HomeStreet, Inc.

Hello, and thank you for joining us for our third 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 8K yesterday and are available on our website at ir.homestreet.com under the news and 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 our 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. Joining me today is our Chief Financial Officer, John Mitchell. 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. We will then respond to questions from our analysts. John?

Thank you, Mark. Good morning, everyone, and thank you for joining us. In the third quarter of 2023, our net income was $2.3 million, our 12 cents per share, as compared to core net income of $3.2 million, our 17 cents per share, in the second quarter of 2023. These results reflect the continuing adverse impact the significant increase in interest rates has had on our business. Our net interest income in the third quarter of 2023 was $4.6 million lower than the second quarter of 2023 due to a decrease in our net interest margin from 1.93% to 1.74%. The decrease in our net interest margin was due to a 25 basis point increase in the cost of interest bearing liabilities, caused in large part by an increase in the proportion of higher cost borrowings to the total balance of interest bearing liabilities. During the third quarter, the cost of deposits increased four basis points, The cost of long-term debt increased 15 basis points, and the cost of borrowings increased 19 basis points. The increases in the rates paid on interest-bearing liabilities were due to the increases in market interest rates during 2023. The income tax benefit realized in the third quarter of 2023 was due to the recognition of return to accrual differences related to tax-exempt income. Our effective tax rate for future periods is expected to be substantially lower than our statutory rate due to the benefits from tax exempt investments in loans. A $1.1 million recovery of our allowance for credit losses was recognized during the third quarter, compared to a $0.4 million recovery of our allowance for credit losses in the second quarter. The recovery for the third quarter was primarily due to reduced levels of higher risk land and development loans, which resulted in lower expected losses. Going forward, we expect the ratio of our allowance for credit losses to our health or investment loan portfolio to remain relatively stable, and provisioning in future periods to generally reflect changes in the balance of our loans' health for investment, assuming our history of minimal charge-offs continues. Our ratio of non-performing assets to total assets decreased from 44 basis points at June 30th to 42 basis points at September 30th, 2023. Non-interest income in the third quarter was consistent with the second quarter of 2023 as we continue to experience low levels of single-family and commercial mortgage banking originations. The $41.7 million decrease in non-interest expenses in the third quarter of 2023 as compared to the second quarter of 2023 was due to the $39.9 million goodwill impairment charge in the second quarter of 2023. Our other non-interest expense declined slightly during the third quarter, As we continue to take steps to defer or eliminate expenses where possible, our common equity Tier 1 and total risk-based capital ratios have improved significantly during the current year. As of September 30, 2023, the company's common equity Tier 1 and total risk-based capital ratios were 9.55% and 12.67% respectively. While the bank's common equity Tier 1 and total risk-based capital ratios were 13.32%, and 14.03% respectively. These ratios have increased this year, primarily a result of seasoning of multifamily loans originated in 2022, which after a year performance qualified for 50% risk weighting. 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 This is historically record velocity and magnitude of increases in short-term interest rates. Our earnings were $2.3 million, and our net interest margin decreased in the third quarter to 1.74% 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 reduced controllable expenses where possible. reduce staff to the minimum levels to transact current business volume in a safe and sound manner, raise new deposits through promotional products, and focus our new loan origination activity primarily on floating rate products such as commercial loans, residential construction loans, and home equity loans. We've been mindful to maintain strong risk management and 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 normalized. The deposit outflows we experienced in the third quarter were primarily due to depositors seeking higher yields. We have not to date experienced any material identifiable deposit loss related to concerns about deposit security. With not 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 and promotional money market accounts. This strategy affords us the opportunity to retain deposits without immediately repricing all of our existing low-cost core deposits. This strategy has over time contributed to rising deposit rates as customers choose to move money to these promotional accounts to achieve higher returns. Our level of uninsured deposits remains very low at 8% of total deposits. This competitive rate environment has resulted in reductions in our net interest margin. While we expect our net interest margin to stabilize in the near term, we do not expect increases in our net interest margin materially until rates stabilize. We utilize both brokered 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, FHLB and the Federal