This Bank Didn't Wait on the Fed to Buy a Deposit-Rich Institution

Pacific Premier Bancorp in Irvine, Calif., didn't wait on Fed action before agreeing to buy another deposit-rich bank.

The $3.8 billion-asset company's agreed Tuesday to buy the $2 billion-asset Heritage Oaks Bancorp in Paso Robles, Calif., in a deal that will increase its deposit base by 52% while lowering its loan-to-deposit ratio from around 101% to 94%.

The strategy makes sense for Pacific Premier, a beneficiary of strong loan growth, particularly in light of the Fed's decision to raise the federal funds rate by 25 basis points.

Deposits are where "all of the franchise value is created," said Steven Gardner, the company's chairman and CEO. Pacific Premier, which has completed seven acquisitions in the last five years, always looks at a target's deposits before considering other factors, he said.

That was certainly the case in 2012, when the company agreed to buy First Associations Bank, a Dallas institution that largely served homeowners' associations, in a deal that Gardner admitted at the time was largely a play for deposits.

Deposits have always been a key source of liquidity, especially for fast-growing banks like Pacific Premier, but they could become a bigger driver of M&A in a rising rate environment, industry observers said. That's because rising rates increase the odds that individuals and businesses will seek out higher-yielding deposits, increasing the value of institutions that can keep their funding costs low.

"There's no doubt that core deposits have become a lot more valuable in a short amount of time just with the expectation that rates are going up," said Matthew Clark, an analyst at Piper Jaffray. "People will care more about core deposits."

In addition to having plenty of low-cost funds, Heritage Oaks has the second-largest deposit market share in San Luis Obispo, Calif., and is No. 7 in Santa Barbara, Calif., according to June 30 data from the Federal Deposit Insurance Corp.

"Those are small and middle-market bank customers," Gardner said. "Those deposits are very sticky and are not price sensitive. They are looking for a bank that is truly their partner and someone they can count on to be there for them through thick and thin."

While the Fed did raise rates, it might take a period of regular increases to meaningfully influence deposit pricing, said Jacquelynne Bohlen, an analyst at Keefe, Bruyette & Woods. While there are banks like Pacific Premier with high loan-to-deposit ratios, the overall industry continues to drown in deposits.

Of course, acquisitions should provide more than just one benefit.

Pacific Premier will also gain a foothold in agricultural lending, an area that requires significant expertise. Heritage Oaks' portfolio includes berry farms and hydroponic operations that cultivate tomatoes and cucumbers — businesses that have done a good job with water management in the face of a statewide drought.

Heritage Oaks hasn't recorded any losses or downgrades tied to the drought, said Simone Lagomarsino, the company's president and CEO.

Pacific Premier, which is "very comfortable with the portfolio," hired third-party experts to help evaluate the ag book, Gardner said. In addition, agricultural credits will make up about 4% of Pacific Premier's total loans when the transaction closes, based on a presentation tied to the deal.

Gardner and Lagomarsino have known each other for more than two decades and in recent years have served on the board for the Federal Home Loan Bank of San Francisco. Still, the deal was reached as part of a competitive bidding process, Gardner said during a conference call to discuss the agreement.

Heritage Oaks, meanwhile, was freed from a consent order tied to Bank Secrecy Act and anti-money laundering compliance about two weeks before the deal was struck. Lagomarsino called the timing a "coincidence" and Gardner said the deal wasn't contingent upon the order being lifted.

Lagomarsino declined to discuss the bank's sales process, but she said selling was the right decision due to the benefits from joining a much larger institution, including a bigger lending limit.

"We will be even stronger together" with $6 billion in assets, Lagomarsino said. "With interest rates as low as they have been our margins have been compressed. Even in a rising rate environment this makes sense, probably more sense, because of the benefits from cost control and top-line growth."

Lagomarsino, who was one of American Banker's Community Bankers of the Year in 2013, will join Pacific Premier's board. Beyond that, Lagomarsino said she was uncertain what role she would take on next, though she may spend more time at Vino Al Lago, the small winery she owns with her husband.

"I will probably do something different than being the CEO of a bank," she said. "I had several people email me and say, 'Now go make wine.' That's likely part of what I will look at it."