2023-03-13 08:02:20 ET
Summary
- PacWest is one of these smaller regional banks feeling the full fallout from the SVB Financial Group situation.
- Without massive interference by the government, continued deposit outflows should be expected for smaller and more challenged banks.
- Uncertainty will likely remain the name of the game for some time.
Investors in the PacWest Bancorp ( PACW ) fear that the bank is on track to suffer the same fate as SVB Financial Group ( SIVB ) . The Los Angeles based bank does not only have concentration risks to the state, but furthermore is actively involved in the start-up and venture capital sphere, a key risk nowadays.
Banking Concerns
Banks at large face two issues at this point in time, and both of these factors are connected. Banks were rich on deposits during the pandemic period, yet with the Fed rising rates in a very aggressive manner last year, banks were slow to raise rates on the deposits. This has resulted in deposit outflows as the gap between rates paid by banks on these deposits and near term risk free rates being substantial.
While banks are still posting solid earnings, amidst low loan loss credit provisions, and typically being reasonably capitalized, this could be largely an earnings issue. After all, many banks have sufficient earnings power, allowing them to hike deposit rates and hence halt deposit outflows, thereby avoiding liquidity issues. For the banks which are too slow in raising deposit rates, unable to do so from an earnings point, or have already seen panic withdrawals, they have to sell assets if they have depleted liquidity.
The problem is that many assets on the balance sheet, and even many liquid assets, often including Treasuries and agencies securities as banks have moved up in the yield curve, by buying long term dated paper, on which they are severely underwater.
This is not an issue if the bank has time to hold onto these assets until maturity, but many banks do not have that luxury position. This position applies to all banks and related financial institutions, although investors and depositors will be looking for relative strength of banks. So while all banks will likely see pressure on interest margins, the bigger and better capitalized banks might benefit from capital inflows from smaller banks which do not enjoy the same amount of fate by customers.
The 2022 Results
Unlike SVB, PacWest has not enjoyed the same enormous pace of growth recently. The company reported total assets of $41 billion by year end 2022, up 2% on the year before. This is financed by $4 billion in equity, $34 billion in deposits and the remainder by borrowings.
The company spent $118 million on in interest expenses to depositors in the fourth quarter, and a total of $200 million for the year. The $118 million number works down to a roughly 140 basis point rate being paid if annualized, although that two-thirds of the deposits carry interest, and the remainder none. Besides higher levels of rates, banks are hurt by a shift towards more interest-bearing deposits as well.
On the asset side, the company has about $7 billion in investment securities, either held-to-maturity or available-for-sale, as well as a $28 billion loan book.
The company posted net interest income of about $1.2 billion on a deposit base of $28 billion, it has quite some room to pay out more to depositors. That is a bit too simplistic as non-interest income is by far not sufficient to offset non-interest expenses. Pre-tax earnings for the year only came in at $567 million, but this comes after some charges taken, suggesting about 2% room to hike deposit rates while maintaining break-even results.
Note that the bank has taken some losses, having posted $790 million in unrealized losses on its securities held until maturity and being available for sale. With book value reported around $28 per share, or $17 per share based on tangible assets, it is clear that the market has discounted the bank here.
A $27 stock just a couple of days ago has fallen to $12 in the aftermath of this, retesting the lows seen around the time of the great recession in 2009, as shares actually peaked around $50 as recent as 2021.
An Update
Amidst the middle of this mess, PacWest provided an update on Friday. The bank reported deposits of $33.2 billion by the 9th of the March, down fractionally from the $33.9 billion number by year end 2022. The company claims sufficient liquidity, including $1.9 billion cash held on balance sheet, a collateralized credit facility from the Federal Home Loan Bank of San Francisco of $4.9 billion, $2.0 billion of the Federal Reserve Discount Window and $5.3 billion in unpledged liquid securities. The bank has not indicated if it needs to sell these at a loss, if needed.
Fortunately the bank has already aimed to shrink the business, as the loan book has fallen by a couple of hundred millions since year end. This is badly needed as the fourth quarter conference call reveals $11 billion in venture related deposits as especially these type of depositors might be scared right now, typically exceeding FDIC limits.
The update from the 9th is not telling a lot. While the bank outflows at SVB predominantly took place on Thursday, we likely have seen outflows since Friday, although the extent of these is only speculation unless more information is provided here.
Concluding Remarks
At the very best this is an earnings issue, but I fear it could be much worse. The truth is that there are few incentives for depositors to hold deposits at a bank which pays a suboptimal rate in relation to risk free rates.
For equity holders the story is a bit different as they site on large losses already, with shares now trading quite a bit below the book value. Investors simply fear that in absence of any announcement by an authority, then deposit outflows continue over the weekend, as the pace of deposits movements nowadays is unprecedented, driven by technology, with SVG reporting $42 billion in requested outflows in a single day.
Depositors absolutely have no incentive to stay with the bank as the asymmetric risk for depositors creates quite some uncertainty for a while to come.
For further details see:
PacWest Bancorp: Too Uncertain To Get Involved