KW - PacWest Bancorp Surges On Win-Win Deal With Kennedy-Wilson Holdings

2023-05-23 10:56:24 ET

Summary

• Kennedy-Wilson Holdings, Inc. and PacWest Bancorp have agreed upon a win-win transaction, providing stability and liquidity for the latter and upside for the former.
• Kennedy-Wilson will purchase $2.6 billion worth of real estate construction loans from PacWest for $2.4 billion, transferring $200 million of extra value from PacWest to itself and its partners.
• This deal offers much-needed liquidity for PacWest and attractive assets for Kennedy-Wilson, resulting in a promising picture for both companies.

May 22nd of 2023 ended up being a really exciting day for shareholders of two very different companies. One of these is Kennedy-Wilson Holdings, Inc. ( KW ), a global real estate investment company that owns, operates, and develops, real estate across various markets in the U.S. and overseas. The other is PacWest Bancorp ( PACW ), a regional bank that has found itself under pressure following the collapse of other regional banks that are not terribly different than it is from a structural perspective.

Even though crisis brought these two firms together, the transaction between KW and PACW looks set to create value for the former, while providing needed liquidity for the latter. In my view, the deal these two companies agreed upon is a win-win for both parties, adding significant stability to PacWest's financial condition while simultaneously creating additional value for Kennedy-Wilson.

A look at Kennedy-Wilson Holdings, Inc.

Those who follow my work closely will know that I have already provided a deep dive into PacWest. I would encourage you to read my articles on the company here and here . However, I have not yet done this for Kennedy-Wilson. As I mentioned already, this enterprise is a global real estate investment company that focuses on real estate across various markets. In particular, it emphasizes the western portion of the U.S., as well as both the United Kingdom and Ireland. As of the end of the most recent quarter , the company had around $23 billion worth of real estate assets under management. These assets included 37,370 multifamily units and 26 million commercial square feet.

All of this may make the company sound like a rather large player in the real estate market. But it's important to note that the numbers I provided consist of both its consolidated portfolio and properties that it has some ownership interest in. At present, the consolidated portfolio includes 10,513 multifamily units, 6.1 million square feet of commercial space, and one hotel. It boasts a 97% ownership over these assets and generates around $310 million worth of NOI (net operating income) from these assets each year. Its co-investment portfolio includes the other 21,863 multifamily units, 18 million square feet of commercial space, and involves the investment of $6 billion of fee bearing capital. These assets bring in $230 million of NOI and fees each year, and the company has only a 25% ownership stake of said assets.

At this moment, market participants are quite worried about our office properties. Around half of all office space in the U.S. is vacant right now, and the shift to remote work could cause a deterioration in this space. Unfortunately, Kennedy-Wilson does have some exposure to this area. But of the estimated $496 million in NOI that its portfolio brings in each year, only 29% is attributable to office properties. The largest share is multifamily, accounting for 54%. Retail makes up another 7%, while its hotel, as well as loans that it owns, and industrial properties, comprise 10%. In terms of geographic focus, 61% of its NOI comes from the western portion of the U.S. 19% is attributable to Ireland, while 17% involves assets in the United Kingdom. The remaining 3% of NOI comes from assets split between Italy and Spain.

In addition to these assets, as well as assets that it benefits from the development of, the company has overseas fee-bearing capital. According to management, this capital is largely third-party committed or invested capital that it manages in its joint ventures and commingled funds. Through these activities, the company earns fees, such as asset management fees, construction management fees, and a variety of other fees. The value of these assets totaled $6 billion as of the end of the most recent quarter, with 51% falling under insurance company activities. 16% is involved in sovereign wealth funds, while 13% is involved in pension funds. This is much more geographically diverse than the company's portfolio of real estate assets. While 28% of assets involve activities in the U.S., Canada is actually more significant to the company because of the fact that 38% of said assets are located there.

Financially speaking, the track record of Kennedy-Wilson has been quite volatile over the past few years. In the chart below, for instance, you can see revenue and certain profitability metrics. Most of these have been all over the map. But this should not be all that big a surprise. The past few years have been very volatile in general. What is perhaps most important, though, is that management continues to grow the enterprise and it has demonstrated that is not afraid to get creative in order to do so.

The most recent example of this was announced by the company on May 19th. On that date, Kennedy-Wilson entered into a loan purchase and sale agreement with PacWest whereby it has agreed to buy, as part of a deal with its partners, $2.6 billion worth of real estate construction loans in exchange for $2.4 billion. In all, this includes 74 different real estate construction loans that PacWest has been hoping to divest itself of in order to raise liquidity because of panic in the banking sector and a run on some of its assets. This is a fairly small haircut in the grand scheme of things, essentially transferring about $200 million of extra value from PacWest to Kennedy-Wilson and its partners in exchange for the immediate liquidity and the assumption of the risk of these assets by their new owners.

Based on the data that has been provided, these assets look to be quite attractive. For starters, the interest rates associated with them are floating, which means that the company is unlikely to be hit if interest rates continue to rise. Though, technically speaking, this does increase the risk of default. Even with the floating rate, the effective interest rate on the assets is about 8.4%. That implies a nice bit of interest income for the owners of the loans. As part of the deal, Kennedy-Wilson and its partners we'll also be assuming all remaining future funding obligations under the loans. And the deal also brings with it the opportunity to purchase additional loans with an aggregate principal balance of around $363 million.

In order to make this deal go through, Kennedy-Wilson is putting up $20 million into an escrow account. But at the end of the day, its total investment in the transaction will be between 2.5% and 5% of the purchase price of the loans, as well as the future funding obligations. This implies a total investment of between $127.5 million and $255 million. On top of benefiting from the assets in question, Kennedy-Wilson will also receive a 15-basis point (of total commitments) fee from PacWest upon closing of the deal. Plus it will receive additional fees of an unspecified amount from its management of these assets.

I think it's clear by this point the extent to which Kennedy-Wilson should benefit. In fact, in response to the news, shares of the company popped up 3.3% during the day. But an even bigger move was seen when it came to shares of PacWest. Its stock shot up 19.6% on May 22nd. Even though PacWest is essentially taking a haircut on these loans and will have to do without the future interest payments from them, it is getting some much-needed liquidity at a time when the market is quite worried about the enterprise and its ability to survive. This is just one additional move in a series of moves that the company has made in order to bolster its liquidity. At the end of the final quarter of 2022, for instance, PacWest had only about $6 billion worth of liquidity. By May 10th of this year, that number had skyrocketed to $15 billion.

This increase in liquidity came even though the company had significantly de-risked itself from a deposit perspective. At the end of last year, $9.5 billion of its deposits were uninsured. By May 10th, this number had dropped to $5.2 billion. What makes this transaction so helpful is that it helps plug the hole in the event that uninsured deposits continue to flee the bank. The market knew that these assets were on its books. But the concern was that the company may need to engage in fire sales, unloading assets at significant discounts to their value, in order to cover deposit withdrawals. But when you consider how small this haircut was, it becomes clear that many of the problems facing PacWest have now subsided.

Takeaway

The way I see it, not every financial transaction can result in both sides winning. But this is one of those instances where that does take place. On the one hand, Kennedy-Wilson Holdings, Inc. and its partners get assets at a nice discount and the cash flows that should come with them in the future. And on the other hand, PacWest Bancorp raises some much-needed liquidity on terms I would not consider to be onerous. Due to how this picture has turned out, I feel comfortable rating Kennedy-Wilson Holdings, Inc. a soft "buy" and I have decided to increase my rating on PacWest Bancorp from a "hold" to a soft "buy."

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