PacWest Bancorp: Attractively Valued With Good Prospects Of Strong Loan Growth

May 08, 2022 12:43 PM ETPacWest Bancorp (PACW)4 Comments1 Like
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Summary

  • The combination of the management’s team expansion efforts, digital platform enhancement, and economic factors will likely drive loan growth in the remainder of the year.
  • The topline is moderately sensitive to interest rate changes.
  • The provision expense, net of reversals, will likely be higher this year relative to last year but below the pre-pandemic average.
  • The December 2022 target price suggests a high upside from the current market price. Further, PACW is offering a decent dividend yield.

Woman holding a mobile phone with loan application approval.

courtneyk/E+ via Getty Images

Earnings of PacWest Bancorp (NASDAQ: NASDAQ:PACW) will most probably dip this year relative to last year because of a higher provision expense, net of reversals. Further, non-interest income normalization will lead to a year-over-year decline in earnings. On the other hand, economic factors will likely drive strong topline growth, which will, in turn, support the bottom line. Overall, I'm expecting PacWest Bancorp to report earnings of $4.43 per share in 2022, down 13% year-over-year. The year-end target price suggests a high upside from the current market price. As a result, I'm maintaining a buy rating on PacWest Bancorp.

Economic Factors and Investments to Drive Loan Growth

The strong loan growth in the first quarter of 2022 pleasantly surprised me. The portfolio grew by a whopping 6% by the end of March 2022 from the end of December 2021, or 25% annualized. Going forward, the loan portfolio will likely continue to grow strongly, albeit at a slower pace than in the first quarter.

Economic factors will likely be the chief driver of loan growth this year. Although PacWest’s branch network is based in California, the company is a nationwide lender. Therefore, national economic metrics are important determinants of credit demand in PacWest’s markets. Both the unemployment rate and the purchasing managers' index indicate economic strength that bodes well for loan growth.

US Unemployment Rate and US ISM manufacturing PMI
Data by YCharts

Although the overall GDP contracted in the first quarter, I'm not too concerned because the breakdown of the factors driving the decline showed that the problem does not lie with demand in the private sector. (For a brief analysis of the advanced GDP report, readers may refer to this article by Seeking Alpha.) In fact, the drop in exports and rise in imports signal that growth in local demand is outpacing local supply. Therefore, the scenario bodes well for credit demand in the coming months.

Moreover, the management intends to continue investing in its existing business lines, as mentioned in the earnings presentation. The management intends to hire additional team members and invest in PacWest’s digital platforms. These measures should translate into loan growth in the year ahead.

Furthermore, the remaining Paycheck Protection Program (“PPP”) forgiveness is likely to have a negligible impact on the total loan portfolio size. PPP loans outstanding totaled $70.4 million at the end of March 2022, representing just 0.3% of total loans.

The management mentioned in the earnings presentation that it is expecting low-double-digit loan growth for 2022. Considering the factors mentioned above, I believe the management’s target is easily achievable. Overall, I'm expecting the loan portfolio to increase by 11% by the end of December 2022 from the end of 2021. In my last report on PacWest, I estimated a lower loan growth for this year. I have revised upwards my loan growth estimate mostly because of the phenomenal performance in the first quarter of this year.

The following table shows my balance sheet estimates.

FY17 FY18 FY19 FY20 FY21 FY22E
Financial Position
Net Loans 16,833 17,825 18,708 18,735 22,741 25,258
Growth of Net Loans 10.0% 5.9% 5.0% 0.1% 21.4% 11.1%
Other Earning Assets 4,245 4,544 4,303 8,263 14,656 12,399
Deposits 18,866 18,871 19,233 24,941 34,998 34,743
Borrowings and Sub-Debt 930 1,825 2,217 471 863 1,940
Common equity 4,978 4,826 4,955 3,595 4,000 3,965
Book Value Per Share ($) 40.5 38.6 41.2 30.8 34.2 33.8
Tangible BVPS ($) 19.1 17.7 19.7 21.3 21.8 21.5

Source: SEC Filings, Author's Estimates

(In USD million unless otherwise specified)

Outlook on Margin Remains Rosy

According to details given in the earnings presentation, only around 36% of the loan portfolio is based on fixed rates. This means that a majority of the portfolio will re-price soon after every rate hike this year. Unfortunately, the liability side is also quite rate-sensitive. As a result, the overall net interest income is only moderately sensitive to rate changes. Due to the balance sheet’s positioning at the end of March 2022, the net interest income could increase by 6.8% over 12 months in the event of a 200-basis point hike in interest rates, according to the management’s interest-rate sensitivity analysis given in the 10-Q filing.

PacWest Bancorp also has the opportunity to improve its balance sheet positioning, which could lead to further expansion in the margin amid a rising interest-rate environment. PacWest Bancorp has a large buildup of excess cash on its books, which the company can quickly deploy into higher-yielding assets. Cash and cash equivalents almost halved in the first quarter, but are still above the pre-pandemic level, as shown below.

PacWest Bancorp Cash and Cash Equivalents

SEC Filings

Considering these factors, I'm expecting the margin to increase by twelve basis points in 2022. Compared to my last report on PacWest, I have revised upwards my margin estimate because of the economic reports released since the issuance of my last report on PACW.

