There’s a lot of work ahead for the management of Banc of California (NYSE:BANC). In addition to the normal integration work that would be required to bring PacWest into the fold after the 2023 merger, management is still restructuring the balance sheet to improve its funding situation, refining the loan book, monitoring a challenging office CRE market, and working to convince the Street on the merits of the PacWest deal.
Expectations appear relatively restrained here, but it’s going to take a couple of quarters (at least) for the “real” BANC to emerge as the company completes the balance sheet restructuring and gets through the bulk of the merger integration. Longer term, though, I like this scaled-up Southern California franchise with leverage to growth opportunities in equipment lending, venture lending, and other niche verticals. Valuation is undemanding, but noisy quarters are a risk and there could be above-average volatility as the Street gets the longer-term earnings potential dialed into expectations.
More Restructuring Seems More Likely
BANC management got busy in the first quarter, restructuring about $9B of higher-cost borrowings. Through selling off loans and legacy securities, the company was able to retire repurchase agreements, repay borrowed funds and reduce its reliance on brokered CDs. All told, management sold around $6B of assets yielding around 3.6% to reduce $9B of wholesale funding that was costing them around 5.2%.
I expect further restructuring in the second quarter, though not to the same extent. Management wants to eliminate a further 15% of the loan book (including the large CIVIC portfolio), and there are still higher-cost borrowings and brokered CDs in the funding base that I believe management would like to replace.
The net impact of these changes is relatively straightforward – exit businesses that are non-core (like CIVIC and premium finance), lower overall funding costs, and shift the funding mix more toward lower-cost and less-volatile sources.
There is also further restructuring to do in terms of deduplicating functions shared with PacWest. Management’s cost save target of 15% is likely conservative, particularly with strategic business exits, and so I do expect more work ahead on the opex side that should drive better long-term returns.
Acceleration Should Become More Apparent In 2025
All in all, I think BANC has an above-average chance to generate above-average growth (relative to its peers) in 2025. If this projection proves accurate, it will be driven by a combination of top-line and opex factors.
On the top line, management’s efforts to restructure the balance sheet and the benefits of purchase accounting accretion should drive above-average net interest margin leverage. I’m looking for NIM to grow from 2.66% in the last quarter to around 2.9% this quarter (Q2’24) and improve a bit more before year-end (2.95%) ahead of another acceleration to around 3.25% in FY’25.
A lot of this should be driven by reduced funding costs. I’m not actually expecting above-average loan growth over the next 18 months, as I think management will be careful with multifamily and CRE lending. I’d also note that the bank has around 5% or so of its earning assets repricing over the next year, which is not bad, but also not exceptional next to names like BankUnited (BKU), Commerce Bancshares (CBSH), or Western Alliance (WAL). The outlook is a little better over the next two to three years, but that of course assumes that the “new normal” for rates is higher than it has been for the last decade.
Cost leverage should be another positive driver, as the company reaps the cost synergies from the PacWest deal and the loan business restructuring. I believe BANC’s efficiency ratio can get below 60% in FY’25, which although still only about average, would represent meaningful operating leverage compared to its peer group over the next 12-18 months (in other words, while I think BANC’s destination is about average, it’s starting from a higher level and will see more leverage as it integrates PACW).
With all of that, BANC should be poised to produce strong double-digit pre-provision earnings growth well in excess of quality peers where I expect mid-single-digit to low double-digit growth (names like East West (EWBC), FNB (FNB), and Pinnacle (PNFP)).
The Outlook
The new BANC is a scaled-up small commercial lender with strong (top 10) share in Southern California and major markets like Los Angeles. At this scale, BANC can offer a higher level of service than community banks (who are more limited on product sophistication) and large regional/national banks, that don’t often do a good job of competing on service quality for smaller commercial customers. I also still do like the growth potential in national equipment leasing and venture lending, though both verticals are getting a lot more crowded since the collapse of First Republic, Signature, SVB, and others (including PacWest) opened the door to hiring away lending teams to establish presences in those disrupted markets.
I’m expecting core earnings to double from FY’24 to FY’26, but FY’24 is an artificially low starting point in some respects. On a more “like for like” basis, I expect long-term core earnings growth in the 5% to 6% range. I do have some concerns about the ROE generation potential and whether or not the bank can out-earn its cost of equity capital, but I expect that picture to clear up over the next 12 months.
Discounted long-term core earnings supports a fair value above $15 today. I get a similar fair value with an 8x multiple on my ’25 EPS estimate; while 8x is well below normal, I think it’s acceptable now given the uncertainties around the business and the credit cycle (particularly in multifamily and CRE office). I do note, though, that the shares look undervalued on ROTCE-driven P/TBV; should BANC get to 10% to 11% ROTCE for FY’25 (below management’s target of 13%), a fair value of $18.50 to $20 is in play.
The Bottom Line
I think BANC will emerge from this period of uncertainty and restructuring as a strong player in the SoCal market, and I think today’s price undervalues the long-term potential of the franchise. I do understand the concerns about credit, though, as well as the uncertainty about what BANC’s true long-term earnings power will be once the restructuring efforts are over. If you can handle elevated risk, I think this is a name to consider, as I do think the shares will re-rate as the Street gets more confidence in its models over the next 12-18 months.
Read the full article here
