PacWest Solves Funding Problem with Square 1 Purchase

PacWest Bancorp in Los Angeles and Square 1 Financial in Durham, N.C., might be near opposite coasts, but their balance sheets seemingly fit like two pieces of a puzzle.

Square 1, a tech-focused lender, still has nearly twice as many deposits as it has loans, despite a 24% increase in its loan book last year. PacWest, with a 101% loan-to-deposit ratio at Dec. 31, is in need of liquidity after buying CapitalSource last year.

PacWest went a long way toward solving its problems Monday, announcing an $849 million all-stock deal for Square 1. The combined company would have $19.8 billion in assets and, more importantly, a 91% loan-to-deposit ratio.

More banks like PacWest that have loan books that overshadow their deposit operations, could be looking for similar deals to help right their balance sheets. One motivator could be regulators that have been historically skeptical of banks with high loan-to-deposit ratios.

“Regulators begin to ask more questions” when banks’ have more loans than deposits, said Matthew Clark, an analyst at Sterne, Agee & Leach. The loan-to-deposit ratio is “a regulatory hot button.”

Matt Wagner, PacWest’s chief executive, and Doug Bowers, Square 1’s chief executive, did not return calls seeking comment, and the companies did not have a conference call to discuss the merger.

Square 1 offers PacWest a long-term play on tech firms, but the seller's low cost of funding could be the immediate draw. From that perspective, the deal makes “enormous sense” strategically, said Christopher Marinac, director of research at FIG Partners. An infusion of cheap deposits could boost PacWest’s bottom line next year by up to 3 cents a share, he added.

PacWest’s loan portfolio increased by 3% in the fourth quarter compared to a year earlier, to nearly $12 billion. Total loans nearly tripled from the end of 2013, reflecting the CapitalSource acquisition.

As a result, it will become “harder and harder to gather deposits” organically when interest rates start to rise, Clark said.

Because of this, banks in similar situations as PacWest may go looking for acquisitions to help right their balance sheets.

“This is a clear positive for banks with solid franchises,” Clark said. “It gives some credibility to banks with national lending platforms, albeit with higher-quality platforms. Excess deposits will also remain in favor.”

PacWest said it expects to complete the Square 1 acquisition in the fourth quarter, at which point the seller will keep its name and operate as a division of Pacific Western Bank. PacWest projected that it could cut nearly $14 million in costs next year, to roughly 20% of Square 1’s annual operating expenses.

The cost-save assumptions as very conservative, Marinac said. PacWest should have no difficulty reaching its goal, he said, calling the acquirer “one of the best companies in the country in being able to extract cost saves.”

“The beauty of this deal is that it’s not driven by cost saves or the need to control costs,” said Emmett Daly, a principal at Sandler O’Neill. Sandler advised Square 1. Wagner “had the wisdom to leave Square 1 alone” by keeping Bowers in the fold.

Though based in North Carolina, Square 1 has deep roots in California, where half of 12 loan-production offices are located. Square 1’s founders, Richard and Susan Casey, worked at Imperial Bancorp in Inglewood, Calif., before raising $105 million in a private placement and starting Square 1 in 2005.

Richard Casey died in 2010. Bowers joined the company in 2011.

Square 1 focuses on lending to technology and life-sciences companies and was successful almost from the start. The company earned $34.1 million last year. Bowers said in a conference call last month that the company, which hired 28 new employees in last year, expected to hire roughly the same amount in 2015.

PacWest, meanwhile, earned $168.9 million last year, fueled by the CapitalSource deal.

Square 1 “wasn’t a company that was running out of steam,” Daly said. “PacWest recognized that fact, valued it and was willing to pay for it.”

The deal price is 263% of Square One’s tangible book value.

Square 1 “represents an excellent opportunity to grow core deposits, expand our nationwide lending platform, and increase our presence in the dynamic technology and life-sciences markets,” Wagner said in a press release announcing the acquisition.

Jackie Stewart contributed to this report.