The Long and Short

Good value in callable community bank paper

| September 16, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Callable community bank paper is available at impressive yields relative to larger, regional bank bullet structures in the investment grade domestic bank sector. Furthermore, the balance sheets of the smaller community banks in the investment grade space appear well equipped to weather potential economic uncertainty, and well positioned to benefit from a higher rates. The HomeStreet Inc (HMST) 10NC5 bonds issued earlier this year offer a compelling risk-reward profile at an attractive discount to par.

Exhibit 1. Community and small regional bank 10NC5 callable notes vs large IG regional bank bullets

Source: Amherst Pierpont, Bloomberg/TRACE Indications

3MM HMST 3.50% 1/30/32 @ $88.25
YTC: 6.64% (~288/5-year)
Issuer: HomeStreet Inc. (HoldCo of HomeStreet Bank)
CUSIP: 43785VAE2
Amount outstanding: $100 million (Non-Index)
Senior Rating: Kroll – BBB/Stable
Subordinated HoldCo Issue: Kroll – BBB-/Stable
Callable @ par 1/30/27
Cpn: 3.50% to 1/30/27; TSFR3M +215 back-end

HMST is headquartered in Seattle, WA and has about 60 branches in its relatively small Westcoast footprint throughout the states of WA, CA, OR, and HI. The bank has total assets of $8.6 billion, which is up from $7.2 billion at year-end 2021, with $6.8 billion in total loans/leases and $6.1 billion in total deposits. Management has mostly pursued a moderate growth strategy over past 4-5 year with few acquisitions since 2016. HMST has moved away from mortgage banking in recent years and become more focused on traditional commercial lending.

HMST has been focused in growing its multifamily loan offerings, which currently represent just under 50% of the total loan portfolio as of the second quarter of 2022, and has increased from 28% at year-end 2020. The remainder of the lending profile is 19% residential, 17% commercial real estate (CRE) plus 8% in construction and development loans, and 6% in commercial & industrial (C&I).

The bank maintains adequate capital ratios relative to its risk profile. The Tier 1 Common (CET1) ratio stood at 8.66% as of the second quarter, with a total risk-based capital of 11.49%.

Non-performing assets (NPA) are at a negligible level of 0.35% of total assets as of 2Q22. The bank has booked enough reserves to cover over 124% of those loans classified as non-performing. The Texas ratio—which measures NPAs and 90-day past-due loans as a percentage of all reserves as well as equity—is just over 5%, which is down from nearly 10% just two years ago. For banks of this size/stature we consider a Texas ratio below 20% as typically manageable.

With its current loan balance larger than deposits, a loan-to-deposit ratio of 110%, HMST has seen its reliance on wholesale funding increase over the past year. As of the second quarter of 2022, reliance on wholesale funding was up to just under 25%, which is elevated but still highly manageable. Dependence on shorter-term wholesale funding sources is also currently elevated at about 22%, but management has demonstrated its ability to temporarily lean on wholesale funding during periods of expansion before demonstrating a more stable funding profile over time.  The use of brokered deposits remains limited at just 4.37% of total deposits.

Dan Bruzzo, CFA
dan.bruzzo@santander.us
1 (646) 776-7749

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