$PACW: Rough Analysis - 2x Potential?

A potentially interesting contrarian buy

Amidst the carnage in bank land over the last couple of weeks is a particularly interesting case: PACW, Pacific Western Bank. It’s become exceptionally hard to value these banks as their balance sheets rapidly change over the last few weeks, so when PACW released a press release late Friday it spurred some interest.

If you’d like to skip the below, essentially I believe PACW is safer than feared and can represent a quick 2x return if the situation does not significantly deteriorate from here. A rough model can be found below.

The key variable with a lot of these banks is trying to determine what the actual rate of deposit outflow is, and the presser which can be found here gives the following data points:

• >$10.8b in available cash, which exceeds uninsured deposits

• Insured deposits exceed 62% of total deposits

Using these we can say that $10.8b is greater than uninsured deposits, which are 38% or less of total deposits. If we assume $10.5b is the uninsured deposit number and is 38% of deposits, this implies a total deposit number of ~$27.6b, down 17% from the $33.1b on March 8th.

This implies a total deposit outflow of ~$6.3b since 12/31.

Now what we can try to do is make a valuation for the bank assuming that deposits do not get much worse, as the press release stated outflows have slowed considerably.

Thus far, $6.3b of deposits would be entirely covered by their liquidity without any need for MTM losses on the loan book and HTM assets. Thus book value should be relatively consistent from 12/31. In this case I’d prefer to use Tangible Book Value which was ~$2.05b at the end of 2021 and should still be the case today. This represents ~$17 per share compared to current prices of $9.28.

The questions is then two-fold - will deposit outflows be so high as to cause MTM losses that eliminated TBV, and will NIM be reduced to the point of extended negative earnings?

On the first point, for deposits to start causing MTM losses would require a net outflow of >$10.8b, which is >70% more than the outflows we have seen thus far, and would crush NIM to the point of unviability regardless, so I don’t believe this is a scenario to consider. If it happens the bank would likely be claimed by the FDIC or fail.

On the NIM point, we can try to calculate NIM currently and speculate on the future.

As of 12/31 NIM was ~ 3.49% for PACW. This created $1.3b in NII in 2022. Other expense and income netted out to ~$675m, so roughly $625m of net income in 2022 for PACW. Thus for the company to start losing money, NII would have to decline by ~$625m.

With some basic math we can try and guess what they are doing with liquidity. Let’s assume a “liquidity cost” of 4.6% which is roughly the current fed overnight rate. Under a basic assumption, lets assume the $6.3b of deposits they lost has been entirely replaced by 4.6% cost Fed loans. This roughly matches up with their press release from 3/9 which stated they had ~$6.9b of liquidity from the FHLB and Fed.

The cost of these loans would be $290m per year, so our $625m of net income would become $335m, hardly negative. Under my slightly more complicated assumptions it’s actually ~$375m of net income, which is plenty fine, and assuming highly elevated liquidity draws, so I believe this would be conservative. At $375m of net income, and call it a PE of 7, the stock would be worth $22 a share, 141% upside from current prices.

So what would ruin our returns?

The model is sensitive to the following assumptions:

• Interest rates. Treasury yields have been heavily volatile recently and fallen substantially since the peak a few weeks ago. I am assuming yields stay relatively flat. If they instead rise, upside and odds of survival move down meaningfully. This is because their borrowing cost depends on yields, as does their asset values.

• Deposits do not meaningfully move out. If ~$5b more deposits exit, fair value can be 20% lower than current prices and cause long term NIM squeezes. I am currently assuming any borrowings can be paid out over time as loans mature and securities can be sold to cover when near term liquidity is more stable. If liquidity draws were more normalized, net income would be closer to $500m instead of $375m.

• The underlying loan credit is good. This seems like a good assumption, but some would argue it isn’t, especially in a recession. I have seen no indications of poor, performing credit from anything I’ve looked at recently, but it is possible.

• That my estimates of current deposits are sound. It’s possible uninsured deposits are say $9b instead of $10.5b, which could imply far higher borrowings that would materially impact Net Income. However with $375m of net income, another $3b of borrowing at ~4.6% would still leave us with $240m of net income, implying upside.

It’s also possible I’m missing something. I spun this up in a day after not looking at PACW previously. I’m not aware of any obvious errors, but they may exist. If the stock drops on news that CS was acquired at a steep discount, I am considering a 2-3% position at the open on Monday, as I believe PACW can represent a ~100% upside in 1y or less under reasonable assumptions.

If you are interested in playing around with a rough model, I made one here. It could be better and more plug and play, but you get what you get.

Thanks for reading and hope this was helpful. As always, feel free to subscribe and share as you wish.