Here's our latest public article about bank safety, initially published on Seeking Alpha, titled "Big Banks Have Massive Exposure: A Review Of The PacWest And Banc Of California Merger."
As part of our ongoing series of articles on bank stability, and at the request of many of our clients at Saferbankingresearch.com, we wanted to address the merger between PacWest (PACW) and Banc of California (BANC).
But before we begin, I want to take this opportunity to remind you that we have reviewed many larger banks in our public articles. But I must warn you. The substance of that analysis is not looking too good for the future of the larger banks in the United States. You can read about them here.
Moreover, if you believe that the banking issues have been addressed, I'm sorry to inform you that you likely only saw the tip of the iceberg. We were able to identify the exact reasons in our public article which caused SVB to fail well before anyone even considered these issues. And I can assure you that they have not been resolved. It's now only a matter of time.
So, let's move on to our view of the merger.
PacWest (PACW) and Banc of California (BANC) have recently announced an all-stock merger. BANC will be a legal acquirer in the deal, and, according to the press release, the combined bank will operate under the BANC name and brand. The structure of the deal suggests to us that both PACW and BANC had faced major issues, which forced the banks to do the merger.
The structure of the deal
As mentioned earlier, this will be an all-stock merger, and BANC will be a legal acquirer. BANC is smaller than PACW, as its total assets were $9B as of the end of the second quarter, while PACW’s assets were $38B. There will be a $400MM capital raise, which will be bought by Warburg Pincus and Centerbridge Partners. In addition, there will be a $7B sale of assets, which include BANC’s single-family mortgage loans, multifamily loans, its securities portfolio, and PACW’s available-for-sale securities. Reuters reported that $1.8B of BANC’s loans will be acquired by JPMorgan (JPM). The proceeds from the capital raise and the sale of the assets, as well as excess cash from the combined bank, will be used to repay $13B of PACW’s wholesale borrowings.
PacWest’s business model is similar to that of Silicon Valley Bank
There are a lot of similarities between PACW’s business model and that of Silicon Valley Bank. First, as the table below shows, 47% of PACW’s total deposits are Venture Banking Deposits and Wholesale Deposits.
Second, PACW’s share of uninsured deposits was 52% as of the end of 2022. Although this share decreased to 29% as of 1Q23, we note that this decline was due to a massive deposit outflow.
Finally, as the table below shows, PACW has significant exposure to available-for-sale securities.
As a result of these issues, PACW had to raise expensive wholesale funding. The weighted average rate of these borrowings was more than 5%, just a tad below its average loan yield. Obviously, any bank will fail in the medium term with such interest spreads.
Banc of California has its own issues
Following the announcement of the deal, some experts said that PACW was rescued by BANC, as it's a much stronger bank with a healthy balance sheet and a better business model. We disagree with that opinion as a deeper look reveals that BANC also faced quite a lot of issues and would likely fail in the medium term without this merger.
According to the table, BANC will sell $3.4B of its loans and $1.2B of its securities.
If we take a look at BANC’s latest 10-Q, we will see that the bank faced a spike in its funding costs while its loan yield increased quite moderately. The average cost of its interest-bearing liabilities grew from 42 bps for 1H22 to 261 bps for 1H23, but its real estate loan yield increased just by 32 bps over the same time period. The numbers show that BANC was trying to improve its asset yield by granting higher-risk C&I loans, as the average yield on its commercial loans increased from 4.98% to 7.97%. While it did have a positive impact on the bank’s net interest margin, that made its loan mix riskier.
BANC also has a very risky securities portfolio as 41% of the book are structured financial products. By comparison, the respective share of its peer group is just 2%. We would not rule out that there were some issues with these products given higher market rates, and these risky securities also will likely be sold in the process of the merger.
We believe that this deal is another sign that a lot of U.S. banks are facing major issues in the current environment. According to media reports, around $2B of BANC’s loans will be bought by JPMorgan. So far, the troubled banks have been rescued by either the FDIC or larger banks.
However, it's worth once again mentioning that the Deposit Insurance Fund balance was $116 billion as of 1Q23, or less than 1% of total deposits in the U.S. banking system. At the same time, larger banks have their own issues, which are likely to have much more negative consequences than the recent banking crisis. These issues were discussed in detail in our previous articles.
At the end of the day, we're speaking of protecting your hard-earned money. Therefore, it behooves you to engage in due diligence regarding the banks which currently house your money. You have a responsibility to yourself and your family to make sure your money resides in only the safest of institutions. And, if you're relying on the FDIC, I suggest you read our prior articles which outline why such reliance will not be as prudent as you may believe in the coming years.
It's time for you to do a deep dive on the banks that house your hard-earned money in order to determine whether your bank is truly solid or not. The methodology is here.