Pacific Premier Bancorp PPBI
December 22, 2008 - 6:37pm EST by
lvampa1070
2008 2009
Price: 3.90 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 19 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

The common stock of Pacific Premier Bancorp (PPBI) trades at 40% of tangible book and 6x current earnings. The stock has suffered from selling pressure that has little to do with intrinsic value or fundamentals: the largest shareholder liquidated its 26% beneficial ownership under duress.  The fundamental outlook is better than for most banks and various factors suggest Pacific Premier’s losses won’t wipe out more than a quarter of book value during the down cycle while the competitive position strengthens as peers fail. In short, the stock could double over 2 years to a reasonable valuation of about 1x tangible book given normal ROTEs of 10-12%.
 
REASONS WHY PPBI TRADES AT 40% OF TANGIBLE BOOK:

1) The largest shareholder liquidated its 26% beneficial ownership under duress.  After receiving an order from the FDIC last April to cease and desist from operating with inadequate capital, Security Pacific Bancorp sold its ownership in Pacific Premier Bancorp during the past several months.  Security Pacific had 60 days to increase its Tier 1 capital ratio to 10.0%.  The FDIC order may be found at the following link:  http://www.fdic.gov/bank/individual/enforcement/2008-04-01.pdf
 
Security Pacific acquired its ownership of Pacific Premier during 2007, it never succeeded in gaining controlling ownership, nor did it gain any board representation.

2) Mistaken association with troubled
Southern California sub-prime residential mortgages.  The predecessor to Pacific Premier Bancorp, known as Life Financial Corporation, consented to an order by the Office of Thrift Supervision (OTS) to cease and desist from various unsafe banking practices in 2000.  The principal problem was that Life Financial acquired sub-prime residential mortgages in volumes that were too large for its capital base.  Today, sub-prime mortgages account for less than 2% of the loan portfolio, and virtually all of them are part of this original portfolio, so they were originated in 2000 and earlier.  There have been numerous high profile failures this year of thrifts in Southern California, and this association doubtless weighs on the valuation of PPBI.

3) Investments in non-agency residential mortgage backed securities equal 37% of tangible equity.
  Pacific Premier invested in the Shay Asset Management’s AMF Funds, and in June redeemed its investment, receiving the securities owned by the AMF Ultra Short Mortgage Fund and the AMF Intermediate Fund.  At the end of September, the bank’s securities portfolio included non-agency RMBS with a par value of $25m and an estimated fair value of $21.3m, or 85% of par.  All of these securities were rated AAA or AA originally, and nearly all were still rated investment grade at Sep 30 (not that the rating has any bearing on the economic recovery, but it is important for determining fair values under mark-to-market accounting).
 
One can get a rough idea of the securities in the portfolio from disclosures by Shay (assuming the holdings haven’t changed materially between June 18 when Pacific Premier received its distribution and November 30). 
 
http://www.amffunds.com/html/AD0902-holdings_usm.pdf
http://www.amffunds.com/html/fdetails-ascpx.php

REASONS WHY PPBI’s EQUITY IS UNLIKELY TO SUFFER LOSSES OF 25%:

1) Pacific Premier was risk averse during the credit boom due to enhanced regulatory oversight.
    Following the OTS order in 2000, a new management team that specializes in bank turnarounds was hired.  Pacific Premier raised new equity capital and redirected the business model toward making loans with better risk adjusted yields.  For the next several years, the bank operated under elevated regulatory scrutiny as new management untangled the bank from the unsafe banking practices employed by prior management.
 
The result is that Pacific Premier has low exposure to high risk loan categories: construction loans (0%) and non-conforming residential mortgages (2%).  The $645m loan portfolio is mostly commercial real estate (CRE), 47% is multifamily, 26% is general CRE (offices, retail, warehouse, etc), and 17% is owner occupied CRE.  Business loans account for 7%.
 
So far, Pacific Premier’s loans are performing far better than the industry.  In aggregate, the ratio of non-performing assets to total assets for FDIC insured institutions is 1.54%.  The ratio for 160 public banks in California is 1.21%, and for 860 public banks outside California it is 1.00%.  Only 0.60% of Pacific Premier’s assets are non-performing.
 
