2024-01-18 07:18:11 ET
Summary
- HomeStreet stock gained +38.07% in a single day due to a merger agreement with FirstSun Capital Bancorp.
- FirstSun is a more solid bank with higher net interest margin and market cap.
- The merger will create a new entity with total assets of approximately $17 billion and operational cost savings.
We entered the regional bank quarterly period and HomeStreet (HMST) surprisingly gained +38.07% in a single day. The motivation was not a flawless quarterly (Q4 2023 is due on January 29) but the news of the merger to FirstSun Capital Bancorp (FSUN) to create a new entity with more weight in the US banking system.
In this article, I will show you the details of the agreement and what it will entail.
The context in which this agreement was reached
Before covering the details of the agreement, I think it is useful to understand the context in which it took place.
As you can gather from my previous articles on HomeStreet, the bank was in trouble because of the rapidly rising cost of liabilities. Deposits were no longer cheap and it was forced to borrow at current market rates. At the same time, the increase in the yield on loans did not offset the increase in the cost of liabilities, and as a result the net interest margin gradually declined.
This issue was manifested as early as the first Fed Funds Rate hike, and until the previous quarter this bearish trend did not stop: we will see in a few weeks whether in Q4 2023 the bottom was reached. From 3% net interest margin, HomeStreet deteriorated to 1.74% during the nightmarish biennium 2022 - 2023. In fact, from the highs of January 2022, the price per share collapsed up to 93%.
Based on this complex situation, in my previous articles I had highlighted all my concerns about it, rating HomeStreet as too risky an investment and therefore to be avoided. In hindsight my timing was bad, but the issues of the past remain. However, the agreement with FirstSun may be a game changer.
FirstSun is a bank with a branch network in Texas, Kansas, Colorado, New Mexico and Arizona and mortgage capabilities in 43 states.
- It has a market cap of $842 million, about 4 times that of HomeStreet.
- It has total assets of $7.75 billion, HomeStreet's $9.45 billion.
- Unlike HomeStreet, its net interest margin has remained high throughout the Fed Funds Rate hike: 4.23% in Q3 2023 vs. 4.26% in Q3 2022.
This last point explains why FirstSun has 4 times the market cap even though it has fewer total assets. The market sees it as more solid overall, mainly due to a rather low cost of deposits. Moreover, its TBV per share is steadily increasing, while HomeStreet is still far from the levels reached in 2021.
In short, between the two banks FirstSun is more solid, which is why HomeStreet is worth less. Once the merger is completed, the latter will continue to operate under its trade name in current markets.
The details of the agreement
The two companies will merge under an all-share agreement, so no monetary amount is included.
- HomeStreet shareholders will receive 0.4345 of a share of FirstSun common stock for each share of HomeStreet common stock. Which means that each share of HomeStreet was valued at $14.75 per share, 37% higher than the closing price on January 12, 2024. This explains the +38% in a single day.
- The parties expect the completion of the merger to occur in mid-2024, and the combined entity will be listed on NASDAQ upon closing.
- To raise capital to support the merger, FirstSun has entered into agreements with investors led by Wellington Management. In total, $175 million shares of common stock will be issued to them: $80 million will be issued to Wellington immediately after the merger announcement and the remaining $95 million will be issued in conjunction with the closing of the merger.
Once the merger is completed, the ownership of the combined company will be as follows:
- Shares issued to HomeStreet shareholders should account for 22%.
- Shares issued to Investors are expected to account for 14%.
- The remaining 64% will be held by FirstSun's ordinary shareholders.
What this agreement implies
This agreement implies that the new combined company presumably operational in 2025 will have the following characteristics:
- Total Assets of approximately $17 Billion.
- Tangible Common Equity at Closing of approximately $1.2 Billion.
- Common Equity Tier 1 Capital Ratio of ~ 9.1%.
- Net Interest Margin of ~ 3.9%. So, closer to FirstSun's current than HomeStreet's.
- Return on Average Tangible Common Equity of ~ 17%.
- EPS increased by 30% over FirstSun's current EPS.
As far as I am concerned, I am quite optimistic about this merger. Beyond having a larger role in the U.S. banking system, the new entity will be able to take advantage of the synergies of the two component banks and this could lead to a number of operational cost savings as well as new opportunities to be exploited.
We are excited to be an anchor investor in the creation of a new $17 billion asset bank serving customers in high growth markets in the US. We believe bringing together these companies and combining their management teams will bolster the scale and diversification of their business and create greater value for shareholders.
Nick Adams, portfolio manager, Wellington Management.
In fact, FirstSun's Southwest presence will be joined by HomeStreet's presence in Southern California, Hawaii, and other key Pacific Northwest markets. The new entity will thus be a premier regional bank operating in the Southwest and the West Coast. In all, there will be 129 branches in some of the most attractive markets in the United States-this merger seems to make sense.
HomeStreet was struggling badly in the current macroeconomic environment, but by merging with FirstSun it could gradually recover. Should rates be cut earlier than expected, the recovery could be even faster. On the other hand, FirstSun carried out the entire transaction by issuing shares, so it did not impact its liquidity. Moreover, it secures a bank at a relatively cheap price: it is true that it paid a premium of 37%, but HomeStreet is still 74% far from its all-time high. Moreover, even after the recent rise, the Price/TBV per share remains quite low: 0.57x vs. 10-year average of 1.05x.
For further details see:
Strategic Merger Between HomeStreet And FirstSun: Everything You Need To Know