Three years ago, it seemed there were more regulators paying attention to HomeStreet Inc. than investors.

The Seattle banking company had a so-called Texas ratio nearing 200% (industry observers consider 100% a sign of possible failure). Few were willing to bet on its survival.

"We knew we were going to have to substantially turn the institution around to be attractive to public markets," says Mark Mason, the company's vice chairman and chief executive. "Though it looked very uncertain at the time, we were able to accomplish that."

Last month, investor demand outstripped the supply of shares in HomeStreet's $96 million initial public offering. Moreover, the transaction will likely rescue HomeStreet from a cease-and-desist order and put it back in the housing game.

"We intend to start growing our balance sheet again" with single-family mortgages, Mason says. "We're going to be hiring more lenders and expanding our retail branch system."

HomeStreet was the first bank to go public since BankUnited Inc. raised $900 million in January 2010. There have been successful private recapitalizations, but HomeStreet is the first since the financial crisis to recapitalize with an IPO. Though HomeStreet is an unusual case, investment bankers hope the move signals a renewed investor appetite for community banks.

"We're seeing an interest finally coming back to the small" banks, says Rick Levenson, president of Western Financial Corp. in San Diego. "If we can get capital going into bigger" community banks like HomeStreet it will start "reaching down to the next level and eventually, start feeding its way down to the small banks."

It won't be easy. Mason can attest to that. After its first IPO filing in May, HomeStreet suspended its offering in August and again in December because of market fallout and uncertainty.

During the company's first road show in late July through early August "every single day we were on the road, the market went down, and two of those days" the decline was more than 5%, Mason says. "That was just bad luck, because we had tremendous interest in the bank's offering."

FBR Capital Markets, HomeStreet's sole investment bank, had experience handling delayed deals and IPO-driven recapitalizations during the savings and loan crisis. FBR's president and CEO, Richard Hendrix, says his firm knew it would be challenging but not impossible to pull off the recapitalization.

"There's a difference between getting something done and getting something done well," Hendrix says. "In this case, waiting until we could get it done well benefited everybody."

HomeStreet entered the crisis with half its loan book in residential construction, and half of that category was raw land and development loans, says Mason, who joined the company in late 2009 as a turnaround specialist. At that time, HomeStreet had fallen under a cease-and-desist order and more than 14% of its assets were nonperforming.

"There were a number of things that had to be done, but at the top of the list was repairing or stabilizing the regulatory relations," Mason says. "Let's face it, at that juncture, they are your most important constituency and the shareholders really have to take a backseat."

Mason first created performance reports and goals that HomeStreet discussed monthly with its three regulators. Mason also helped retrain staff to get rid of nonperforming assets as quickly as possible, rather than waiting for market improvements and better pricing.

"In a falling market when you need to shrink the balance sheet to stay capital compliant … you have to meet what the market is willing to give," he says. "Waiting for a better price often results in a worse price."

In 2009, HomeStreet's classified assets peaked at $760 million, or more than one-fifth of total assets. At the end of 2011 the number was $188 million, or 8% of total assets. Total nonperforming assets were cut in half, to 5.1% of total assets at Dec. 31 compared with a year earlier.

Monthly meetings with regulators have continued. Mason says transparency, paired with surpassing monthly goals, led regulators to give them more time to raise capital, even though a public offering sometimes seemed to be a risky proposition.

"Asking [the regulators] to consider an unusual or alternative approach can be challenging unless you have credibility. And credibility was earned," Mason says.

HomeStreet also had to earn credibility with investors by continuing to show that it could surpass performance targets despite two failed attempts to go public last year. In the end, it was the company's mortgage business — the same area that received a black eye from the financial crisis — that made HomeStreet attractive to investors.

"Without its mortgage operation and the associated earnings, it would have been more difficult" to do an IPO, Hendrix says. "The earnings allowed them to charge the credit issues off at a more rapid rate than otherwise possible."

HomeStreet turned a $16.1 million profit last year after several years of net losses. For 2010 the company reported a loss of $34.2 million.

Existing shareholders benefited because they took on less dilution than they would have had HomeStreet gone to the market earlier.

By February, the company had recognized higher returns so it needed to raise less capital. HomeStreet restructured the initial public offering to include fewer shares at a higher price per share, which allowed its existing shareholders to retain a higher stake.

HomeStreet sold shares at 85% of tangible book value. For a distressed bank, industry observers say any offering near book value is a big improvement from a year earlier, when offerings were at half of book value or less.

Levenson says pricing is improving, however slowly, as more banks raise capital for offense rather than to repair credit losses.

Still, Levenson says he wrote a fairness opinion just last week for a California community bank that was considering an offering that he priced at 50% to 55% of tangible book value.

Pricing "hasn't changed very much but I do think it is changing," Levenson says. "You will see more and more banks trade at closer to book and more capital raises are going to be done that are less dilutive."

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