Careful underwriting is another reason to expect solid loan performance, in addition to the reasons discussed – a risk-averse management team, limited exposure to the highest risk loan categories, and enhanced regulatory scrutiny following the order to cease and desist in 2000.  Nearly every loan has a personal guarantee (3% exceptions). The largest loan is $12m.
 
The typical loan-to-value at inception for multifamily was 64% and for other commercial real estate was 62%.  Given that the interest coverage is not typically less than 1.2x, if net operating income can decline by 25% (seems draconian, but say 7.5% decline in occupancy and 7.5% decline in rates, plus margin deterioration for fixed costs) and the bank forecloses, then cap rates can still increase by 100bps from 5.5% to 6.5% before the bank begins to really take losses on foreclosures.  The average loan is over 24 months old, and the bank sold off nearly its entire 2007 production.

2) The bank has sufficient capital to hold the RMBS to maturity.
  Tier 1 capital amounted to $65m, or 8.96% of tangible assets.  Technically, well-capitalized is over 5.0%; really, it is whatever the regulators say.  And they are telling Pacific Premier they would like it to be 10.0%, including TARP.  Pacific Premier received verbal feedback that if it applied for TARP proceeds its application would be approved.  The bank is eligible for up to $22m.  So with $87m of Tier 1 capital, its pro-forma capital ratio would 11.9%.

Scenario #1:
If the RMBS were immediately valued at $0, the Tier 1 ratio would fall to 10.3%.  So even if the RMBS is worthless immediately, the bank is still “well-capitalized” and is trading at 55% of diluted tangible book.  But provisions to the loan loss reserve have been and will continue to increase.

Scenario #2:
If the RMBS recovers just 50% of par over the next three years, this would equal roughly $9m of incremental losses spread across 12 quarters, or $0.75m per quarter, pre-tax.  The bank’s pre-tax pre-provision income last quarter was $2.25m.  If this run-rate continued, the sum for the next 12 quarters would be $18m (2.8% of loans).  Given pro forma Tier 1 capital of $87m and tangible assets of $735m, the bank is able to provision $2.5m per quarter for the next 12 quarters and maintain a capital ratio greater than 10.0%.  The cumulative provision would be $30m, or 4.7% of net loans.  The provision during the past two quarters has been $0.7m (3Q) and $0.8m (2Q).  In this scenario, at the end of 12 quarters, the diluted book value per share would be $6.50, and today the stock trades at 60% of this projected book value.

3) Insiders have been purchasing stock recently.
  I weight this factor lightly, and only because the management of Pacific Premier is not in denial about the credit outlook.  They are preparing for a flat bottom in 2011 that will last two years.  There are $60m of loans on the watch list and the bank has obtained updated financials and visited the properties to make updated appraisals.  This sort of vigilance adds influence to the recent insider purchases.  Moreover, there were six buyers of the 26% position that Security Pacific sold, and the buyers include a current and a former director of Pacific Premier.
 

Comparison

Tang. Equity/
Tang. Assets

NPA/
Assets

REO/
Assets

Construction/
Total Loans

Home equity/
Total Loans

5yr Avg. ROE

All Cali banks trading
between 30-50% of book (22)

9.50%

2.76%

0.28%

17%

4%

8%

All US banks trading between
30-50% of tangible book (113)

8.95%

3.30%

0.62%

20%

4%

7%

Pacific Premier Bancorp
(PPBI, 40% of tangible book)

7.65%

0.70%

0.00%

1%

0%

13%

Catalyst

1) Acquiring deposits of a failed bank from FDIC. Pacific Premier has a high loan-to-deposit ratio and relies on FHLB borrowings. This makes the bank liability sensitive, which is positive for profit margins in the near term, but deposits would improve earnings reliability.

2) Seasoning of RMBS that potentially resulted in an earnings gain and increase in book value (this is a low probability event).

3) Time. Given reasonable expectations for 100% upside, a 2-3 year time horizon is budgeted.
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