|Shares Out. (in M):||50||P/E||13.8||10.5|
|Market Cap (in $M):||1,048||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
Banc of California, Inc. also known as “BANC”, or the “Company”, is a regional bank exclusively operating in the State of California. As of 4Q16 (pro forma for the mortgage banking divestiture), the Company had assets of approximately $10.6B, deposits of ~$9.1B, and loans held for investment of roughly $6B (mix was 35%, 37%, 26%, & 2% split between residential, CRE & MF, C&I, and other, respectively). BANC’s pro forma branch footprint consists of 37 locations in Southern California. After pruning its PCI (“purchased credit-impaired”) loan book and divesting its commercial equipment finance unit, credit metrics remain at trough levels with non-performing assets totaling just 16 basis points.
BANC’s exclusive focus on California is a key point of differentiation among other mid-sized banks. Most notably, with population growth and household income both ~15% above the national average, along with a robust small business footprint (3.5MM+), we believe future growth opportunities continue to be vast. Given these underlying demographics, we believe the Company operates in one of the most attractive banking markets in the country.
Recent Change Has Laid the Foundation for Higher Profitability:
Banc of California has been on our radar for some time but we never could justify ‘paying up’ for a bank that had such a heavy mortgage banking presence and a polarizing CEO.
After an ousting of the CEO, the Company has undergone a fundamental transformation in the span of several months. We believe these changes significantly improve the risk/reward profile and have BANC positioned to potentially deliver sizable upside for investors in the future. Consider the following:
The Company announced the resignation of the Chairman & CEO and named a new Chairman of the Board
The Board concluded that its independent investigation of allegations made by a short seller found no violation of law (Side note: WilmerHale conducted the investigation and the individual who led the effort was previously a senior member of SEC’s enforcement division)
Activists replaced more than 50% of the Board in a span of ~8 weeks
Lastly, the divestiture of its mortgage banking division (Banc Home Loan, “BHL”), in our opinion, will lead to more predictable results and shift the Company’s strategic focus to the more valuable commercial banking franchise
Ultimately, we believe this substantive change will result in the elimination of the Company’s significant valuation gap to its peers and position BANC to deliver sustainable value creation for shareholders going forward.
BANC 2.0: What is the Normalized Earnings Power?
A substantial portion of BANC’s earnings have historically been driven by transaction-related volume tied to its mortgage banking arm and net interest income (“NII”) from its residential loan book. However, a strategic transformation is underway to shift earnings power of the business away from transaction-related items to more predictable, higher quality spread-based income. As mentioned, this shift was significantly accelerated with the sale of its BHL division in 1Q17. We believe these changes will lead to improved earnings quality, and as a result, a higher multiple ascribed to the Company’s future income. For reference, only 54% of its revenue was derived from NII in 2016. However, pro forma for the sale of BHL, NII will now constitute close to 80% of the Company’s revenue generation in the future.
Although the Company lost close to 35% of its revenue base with the sale of BHL, the earnings power of this business has not been fundamentally altered given the expense load associated with mortgage banking. All else being equal, BANC would have earned ~$1.67/share in 2016 (vs. $1.94/share reported) if one were to exclude its BHL division. Going forward, we believe the Company has the ability to fill the remaining gap much sooner than many expect. This is predicated on several factors:
First, management’s targeted growth profile of 15%+ results in BANC having sufficient liquidity (and capital) to grow. This dynamic will allow BANC to reconstitute the balance sheet in a more profitable manner in 2017. From a liability perspective, the historical burden to fund growth with high cost deposits is substantially reduced. This will ultimately result in a lower cost of funding as management lets promotional deposits roll off (est. 1-1.25% range). Concurrent with this, the Company will also be able to reengineer the asset side of its balance sheet by reducing the lower yielding securities book and using these proceeds to fund the loan book.
Second, BANC’s expense load is being cut significantly. By divesting BHL, the Company will save over $120MM in expenses annually. In addition, management is also targeting another $50MM in annualized expenses. In aggregate, a combined $170MM in annual cost take out will result in the Company achieving an efficiency ratio of sub-60% by 2018.
As a result, BANC has the ability to achieve normalized earnings of ~$2.00/share in 2018. We believe 2017 will be a transition year as the Company repositions the balance sheet. Even so, we suspect the earnings power of this business will really become evident in the back half of the year.
*Assumes 25% effective tax rate
Comps: Taken together, we believe the market is underestimating the true value of this banking franchise. With peers (CATY, CVBF, EWBC, HOPE, FRC, OPB, PACW, PPBI, SIVB, WABC, WAFD, & WAL) trading around 15x forward earnings, BANC’s 2018 core earnings power of $2/share should result in the Company trading closer to $30/share, or approximately 43% higher than current levels. On a P/TBV basis, peers are trading near 2.5x TBV, which equates to a valuation of $35/share for BANC.
M&A Take-out Earnings w/ Cost Synergies: We also looked at a range of deals in the space and analyzed BANC from a take-out earnings perspective. This method is beneficial because it considers the earnings power of the underlying business but also gives credit to excess capital (not particularly applicable to BANC) and cost synergies that will ultimately be extracted in an M&A scenario. Based on 30 transactions announced since 2012, with deal values greater than $400MM, the median total cost take-out was approximately 30% of total non-interest expense. This resulted in a median pro forma P/E multiple of 11.8x. Applying this methodology to BANC’s normalized earnings (ex-BHL), the Company’s valuation would be close to $35/share.
Highly Strategic Banking Franchise with Multiple Ways to Realize Value for Investors:
Taken together, we believe the ‘new and improved’ Banc of California represents an attractive risk/reward value proposition in the regional banking space—both on an absolute and relative basis. From an operational perspective, the shift in the Company’s earnings mix to higher quality spread income will naturally lead to multiple expansion as the market begins to value BANC more in-line with its peers. From a strategic perspective, BANC now offers potential bidders a commercial lending platform that is of scale and positioned in one of the most attractive markets in the country. As such, we believe BANC being sold is not a matter of ‘if’, but rather a matter of ‘when’. Given the elevated currencies of potential acquirers, one can apply a sizable premium and still have the deal be accretive under most scenarios.
In aggregate, investors have multiple ways to win from both an operational and strategic perspective. We believe the underlying dynamics provide a nice set-up for investors and position BANC as a name to own.
1Q17 earnings (mainly, there is potential for more detail regarding operational plans/earnings targets for 2017/2018)
Appointment of new CEO
Tax & regulatory reform