Net Provision Expense Likely to Remain Below Historical Average

PacWest’s provisioning expense was near zero in the first quarter of 2022. Further reserve releases are likely because of the following factors.

  1. The management mentioned in the presentation that it expects the allowance level to continue to decline towards the Day 1 CECL allowance ratio of 1.0%. At the end of March 2022, allowances made up 1.12% of total loans.
  2. The allowances appeared somewhat excessive relative to the portfolio's credit risk at the end of the last quarter. According to details given in the earnings release, allowances made up 0.81% of total loans while classified loans and leases made up 0.34% of total loans at the end of March 2022.

On the other hand, the anticipated loan growth will require significant provisioning for expected loan losses. Overall, I'm expecting the provision expense, net of reversals, to be below the historical average this year. I'm expecting the provision expense to make up around 0.12% of total loans in 2022. In comparison, the provision-expense-to-total-loan ratio averaged 0.24% from 2017 to 2019.

Expecting Earnings to Dip by 13% Year-Over-Year

Earnings in 2022 will likely decline relative to last year because of higher net provision expenses. Moreover, non-interest income will likely decline to a more normal level this year after remaining elevated in 2021. The heightened non-interest income for 2021 was attributable to certain one-off items, which will not recur this year.

On the other hand, the anticipated loan growth and margin expansion will boost the bottom line. Overall, I'm expecting PacWest to report earnings of $4.43 per share, down 13% year-over-year. The following table shows my income statement estimates.

FY17 FY18 FY19 FY20 FY21 FY22E
Income Statement
Net interest income 980 1,041 1,015 1,015 1,104 1,260
Provision for loan losses 58 45 22 339 (162) 30
Non-interest income 129 149 143 146 194 159
Non-interest expense 496 511 502 1,984 637 682
Net income - Common Sh. 358 465 469 (1,239) 597 520
EPS - Diluted ($) 2.91 3.72 3.90 -10.61 5.10 4.43
Adjusted EPS - Diluted ($) 2.91 3.72 4.06 2.12 5.10 4.43

Source: SEC Filings, Author's Estimates

(In USD million unless otherwise specified)

In my last report on PacWest Bancorp, I estimated earnings of $4.49 per share. I have now slightly tweaked downwards my earnings estimate because the non-interest income was much lower than I expected in the first quarter of 2022.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and the timing and magnitude of interest rate hikes.

Maintaining a Buy Rating

PacWest Bancorp is offering a dividend yield of 3.1% at the current quarterly dividend rate of $0.25 per share. The earnings and dividend estimates suggest a payout ratio of 23% for 2022, which is much below the pre-pandemic normal of over 60%. Therefore, there is a chance that the company will increase its dividend. However, the full reinstatement of the pre-pandemic dividend level of $0.60 per share is unlikely in the next couple of years.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value PacWest Bancorp. The stock has traded at an average P/TB ratio of 2.04x in the past, as shown below.

FY17 FY18 FY19 FY20 FY21 Average
T. Book Value per Share ($) 19.1 17.7 19.7 21.3 21.8
Average Market Price ($) 49.5 48.7 37.8 22.6 41.5
Historical P/TB 2.59x 2.75x 1.92x 1.06x 1.91x 2.04x
Source: Company Financials, Yahoo Finance, Author's Estimates

Multiplying the average P/TB multiple with the forecast tangible book value per share of $21.5 gives a target price of $43.9 for the end of 2022. This price target implies a 35.5% upside from the May 6 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

P/TB Multiple 1.64x 1.84x 2.04x 2.24x 2.44x
TBVPS - Dec 2022 ($) 21.5 21.5 21.5 21.5 21.5
Target Price ($) 35.3 39.6 43.9 48.2 52.4
Market Price ($) 32.4 32.4 32.4 32.4 32.4
Upside/(Downside) 9.0% 22.3% 35.5% 48.8% 62.1%
Source: Author's Estimates

The stock has traded at an average P/E ratio of around 11.7x in the past, as shown below.

FY17 FY18 FY19 FY20 FY21 Average
Earnings per Share ($) 2.91 3.72 4.06 2.12 5.10
Average Market Price ($) 49.5 48.7 37.8 22.6 41.5
Historical P/E 17.0x 13.1x 9.3x 10.7x 8.2x 11.7x
Source: Company Financials, Yahoo Finance, Author's Estimates

Multiplying the average P/E multiple with the forecast earnings per share of $4.43 gives a target price of $51.7 for the end of 2022. This price target implies a 59.6% upside from the May 6 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

P/E Multiple 9.7x 10.7x 11.7x 12.7x 13.7x
EPS 2022 ($) 4.43 4.43 4.43 4.43 4.43
Target Price ($) 42.8 47.2 51.7 56.1 60.5
Market Price ($) 32.4 32.4 32.4 32.4 32.4
Upside/(Downside) 32.2% 45.9% 59.6% 73.3% 87.0%
Source: Author's Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $47.8, which implies a 47.6% upside from the current market price. Adding the forward dividend yield gives a total expected return of 50.7%. The significant price downside suggests that the market is over-reacting to the earnings outlook. Based on the total expected return, I’m maintaining a buy rating on PacWest Bancorp.

This article was written by

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Around 10 years of experience covering Banks and Macroeconomics. Passionate about discovering lucrative investments and generating alpha.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.

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