KBRA Places Ratings for HomeStreet, Inc. on Watch Upgrade Following Merger Announcement

KBRA places the ratings of Seattle, Washington-based HomeStreet, Inc. (NASDAQ: HMST) ("HomeStreet" or "the company") on Watch Upgrade, including the senior unsecured debt rating of BBB-, the subordinated debt rating of BB+, and short-term debt rating of K3 following the recently proposed merger announcement with Mechanics Bank ("Mechanics"). In addition, KBRA also places the ratings of HMST's lead subsidiary, HomeStreet Bank, on Watch Upgrade, including the deposit and senior unsecured debt ratings of BBB, the subordinated debt rating of BBB-, and the short-term deposit and debt ratings of K3.

Key Credit Considerations

On March 31, 2025, Mechanics Bank—a privately owned institution majority-owned by the Ford Financial Fund—and HomeStreet, Inc., the holding company of HomeStreet Bank, announced that they had entered into a definitive merger agreement to combine in an all-stock transaction expected to close in the third quarter of 2025, subject to customary regulatory approvals. The transaction is structured as a reverse merger: HomeStreet Bank will merge with and into Mechanics Bank, with Mechanics treated as the accounting acquirer while HomeStreet is considered the legal acquirer. Existing shareholders of Mechanics Bank will receive newly issued shares of HomeStreet common stock, resulting in Mechanics shareholders owning approximately 92% of the combined company. The transaction valued HMST at ~$300 million. Upon completion of the merger, HomeStreet, Inc. will be renamed Mechanics Bancorp and remain a publicly traded company. The pro forma Board of Directors and Executive Leadership Team will remain predominantly composed of Mechanics representatives, with Carl Webb continuing as Executive Chairman and C.J. Johnson as CEO. HomeStreet is expected to appoint one director to the nine-person board, and Mark Mason, HomeStreet’s current CEO, will be retained as a consultant for two years.

The announcement of the merger was not unexpected following the termination of the previously announced merger agreement with FirstSun Capital Bancorp (KBRA senior unsecured debt rating: BBB / Stable Outlook) in the fourth quarter of 2024. In the aftermath, HomeStreet’s management expressed a clear intent to continue to consider alternative strategic options, including a potential sale of the company. KBRA views the proposed combination with Mechanics Bank favorably, noting that Mechanics is a larger institution with a stronger credit profile, and that the current regulatory environment appears more conducive for approval. Collectively, these factors support an increased likelihood of the transaction receiving regulatory approval and reaching a successful close. Notably, the Ford Financial Fund—expected to maintain a 74% ownership stake in the combined company at closing—has a demonstrated track record of regulatory execution, having secured approval in six months or less for each of its last four bank acquisitions since 2015. The combined institution is projected to have approximately $23 billion in pro forma assets and would rank as the third-largest West Coast and California-based bank by deposits (among banks headquartered in California, Oregon, and Washington with less than $250 billion in total assets), with nearly $19 billion in deposits across a 168-branch footprint. The combined entity is also expected to maintain meaningful deposit market share, ranking third overall in both the Seattle and San Francisco MSAs, based on the same peer group criteria.

Following deal close, the pro forma company is expected to reflect a favorable liquidity and funding profile. This will be supported by the anticipated balance sheet restructuring, in which Mechanics’ leadership team intends to run off approximately $2.0 billion of HomeStreet’s noncore and higher-cost funding sources, which is expected to be facilitated by excess liquidity at Mechanics and the liquidation of HomeStreet’s securities portfolio. As a result, the pro forma company is expected to have a loan-to-deposit ratio of 78% and cash and securities representing 25% of total assets at closing—both of which compare favorably to the higher-rated peer groups. Furthermore, the company is expected to be entirely core deposit funded, with no brokered deposits or FHLB advances outstanding. The deposit mix is projected to remain strong, with noninterest-bearing deposits comprising approximately 35% of total deposits. In addition, the granularity of the deposit base—reflected in Mechanics Bank’s average account size of $45,000—should support a relatively low deposit beta. Notably, Mechanics has demonstrated a cumulative deposit beta of 28% during the current interest rate cycle, and management forecasts a cost of funds of approximately 1.40% by 4Q25, down significantly from 3.27% for standalone HomeStreet.

With respect to loan composition, the combined institution is expected to maintain a high concentration in CRE, which is projected to represent approximately 55% of total loans, or 390% of total risk-based capital at closing. However, this exposure declines meaningfully when excluding multifamily loans, which are expected to comprise 36% of total loans. On an adjusted basis, investor CRE concentration excluding multifamily is estimated at 119% of total risk-based capital. Importantly, both HomeStreet and Mechanics have demonstrated strong performance in their multifamily portfolios. HomeStreet has not experienced any charge-offs in this segment since it began originating multifamily loans over 30 years ago—a testament to its historically conservative underwriting. Similarly, Mechanics has exhibited disciplined credit practices in the segment, with an average LTV of 52% and DSCR of 1.65x. Looking ahead, management plans to reduce overall CRE concentration over time—targeting levels below 300%—and is also exploring strategic options related to HomeStreet’s Fannie Mae DUS license. Outside of multifamily, Mechanics' conservative credit culture is also reflected in the C&D and broader CRE portfolios, where the bank has reported NCO ratios of less than 5 basis points, excluding acquired loans, over the last ten years. That said, Mechanics has experienced a slightly higher NCO ratio compared to similarly sized peers in recent years, though we recognize that this is largely due to its auto portfolio, which is currently in runoff. This is expected to be completed within the next 3–4 quarters, with servicing being outsourced in 2Q25 ahead of a potential sale of the book.

Office exposure across both banks is considered manageable, comprising slightly more than 5% of total loans. Mechanics’ underwriting standards remain strong in this segment as well, with average LTVs and DSCRs consistent with those in multifamily lending (52% and 1.65x, respectively). These conservative underwriting practices are further supported by the $85 million credit mark taken against HomeStreet’s loan portfolio, which equates to 2.3x the bank’s existing reserve of 0.62% of total loans as of 4Q24. This adjustment was informed by an extensive due diligence process conducted by Mechanics and several reputable third-party advisors. Post-mark, the combined company is projected to hold reserves of approximately 1.0% of total loans—a level that appears adequate given the risk profile of the loan mix and comparable peer institutions.

The combined institution is also expected to maintain a strong loss-absorbing capacity, underpinned by robust earnings capacity and a solid capital base, including a projected CET1 ratio of 12.4% at close, in spite of the meaningful interest rate marks being recorded (~$200 million HMST's loan portfolio) and HomeStreet's weaker capital position (CET1 ratio of 8.6% at YE24). However, the combined company’s planned capital return strategy warrants continued monitoring given its elevated dividend payout target and the potential impact on retained earnings. While internal capital generation may be constrained, this is partially offset by the expectation for shrinking the balance sheet—consistent with the historical trajectory of several Ford Financial Fund-owned banks. Additionally, the company has no current plans for share repurchases or incremental bank M&A activity. The dividend strategy is expected to remain variable and earnings-driven, with a target payout ratio of 90% or higher. Despite the high payout, management anticipates that the CET1 ratio could increase to approximately 14.0% by year-end 2026, aided by earnings retention and balance sheet deleveraging.

As outlined in prior publications, HomeStreet has faced material profitability challenges, including operating losses in both 2023 and 2024. These losses were primarily driven by asset-liability management and interest rate risk issues, which led to significant NIM compression. In contrast, Mechanics Bank has consistently delivered strong performance, with ROA averaging 1.1% from 2021 to 2023. While 2024 results were impacted by securities sales and associated losses, core earnings remained broadly in line with historical levels. Many of HomeStreet’s NIM-related pressures are expected to be resolved through purchase accounting. The loan portfolio will be marked to fair value, and a significant portion of high-cost, noncore funding is expected to be repaid using proceeds from HomeStreet’s securities portfolio and Mechanics’ excess liquidity. As a result, the pro forma earnings power of the combined institution is anticipated to be peer-leading, with management projecting a 2026 ROA of approximately 1.4% (and 1.5% during 2027). This projection reflects both the anticipated balance sheet repositioning and full realization of pre-tax cost savings totaling $82 million, or roughly 42% of HomeStreet’s standalone expense base. That said, KBRA acknowledges that revenue diversification is expected to remain modest relative to larger and higher-rated peers. Noninterest income at Mechanics has historically accounted for just over 10% of total revenues. In addition, the potential sale of HomeStreet’s Fannie Mae DUS license and the strategic shift away from gain-on-sale mortgage income are expected to create headwinds to fee income generation. However, management has outlined plans to invest in and expand its wealth management division, which could contribute to improved revenue diversity over time.

Rating Sensitivities

The Watch Upgrade for HomeStreet’s ratings reflects the expectation that the proposed transaction will receive the necessary regulatory approvals and close in a timely manner. It also recognizes that HMST will be merging with and into a larger, more diversified institution. The Watch Upgrade is further supported by the view that Mechanics Bank—while not currently rated by KBRA—would likely carry higher ratings than HomeStreet, given its stronger financial profile and balance sheet positioning. The Watch Upgrade also incorporates the assumption of effective post-merger integration and achievement of the combined company's stated financial targets across earnings, capital, funding, and liquidity metrics. KBRA believes that these outcomes are highly likely, given Mechanics Bank’s historical execution and the long-standing track record of the Ford Financial Funds. As such, if the transaction closes as expected, KBRA anticipates that HomeStreet’s ratings would be upgraded from current levels. Conversely, if the transaction is terminated, HomeStreet’s ratings would likely remain at current levels, potentially with the continuation of a Negative Outlook.

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