Turning back to a favorite topic of this blog—Roaring Blue Lion’s activist campaign against HomeStreet (Nasdaq:HMST)—I am going to predict that, by the time all this is said and done, HomeStreet is really going to regret not just giving Roaring Blue Lion a board seat when they asked for it last year.
“Wait”—a faithful reader of this blog might say—“you’ve been pretty critical of Roaring Blue Lion in the past—so what has changed?”
The answer is that a number of things have changed.
To begin with, HomeStreet’s first quarter earnings were a bit of a disaster and starkly illustrated how dire the situation has become for HomeStreet’s mortgage business. Per HomeStreet’s CEO on their earnings call:
“In the first quarter of 2018, we met many challenges. The limited supply of new and resale housing has become acute and has now become a nationwide phenomenon with many markets experiencing the lowest historic levels of new and resale housing ever observed. The yield curve has flattened considerably to near historic lows. We have experienced higher levels of negative convexity in our servicing portfolio and the debt capital market experienced periods of extreme volatility during the quarter. Additionally, lower industry loan volumes substantially increased price competition in the quarter. These challenges meaningfully reduced our profit margins, mortgage loan volume, and mortgage servicing income in the first quarter, making a quarter that already reflects seasonally low volume more difficult, and driving an operating loss from the mortgage banking segment in the quarter, despite significant restructuring and cost reductions last year.”
My translation: “(i) not enough people are buying houses, (ii) even when we make mortgage loans, we don’t make enough money on them and (iii) mortgage servicing rights haven’t actually turned out to be much of a hedge against the impact of rising rates on our mortgage business. In addition, since mortgage is such an incredibly competitive business, now that there is not as much of it to go around, pricing is brutal. Given that the first quarter is usually pretty bad for mortgage anyhow because of seasonal home buying patterns, we really took it on the chin, even after cutting the business to the bone last year.”
Secondly, as HomeStreet’s stockholder meeting approaches, the dueling appeals to stockholders and proxy advisors are starting to come fast and furious and, in Roaring Blue Lion’s case, with significantly more polish and focus. I don’t know if Roaring Blue Lion brought in some new advisors or were just playing rope-a-dope in the early rounds of this contest, but they have definitely stepped up their game in the last week or two.
Both HomeStreet and Roaring Blue Lion have made presentations to ISS followed by a rebuttal presentation from HomeStreet, that was re-rebutted in turn by Roaring Blue Lion.
Based on this flurry of activity, a few things are pretty clear.
First, HomeStreet’s business strategy is not working. Their attempts to diversify away from mortgage and into commercial and consumer banking, while well-intentioned, have not been nearly enough to cushion the negative impact that higher interest rates have had on their mortgage business.
One of the issues that generally everyone has with the mortgage business is its volatility—there are periods of boom and periods of bust. I appreciate that HomeStreet tried to mitigate the boom/bust nature of mortgage by building out other business lines, but, based on their own materials, my conclusion is that the investment in commercial and consumer is not really panning out. When mortgage was booming, the investment in commercial and consumer banking was a drag on earnings and now that mortgage is bust, those businesses don’t generate enough earnings to offset the impact of the precipitous decline in the mortgage business.
The result is a pretty low performing bank that, left to its own devices, has two paths to (self) improvement. The first path, which is out of its control, is that the mortgage market improves significantly. The second is redoubling their efforts to build out commercial and consumer. Put succinctly, their options are hope and hard work (and more expense) and neither path has a guaranteed outcome. In comparison, the steps suggested by Roaring Blue Lion—sell HomeStreet’s mortgage servicing rights, scale back on mortgage, cut costs in the consumer business and focus more on the commercial business—seem to offer the possibility of great stockholder value than what is currently on offer.
Obviously, however, the quickest and surest way to maximize stockholder value is for HomeStreet to pursue a sale, but neither side is talking about that, yet anyway . . .
Second, HomeStreet is spending an incredible amount of time, energy and money on their battle with Roaring Blue Lion, all of which could clearly be better spent on trying to deal with the challenges in their business (or, as far as I am concerned, extolling the virtues of their business to potential suitors).
Third, I am relatively confident that Roaring Blue Lion will come out as the winner in this. My guess is that either they manage to secure enough votes to defeat the two HomeStreet directors who are up for election or HomeStreet decides to follow the first rule of holes and settles this by giving Roaring Blue Lion a board seat.
While I may be relatively confident that Roaring Blue Lion will come out as the winner, I am really confident in declaring HomeStreet (really its board and management) the loser. Not only has all this (including their own presentation materials) laid bare the fundamental flaws in their business—namely their over-dependence on mortgage and their inability to get their commercial and consumer banking business to scale before mortgage tanked—but the fight with Roaring Blue Lion is clear evidence of misplaced priorities.
I appreciate how HomeStreet’s management and board might have resented Roaring Blue Lion’s demand for a board seat. However, it would have been a lot easier, all things considered, to have just given them a board seat and avoid a costly and distracting proxy fight at what has turned out to be an incredibly inopportune time, particularly since Roaring Blue Lion’s influence once on the board could have easily been muted.
I guess it could be worse (at least for HomeStreet’s management)—Roaring Blue Lion could finally realize that the best path to really maximize stockholder value is through a sale . . .