Capital-Rich PacWest Boosts Dividend as M&A Interest Wanes

CapitalSource is living up to its name now that it is part of PacWest Bancorp.

Just a few quarters after buying the specialty finance company, the $16 billion-asset PacWest is building capital through earnings faster than what it expected, and perhaps faster than what it wants on its balance sheet.

The company's leverage ratio at Sept. 30 was 12.17%, up from 11.73% at March 31, before the deal closed. With analysts expecting the Los Angeles company's annual earnings to rise by 51% next year, the coffer is only going to continue to swell.

PacWest could look to use that capital for another transformational deal, but analysts said it is unlikely given limited selection and management's pickiness. To that end, PacWest has found a way to take the edge off — announcing earlier this month that it would double its quarterly dividend to 50 cents a share.

"The first couple of quarters after CapitalSource have been good coming out of the gate," with capital accretion exceeding management's expectations, said Gary Tenner, an analyst at D.A. Davidson. "They are confident about where they are with their capital needs, and they're less inclined to do M&A, so it makes sense to give what they can back to shareholders."

Matt Wagner, PacWest's president and chief executive, did not return a call for comment, but he said in a press release that the company's "quarterly growth and earnings have been excellent and capital continues to build."

PacWest is "pleased that this increased regular quarterly dividend provides a solid return to our stockholders," he added.

The stock has reacted positively since the announcement, with shares trading at nearly $46 a share, up 8% from the day before the increase was unveiled.

The move to return more capital to shareholders was expected. Several analysts noted after the release of the company's third-quarter results that they expected either a dividend increase, a special dividend or both. Still, the move happened earlier than expected — many observers said they thought it would be raised next year.

The decision to boost the dividend indicates how capital is being viewed on banks' balance sheets. While capital might be king, heavy weighs the proverbial crown when it is deemed excessive. The industry generally views a tangible common equity ratio of more than 8% to be considered high. PacWest's was 12.2% at Sept. 30.

Too much capital can be a drag on return on equity and, ultimately, stock price. A lower stock price can make it harder to use capital to make acquisitions.

PacWest is a bit of an outlier in that regard. Analysts said the company hasn't been penalized for having high capital ratios because of its profitability. Observers are willing to focus on PacWest's above average return on assets of 1.73%, rather than its 10% return on equity, which is close to the accepted industry benchmark. (Still, observers could also focus on the company's return of tangible equity, which was 15.76% at Sept. 30.)

"For most banks, this much capital would be a big drag, but PacWest has such a strong ROA," said Bob Ramsey, an analyst at FBR Capital Markets. "Most banks would be happy with an ROA of 1%."

The dividend hike also speaks potentially to an evolving regulatory environment. For instance, two other West Coast banks recently announced that regulators would allow them to upstream capital from the bank to the holding company.

"The regulators must feel pretty good about where the company is to let them increase the dividend payout," Ramsey said of PacWest.

Given that the new dividend will likely be outpaced by earnings growth, Ramsey said he thinks the company will also award a special dividend at some point.

Several other banks have turned to special dividends to help manage capital. First Financial Bancorp in Cincinnati used a special dividend on top of its regular dividend to pay out all of its earnings for several quarters. It ended that in the third quarter of last year. First Financial has recently been buying banks.

Executives of Pacific Continental in Eugene, Ore., said on Thursday that, with the planned acquisition of Capital Pacific Bancorp, they would likely suspend their special dividend and a repurchase program designed to pay out all of its earnings.

The PacWest dividend increase should average about a 70% earnings payout.

The increase is, however, reflective of PacWest's negative view of current M&A. Wagner and his company rarely host conference calls, typically don't present at investor conferences and do not grant interviews, so it hard to pinpoint PacWest's exact feelings about M&A, but analysts who regularly meet with management said the team is not interested.

Given CapitalSource's ability to generate new loans, PacWest could eventually look to buy an under-levered institution with a cheap cost of deposits, though that deal seems unlikely now, analysts said. Also, given the attractiveness of the PacWest-CapitalSource combination, the bar for future acquisitions has been raised.

"They are so profitable and are having a hard time justifying using their capital to deal to get a lower level of return," said Aaron James Deer, an analyst at Sandler O'Neill. "The question is, 'What can we acquire that is going to be accretive to that profitability?'"