WAL - PacWest: Down But Not Out

2023-05-06 08:48:57 ET

Summary

• I update readers about my PACWP position and view of the recent events.
• I believe a 2008 statement by the SEC is still very relevant today and why officials should look closely at the ongoing trading activity.
• I provide my commentary on PacWest's latest press release. Most seem to be missing out on a few keywords.
• PACW announced the payment of its quarterly dividends.

Following the takeover by the FDIC of First Republic Bank (FRCB) and its subsequent sales to JPMorgan ( JPM ), panic selling has returned in full force, targeting those names that are seen in the US banking sector as the next weak link. A wave of selling has pushed to new lows, among others, PacWest Bancorp ( PACW ), Western Alliance Bancorporation ( WAL ), and First Horizon Corporation ( FHN ).

I recently wrote in this piece that I held (and still hold) a position in PacWest Bancorp Preferred shares ( PACWP ). I viewed their 7.75% non-cumulative issue as an attractive, albeit risky, play. The bank's association with First Republic or Silicon Valley Bank (SIVBQ) looked to me based on geographical location alone. In addition, at the end of April, volatility seemed to be already subsiding following decisive actions to stabilize the banking sector. PACW did report 1Q23 results, which were better than expected by analysts, and caused a mini rally in the share price. According to management, there was not much standing in the way of a further recovery in the level of deposits.

As a PACWP holder, I was taken aback by the new selling wave. I could not foresee such a scenario playing out right after FRC's default, which, as I stated in my article, was already to be expected as the most likely outcome. The resulting timing of my piece now low looks very poor. Nonetheless, I'd argue that modeling my recommendation on the available information as of 1Q23 results was the most sensible thing to do for my readers at the time of writing. As I highlighted, PACW results were sound from a fundamental perspective, and the bank is still fundamentally sound now.

That said, following recent events, readers have asked me in comments and messages for an update. Here it is, but I am no insider, and my knowledge is limited to public information available. At the time of this writing, PACW has just declared quarterly dividends. The payment on common shares got slashed to $0.01, but PACWP's preferred amount of $0.4845 was maintained. The excellent news validates the investment case I highlighted in my first article.

I never wish to blame a potential investment loss, or a wrong call I make, on market manipulation, and I believe this would be foolish and immature. Short sellers are essential for the correct functioning of the markets, and sometimes my thesis is simply flawed. I could be wrong on PACW for several reasons that have nothing to do with short selling. However, I can't rule out that market manipulation alone could generate an undesired outcome for PACW or other banks under the current circumstances. It would also be foolish not to acknowledge this fact. It is no coincidence that Reuters published an article this week reporting that officials are (finally) looking into the possible manipulation of regional banks' share prices. Seeking Alpha also picked up the argument here . It is not my place to say whether the activity should be legal or banned. But as an investor, the main problem I see in the case of PACW, WAL, and other banking institutions is that if the shorts' narrative pushes powerfully enough, it can bend the business reality towards the desired outcome (the so-called self-fulfilling prophecy). For this reason, allowing the short selling of financial stocks at this time could be the wrong thing to do. Unlike other companies, banks must rely on the confidence of their customers to stay in business:

Unbridled short selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to true price valuation. Financial institutions are particularly vulnerable to this crisis of confidence and panic selling because they depend on the confidence of their trading counterparties in the conduct of their core business. (the SEC)

As seasoned investors pointed out during the past few days, the Securities and Exchange Commission did halt the short selling of financial stocks to protect investors and markets during the 2008 crisis. And the above statement was the explanation provided for their action. So, even if PACW was doing fine at the time of my first article, and I believe it should still be fine now, things can change fast due to market manipulation alone. Then SEC Chairman Christopher Cox, in his 2008 remark, openly stated that the SEC was committed to "using every weapon in its arsenal to combat market manipulation." My only two questions would be: are fundamentally sound regional banks relevant enough to deserve protection from manipulation by the SEC? Or are only the "too big to fall" names entitled to it?

