Regulators' sensitivity to commercial real estate and the higher-for-longer rate outlook led to FirstSun Capital Bancorp and HomeStreet Inc. amending their merger agreement.
The recently amended agreement includes a slew of changes, such as raising more capital in conjunction with the deal, lowering the exchange ratio and termination fee, and extending the expected closing time frame to late 2024 from mid-2024. Another major change is that FirstSun's unit Sunflower Bank NA will switch to a state-chartered bank and Federal Reserve member from its status as a national bank overseen by the Office of the Comptroller of the Currency (OCC).
FirstSun decided to switch to a state-chartered bank after initial discussions with the OCC made it clear that there would be hurdles to approval due to the companies' commercial real estate (CRE) exposure.
"In our discussions with the OCC in Washington, it became obvious that we would not gain near-term approval given their recent experience with multifamily and CRE positions," FirstSun President, CEO and COO Neal Arnold said during a call May 1. "We believe their position also resided in the fact that they were not the primary regulator for HomeStreet. The Fed is taking a very different approach, in part due to the changes we have made through the transaction."
The companies are hopeful the charter switch and other changes to the merger agreement will lead to a smooth regulatory approval process and a stronger pro forma combined company after recent operating environment shifts related to CRE and higher-for-longer rates.
CRE drives charter switch
Since the deal was announced mid-January, regulators have become more sensitive to banks' CRE and multifamily exposure, Arnold said. As a result, the companies decided to switch the charter of FirstSun's bank subsidiary away from the OCC, which is even more sensitive to CRE and multifamily issues right now.
"We believe the Fed and the state of Texas have a firm understanding of our business and the nature of our CRE risks," Arnold said. "Our belief is that CRE is not the same across all categories and all geographies. It's particularly distinguished when comparing West Coast multifamily and East Coast, New York multifamily. We've had a significant interaction with the state of Texas and the Fed, and we believe there's a pathway for this merger application to be approved."
The OCC is likely more sensitive to CRE and multifamily exposure due to recent issues surrounding New York Community Bancorp Inc., Piper Sandler analyst Matthew Clark said in an interview. The agency is likely not differentiating between multifamily portfolios in New York versus the West Coast, whereas the Federal Reserve and Texas regulators understand better or are more willing to differentiate, Clark said.
There are likely to be more instances of banks switching charters to aid deal approvals, Clark said, adding that the OCC is considered the "more challenging regulator to deal with."
In another attempt to aid the approval process, FirstSun expects to reduce its CRE concentration by about $300 million. As a result of the reduction and the company's planned capital raise, FirstSun's CRE to total risk-based capital ratio will be about 385% at close, down from about 425% when the deal was announced, and will go down toward 300% in 2025 and 2026, CFO Robert Cafera said.
"This could be the new norm in terms of reducing your CRE concentration closer to that 300% threshold that we've all known about but has been somewhat flexible in years prior," Clark said.
Raising capital
When the deal was announced, FirstSun said it would raise $175 million
Moreover, changing the regulatory track should help the company easily raise more capital.
"Time is money, and they want clarity, and that's not really too much to ask for with contracting private parties with private capital on the line," former acting Comptroller Keith Noreika, now chairman of the banking supervision and regulation group at Patomak Global Partners, said in an interview.
The company is working with the original investor group to secure the additional $60 million in private capital, and it has all but $15 million of that additional cash secured so far, the CFO said on the call. The company has not yet started the sub debt issuance but "we have already had several inquiries as to getting on the list for that subscription," Cafera said.
Purchase price reduction
The banks also changed their exchange ratio to 0.3867 FirstSun share per HomeStreet share, a reduction of about 11% as a result of the higher-for-longer impact on HomeStreet's net interest margin (NIM) and bottom line, executives said.
"Obviously, with a change in our rate forecast, there's impacts on funding cost for HomeStreet. In addition to which, we continue to see somewhat higher migration from lower-cost products, the higher-cost products. And if we extend that forward somewhat, it continues to have a more negative impact on our net interest margin," HomeStreet's Mark Mason said on the call. "Beyond that, we're not seeing blue sky in our single-family mortgage business from a noninterest income standpoint. And if you extend that far, they're similarly detrimental to the next couple of years in net income."
HomeStreet's NIM declined to 1.42% in the first quarter from 1.62% in the linked quarter, according to S&P Global Market Intelligence.
"The profitability at HomeStreet's worse than expected given the fact that rates are higher and not expected to come down as much," Piper Sandler's Clark said. "HomeStreet, on a standalone basis, desperately needs rate cuts."
Termination fee reduction
Another change in the updated merger agreement is that HomeStreet would only have to pay $2.6 million if the deal were terminated, in addition to reimbursing FirstSun's transaction fees and expenses, under certain circumstances if it gets a competing proposal within 30 days after the amendment. Otherwise, the termination fee would still be $10 million, as in the original agreement.
That move is likely FirstSun's way of saying "'If there's someone else out there that thinks they can pay a better price, we're not going to get in the way,'" said John Gorman, partner at Luse Gorman PC who represents financial institutions on M&A, regulation and other topics.