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PacWest and Banc of California merge to downsize

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2023-07-27

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Mergers typically result in larger combined entities, but a recent bank deal is bucking the trend by pursuing a different path -- one that could potentially unlock more lender mergers in the future.

Following the recent deposit crisis and loss of market confidence triggered by the collapses of Silicon Valley Bank, Signature Bank, and First Republic Bank earlier this year, regional banks are seeking ways to bolster their resilience, with some considering mergers as a viable option. However, creating bigger banks through mergers can be a contentious issue in Washington, with concerns over the overconcentration of larger banks being raised.

Nonetheless, a deal that surfaced on Tuesday may present a solution that satisfies the parameters while showing a way forward. Beverly Hills-based PacWest, which experienced significant deposit outflows in the first quarter and saw its shares plummet by almost 90% since the end of last year, is merging with a smaller rival, Banc of California, headquartered in Santa Ana, Calif.

The proposed merger will bring together two Golden State banks with a focus on business banking through their network of over 70 branches, positioning them as one of California's largest banks by deposits. However, the unique aspect of this deal is that the combined entity will ultimately be smaller in terms of total assets compared to the two individual lenders' second-quarter levels. In a call with analysts, executives disclosed that they had already presented the deal to regulators and believe they can finalise it later this year or in early 2024.

The intriguing aspect of this merger lies in the ability to shrink the banks' assets by selling off low-yielding assets, such as mortgages and securities earning 3.75%, and paying down wholesale funding, including government-backed borrowing costing 5%. While the banks had a combined $48 billion in assets in the second quarter, the merged entity anticipates emerging with $36 billion, aiming to bolster their net interest income next year through this repositioning.

For regional banks, selling low-yielding assets has been a desired goal, but it has been challenging due to the risk of generating losses as higher market rates have depressed the value of these assets. This, in turn, could lead to a depletion of capital levels, putting the banks at risk of falling below regulatory required ratios.

The PacWest and Banc of California merger may pave the way for other banks to follow suit. To make low-yielding asset sales more feasible, this deal incorporates outside capital from investors like Warburg Pincus and Centerbridge Partners, who will contribute $400 million in newly issued equity. The presence of external funding reflects the changing landscape for banks and the potential for similar deals to become more feasible.

In comparison to earlier this year, investors would have likely demanded far more stringent terms, as waiting to take over a failed bank could yield an incredibly advantageous deal. However, a series of second-quarter reports that surpassed investors' low expectations and demonstrated deposit stability may have provided potential acquisition targets with newfound leverage.

Many regional banks are already engaging in asset "diets" to downsize ahead of anticipated Federal Reserve capital requirements, even for midsize banks. Now, smaller banks with excess capital may have the opportunity to strike deals with competitors on favourable terms.

While this merger doesn't solve every concern that investors may have about regional banks, it presents a promising solution and signals potential for a new wave of lender mergers. Banks will continue to face challenges and need to tackle them through numerous strategic moves, one small step at a time.

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