PacWest (PACW) has built a name for itself gobbling up traditional banks, but its deal for CapitalSource (CSE) shows how that strategy may not be enough — for anybody.
Unquestionably PacWest's $2.3 billion agreement to buy CapitalSource, a commercial finance company, is a great match. The market embraced its promising metrics, including a strong tangible book accretion and eye-popping earnings projections.
A lot will be made, and justifiably so, about how the deal fulfills CapitalSource's goal of becoming a full-fledged bank. It has a lot of loans and an industrial loan company charter, and it needed more of the low-cost funding that a depositary institution brings.
Yet PacWest would not have agreed to pay the highest price for a U.S. bank deal in nearly a year if it didn't have equally strong imperatives.
"All of us know how frustrated these guys are by the slow economy," says Chris Marinac, an analyst at FIG Partners. "It is like a Nascar driver sitting in a 35 mile-per-hour zone."
PacWest executives have appeared restless, or perhaps disillusioned, with acquisitions — at least ones involving other community banks.
In a research note late last year, Sandler O'Neill analyst Aaron James Deer said after a meeting with executives that although their search for a deal was ongoing, nothing promising seemed to be on the horizon. Management found issues with nearly every potential target investors suggested.
Meanwhile, PacWest has struggled to produce loan growth. Its loans contracted 3.3% in the first quarter, and would have shrunk again in the second quarter had the company not completed its acquisition of First California Financial Group (FCAL) in the quarter. Also, its loan-to-deposit ratio at the end of the quarter was 80%.
Matt Wagner — in his first conference call in more than a decade as chief executive of PacWest --said during a conference call Wednesday that loan growth has been tough in light of the company's refusal to sacrifice margin. And he didn't want to buy a bank suffering the same problems.
"Most of the community banks you are looking at today, you've got anywhere from a 40% to 70% loan-to-deposit ratio," Wagner says. "You've got a big-buying portfolio that I don't need. I am going to end up with a bunch of excess deposits."
CapitalSource would help PacWest put its existing deposits to work and could once again make community bank M&A attractive to Wagner. CapitalSource, which lends across the country in a handful of different industries, reported loan growth of 6% in the second quarter from the previous quarter.
"With CapitalSource and their superior loan-generation platform, I've got that now," Wagner says. "If we buy a company with an under-leveraging balance sheet, I've got the ability to leverage that now into good, high-performing loans."
His counterpart offered, appropriately enough, complementary comments on the call.
"What we bring relative to the origination platform, coupled with what … PacWest brings with the branch network, is exactly what we have been looking for for shareholders," said Jim Pieczynski, chief executive of CapitalSource. "From my perspective it truly is a match made in heaven."
The market blessed it, too.
On Tuesday PacWest's stock rose nearly 8%, to $34.96, while CapitalSource was up 22% to $11.99.
Investors and analysts. The deal between the two Los Angeles companies was announced after the market closed Monday.
The $6.7 billion-asset PacWest agreed to pay 170% of tangible book value for the $8.7 billion-asset CapitalSource.
While CapitalSource has managed to produce loans, the pairing with PacWest brings the company the solid deposit base it has been trying to get since at least 2007 when the capital markets began to freeze.
As an industrial loan company, its funding is largely limited to certificates of deposit. CapitalSource's cost of funds was 88 basis points at the end of second quarter, while PacWest's was 17 basis points. The combined company's cost of funds is projected to be 31 basis points.
Still, PacWest laid out a three-year plan to wind down the deposits and get the cost down to where PacWest was before the deal.
The deal fits into a larger trend of banks looking to specialty finance companies, particularly those with national platforms, as a source for loan growth. Observers say this deal may ramp up that kind of activity.
"The market is cheering it on. All the messages that this deal is sending is an indication that we will see more like it," says Sameer Gokhale, an analyst at Janney Montgomery Scott. "It makes sense — they have the ability to originate loans, but don't have access to the types of deposits that banks have."
Analysts were exceedingly positive about its metrics, including 10% tangible book accretion, a rarity in the current acquisition market, and an 18% expected boost to earnings in 2015.