairly aggressive with our buyback program. though we have been careful during the pandemic to structure our buyback program so that buybacks during the quarter has generally not exceeded what we've earned in the quarter in conjunction with dividends, total distributions if you will. And we were sensitive to that relationship as the pandemic has extended to return -- to maintain a somewhat higher level of capital than we would target in a normal course.

And going forward, as the pandemic -- cross my fingers on this one, as the pandemic ends and does it extend, you may see us extend the buyback activity beyond current earnings in conjunction with dividends that would have the impact of reducing our capital ratios somewhat, not significantly, but beyond current levels, which means that relative to capital earnings, our buyback program may be slightly elevated.

Steve Moss -- B. Riley FBR Inc. -- Analyst

OK. Great. That's helpful. Thank you very much and a nice quarter.

Mark Mason -- Chairman and Chief Executive Officer

Thank you, Steve.

John Michel -- Chief Financial Officer

Thanks, Steve.

Operator

This concludes our question-and-answer session. Now I'd like to turn the call back over to Mr. Mark Mason for final remarks. Please go ahead, sir.

Mark Mason -- Chairman and Chief Executive Officer

We appreciate -- well, before we leave, we're looking at the queue. Does Jeff Rulis have another question? Are we looking at the queue on? Operator, can you check?

Operator

Yes. I'll get them back in. Give me a moment, please. Alright.

Our next question will be from Jeff Rulis, a follow-up from D.A. Davidson. Please go ahead.

Jeff Rulis -- DA Davidson & Co. -- Analyst

Sorry guys, not to hold everyone up, but just a quick question on the EPS being understated. I think a big piece of expectations might be at least year over year '21 versus '22 is on the provision year to date at $9 million recapture added. Is -- are those -- are you excluding that in that conversation? Just wanted to kind of get your sense and if you're including it, I guess, any expectations you have on the provision line for '22 are relevant?

Mark Mason -- Chairman and Chief Executive Officer

Great, and thanks for asking that question. We are anticipating, again, absent changes in COVID-related risk or other credit risks. We are anticipating further drawdowns in our ACL next year. If we realize what I would consider a normal -- a full normalization of that credit risk related to COVID next year.

we would likely normalize our ACL levels or coverage levels if you will, which would anticipate us recovering the remainder of provisions we established against pandemic-related risk offset by growth in the portfolio. And whatever other adjustments we might feel are needed to adequately state our ACL in relation to, obviously, the new standards. But if you consider that we've had a growing composition of multifamily loans in our held-for-investment portfolio. And that potential impact on the ACL, our ACL could end up at or slightly lower relatively to where we were pre-pandemic.

We have not had losses in multifamily loans as an institution as a simple statement. And our relative credit risk, when you consider our high composition of real estate-related lending and the hard collateral conservatively underwritten comes with it. We have a lot of safety in our ACL coverage. And so our next year's comments do contain the assumption that we will recover all or substantially all of the pandemic-related provisions from 2020, offset by portfolio growth.

Jeff Rulis -- DA Davidson & Co. -- Analyst

Got it. So if you're growing loans, 10 to 15% in '22, we could see a continued drawdown of reserves in '22, so be it that the provision line is a net benefit --

John Michel -- Chief Financial Officer

Yes. Yes. Yep.

Mark Mason -- Chairman and Chief Executive Officer

Absolutely.

John Michel -- Chief Financial Officer

That's correct.

Jeff Rulis -- DA Davidson & Co. -- Analyst

OK. Thank you, guys.

Mark Mason -- Chairman and Chief Executive Officer

You got it.

Operator

Thank you. That will conclude our question-and-answer session. We'll go to Mr. Mark Mason now for closing remarks.

Thank you.

Mark Mason -- Chairman and Chief Executive Officer

Thank you, operator, and thank you to everyone who joined us today for your attendance and patience in our prepared comments and the great Q&A. We look forward to talking to you next quarter.

Operator

[Operator signoff]

Duration: 40 minutes

Call participants:

Mark Mason -- Chairman and Chief Executive Officer

John Michel -- Chief Financial Officer

Jeff Rulis -- DA Davidson & Co. -- Analyst

Steve Moss -- B. Riley FBR Inc. -- Analyst

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