KW - A Home Run For PacWest Bancorp And Ares Management

2023-06-28 10:36:37 ET

Summary

• PacWest Bancorp has entered into an agreement to sell a large portion of their Lender Finance portfolio to Ares Management Corporation to boost liquidity and pay down debt, following a significant drop in their share price due to the banking sector's uncertainty.
• The agreement includes selling off loans with aggregate commitment amounts totaling $3.54 billion, which will help PacWest Bancorp improve its financial condition, particularly by reducing its high-interest borrowings that have been impacting its bottom line.
• The transaction also benefits Ares Management by providing a significant increase in the company’s exposure to alternative credit activities, which it has identified as a high-value target and a significant growth area for individual investors in the private wealth area over the next several years.

Although there have not been any meaningful bank failures recently, concerns still exist over the health of the banking sector following the collapse of some beginning in March of this year. Most of the bank stocks that I have looked at over the past month have shown some signs of recovery from a share price perspective. But none of them has recovered their pre-crisis price.

One of the firms that has been deemed most susceptible to the uncertainty plaguing the sector is PacWest Bancorp (PACW). But hopefully for those who are long the stock, the most recent maneuver made by management should help to put to bed, once and for all, any fears that the bank might ultimately fall apart.

Another move aimed at boosting liquidity

Shares of PacWest Bancorp closed up 4% on June 26th after news broke that the regional bank entered into an agreement to sell off some additional assets in order to boost liquidity and pay down debt. With the exception of the banks that ultimately collapsed as a wave of customer withdrawals swept the industry starting in early March of this year, PacWest Bancorp has seen its share price negatively impacted more than perhaps any other player. From the end of February of this year until shares bottomed out, the stock dropped as much as 91.1%. Even today, after staging a remarkable recovery from that bottom, the stock is still down 72.9%.

Along the way, management has embarked on a number of interesting moves aimed at increasing confidence in the financial institution and ensuring that a collapse of it will not take place. The latest example of this was announced on June 26th in a press release wherein management revealed that they agreed to sell a large portion of their Lender Finance portfolio to Ares Management Corporation (ARES). For clarity, this particular portfolio of assets largely consists of loans that are made to companies for the purpose of purchasing finance receivables or to extend finance receivables to the underlying obligors.

This is a rather nuanced corner of the finance realm. So, a little bit of additional detail is warranted. When companies engage in revenue-generating activities, they are not always paid immediately. This creates a receivable on their balance sheet that they then reduce as they are paid for services they completed. Companies often value immediate liquidity. So when that is the case, they will often sell those receivables at a discount to some other party, leaving that party with some or all of the risk of collecting payment and granting the originator of the receivable a lump sum cash payment.

PacWest Bancorp enters into this picture by giving firms the ability to borrow the proceeds they need in order to acquire these receivables. Often, the borrowers in question are lenders to small businesses, commercial real estate lenders, consumer lenders, and even timeshare operators. The loans that PacWest Bancorp gives out are almost always structured as revolving credit facilities, and they usually mature between one and three years out from the date of issuance.

Given the structure of these receivables, there are two primary components that deserve attention. The first would be the principal balance already borrowed. And the second would be a commitment that the borrower of the loan can tap into for the purpose of acquiring additional receivables. In this particular arrangement with Ares Management, PacWest Bancorp has agreed to sell off loans with aggregate commitment amounts totaling $3.54 billion. This includes an aggregate outstanding principal balance of $2.21 billion, with the remainder coming in the form of untapped capacity.

The deal in question will close in multiple tranches. The first of these already closed on June 22nd and involved $2.07 billion worth of principal balance loans and $187.14 million out of the $1.33 billion of unfunded commitments. The company got very close to full value on these assets, receiving gross proceeds before transactions costs of $2.01 billion. This on its own is incredibly bullish for shareholders. After all, companies that are in a state of financial distress often have to sell their assets off at significant discounts to what they would normally be worth. This is not an example of that taking place.

