AUG 1, 2013 1:30pm ET

HomeStreet Joins Banks on Rebound in Pacific Northwest

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HomeStreet in Seattle is hoping two recent deals will help make the "home" part of its name a little less important.

Its agreements to spend $37.3 million for Fortune Bank in Seattle and Yakima National Bank in Washington would help the home lender diversify into commercial lending. Moreover, they have punctuated its makeover.

HomeStreet recapitalized itself in 2012 by going public, and earlier this year the Federal Reserve freed it from a written order that capped the mortgage lender's escape from the brink of destruction. The $96 million in equity the company raised in its initial public offering was intended to fix the bank and give it a budget to remodel itself through acquisition.

"Most of our earnings historically have come from mortgage banking," CEO Mark Mason said Tuesday. "We are trying to balance the business by growing our traditional commercial business lines to equal that of the mortgage business."

HomeStreet joins a group of recapitalized banks that are using investor money for deals that alter their profiles. There are such banks across the country, but HomeStreet finds itself in particularly good company in the Pacific Northwest with banks like Sterling Financial and AmericanWest Bank, both in Spokane, Wash.

With several acquisitions completed, those other banks have entered a new phase where they are pruning extraneous branches. HomeStreet's recapitalization came significantly later than AmericanWest's or Sterling's, but it is turning that timing to its advantage, too. It is set to acquire two branches from AmericanWest in the fourth quarter.

"What you are seeing in all of these is this: they did a turnaround, now they are trying to put their capital to work," says Stephen Klein, an attorney at Graham & Dunn in Seattle, which represented Fortune Bank in the deal. "They are all trying to gross up earnings by taking advantage of consolidation and driving efficiencies."

Many of the recapitalized banks are motivated to increase assets and earnings at the urging of their investors, who will eventually want to cash out, Klein says.

For the $2.7-billion-asset HomeStreet, the deals are nominally small—Fortune has $142 million in assets, while Yakima has $125 million in assets.

However, Mason argues that they have a greater value.

Both have sizable portfolios of commercial and industrial loans and owner-occupied commercial real estate loans. They make up 60% of Fortune's overall lending, and 43% of Yakima's. The additions would increase HomeStreet's commercial slice to 16% from 11%, while decreasing one-to-four family mortgages to 52% of its total from 58%.

The commercial business could also grow quickly once the deals close, say the sellers, because their lenders will be able to pursue larger credits.

"All of our relationship officers…are used to dealing with larger deals and we'll be able to do that as soon as we close the merger," said David Straus, chief executive of Fortune, during a conference call on Monday. "Together with Jeff Newgard here at Yakima National Bank we can continue to build a great business banking group or commercial banking group at HomeStreet."

Paul Miller, an analyst at FBR Capital Markets, called the deals a good way of "reinvesting excess capital to get a better earnings stream."

The deals coincided with a shift in the mortgage market. In 2012, HomeStreet's mortgage focus led to earnings of $82.1 million, up fivefold from 2011. However, with long-term interest rates rising, the company's earnings growth stalled last quarter.

On Monday, it reported second-quarter earnings of 82 cents per share, compared with Wall Street's expectation of 86 cents per share. The earnings miss may have excluded HomeStreet from the recent trend of buyer's stock rising upon deal announcements.

Instead, its shares fell 4.77% on Monday, to $21.72. The stock rallied a bit before settling back to $21.70 at the close Wednesday. Mason said he expected the stock to rise after the deal announcements late Friday, but noted that it has risen from $19.76 at the end of the second quarter.

"I was a little surprised by [Monday's] price performance," Mason said. "Our results fell short of what shareholders may have anticipated…but I think our stock price is reasonable in light of everything."

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