SBNY - PacWest Bancorp: Fighting Back Against Doomsday

2023-03-19 04:02:05 ET

Summary

• PacWest Bancorp experienced substantial deposit outflows following their March 10 update. In this article, we dissect the numbers for investors to assess.
• The bank has seemingly tapped into substantial backup liquidity capacity to curb uninsured deposit outflows. Investors should note that further support is crucial to boost confidence.
• VC exposure continues to pose a significant risk, especially considering its role in the downfall of Silicon Valley Bank.
• For investors eyeing a highly speculative buying opportunity, it's vital to weigh the potential risk of complete bank collapse due to an escalating liquidity crisis resulting in insolvency.
• The FDIC has demonstrated its resolve toward swift action to protect depositors' interests, which could leave investors and owners stranded, suggesting a total wipeout for investors is a distinct possibility.

PacWest Bancorp ( PACW ) investors have had to endure the worst decline in recent times following the collapse of Silicon Valley Bank or SVB ( SIVB ) and Signature Bank ( SBNY ).

The selloff matched the pessimism seen in the 2007/08 financial crisis and surpassed the level of decline in the 2020 COVID pandemic.

Regional and smaller banks like PacWest Bancorp have been pummeled as investors fear the worst outcome: bank failure. These investors have seen the unprecedented rapid collapse triggered by the infamous " social media bank run " that led to the demise of SVB.

Moreover, PacWest Bancorp's venture-focused depositors spooked investors as VCs turned against SVB despite decades of close partnership. As such, we believe it's justified that investors want further clarity from PACW regarding its VC exposure after witnessing the SVB carnage.

In a press release yesterday (March 17), management provided a timely update for investors and discussed its VC exposure.

Accordingly, PacWest Bancorp held $10.8B in cash as of March 17, up significantly from its previous update of $1.9B on March 9. As such, we believe PACW tapped into its liquidity facilities, which amounted to about $14.1B based on its March 7 update.

However, the bank didn't disclose whether it borrowed from the recently established Bank Term Funding Program or BTFP. The facility was set up after the collapse of SVB and SBNY to backstop US banks against further significant deposit outflows.

Notwithstanding, based on its updated disclosure, we believe a significant level of uninsured deposits has flowed out.

Hence, we wouldn't be surprised that PacWest has leveraged most of its previous $14.1B liquidity while tapping into the BTFP. In addition, the bank disclosed a $2B available on the Fed Discount Window, but whether it received an upgrade wasn't discussed.

Hence, we believe its liquidity capacity has been substantially impacted by the recent deposit migration, as PacWest stressed: "The bank experienced elevated net deposit outflows, concentrated primarily in our Venture Banking business line."

We noted that PacWest had $17.81B in uninsured deposits against its total deposit base of $33.94B at the end of 2022. The bank disclosed that its total deposit base fell to $33.2B on March 9.

Hence, it's clear that PacWest Bancorp suffered a significant withdrawal event by its VC base, as the bank reported that "as of March 16, 2023, insured deposits exceed 62% of total deposits, including accounts eligible for pass-through insurance."

Notably, PacWest Bancorp did not disclose its total deposit base at its most recent update, which likely didn't improve confidence. Still, we can infer the amount of uninsured deposits that flowed out of the bank since 31 December 2022.

Accordingly, First Republic Bank ( FRC ) updated on its March 16 release that " insured deposits from close of business on March 8, 2023, to close of business on March 15, 2023, have remained stable."

As such, we believe it implies that the loss of insured deposits is likely much less significant, which we can then use to model PACW's metrics.

Taking a 5% to 10% haircut on its insured deposit base of $16.13B as of 31 December 2022, we assumed that PACW posted an insured deposit base of about $14.92B at the midpoint of the haircut range.

Since PACW highlighted that insured deposits accounted for more than 62% of its total base, uninsured deposits have likely dropped to less than $9.14B, for a total deposit base of about $24.06B.

As such, PACW could have lost about $8.7B in uninsured deposits since the end of 2022, representing more than a 50% drop. It also aligns with management's commentary that "available cash exceeds total uninsured deposits."

Hence, we believe the liquidity raised has been used to cover these withdrawals. The critical question facing investors is whether this group of VCs will continue to draw down their uninsured deposits further?

Management attempted to assure investors that insured venture deposits "account for more than 77% of total venture deposits." In addition, VC deposit as a total of total deposit has dropped to 25%.

Hence, the position from management likely suggests that PACW should not face a significant liquidity crisis attributed to VC withdrawals moving forward. Management added: "Since Monday, March 13, 2023, net outflows have fallen sharply, with deposit balance fluctuations substantially stabilizing."

It's consistent with the experience of First Republic Bank, as FRC highlighted: "daily deposit outflows have slowed considerably," assuring investors about its liquidity position.

Analysts estimated that about $89B of deposits flowed out of FRC over the past week, which could have impacted its total deposit base by about 50% since 31 December 2022.

We assumed that most of it belonged to the uninsured base, consistent with the experience of PACW, as discussed earlier.

Therefore, the defense mounted by the Fed, FDIC, and the US government appears to have helped restore confidence in the US banking system. PacWest Bancorp and its peers need such assurance to defend itself against a mounting crisis that threatens to engulf the regional banks.

However, fears of a 2008-esque liquidity-driven event have not manifested in credit spreads . Current indicators suggest that liquidity-driven fears remain well below the levels seen in the 2007/08 financial crisis and the 2020 COVID pandemic.

Distressed debt specialist of Oaktree Capital Management Howard Marks also stressed that " t he cases of SVB and other regional US lenders that failed are 'more one of a kind' and unlikely to have a systemic impact on the US economy." Hence, if the outflows could slow considerably, it could give PACW time to rebuild its deposit base and bolster its balance sheet moving ahead.

Banking has always been about a business of confidence. Therefore, its VC deposit base remains a concern after what it did to SVB, which could leave PACW more vulnerable than its less VC-exposed peers.

Of course, bulls could argue that bank runs could affect non-VC exposed banks, as seen in the real estate heavy-Signature Bank and private banking-focused First Republic Bank.

Our price action analysis suggests that PACW has been battered massively. As such, its reward/risk looks attractive if it could survive the crisis, as the market is forward-looking.

Hence, we believe the market has already reflected a significant impact on its forward earnings estimates, but the focus remains on its liquidity and solvency now.

Investors considering adding exposure need to be wary that the risk of failure is high, worsened by its VC exposure.

Also, PACW's price action for a bullish reversal has not been validated yet. Therefore, an entry now is considered premature for investors requiring a confirmation signal. While some investors could consider "front-running" the market, it's critical to consider that the bullish reversal signal may fail to arrive accordingly.

Hence, investors must understand that their investment could be wiped out if the crisis worsens unless PACW can further extend its liquidity capacity. So investors should closely monitor that for now.

Investors should also note that our thesis is firmly predicated on the survival of PACW and the subsequent bullish reversal price action on PACW.

Rating: Speculative Buy.

Note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. Our cautious/speculative ratings carry a higher risk profile. They are only intended for sophisticated investors/traders. We urge new or inexperienced investors to avoid relying on such ratings. Moreover, investors must exercise prudence and devise appropriate risk management strategies, such as pre-defined stop-loss/profit-taking targets, within a suitable risk exposure.

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