CapitalSource, Inc. (CSE) PacWest Bancorp - M&A Call

Jul.23.13 | About: CapitalSource, Inc. (CSE)

CapitalSource, Inc. (NYSE:CSE)

July 23, 2013 11:00 am ET

Executives

Dennis Oakes - Senior Vice President of Investor Relations & Corporate Communications

Matthew P. Wagner - Chief Executive Officer, Director, Chairman of Asset Liability Management Committee, Member of Credit Risk Committee, Member of Executive Committee, Chairman of Pacific Western Bank, Chief Executive Officer of Pacific Western Bank and President of Los Angeles Region - Pacific Western Bank

James J. Pieczynski - Chief Executive Officer, Director, Member of Asset/Liability Committee, President of Capitalsource Bank and Director of Capitalsource Bank

Victor R. Santoro - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Executive Vice President of Pacific Western Bank and Director of Pacific Western Bank

Analysts

Bob Ramsey - FBR Capital Markets & Co., Research Division

Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

Scott Valentin - FBR Capital Markets & Co., Research Division

Joe Morford - RBC Capital Markets, LLC, Research Division

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

Christopher W. Marinac - FIG Partners, LLC, Research Division

Kevin B. Reynolds - Wunderlich Securities Inc., Research Division

Gary P. Tenner - D.A. Davidson & Co., Research Division

Brian Hagler - Kennedy Capital Management, Inc.

Mark C. DeVries - Barclays Capital, Research Division

Operator

Good morning, and welcome to the PacWest and CapitalSource Merger Conference Call. [Operator Instructions] Please note this event is being recorded. And I would now like to turn the conference over to Dennis Oakes. Please go ahead.

Dennis Oakes

Thank you, Amy. Good morning, and welcome to the PacWest and CapitalSource Merger Conference Call. With me today are Matt Wagner, CEO of PacWest Bancorp; Vic Santoro, Executive Vice President and CFO of PacWest Bancorp; Jared Wolff, President of the LA region of Pacific Western Bank; CapitalSource CEO, Jim Pieczynski; and CapitalSource Bank Chairman and CEO, Tad Lowrey. This call is being webcast live on the CapitalSource website, and a recording will be available later today. The merger press release on our website provide details on accessing the archived call. An investor presentation providing additional details on the merger, is posted on both the PacWest and CapitalSource Investor Relations website and will be referred to during the call this morning.

Investors are urged to carefully read the forward-looking statements language in both the merger press release and the investor presentation, but essentially they say the following: both communications contain forward-looking information about PacWest, CapitalSource and the combined company after the close of the transaction, but is intended to be covered by the Safe Harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact are forward-looking statements. Such statements involve inherent risks and uncertainties, many of which are difficult to predict and are generally beyond the control of PacWest, CapitalSource and the combined company. Forward-looking statements speak only as of the date they are made, and we assume no duty to update such statements. We caution readers that a number of important factors could cause actual results to differ materially from those expressed in or implied or projected by such forward-looking statements.

Pro forma, projected and estimated numbers in the merger release and investor presentation are used for illustrative purposes only and are not forecast, and actual results may differ materially. Matt and Jim will have some brief opening remarks And then, we will open up the lines for questions regarding the merger. Any questions regarding the second quarter earnings of either company will be addressed outside of this call. Because of the joint nature of the call, we anticipate that there may be a number of questions, so we kindly ask callers to restrict yourself to one question and a brief follow-up. Matt?

Matthew P. Wagner

Thanks, Dennis. Good morning, everybody. This is my first conference call. I'm sure I'll get a hard time from you about it at some point, but -- so it's a new thing for me. We're very excited to be here today. I'm very excited to have Tad and Jim join us and to announce this transaction. I think it's certainly transformative for both of our companies. It very much is a win-win situation, a combination of strength that will result in a very significant and a high-performing company. Jim, do you want say a couple of words, and then I'll jump into the deal?

James J. Pieczynski

Sure. And I think -- and I echo Matt's comments. I think this is a marriage of 2 perfect matches here. I think what we bring relative to the origination platform, coupled with what PacWest brings with the branch network, is exactly what we've been looking for as shareholders of CapitalSource. So from my perspective, it's just a -- it truly is a match made in heaven.

Matthew P. Wagner

So by the way, the Cap source -- or the PacSource comment wasn't meant to be an announcement of a new name. Let's jump into the transaction. It's a fixed exchange ratio consisting of 0.2837 a share of PacWest and $2.47 in cash, which is a fixed cash amount. $11.64 in value per the CapitalSource share based on our closing price 2 days ago.

James J. Pieczynski

Friday.

Matthew P. Wagner

Transaction value, approximately $2.3 billion. The ownership will be 45% PacWest, 55% CapitalSource. There is a termination provision in here with a 19.9% stock option. The board will consist of 8 people from PacWest and 5 people from CapitalSource. John Eggemeyer, our current Chairman of Pacific Western, will be the Chairman. The management will be -- I'll be the CEO, this is Matt being the CEO, and Jim will be President of the new CapitalSource division of Pacific Western Bank.

The merger-related charges after tax will be approximately $80 million. The targeted cost saves are $47 million pretax by 2015, which represents 23% of CapitalSource's noninterest expense and probably more importantly, only 12% of the combined noninterest expense. Of course, there'll be takeouts to bond both sides to this.

The compelling returns, and I -- this is just a terrific deal. In my opinion, I don't think you'll see many deals that result in a 10% tangible accretion to book value. 2015, after full integration, EPS accretion of 18%, and we've also projected a little over 9% accretion in '14, estimated internal rate of return of 20%. We'll continue to maintain the PacWest dividend of $0.25 a share on a quarterly basis. Of course, this will take regulatory and shareholder approval, and we anticipate that to be done in the first quarter of '14.

Some of the transaction highlights on Page 2. And I'll touch on continuity, financially compelling and risk management factors. PacWest growth will continue as a highly profitable business-focused bank. It will create the sixth-largest publicly owned bank, headquartered in California. Top decile net interest margin from strong asset yields and very low cost funding. We'll greatly improve the loan diversification of the combined company, with a broad and middle market reach, outstanding profitability and excellent asset quality. We've talked a little bit already about the accretion to earnings. Also, this company, we're projected to do about a 1.65% ROA by 2015 and a return on tangible common equity of 17%. Again, once again, it's 10% accretive to tangible book value. We're going to -- this company is going to start out of the chute with some very strong capital ratios, which I think will hopefully help us speed the regulatory process. We'll have tangible common equity on a pro forma basis of 10.5%. This is at the holding company and at the bank level, we'll also be at 10%. Tier 1 will be 11.7% and risk-based cap -- total risk-based capital at 15.7%.

The risk management factors, as most of you know, PacWest has a track record of successfully integrating 26 different transactions since 2000. Top funding and leading teams will be drawn from each firm. And again, if you step back and think a little bit about the cost takeouts, obviously, there's not -- all the top performers and originators will remain in place. The credit metrics for the combined company are still excellent, and we have excellent coverage on any problem assets.

The next page is the transaction financial rationale, and you can see some of the multiples to book value. I think this is a reasonably and prudently priced transaction that's going to result in great benefit for both of our shareholder basis and the returns. I can keep saying them over and over again because they're fun, but I won't bore you with that.

The next 2 pages, Page 6 and Page 7, are really overviews of PacWest and CapitalSource and give you information about margins, the non-accrual loans and those kinds of things. I think if you guys would spend any time with this deck, so far, you can see where the strengths are. PacWest has an excellent low-cost deposit base and the asset generation side of CapitalSource is very superior. It's really a very cool marriage, and I think we'll work very well together. Jim, why don't you touch on some of the things on Page 8?

James J. Pieczynski

Yes. So focusing on Page 8. When you look at the pro forma company going forward, as Matt said, what we're excited about is being able to pair the national lending platform under the CapitalSource division with the low-cost deposit base associated with PacWest. The other very important thing for us as well is that the CapitalSource brand will continue. So the CapitalSource brand will continue to be a division of PacWest and we will have business as usual. In terms of the middle-market lending lines that we have, obviously, we've got our -- the industries that we focus on, we've got healthcare, technology, our private finance companies, the security business, premium finance, transportation and energy, and we also have an ability to do our commercial real estate and multifamily as well. So we think in terms of the origination platform, it's incredibly solid. And then when you pair it to the right, looking at the branch network that we have, there'll be a strong, solid branch network. And what I'm personally very excited about is, if you look at PacWest's cost of funds in the second quarter, their deposits was averaging 17 basis points, which is something that we have always wanted to marry to our origination platform. So again, I think we bring the best of both companies to the transactions.

If you go to Page 9, you'll look at the lending platform which, when you look at the diversification that we get, now obviously, the percentage of CRE loans drops as a percentage of the total portfolio, but is still a healthy part of the portfolio. And we add on these different components, the asset base to cash flow that, with that CapitalSource, is really bringing a significant level to. In addition to that, we also diversify the base geographically as opposed to PacWest's at 75% of the leading in California right now, that drops to 44%. And again, I think the diversification clearly helps the company out.

Matthew P. Wagner

Okay, over on the deposit side on Page 10, you can see down on the bottom on the pie charts, our cost of funds for the second quarter is 17 basis points; CapitalSource, 88 and then the combined mix after we're done here and it's a very compelling argument. Now that being said, deposits look easy at a lot of institutions right now, but I think if you look at the history of PacWest in the higher interest rate environments, we still were able be top quartiles, not top decile, in terms of our deposit base. So we think as we move forward in the economy and as rates start to inch their way up, we can still maintain the superior position there. CapitalSource, with their charter, they're not permitted to offer demand deposit accounts and therefore, hasn't been deposit-focused with their lending relationships. That's something that can change. Now that doesn't change overnight, and that will take us some time and we'll have to integrate that in. But going forward, it will become a big part of the origination teams within CapitalSource, as we do at PacWest, in attracting deposits to the company also. Over time, the company expects to replace rate-sensitive CD customers with more core commercial banking clients. It has been our history in the past, we've achieved it with other, probably more notably, the 2 lost share deals that we did that had a more of an S&L kind of deposit base to them and we've been able to transform their deposit base to look very similar to the core PacWest branches in the core PacWest mix of deposits. We've talked about the EPS accretion, that's all here. It shows you the 2014, as well as 2015, which is fully integrated. Now we hope to achieve the cost savings and some of the transformation here quicker than this model, but it's always good to be conservative with these things, and we hope we can do it in a much smoother way. A lot of work has already been done via the due diligence process and via the questions about the different IT platforms and what works best for the combined company. And so those things are happening as we speak.

Page #12 goes through some of the key metrics in terms of the performance and franchise value of the combined company. It's exciting to look at. I mean, the kinds of efficiency ratios that can be achieved, the kinds of returns on assets and returns on capital on common equity and common equity that is kind of world-class in terms of capitalization and safety, soundness, fortress, balance sheet, any buzz words you might want to use.

Again, we show capital ratios. Once again, on Page 13, the different sectors. And I think what's very interesting is Page 14 where we look at peer capitalization metrics for both California banks and then the top 10 nationwide. And you can see that the combined PacWest, CapitalSource is near the very top of those, and I think that there's a lot to be said for that and gives us a lot of flexibility going forward after this transaction is not only closed, but integrated.

We've talked early about the board compensation and -- our board composition, excuse me, compensation, we're not going to pay them. Actually, we probably will but hopefully not that much. It's a split board, leaning a little bit more on the PacWest side. And when you look at down below the executive management, you see key personnel there from both organizations. I will tell you that there are a lot of -- if you look at the 2 organizations there, the CapitalSource people tend to be a bit younger than us at PacWest, and there's a lot of people underneath these box -- these key boxes you see here that are the future of the company. And things will evolve and things will change, and we've got a strong -- not only do we have strong key management at the top, but we've got a really strong bench behind these guys. So the fair value marks, Vic, why don't you do that?

Victor R. Santoro

These fair value marks are all estimates as you all know, they're all subject to change when we finally close the deal out in the future. But the major ones, CapitalSource's Trust Preferred Securities, $138 million there and that's going to be amortized over the 22-year life of those Trust Preferred Securities. The loans, at $206 million, that's in two parts, that's basically the allowance for credit losses that CapitalSource has, about $120 million and then a further write-down of about $86 million based on interest rate. Now that $86 million, that's being taken into income, amortized into income over a 5-year period. The core deposit intangible, that's minor here because of CapitalSource's deposit base, but it's $9 million. And that'll be amortized over about 3 years. And then we have some others, other things to mention. These other assets, write-ups, some securities and that's over the life of the securities and there's another adjustment to deposits. And also, the Federal Home Loan Bank debt that CapitalSource has, that's fair value in which you wind up doing is setting as a liability for practical purposes, the prepayment fee on that.

The other thing that has had some notoriety in discussions we've had yesterday and also today is the deferred tax asset that CapitalSource has. And based on how the transaction is structured for tax purposes, CapitalSource will be the acquirer. And because of that, its tax attributes carry forward and remain. And therefore, all of its net operating losses will not be limited going forward. We'll be able to use them. That also means that the deferred tax asset is realizable. So that works out very, very well for both companies combined.

Matthew P. Wagner

Thanks, Vic. Okay, in conclusion, I'm very excited about this deal. I think it makes great sense. We are creating a superior middle-market lender and leading Southern California core deposit funded bank that, I think, we can only build even further on. It's a reasonably priced merger and creates great financial benefits for each sets of shareholders. The transaction, even though it's large, I think it's pretty straightforward, easy-to-understand assumptions and the integration plan. It's a winning financial model of superior commercial asset generation with low-cost funding going forward and some amazing profitability metrics. The combined company shareholder returns and capital ratios are among the highest in the country. So we've got something that can perform at a very high level and a very safe fortress balance sheet kind of way, and I think it creates a great company. And those of you that are on the line that have supported us all along, I thank you for that and look forward to working with you in the future. And that sort of wraps it up. I think we're going to go to questions? So how do we do that? Okay.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Bob Ramsey at FBR.

Bob Ramsey - FBR Capital Markets & Co., Research Division

First question. I was curious if the $206 million loan marks that's assumed is before or after you net the reserves?

Matthew P. Wagner

That is the gross amount, Bob, and it's $120 million for the loss reserve and then $86 million for the fair value adjustment.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Okay. And then could you talk little bit about the due diligence process performed around the CapitalSource loans?

Matthew P. Wagner

Go ahead, Vic.

Victor R. Santoro

Sure, we did it internally. Our credit team here in LA looked at a sampling of the credits, but they also spend a lot of time with the lending people, reviewing, underwriting and monitoring and seeing how that goes. Overall, we were satisfied with the level of underwriting, the level of monitoring and the credit metrics that CapitalSource has been reporting.

Matthew P. Wagner

Bob, to add to that, we think CapitalSource has been very aggressive in dealing with any kind of problem situations they've come up with, and they're also very aggressive in terms of their loan marks and their grading. Aggressive, meaning conservative.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Got you. I know what you meant, I know what you meant. And then I'm curious, how do you think about the impact that CapitalSource has on provisioning going forward? I mean, I can appreciate theoretically the loans or marks, you don't have legacy credit costs, but it is going to bring higher loan growth, stronger loan growth. What are you planning to provision on growth out of the CapitalSource platform on a go forward basis?

James J. Pieczynski

This is Jim. From our perspective, I would expect the provision for the CapitalSource loans to be similar to what we've been doing historically. If you look at our loan loss typically is, we're at a roughly 150 basis points is kind of -- we're a little bit above that in terms of our loan loss reserve relative to our loans. And what we've kind of indicated is that our provisioning going forward is generally in that 40 basis points a year on the underlying loan portfolio. I would expect that to continue.

Matthew P. Wagner

We don't like to give you too much guidance, though, Bob.

Victor R. Santoro

And then also, Bob, just to remind everybody, the numbers that are in these materials are based on analyst estimates, so [indiscernible] what you guys have forecasted and then we adjust it by the purchase accounting adjustments going forward.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Okay. And then last question and I'll hop back out. But I know you all have said the anticipated close date is in the first quarter. If the shareholder votes are in the first quarter, is it fair to assume that it closes at the very end of the period or how are you thinking about timing?

Matthew P. Wagner

I don't think we have that. We can't really answer that yet.

Operator

The next question is from Aaron Deer of Sandler O'Neill and Partners.

Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division

Matt, I just want to follow up on your deposit discussion. When you look at CapitalSource's borrower base, where do you kind of see the most opportunity for deposit gathering and trying to lay your deposit functionalities onto that base? Is it limited to kind of the small and midsized businesses within California or can you go beyond that geography through technology and what kind of -- I just wondered if you can put some sort of scale on what the deposit opportunity is and what kind of conversion rate you might expect?

Matthew P. Wagner

Well, Vic can give an answer to the last part of that, Aaron. But I think just in general, it's always been kind of accretive around PacWest, that we ask everybody for deposits, whether they're local or not. And we've been pretty successful with that. And so that's what we'll have to do going forward. A lot of these guys are, they're transaction guys, they're originators and that's a different mindset for them. So that will take some time to do. But also, within just the branch structure and in some cases, we have overlaps so we'll combine branches, the CapitalSource branches that survived the consolidation will be morphed into something that looks more like a standard Pacific Western Bank branch. And by that, you're going to start attracting customers that not only buy CDs from you but also have other banking needs. We were able to do that pretty success -- quite successfully with the affinity branches that we've picked up in FDIC transactions. So it gives us pretty good confidence hat we can do that. Vic, do you want to talk about what we have?

Victor R. Santoro

Yes, Aaron, the way it phases in, it phases in over 3 years, that's our current plan and that's what everybody's committed to do is migrate those deposits and then achieve the overall funding improvement over a 3-year period. So just based on the numbers alone, it's about $13 million pretax improvement in each year 2014, '15 and '16. So as Matt says, there's a plan to do it. It's not going to be an easy job, it's going to be a difficult job to do, but everyone's committed to getting it done.

Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division

Okay, and then as a follow-up, the accretion estimates then are based solely, I guess, then, on the existing balance sheets -- well, I guess, with the adjustments you intend to make, but you're not assuming any sort of change in the interest rate environment? Is that correct?

Victor R. Santoro

That's correct.

Operator

The next question comes from Todd Hagerman with Sterne Agee.

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

A couple of questions. Matt, I just want to focus on Page 12 of the deck in terms of the pro forma financial numbers and what I'm thinking about is a couple of things. Vic talked about some of the accretion in terms of, like, the spread, for example. But as I look at that, the page, I think about the 20% IRR, the numbers are certainly very compelling. And I'm just wondering, just in terms of, one, are those -- those are the numbers in terms of what we're looking at today in terms of reported earnings? And then just in terms of timeframe, the transition towards those metrics, but more importantly, if I think about your earnings accretion or what you've laid out relative to consensus expectations, it seems like there is more upside relative to the 20% IRR and where you're going here on a pro forma basis, particularly as you think about improving credit, lower environmental costs, the potential for higher rates. I'm just trying to reconcile the initial accretion expectations relative to what appears to be very high-performance numbers.

Matthew P. Wagner

Well, Todd, we never like to disappoint. I mean, Vic, [indiscernible]?

Victor R. Santoro

I don't I'll answer any differently but I'll just point out, Todd, that on Page 12, the column that says pro forma with transaction adjustments, what that represents is the June 30 numbers for both with the quarters, the June quarter annualized and then the purchase accounting adjustments put through on a 1-year basis to come up with all those percentage and ratios. That's what that represents.

Matthew P. Wagner

There's a lot of opportunities here in this transaction and we've approached this in a very conservative way. Again, we don't like to disappoint. We don't like to make promises we can't keep. We've done a very large amount of due diligence on each other's companies, and I think we understand them well and we know that there are upsides. But there's also a lot of uncertainty in the world right now, and we prefer to approach this in a conservative manner.

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

Okay. And then just another one. Just, Vic, in terms of the interest rate sensitivity on a go forward basis, a lot of moving parts between folding in the FCAL transaction relative to the CSE transaction, how do you think -- just in terms of your timing and kind of the 2-year integration, what's kind of the expectation in terms of the interest rate sensitivity, in terms of today being quite asset-sensitive and how that may change over time?

Victor R. Santoro

Well, if you look at just PacWest combined with FCAL, FCAL made us a little bit less liability sensitive. But with CapitalSource, we're going to be headed more towards asset-sensitive, which will help in a rising rate environment. And that will progress over a year or 2 period, Todd, as the deposit base gets migrated out into something closer to ours.

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

Okay. And then just lastly, in terms of just the transaction itself, Matt, you talked about conservatism, if I think about the 26 deals, if you will, normally the cost savings for the most part are recognized pretty close to the closing date. How do you view this transaction and if you could kind of help us with a 2-year timeline. As we step through the 2 years, what kind of the differences or the challenges that you see in terms of the integration? I don't know if there's different platforms per se between the 2 companies, but how shall we think about this 2-year timeframe relative to your previous 26 deals where a lot of the stuff is kind of front-end loaded?

Matthew P. Wagner

Good question, Todd. I think it's a very conservative approach to looking at. I think there's a lot of things that can be done quite quickly here, and we'll do it and then we'll basically operate in the same way we normally do. The core systems, the core banking systems, that's pretty straightforward. I mean, that's our daily wick. We do that very, very quickly. There are specialty systems though, within CapitalSource that need further investigation, but there's a lot of things there that are very robust and very specific to some of the finance, specialty finance kinds of businesses and will need to be maintained further and probably have a lot of usefulness for the core PacWest portfolio, too. So some of the ways they've approached things. The other thing that you got to keep in mind here, guys, we're rocketing through $10 billion, and no one's asked that question. But clearly, our regulatory burden is going to go up and we need to make sure that we approach this in a very conservative way, have all of our ducks in order as it relates to stress testing and everything that it means to be bigger than a $10 billion bank, bigger than a $15 billion bank. We made those commitments to our regulators and those are promises that we must keep. So we want to approach this, particularly given that regulatory issue in a very conservative way and maybe that's a little bit slower approach than PacWest normally has taken, but again, I think a lot of the stuff can be done very quickly and without a lot of angst internally, too.

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

Maybe if I could just sneak...

Victor R. Santoro

Todd, another think I'll add is that is, both companies -- I mean, I've gotten to know CapitalSource over the last couple of months. I mean, it's a very, very well run company. They have a lot of good things. And what we're going to do, jointly, is pick the best of both. That's what's going to happen going forward, and that will take some time. That's why we see these cost savings coming in over a 2-year period.

Scott Valentin - FBR Capital Markets & Co., Research Division

Okay. And then, if I could just slip another one in, just in terms of capital. Matt, again, just basically status quo on the dividend. But as I think about the transformational nature of the deal, 10% plus tangible equity, the accretion, how does this potentially change on a go-forward basis in terms of your priorities between dividends? Buyback, for example, CSC has that and future M&A which has been kind of in your wheelhouse for so long.

Matthew P. Wagner

I think, a really good question, Todd. I mean, I'm still a strong proponent of the dividend and I like giving money back to shareholders and let them decide how they're going to spend it versus doing buybacks, which I know CapitalSource has been known for. But that was a very different sort of situation, where they were in a liquidation mode of their Parent company and giving the money back to their shareholders, and still maintaining extraordinarily high capital ratios. But going forward, I don't think that you'll see PacWest announcing buybacks. We do like our dividend, we think it's pretty sacred and we'd always look to, hopefully, with the kinds of profitability -- from this transaction and the FCAL integration -- hopefully, increase that at some point in time, in terms of M&A activity. I mean, I really think this sets us up for some excellent future prospects for M&A, and one of the issues is -- I mean, let's just step back and take a look at PacWest prior to CapitalSource. You've got an excellent company, a great core deposit base, somewhat challenged on the asset generation side, partially because of our philosophy that wants to maintain a top decile margin and not take extraordinary duration risk which, frankly, is what the market is doing right now. So when I look at a deal where there's nice overlap, for instance, an end-market deal where there's 40%, 50% kind of overlap to superior cost takeouts -- that works, but in most of the community banks you're looking at today, you've got anywhere from a 40% to a 70% loan-to-deposit ratio, you've got a big bond portfolio that I don't need. So I'm going to end up with a bunch of excess deposits that, in the current platform, I have a tough time deploying into loans that meet our expectations and our risk-adjusted returns. With CapitalSource and their superior loan generation platform, I've got that now. If we buy a company with an underlevered balance sheet, I've got the ability to lever that now, into good high-performing loans. So M&A will be part of our future, and it makes it easier.

Operator

Our next question comes from Joe Morford from RBC Capital Markets.

Joe Morford - RBC Capital Markets, LLC, Research Division

Just following up, I guess, on Todd's question first. Can you detail the $47 million of cost savings and where exactly they'll be coming from? It sounds like there's going to be some branch consolidations, including that.

Matthew P. Wagner

Well, there certainly is overlap in the branches. I think 15?

Victor R. Santoro

15.

Matthew P. Wagner

Overlaps. So you have that. Saying that, Joe, CapitalSource's branches don't have 10 or 15 employees in them. They're very lightly staffed because of the nature of their deposit basis. So you've got that. I mean, you've got systems, you've got professionals, you've got boards of directors, you've got -- I mean, there's lots of things. You've got auditors, whatever else you want. I mean, these numbers, in terms of cost takeouts, are extraordinarily low for us.

Victor R. Santoro

And I think if you look at the theme, the theme is that a lot of the cost structure that comes over, comes over associated with the origination function and the underlying portfolio group that manages those loans. That's all going to stay in place, and it's really kind of on the branch overlaps, as was mentioned, along with the kind of the corporate support functions, is where you're going to get the eliminations.

Joe Morford - RBC Capital Markets, LLC, Research Division

I guess, on that point, can you just talk about how the credit approval process and underwriting will work going forward, and just how you're going to combine these 2 lending platforms?

Matthew P. Wagner

Well, actually, if you look at the org chart, in a lot of ways, we don't combine them, Joe. You've got the community bank, which Jarod will run, which is basically the core of PacWest. Now, there is some overlap with this and we'll work through some of those things, and we have a whole credit administration side on the way we approved loans here at PacWest. I'd have to tell you, in doing due diligence with CapitalSource, we learned some of the ways that they go about things are superior to what we do and we've already adopted them at PacWest. And so a lot of those kinds of functions and how it works today won't change at either company.

James J. Pieczynski

But, I think it's important to note that, for example, all the people that are currently on credit committee at CapitalSource, that consists of the credit committee CapitalSource, will be in the organization going forward. So in terms of looking at it is CapitalSource division, candidly, it's business as usual, the way that we've been operating.

Joe Morford - RBC Capital Markets, LLC, Research Division

Okay, that's helpful. And then I guess, lastly, can you also provide any kind of breakout as to the $80 million of merger charges after tax? It seems like a rather large number and just what's -- kind of curious what that all encompasses?

Victor R. Santoro

All the usual stuff, Joe. It's the investment banking fees, the lawyer fees, the accounting fees, the due diligence fees, outside consultants. It includes severance, a prepayment penalty on the Federal Home Loan Bank that thing we're thinking about paying off, and it includes a whole bunch of it. It also includes the vesting of restricted stock. That actually vests on both sides, so that winds up as a charge there. So there's a lot of things in it and they're probably still moving and still not finalized. It all come out in the final analysis, but we believe that $80 million after-tax is a conservative amount at this point, for purposes of making all these estimates.

Joe Morford - RBC Capital Markets, LLC, Research Division

And over what timeframe is that likely to come back?

Matthew P. Wagner

Front-end loaded, most of it.

Victor R. Santoro

No. I mean, like the investment bank fees aren't paid in to the deal closes. So there's a good portion there. I would say, Joe, it's probably...

Joe Morford - RBC Capital Markets, LLC, Research Division

First year or...

Victor R. Santoro

Maybe 10% of it comes between now and close.

Matthew P. Wagner

No. But it's the first year, Vic.

Victor R. Santoro

First year, definitely, it all happens at the closing date, yes.

Operator

The next question comes from Julianna Balicka, KBW.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

I wanted to ask a few follow-ups on some of your commentary. One, just to outline -- since we're just outlining to previous questions and what was in the numbers. Looking at your Slide 11, where you show your accretion and the exact estimate breakout, it looks like $145 million in '14, a $180 million in 2015 coming from CapitalSource's incremental contribution. So, within that, what's the baseline, that you're starting for that contribution? Is it like second quarter annualized, is it some kind of analyst estimate? And within that, how much of the cost saves are you -- does this assume all the cost save, does it assume a fair value creation, does it assume any growth, does it assume the better margin from the combination of the improved cost of funds, et cetera?

Victor R. Santoro

You didn't leave anything out, Julianna. First, Julianna, it's all based on analyst estimate, the I/B/E/S Estimates. Advantage, the purchase accounting stuff, that's amortized. And I mentioned earlier the loan market is amortized, $86 million over 5 years; the securities, right up, $28 million over 3; the time deposit adjustment is $7 million over 3; and then the trust preferred is $137 million over 22; and then the cost savings go in at about half of the $47 million in 2014, with all of it realized -- with the balance realized in 2015. And then on the funding improvement, it's about $13 million each year. And it's all pretax, 2014, '15 and '16.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

And the funding improvement is not cumulative, it's just $13 million per each year, not like $13 million plus $13 million?

Victor R. Santoro

No, it would be $13 million plus $13 million, sure, because it's 1/3 each year, you improve 1/3 each year. So the first year is about $13 million, then it goes to $24 million, then it goes to $38 million in '16.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

Good. And then In terms of any assumption on growth there, since CapitalSource had already a fairly good growth rate going on.

Victor R. Santoro

Whatever it was in the analyst estimates. I don't have that at my fingertips.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, very good, understood. And then if I could follow up a little bit more, in terms of your discussion on the changes to the business model a little bit, integrating the deposit gathering aspect onto CapitalSource's origination platform. From the perspective of some of CapitalSource's teams being outside of California, around different parts of the country, how is that going to fit into gathering deposits from the loan to their underwriting there? Are you going to have to open new branches or is all going to be remote? I mean, just trying to understand how that would work? And also, the other half of that is -- within CapitalSource's branches, you talked a little bit about the branch overlap, but the customers that CapitalSource has in their branches in California are older people retirees with CDs. So I'm trying to imagine how that would transform itself to your typical deposit profile and whether or not you actually maybe sell some of those deposits or just more in wholesale, kind of remove them. Kind of, overtime, brining in like your exiting customers into those branches.

Matthew P. Wagner

Well, I should have taken notes because I can't remember all of your questions. In terms of the current loan customers that are part of CapitalSource, I mean, you just go to those people and ask them for their deposits, over time, and you could certainly do that remotely. No, we're not going to open branches in Chevy Chase, Maryland or in Connecticut or any place else. That's not the intention. But, as you know, whether it's large real estate customers, large healthcare customers, they have a lot of different deposits that go to different institutions and, in fact, in the case of some of the larger real estate, most of their lenders never ask for their deposit. So if you ask for them, you're likely to get them. And we've had tremendous luck here at PacWest, in doing that in the past and transforming deposit basis that we've taken on, albeit more community bank kinds of banks, but we've been able to do that and we think that will be -- we haven't put any heroic kinds of projections in here for that stuff and even if you pulled that out of the accretion, the numbers are still very, very high. So I think it's definitely achievable. We have the people that do it today, and know how to do it and know how to communicate it, both with the employees and the customers. So you do that. In terms of how old Jim's customers are and Tad's customers are, on the branch side, I don't know that.

James J. Pieczynski

Right, our customers are -- at the branch -- let me just kind of address that too. First, relative to our commercial customers, one of the things that we do, obviously, is a lot of asset-based lending. In connection with that asset-based lending, we have a lot of lockboxes One of the things that CapitalSource has not been able to do is to have lockboxes and kind of create that relationship with the customer because of the fact that we don't have the ability to offer DDA. Now we'll have that have that ability to offer DDAs, which means we can say, we can provide it, we can do the lockbox, we can move accounts there and we've got the ability to do that, that we don't have right now. In terms of our retail customers, you're right, the average age of our customers, in their later 60s now, and they are a CD-oriented shop. From our perspective, we view it that we would be able to migrate the CDs of those existing customers more to kind of the PacWest platform, for CDs, and be able to also offer those customers other depository products such as checking accounts and the like. So, yes, it's going to take some time, but as Matt said, it's not a heroic concept that's built into the projections here. We just know intuitively that, that's an added value that we can bring.

Matthew P. Wagner

Also, Julianna, actually Jarod pointed out to me, their largest geographic concentration in their lending platform is California. So those customers are already here.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

Great. And then in terms of your own lenders, what can we think -- how can we think about any changes to what they'll be doing? Will there be more expansion of products? I mean, synergies on your side?

Matthew P. Wagner

Yes, I mean, I think it's going to be more business as usual, but they'll have expertise they can draw from CapitalSource people for a lot of interesting things that they do that we haven't done before. And so I think, if anything, it adds arrows to their quiver, in terms of servicing their current customers and future prospects.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

And then, finally, I have a trading-related or a more housekeeping-related question. The shares that you're going to have to issue for this transaction, will you be needing a separate shareholder vote to approve the higher amount of shares versus what you have authorized or is that already within your current authorization?

Victor R. Santoro

Well, it'll be in the proxy statement to get an increase in the authorized shares, Julianna.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

And do you have a sense on the timeline on that?

Victor R. Santoro

The agreement, which is going to be filed the next couple of days, says that the S4 has to be filed within 45 business days of signing, and then naturally it's subject to SEC review. So it's hard to say what the timing will be because you've got to wait for the SEC to approve it.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

Right, before the shareholders vote on it?

Victor R. Santoro

Right.

Operator

Our next question comes from Christopher Marinac at FIG Partners.

Christopher W. Marinac - FIG Partners, LLC, Research Division

Vic, one for you on the tax rate. Do the pro formas we see on Slide 11 include a full tax rate or any recognition of the DTA and NOL?

Victor R. Santoro

No, it's just the full tax rate, Chris. 41.5%, that's what's in there.

Christopher W. Marinac - FIG Partners, LLC, Research Division

Okay, so that could possibly be different as you get further into this?

Victor R. Santoro

Yes, with the adjustment of valuation reserves, although the adjustment of valuation reserve could very well happen at closing, i.e. we happened really analyzed that completely yet. But if you look at these numbers in that slide, that the pretax earnings that are shown here are -- in 2014, it's $417 million and then $495 million in 2015. CapitalSource has an NOL carryforward at the end of December 2012 of about $480 million. So a lot of that's going to be used up pretty quickly.

Christopher W. Marinac - FIG Partners, LLC, Research Division

Got you. Okay, very good. And then back to the point that Mike [ph] was making earlier, about regulatory cost and stress testing, et cetera. Do any of your costs or system improvement get covered by the merger charge or will those be ongoing investment next year, end of '15?

Matthew P. Wagner

Those will be ongoing.

Victor R. Santoro

Any investments we make, I mean they're not going to be written off, they're going to be capitalized. That's the way they're going to work, so any improvements we make to systems, to enhance them, to help out with the stress testing and the capital planning and so on, that'll be balance sheet stuff.

James J. Pieczynski

But, clearly, a lot of the cost associated with that are involved in the personnel aspect of it, and so we've got a lot of personnel that are coming over from CapitalSource that'll be supplementing the people that are at PacWest right now, in order to kind of have kind of the robust stress testing and capital planning that we need.

Matthew P. Wagner

They were really 90-plus percent there.

James J. Pieczynski

I mean, as you all know, we were getting ready to file -- kind of getting ready for bank holding company and having our systems, and processes and procedures in place. And so I think we've been able to take kind of what we've been doing in marrying that with what PacWest has been doing. Okay, let's combine this and take the best of this. And when we present this to the regulators for approval, I think we'll come with a very clean package.

Christopher W. Marinac - FIG Partners, LLC, Research Division

Great. And then I guess just one further question. You mentioned about the 3-year transition on deposits and the benefit, $13 million each year. What does deposits -- or what do you think they may look like at the end of 3 years? I mean, is the mix math going to be similar to where PacWest is now or is it hard to predict at this point?

Matthew P. Wagner

Well, I mean, I'd just be giving you a guess, Chris. But, I mean, I think you're probably -- in 3 years time, you're not probably going to be back to 40-plus percent DDA, but you'd probably be well on your way to it. In the low 30s, maybe even a little bit better than that. And if you look at overall core, I think you can transform that even quicker. And, again, as I mentioned back before in the deployment of capital, future acquisitions could become a big part of that too. You've got a lot of community banks out there that have very underutilized balance sheets, which I think a platform like the new PacWest could probably deploy very effectively.

Operator

The next question comes from Kevin Reynolds at Wunderlich Securities.

Kevin B. Reynolds - Wunderlich Securities Inc., Research Division

Most of my questions has been answered but I just wanted to sort of, conceptually, get a feel for the combination here. I mean, should we be thinking about this as a marriage where everyone is sleeping in the same room or should we think about it more as roommates, where we're going to see sort of keep the operations separate for a while and just sort of kind of bump into each other in the hallways until we fully get this pulled together in the next 2 to 3 years?

Matthew P. Wagner

No. I mean, I think it actually is a marriage. I think the last deal we did was a little tricky because it wasn't overly friendly. This one couldn't be more of the opposite, and I think there's a lot of things that the companies can learn from each other. We already have, actually, in the past few months. There's a lot of compatibility here. Jim and I are both Midwesterners by background, which is very helpful. I think there'll be groups within CapitalSource that we won't see very often. They're in different locations and that sort of thing, and as long as they're doing their thing and Jim's satisfied with how they're performing, they're probably not going to spend a lot of time in West LA. It just doesn't make sense to do that. But I think it's going to come together really well. I mean, this is a very good thing. I mean, you can see the reactions from the stock today, and I think people understand what it means and we're going to have a lot of happy employees out there.

Kevin B. Reynolds - Wunderlich Securities Inc., Research Division

Okay. And one other question, I guess as a follow-up. You mentioned sort the last deal and there's been some talk about the regulatory burden now that you're going to be $15 billion-plus. But, sort of putting those 2 things together, how comfortable are you at this point with, I guess -- I know you don't have regulatory approval and you won't have it for a while. But on the heels of the FCAL deal, where is that integration-wise? And then I suspect you're probably very far along in what you set out to do there, but how do the regulators feels about you doing something of this size so quickly after that? And then what are the things, if they are worried at all -- and I'm sure they've got some minor concerns on their best day -- what are the things that they would be the most concerned about, that you really need to address, to give them comfort as you get closer to the closing date?

Matthew P. Wagner

Well, to give an enough data on FCAL, I mean, we did close on May 31, and we converted over the weekend of the 14th of June, and that went extremely well. So that's fully integrated. We still have a little bit of hangover from the EPS division, as we're winding that down, but that's going very, very well and I think the regulators were satisfied with how we handled that, and everything else. So I guess, Vic, would you call it 98.5% complete?

Victor R. Santoro

Yes, easily.

Matthew P. Wagner

In terms of integration, everything's done. So of course I'm never going to try tried to speak for a regulator, that would be suicide in a lot of ways. But we did preview this transaction with all of the affected regulators, the Department of Financial Institutions in California, the FDIC and the Federal Reserve, and I would say the reception was warm, from them. They understand where we're coming from, with this. I think they appreciated the approach that we're taking with it. I think the appreciate the high-capital levels that we're going to have in this transaction. And we acknowledge the work that needs to be done to comply with everything about Dodd-Frank and everything else involved there. And we've committed the resources to making that happen. So I anticipate and I have to -- and you know me, that I'm an optimist -- but I anticipate no issues there really. It won't be fast, is my guess. Simply because all these things seem to take a little bit longer than they used to. But I don't anticipate any issues.

Operator

The next question comes from Gary Tenner at D.A. Davidson.

Gary P. Tenner - D.A. Davidson & Co., Research Division

Just a couple of questions, I think most of mine have been asked and answered as well. To make sure I understand what your comments were earlier, on the credit front going forward, should we think about it as the CapitalSource division having its own dedicated sort of credit underwriting group and then the community bank piece staying at PacWest. Is that right way?

James J. Pieczynski

Right, so maybe we way we look at it as exactly that. So if you look at the CapitalSource division, kind of our group is going to continue the way it is. So the current Chief Credit Officer of our company will be the Chief Credit Officer of the CapitalSource division; and then Brian Corsini, who is the current chief credit administration officer at CapitalSource, will be the Chief Credit Officer of the entire organization; and Brian will continue to stay on credit committee. So, in terms of it going forward, it'll be operating exactly the way that it does today.

Matthew P. Wagner

Yes. And at the community bank, same thing. We'll have Bob Dike, who is our current Chief Credit Officer for PacWest, will be the Chief Credit Officer for the community bank.

Gary P. Tenner - D.A. Davidson & Co., Research Division

Okay, great. And then just one quick question, Vic, I missed when you were going over some of the cost saves us stuff. What was your comment on the branch closures at CapitalSource overall?

Victor R. Santoro

It's 15 offices, overlap, Gary. There's going to be some closures. We don't know which ones yet but there certainly will be.

Matthew P. Wagner

Yes.

Operator

Our next question comes from Brian Hagler at Kennedy capital.

Brian Hagler - Kennedy Capital Management, Inc.

You touched on this earlier but can you give us a sense of timing as to when the DTA could be recaptured?

Victor R. Santoro

It would be probably early in the -- once we close, that would be my guess. As I said earlier, Brian, we really haven't delved into that in any great depth. But it has a very good chance, most of it could be recaptured at the closing.

Brian Hagler - Kennedy Capital Management, Inc.

Okay. And this would be in addition to the 10% tangible book accretion assumption, correct?

Victor R. Santoro

Yes, that's right. It would be, yes.

Brian Hagler - Kennedy Capital Management, Inc.

Okay. And then, lastly, if I read this correctly as well, you basically -- given the NOLs that are there, you basically don't have any tax benefits assumed in Europe '14 or '15 pro forma estimates either. Is that correct?

Victor R. Santoro

Right, that is correct.

Matthew P. Wagner

Full tax.

Operator

And the last question comes from Mark DeVries at Barclays.

Mark C. DeVries - Barclays Capital, Research Division

Jim, could you give us some color on the process, the CapitalSource through -- and some of the bank, how long that process was, how comprehensive? And at what point in the process you really started to see some real interest?

James J. Pieczynski

Relative to this, Matt and I had met, kind of talked about, does this make sense. And we thought it -- we kind of look at each other's company and what he loved about our company was the fact that we have the origination platform and what I loved about his company was that he's got the community banking model with the low-cost deposits. We said, Jesus, it's something that really does make sense and so we started moving down the path. And obviously, knowing that, a big part of the consideration we were going to be having was a 55% ownership interest in this company. We really had to kind of take a step back and do the diligence on their portfolio and their businesses as well and so we brought all of our credit and underwriting people in to do the diligence on their side, and of course, throughout the other areas as well. So we did a very detailed, thorough diligence process to get comfortable, recognizing that the currency that we were getting for transaction with PacWest stock. So we did, a significant level. We've spent several months on this, and every time we kind of kept looking deeper and deeper and deeper, it just looked better and better. So it was a very easy deal to come to. And I echo what Matt said, I think the cultures of our company are very similar and that I think we've got a lot of hardworking energetic people that will work very well together, and so I think we complement each other incredibly well.

Mark C. DeVries - Barclays Capital, Research Division

Okay. Were there other potential suitors who came forward in the process?

James J. Pieczynski

I'm not going to kind of discuss that here. Read the proxy.

Victor R. Santoro

Yes. Thanks, everyone. Just a reminder that the replay of this call will be up on our website later today. Thank you.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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