Since the US banking industry was rocked by the failures of Silicon Valley Bank on March 10, 2023, and Signature Bank on March 12, 2023, PacWest Bancorp (NASDAQ:PACW) has been splashed across headlines as one of the banks facing a strain on its deposits. The crisis developed as real-time information about possible weaknesses of different banks was disseminated among a social media-connected populace and magnified by algorithms. Investors in the stock market began placing bets on the subsequent dominoes to fall as anxious depositors started shifting their money from smaller regional banks to larger too-big-to-fail national banks in an effort to protect their wealth. It didn’t take long for banks like First Republic Bank and PacWest to come under close scrutiny, presumably as a result of their greater reliance on uninsured deposits, their geographic concentration in California, and their connection to the venture capital business through deposits and loans.

First Republic’s stock price is down 89% and PacWest’s stock price is down 66% from their closing levels on March 3, just before the SVB debacle, as a result of the subsequent sell-off. Comparatively, the Financial Select Sector SPDR ETF only fell by 13% during the same time period. It’s tempting to believe that First Republic and PacWest equities may be valued for the worst-case scenario of a bank failure and that their share prices could significantly increase after investor jitters have subsided. To assist any investors looking for a hidden treasure among the wreckage of the SVB disaster, here is my opinion on sorting reality from fiction regarding the PacWest narrative. I won’t delve too deeply into First Republic’s possibilities because SA Contributor Siyu Li has already done a great job of doing so here and here.

Calculating the Size of the Bank Run

It is useful to directly compare PacWest’s situation to that of First Republic, a larger participant in the regional banking industry who experienced significantly more of the onslaught of deposit withdrawals and the pounding of its stock price, to put PacWest’s issue in the context of smaller banks.

As of December 2022, PacWest’s total assets were $41 billion, or little under one-fifth of First Republic’s $213 billion total assets.

According to management disclosures, PacWest has lost 20% of its deposits, which is nothing compared to the First Republic, which, according to unconfirmed media sources, has lost nearly 50% of its holdings.

According to the New York Times, the First Republic lost almost $70 billion in deposits in recent weeks, or nearly half of its total depositor base as of the end of last year.

The Fed Discount Window and other facilities have been used by PacWest to increase its liquidity by up to $17.7 billion, a far lesser amount than the approximately. First Republic drew $149 billion in liquidity from several sources.

After all, is said and done, it appears that the outflow of deposits from smaller regional banks to larger banks has slowed, and everything mentioned above is now outdated. The comparison nonetheless provides a useful benchmark for determining the level of harm given that these institutions’ stock values are currently under pressure.

PacWest Story

In my perspective, a few general rules-of-thumb have influenced depositors’ actions in reaction to worries about spreading the ill-fated SVB’s problems, namely increasing reliance on uninsured deposits, investment connection, solvency issues, and inadequate liquidity management.

Increasing Reliance on Uninsured Deposits

Because depositors were understandably anxious that deposits beyond the $250,000 FDIC insurance threshold were at risk in the event of a bank failure, uninsured deposits turned out to be the Achilles heel in the current banking worries. Anybody searching for banks that rely on uninsured deposits is likely to come across PacWest, which has 52% of their deposits in that manner as of December 2022.

PacWest’s uninsured deposits were just 35% of the total as of March 20th due to the subsequent binge of shifting uninsured deposits to other banks (per 8-K filing of Mar 22nd). Also, the filing demonstrates that the bank is now prepared to handle additional withdrawals of uninsured deposits, with a cash level properly covering about. 100% of the savings are still uninsured. The Federal Reserve discount window, the recently launched Bank Term Funding Program, the Federal Home Loan Bank, and most significantly from the private sector in the form of a new senior asset-backed financing facility from ATLAS SP Partners have all been used by the bank to boost liquidity, as was previously mentioned.

Investment Connection

In terms of conducting a significant amount of business with California’s venture capital industry, many individuals would have singled out PacWest as being comparable to SVB.

