PPBI - Pacific Premier Bancorp Idling Ahead Of A More Supportive Macro

Summary

• Pacific Premier posted a "muddle through" sort of quarter, with lackluster spread growth but decent expense management.
• Management has been careful with underwriting standards for a long time, driving a below-average history of credit losses, but that means less active lending in this uncertain macro environment.
• Loan yields can still improve from here, but funding costs are likely to rise faster, pressuring spreads and top-line growth until the Fed eases off.
• Long-term core earnings growth of around 7% isn't enough to make this a compelling buy candidate now.

These aren't the best of times for Pacific Premier Bancorp ( PPBI ), as higher deposit costs and more caution on lending in the face of a more challenging macro environment is likely to limit core earnings growth over the next couple of years. While there are certainly multiple positives with Pacific Premier, including historically good credit and profitability, as well as the opportunity to leverage competitor acquisitions in its footprint to acquire employees and clients, the reality is that Street isn't likely to warm up to the name until there's more upside in view for spreads and loan growth.

There are a lot of things I like about Pacific Premier, and the bank has a good historical growth track record (close to 9% annualized tangible book value growth). The issue I have now is that I can't really push my model to a point where I find the valuation exciting - I can get to maybe 10% to 15% undervalued, but I question whether that's enough when a lot of quality banks are trading even more cheaply.

Near-Term Struggles Evident In Fourth Quarter Results

Pacific Premier's fourth quarter results underscore some of the near-term growth challenges that are likely to weigh on sentiment.

Revenue rose 4% year over year but was basically flat sequentially, missing by about 1% or $0.015/share relative to sell-side expectations. Spread income rose more than 6% yoy as reported, and was almost flat sequentially, with net interest margin up just 8bp yoy and flat sequentially at 3.61% (core net interest margin was flat yoy and down 6bp to 3.38%). Earning asset growth was basically nil on a sequential basis.

Fee-based income isn't a large part of the revenue mix (about 10%), but also didn't really contribute to sequential growth (down 0.3% qoq), with trust income down about 2.5%.

Operating expense were up 2% yoy and down 2% qoq, and solid operating efficiency (a 49.1% efficiency ratio, 90bp better yoy and qoq) is a positive. Operating expenses clawed back a little of the top-line miss, but pre-provision operating income rose an unremarkable 6% yoy and 2% qoq, a little softer than I'd expected. All told, the bank missed by about a penny, but I wouldn't say there were any areas of real concern apart from known pressures on the business.

Battening Down The Hatches

Pacific Premier has an enviable track record where credit quality is concerned, with net charge-offs trending between 0.01% and 0.16% over the last decade. Part of that performance comes from an abundance of caution with its loan underwriting, and management is pulling in a bit as the economic situation becomes more uncertain.

Loans grew just 3% year over year and shrank 2% sequentially, and that's quite a bit weaker than the 2% to 3% growth many banks have delivered (let alone growth-oriented banks). Core C&I and CRE lending both contracted (the latter down 3%), while multifamily lending was down about 2% sequentially.

Loan yields improved 48bp yoy and 33bp qoq, and while the bank's loan yield of 19% doesn't look great, hedges on fixed-rate loans mean that the real underlying loan beta is closer to 25% to 30% - not exceptional next to many of the larger regional banks I've covered lately, but not terrible.

Meanwhile, funding costs remain well-controlled as Pacific Premier continues to leverage a high-quality low-cost deposit base. Total deposit costs increased 55bp yoy and 37bp qoq to 0.59%, which remains pretty attractive on a comparable basis, and the deposit beta is only about 15% (management reported 18% versus my calculated 15%).

Beta is likely to head higher, as non-interest-bearing deposits did decline about 7% this quarter (in line with the broader average for small/medium-sized banks), but the loan/deposit ratio isn't too bad (about 84%) and I don't get the sense that the bank will be looking to significantly scale up lending anytime soon.

Opportunities To Benefit Indirectly From M&A

Historically an acquisitive bank, Pacific Premier has been content to stand pat since the 2020 $1 billion acquisition of Opus. I believe management would be willing to do a deal on the right terms, and the CET1 ratio of 13% is perfectly fine, and management has talked in the past of being willing to look outside of its traditional California footprint, including further expansion in the Pacific Northwest, or expansion into markets in the Rockies or even Texas.

But even without doing a deal, the bank could benefit from M&A. When banks merge it's pretty common to see elevated turnover among both employees and bank customers (I've seen reports of 3x normal turnover being common). There are three significant new deals in the bank's footprint - the merger of equals between Columbia ( COLB ) and Umpqua ( UMPQ ), U.S. Bancorp 's ( USB ) acquisition of Union Bank from Mitsubishi UFJ (MUFJ), and Bank of Montreal 's ( BMO ) acquisition of Bank of the West from BNP Paribas ( OTCQX:BNPQY ).

I don't know how aggressive Pacific Premier will want to get, but I do believe there will be opportunities to gain revenue producers (loan officers) and commercial customers (particularly smaller commercial customers) from these deals over the next year or two - as a reminder, Pinnacle Financial ( PNFP ) has feasted on luring away bankers from large banks integrating deals in the Southeast U.S. and it's not exactly an unproven model.

The Outlook

I'm looking for muted pre-provision and core bottom-line earnings performance in the near term, with core earnings likely to fall around 2% annualized from FY'22 to FY'24. I do expect a meaningful recovery as the Fed eases off and as the economy recovers, and I'm expecting close to 6% growth over the next five years and closer to 7% growth over the longer term.

Discounted back, though, that growth isn't enough to drive a really exciting fair value. If I give Pacific Premier a little "extra credit" for its lower credit risk (a lower discount rate), I can bump up the fair value estimate to around $40, but my core discounted earnings model, as well as my ROTCE-based P/TBV and P/E models (the latter using a 12.5x forward multiple) suggest a fair value around the mid-$30s.

The Bottom Line

I won't be surprised if I hear from long-term shareholders in the comment section who are perfectly happy with their slow-and-steady wins the race bank, and after all the shares have outperformed the sector over the last decade (though not over the last five years or the last year).

Still, looking at the numbers now, while I can understand holding the shares, and I can come up with a more bullish growth scenario on the basis of M&A disruption, I can't really say it's a table-pounding buy at this price.

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