Even though details were never set in stone and the transaction was never guaranteed to take place, it was very likely that this maneuver was going to happen. I say this because, during its first quarter earnings release, management announced that it was transferring $2.7 billion of its Lender Finance portfolio from Held-to-Maturity status to Available-for-Sale status. This only happens when a company plans to sell off or otherwise monetize the assets over the next 12 months or less.

The objective here is really for the company to improve its financial condition. We don't know what kind of interest rate it was receiving on these loans. But we do know that it does have a good amount of borrowings to pay back. At the end of the most recent quarter, the company had $11.88 billion worth of debt on its books. That was up from $1.76 billion reported one year earlier. The $5.45 billion of Federal Home Loan Bank lending that it had it came at a 5.07% annual interest rate. The interest rate for the Bank Term Funding Program was a bit lower at 4.38% and totaled $4.91 billion. The company also had $1.39 billion worth of repurchase commitments at an 8.50% interest rate. And it had $128.38 million worth of credit linked notes at an annual interest rate of 15.24%.

These high interest borrowings were set to materially impact the company's bottom line. The weighted average borrowings that it had during the first quarter of the year came out to $5.29 billion. That resulted in the net interest margin for the company declining to 2.89% compared to the 3.41% that it had during the final quarter of its 2022 fiscal year. There is no doubt that keeping such a large balance on its books would make that picture in the second quarter even more painful.

Of course, we also need to keep in mind that the company still has uninsured deposits that could be susceptible to a bank run. I don't believe this is highly likely. But only 71% of its deposits as of the end of the most recent quarter were insured. This marked a significant improvement over the 48% that the company had classified as insured at the end of the 2022 fiscal year. But that improvement came at a cost of a $5.7 billion plunge in overall deposits for the company.

This is not the first maneuver that the company has made like this. In late May of this year, the company struck a deal with Kennedy-Wilson Holdings ( KW ) whereby Kennedy-Wilson agreed to purchase $2.6 billion worth of real estate construction loans from PacWest Bancorp in exchange for $2.4 billion. If it sounds like the company is taking a random approach to which assets it offloads, I can assure you that's not the case. Management even stated that their goal is to get rid of the more exotic financing activities that they have been engaged in. Instead of focusing on those areas, they hope to focus their efforts moving forward on more traditional community banking activities.

PacWest Bancorp is not the only winner from this transaction. Ares Management also stands to benefit. You see, in its latest investor presentation , Ares Management estimated that the alternative investments category should prove to be a significant growth area for individual investors in the private wealth area over the next several years. In 2022, $4.2 trillion globally we're invested in alternative investments for individual investors. That number is expected to grow to $12.8 trillion by 2032. This particular portfolio of assets falls right in that space. And it just so happens that this is a space that the company has identified as a high value target for it. The overall addressable market associated with credit is estimated to be $10.9 trillion.

At this time, Ares Management has about $235 billion worth of assets under management dedicated to this niche. But when it comes to alternative credit specifically, that number is only $24 billion. While small, the amount that they have now represents a 38% annualized growth rate over the $5 billion that the company had as of the end of the first quarter of its 2018 fiscal year. In fact, of all the different categories that Ares Management broke their assets under management into, this has been the fastest growing niche for the business. So even though this transaction is small on its own relative to the overall portfolio size of Ares Management, it actually will significantly increase the company's exposure to alternative credit activities, helping it to meet its growth goals moving forward.

Takeaway

From what I can tell, PacWest Bancorp and Ares Management are both experiencing a win-win situation in this environment. On the one hand, PacWest Bancorp gets to raise some much-needed liquidity and can use that to reduce debt and, hopefully, increase its net interest margin. On the other hand, Ares Management gets a nice little injection of capital that it has been prioritizing as a growth area for the past few years. At the end of the day, I see this as nothing but a positive for both firms.

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