Given that PacWest is based in Los Angeles, California, has full-service branches there as well as in Durham, North Carolina, and Denver, Colorado, and has a sizable concentration of collateral assets there, calling it a bank of the venture capital business was not an overstatement. The lack of venture capital investment that began in 2022 appears to have been a blessing in disguise for PacWest, since its venture banking deposits had a 27% Y-o-Y reduction in 2022.

Venture banking deposits were 33% of the total as of December 2022 following this Y-o-Y loss, and they further decreased to just 24% of the total by March 20th after experiencing a 43% decline in less than three months. Other account types, such as community bank and wholesale deposits, fared far better during the current wave of deposit withdrawals.

Regarding identifying exposure to the venture capital sector, the bank’s asset segmentation is fairly scant. For instance, as of December 2022, we estimate that commercial loans to venture capital firms will represent 7% of the loan book. I’d be concerned about additional indirect exposure from home mortgages given to venture capitalists and commercial mortgages secured by properties held by venture capital firms.

Solvency Issues

Investors seeking a repeat of SVB’s bankruptcy due to unrealized losses on held-to-maturity (HTM) investments turned to PacWest, which as of December 2022 had an HTM portfolio equivalent to 5.5% of its total assets and an 8.2-year duration. Additionally, it had a larger available-for-sale (AFS) portfolio that represented 11.7% of its assets and had a duration of 5.9 years. Unrealized losses on this portfolio were being covered by shareholders’ equity rather than the bank’s statutory capital. A rule of thumb for a bond’s sensitivity to interest rate changes is length; the longer the term, the greater the decrease in bond price for a given increase in interest rates, and vice versa.

I believe that PacWest’s tangible book value (TBV) will be reduced by 8% rather than 35% as a result of unrealized losses on its HTM portfolio.

First Republic and PacWest are trading at 0.28x and 0.60x Price to Tangible Book Value multiples, respectively, in terms of valuation. Investors’ skepticism over First Republic’s potential strategic options, in my opinion, is reflected in the stock’s bigger discount.

In the event that loans are sold to increase liquidity or a larger player acquires the bank as part of a rescue plan, there might be a far higher adjustment to tangible book value due to a haircut on the loans. Given the greater extent of its liquidity stress and its constrained strategic options, both of these scenarios are plausible for the First Republic. However, PacWest appears to be in a better position as management declared on March 22nd that it would not be wise to proceed with a capital issue transaction at this time. It is important to note that First Citizens Bank purchased $72 billion in SVB loans at a $26.5 billion discount (or 23% haircut) if we are looking for a rough haircut adjustment. If First Republic, which may be looking to sell certain loans or maybe put itself up for sale, is given a similar haircut, its tangible book value appears to be in pretty jeopardy. To me, PacWest’s TBV of $15.7 per share appears to be a more reliable anchor when attempting to determine the share price of a company.

Better Liquidity Management

In my opinion, PacWest had a little better liquidity situation than the First Republic in December 2022. Despite being a considerably lesser player, PacWest achieved this. We will have to look at other places, such as the number of liquidity buffers maintained in the form of cash and high-quality liquid securities, since it is not really viable to recreate the typical liquidity indicators used by banks, such as Liquidity Coverage Ratio (LCR) from 10-K reports. With 23% of the balance sheet, PacWest’s liquidity reserves were much higher than First Republic’s 17% in December 2022.

The number of liquidity reserves held by these two banks, in my opinion, was not required by regulation, therefore their level of liquidity was merely a reflection of good management.

In addition, PacWest management distinguishes out for its proactive approach to the liquidity situation, in my opinion. Compared to other banks, it has been more forthcoming in providing updates on its liquidity condition and the initiatives it is taking.

Final Reflections

Overall, I think the decline in the stock price of PacWest is justifiable. At this difficult time, the management has been aggressively keeping the market informed about its liquidity status. In comparison to one of its larger regional peers, PacWest’s exposure to uninsured deposits and unrealized losses on the HTM portfolio was much smaller. Also, the bank probably employs superior methods for managing liquidity. A haircut on loans tied to venture capital does not appear to be a base case outcome of PacWest’s road to normalcy. Investors ought to consider establishing a position in this speculative microcap, in my opinion.

Featured Image: Unsplash @ homajob

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