It would make sense if a few prominent players were behind this new wave of selling on regional banks. The timing doesn't seem accidental. With FRC out, players likely cashed in big profits and had to decide where to move their next wager quickly. The stock trading volume for PACW went through the roof in the last few days. Similarly, the premium offered on options skyrocketed. With Friday's action, I am intrigued by PACW's finishing at $5.76, considering that the most sought-after option two days ago was the $5 strike Put expiring May 5, changing hands at roughly $0.5. Could it be that some big players got involved on the other side of the trade Friday and managed to burn the shorts? The stock volume reached a new high Friday, and the volume traded was just astonishing, surpassing the record of Thursday.

PacWest management responds

While the trading action seems to suggest extraordinary events are taking place, the importance I have given to the SEC statement earlier in the article strictly connects to the fact that, from a fundamental perspective, nothing changed for the bank. Even if news outlets came up with all sorts of possible explanations for the flash crash during the week, PACW management issued a press release that once again remarked what was more or less already known the previous week at the time of the 1Q23 call. Here are the main points:

1. Regarding the Bloomberg report of a sale, there was nothing much new to the story than what already circulated on Bloomberg on April 21. The sale concerns the lender finance loan portfolio held for sale at the end of 1Q23.

As previously announced , the Company has explored strategic asset sales, including moving the $2.7 billion Lender Finance loan portfolio to held for sale in 1Q23. This planned sale remains on track and upon completion will accelerate our CET1 capital ratio to 10%+ (May 3 press release)

2. Anything other than a loan portfolio sale could happen, but that does not mean receivership or FDIC involvement. A strategic review of the options at hand has been carried out since March and communicated to investors.

Our message remains consistent with what was conveyed last week with earnings.

Recently, the Company has been approached by several potential partners and investors - discussions are ongoing. The company will continue to evaluate all options to maximize shareholder value (May 3rd press release)

Critical keywords used here: institutions are approaching PACW, and not the other way around as some commenters seem to think. Most likely, the same institutions involved during the March talks (Apollo-backed Atlas SP Partners or others) could be knocking again at PACW's doors for other lucrative deals, including a going private transaction at a bargain price.

3. There was no further deposit turmoil following the FRC sale and other news. While there was a noticeable slight decrease of $0.2 billion, The level remains healthy and above the $27.1 billion reported at the end of the first quarter.

The bank has not experienced out-of-the-ordinary deposit flows following the sale of First Republic Bank and other news. Core customer deposits have increased since March 31, 2023. (May 3rd press release)

PACW is down but not out (yet). The risks are high, but I have nothing to beat myself for recommending PACWP to readers. I still believe the bank was a well-run operator caught in the crossfire. To prove this point, I re-share a dated yet actual tweet by Michael Burry. The simple chart shows where PACW started at the beginning of this crisis and why PacWest differs from FRC.

Things only got better with management's actions. I have no idea what will happen with traders ganging up on PacWest. As long as massive short-selling is allowed, anything can happen. But fundamentally, it was a quiet week for PacWest. Almost too quiet. Dividends could have been announced a bit earlier, probably. I understand the Board might have taken a wait-and-see approach in light of the recent events. However, I'd argue that, especially in times of extreme volatility in the stock price, it is better to keep a resolute and confident attitude in maintaining optics. One quarter's dividend payment is nothing, financially speaking, compared to the loss of confidence of the remaining investors, which can whack the stock price once and for all.

I applaud the choice to reduce the payout to $0.01 for the common and maintain the preferred. It is a prudent decision that increases financial flexibility and, at the same time, makes a clear statement to the market. PacWest might be down, but it is not out!

I didn't sell

Just a small final clarification. It will also be in my disclosure, but for full transparency (and at the cost of appearing even more wrong later), I'd like to highlight I did add a bit on the dip. The risk-reward proposition has increased so much that it might only suit those willing to accept a non-indifferent risk of a complete write-off. Please invest only after your due diligence. It does not represent investment advice, only my sincere view and individual position.

For further details see: