Pacific Premier Bancorp: Insiders Are Buying Cheaper Shares, Should You?

| About: Pacific Premier (PPBI)


Pacific Premier shares have fallen and insiders are buying.

Growing through acquisitions, one-time charges are clouding earnings but the share count is up and profitability is in question.

Pacific Premier has a very clean loan portfolio and interest costs are at all time lows but, profits are heavily dependent on these two aspects that could come under pressure.

When to buy a stock has to be one of the toughest questions an investor needs to decide. When to investigate, on the other hand, is fairly easy and there are a lot of tools or angles one can use to start a search. I typically get caught up in certain themes or ideas that I use to define a population but for my review of Pacific Premier Bancorp (NASDAQ:PPBI), a falling stock price and news of insider purchases got my attention.

After trading around its 52-week high of $17.48, shares of Pacific Premier Bancorp nosedived right after the bank reported its first quarter earnings. Shares now trade 16% lower but we need to be mindful that they are still up close to 50% from where they were at the same time last year.

The Fall

Looking through the financials, the bank's earnings appear to have been hit by some regularly occurring one-time charges. In fact, just about every one-time charge I can think of has been passing through the income statement. You have merger related charges, higher provision expenses due to the change in the bank's portfolio composition, a rather large charge paid to terminate services from a discarded payment processing system provider and even an increased legal and audit related fee tied to the processing system's replacement. All told, these one-time charges brought down regularly reported earnings in the first quarter by over $1.5 million pre-tax. Without these charges, after tax earnings would have been almost 50% higher.

Earnings of $0.15 per share in 1Q2014 were down 37.5% from the fourth quarter of 2013 and slightly above the $0.13 reported during the same time last year. And, looking back, even these past results were after merger related expenses of $203K and $1.745 million were factored in (in 4Q2013 and 1Q2013 respectively, they were at $626K in 1Q2014). Needless to say, it looks like we may have found our culprit.

What Are They Building?

Moving over to the balance sheet, it's easy to see where the acquisitions have added when the loan portfolio has grown 41% in the last year. Commercial and industrial loans have been the fastest growing loan type (up 93% YOY) and multi-family real estate loans have also grown significantly (up 60% YOY), but the mix between business and real estate loans has held fairly stable around 45% and 55% respectively.

From most recently filed 10-Q

Even with the new loans and the increased provisional charge in the first quarter ($485K more than net charge-offs of $464K), allowances have been right around $8 million in each of the last five quarters despite the bank's portfolio surge. Even so, allowances have covered all nonperforming loans three times over in every period reported and even the balance of delinquent loans are less than half of the small amount reported in the first quarter last year ($3 million). With only 0.2% of all assets classified as nonperforming, Premier Bancorp is as clean as it gets.

On the other side of the equation, deposits grew faster than loans in the first quarter but the loan to deposit ratio is still up 15% from the same time last year. At 92.4%, the bank is close to the point where we see non-deposit liabilities start to cut into margins. I say close, but as the bank stands now, this is a non-issue as the yield on all interest-bearing liabilities has decreased to 0.52%. I'm not sure you can find a cheaper yield paid elsewhere, though I wouldn't be surprised, but it's at these low points that I start to wonder how heavily this low cost is being relied on. We don't know if or when rates will rise but we can assume that if they do, depositors will eventually start searching around for higher rates. For Premier Bancorp, this means management may find themselves in a position where they have to significantly increase deposit rates to entice its customers to stay. This is an industry-wide issue but one that I think should be given more thought here considering the very high loan to deposit ratio, the below average Tier 1 ratio of 10% and the fact that 26% of all liabilities are in non-interest bearing deposits that make up the exact pool of asset support that customers could potentially start to shop around with.

Is it worth more now?

Even with a lot more earnings power, new investors (and old) should be mindful of the very large increase in diluted shares outstanding that are the result of much of the bank's expansion. Now at 17.4 million, diluted shares outstanding are up 59% since the end of 2012 and will require an equal increase in income just to avoid an earnings per share decline. This is a very large hurdle that has not been cleared and is magnifying the current one-time charges that a casual reader may have overlooked. Despite this, I think shares are adequately priced at 1.57Xs tangible book value based on the solid financials, but that is probably valuing quality at 100% because earnings power has been significantly diluted.

The bank's tangible common equity ratio is averaged at 9.3% and I don't see many reasons to believe ROTCE could possibly get to anything above 15%. This sounds solid, but remember, new investors have to pay a premium for that (which makes it less valuable) and the portfolio is almost fully maxed out. This meaning that the only way to boost the bank's moderate earnings would be to expand more (potential dilution) or wait for the one-time charges to play out. Of course, this would help, but one needs to also factor the rising risk that the charges for the bank's extremely low cost liabilities start to rise and the possibility that the nonperforming asset needle begins to move. Both are very positive aspects of the bank right now but, remembering the fall from the refinance boom, I'm trying to avoid relying on anything close to an all time high and/or low.

In addition to potential marginal pressures from the cost side, Pacific Premier's earning assets have been yielding less and less every time investors have been shown an update. This may be an industry-wide phenomenon but the bank has been only able to add to income by increasing loans and this route, unless another acquisition is planned, is almost completely maxed out. With such a high L/D ratio, the bank's hands are increasingly getting tied and the provisional expense could also start to eat up interest income (that now makes up over 85% of all revenues). Provisions do cover nonperforming allowances by a healthy margin but they still pale in comparison to the growing portfolio. At 0.65% of all loans held for investment, the bank's coverage ratio is rather thin as the majority of banks I've covered have two times that rate when their portfolios are more established and were internally generated. Just to put this into perspective, doubling the current allowances to bring coverage up to just above 1.5% of the bank's loan portfolio would require a pre-tax charge equivalent to one full quarter of the bank's earnings AFTER adjusting for the flurry of nonrecurring charges that have been lowering GAAP income. This is not to say the bank is doing anything wrong or over reporting income but, apples to apples, the allowance balance is low and stands to increase despite the small portion of nonperforming loans.

Bottom Line

Insiders may be buying, the stock may be cheaper and the books may be attractive but I see a very long uphill battle for higher earnings because the cloud of acquisition has required a lot of extra shares and margins look razor thin. On top of this, I don't see how the bank can improve much more than the short-term drag on earnings and I'm fearful that the sunny side of this story could potentially be clouding up a lot of immeasurable risks.

Management is buying and has created one of the cleanest bank balance sheets I have found, so I wouldn't be surprised if they prove me wrong. Structurally, though, you can't fight much against the moderate asset to equity ratio and the fact that all returns squeezed out of the bank's assets are already being valued at a premium. I personally like to be paid to wait but there's no dividend to speak of and until the loan to deposit ratio falls I don't expect there will be one. With that, I'm staying away but will probably revisit in 4-6 months to check in on what looks like a very challenging situation for a bank with an ideal loan portfolio.

The company 10-K can be found here.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.