Reserve Bank term funding program, interest rates have generally been lower than broker deposits, and as a result, our borrowing balances have been increasing and our broker deposit balances have generally been decreasing. While this may affect some metrics such as our loan to deposit ratio, We believe that this is the best choice today as it minimizes our funding costs and we continue to have substantial borrowing availability beyond our needs and usage today. We continue to experience the cyclical downturn in single family and commercial mortgage loan volume as higher rates and spreads dampen the demand for new loans. Volumes in the third quarter were consistent with the second quarter and we do not expect seasonal volumes to increase until rates and spreads stabilize and then start decreasing. In our residential construction business, our builders have continued to increase their land acquisition and new project development, and our commitments and loan balances have begun to increase again. At quarter end, our cash and securities balances of $1.5 billion were 16% of total assets, and our contingent funding availability was $5.1 billion. equal to 76% 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. Asset quality remains strong in the third quarter as total past due and non-accrual loans and non-performing assets all decrease in the quarter. Our loan delinquencies remain at historically low levels and our net charge jobs during the third quarter were only $500,000. Our portfolio has been conservatively underwritten with a very low expected loss potential. As a result, credit quality remains solid, and we currently do not see any meaningful credit challenges on the horizon. We are continuing to limit loan originations, focusing on floating rate products such as commercial loans, residential construction, and home equity loans. We are generally not making any new multifamily loans today with the exception of Fannie Mae DUS loans, which we sell. We are 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 the loans. Despite our significantly reduced loan origination volume, our loan portfolio has not declined materially. as a result of prepayment speeds which continue at historically low levels, particularly for multifamily loans. At September 30th, 2023, our accumulated other comprehensive income balance, which is a component of our shareholders' equity, was a negative $127 million. While this represents a $6.76 reduction to our tangible book value per share, We know it is not a permanent impairment of the value of our equity and has no impact on our regulatory capital levels. Given the available liquidity, earnings, and cash flow of our bank, 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. During the third quarter, the company evaluated an unsolicited, non-binding, written proposal to purchase our Fannie Mae multifamily DUS business for $57 million. We analyzed this proposal and determined that the price proposed was inadequate in relation to the resulting benefit and value of the DUS business to our company, which includes our related loan servicing asset of $31 million as of September 30, 2023. Our Board of Directors determined that a sale of the DUS business at this price was not in the best interest of the company. Both prior to and since the receipt of this offer, we have received and responded to other parties interested in buying our DOS business. We have not to date received any other formal offers. Last week, the Board of Directors approved a $0.10 per share dividend payable on November 22, 2023. This dividend amount was unchanged from the prior quarter. In the near term, we anticipate stable levels of loans held for investment and deposits stable net interest margin, increasing non-interest income, and stable non-interest expenses, except for seasonal increases in compensation benefit costs expected to occur in the first quarter. Additionally, with our strong capital levels and low level of credit risk, and excluding unforeseen events or economic changes, we do not foresee circumstances that would impact our ability to get through this cycle remaining profitable. the current interest rate environment has created significant challenges for our company. In particular, the rate competition for deposits from banks, money market funds, and treasury bonds is significant, and some of our customers have moved some of their funds. Additionally, our interest rate-sensitive residential and commercial mortgage banking businesses are experiencing historically low originations, further challenging our earnings. However, these conditions will change when interest rates stabilize and ultimately decline. Historically, an environment of stable rates has provided significantly better financial performance for our bank. We believe that we are doing all the things appropriate at this time to endure this period and preserve the value of our business so that we can take advantage of the upcoming beneficial rate cycle. In summary, our challenge and our opportunity is time. The simple passage of time will provide the opportunity for our net interest margin to normalize and loan origination volume and revenue in our residential and commercial mortgage banking businesses will improve significantly. Our ability to negotiate this period is supported by our strong credit, sufficient capital, and loyal customers. With that, this concludes our prepared comments today. We appreciate your attention. John and I would be happy to answer questions from our analysts 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 question and answer session. Operator?