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PACW > SEC Filings for PACW > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for PACWEST BANCORP

Form 10-Q for PACWEST BANCORP


8-Nov-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Information

This Quarterly Report on Form 10-Q contains certain forward-looking information about the Company and its subsidiaries, which statements are intended to be covered by the safe harbor for "forward-looking statements" provided by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact are forward-looking statements. Such statements involve inherent risks and uncertainties, many of which are difficult to predict and are generally beyond the control of the Company. We caution readers that a number of important factors could cause actual results to differ materially from those expressed in, implied or projected by, such forward-looking statements. Risks and uncertainties include, but are not limited to:


lower than expected revenues;


credit quality deterioration or pronounced and sustained reduction in real estate market values could cause an increase in the allowance for credit losses and a reduction in earnings;


increased competitive pressure among depository institutions;


the Company's ability to complete future acquisitions and to successfully integrate such acquired entities or achieve expected benefits, synergies and/or operating efficiencies within expected time frames or at all;


the possibility that personnel changes will not proceed as planned;


the cost of additional capital is more than expected;


a change in the interest rate environment reduces interest margins;


asset/liability repricing risks and liquidity risks;


pending legal matters may take longer or cost more to resolve or may be resolved adversely to the Company;


general economic conditions, either nationally or in the market areas in which the Company does or anticipates doing business, are less favorable than expected;


environmental conditions, including natural disasters, may disrupt our business, impede our operations, negatively impact the values of collateral securing the Company's loans or impair the ability of our borrowers to support their debt obligations;


the economic and regulatory effects of the continuing war on terrorism and other events of war, including the conflicts and uncertainties in the Middle East;


legislative or regulatory requirements or changes adversely affecting the Company's business;


changes in the securities markets; and


regulatory approvals for any capital activities cannot be obtained on the terms expected or on the anticipated schedule.

Overview

We are a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Our principal business is to serve as the holding company for our subsidiary bank, Pacific Western Bank, which we refer to as Pacific Western or the Bank.

Pacific Western is a full-service commercial bank offering a broad range of banking products and services including: accepting demand, money market, and time deposits; originating loans, including


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commercial, real estate construction, SBA guaranteed and consumer loans; originating equipment finance leases; and providing other business-oriented products. Our operations are primarily located in Southern California extending from California's Central Coast to San Diego County; we also operate three banking offices in the San Francisco Bay area, a leasing operation based in Utah, and asset-based lending operations based in Arizona as well as San Jose and Santa Monica, California. The Bank focuses on conducting business with small to medium sized businesses in our marketplace and the owners and employees of those businesses. The majority of our loans are secured by the real estate collateral of such businesses. Our asset-based lending function operates in Arizona, California, Texas, Colorado, Minnesota, and the Pacific Northwest. Our equipment leasing function has lease receivables in 45 states.

Pacific Western competes actively for deposits, and emphasizes solicitation of noninterest-bearing deposits. In managing the top line of our business, we focus on loan growth, loan yield, deposit cost, and net interest margin, as net interest income, on a year-to-date basis, accounted for 94% of our net revenues (net interest income plus noninterest income).

Total assets increased $216.9 million during the third quarter due primarily to the acquisition of American Perspective Bank, or APB, on August 1, 2012. At September 30, 2012, gross non-covered loans and leases totaled $3.1 billion and the covered loan portfolio was $567.4 million. The gross non-covered loan and lease portfolio increased $206.2 million, due mainly to the addition of $197.3 million in loans from the APB acquisition. When the acquired loans are excluded, organic non-covered loan and lease growth was $8.9 million. This growth was a combination of new loans and leases and reductions due to (a) a sale of a $17.9 million classified loan at a slight discount and
(b) refinancings of existing loans by other lenders. During the third quarter, we observed that $84.0 million of our loans with individual loan balances of $1.0 million or more were refinanced by other lenders. We further observed that the rates on these takeouts ranged from a low of 3.85% to a high of 5.00% and fixed terms ranged from a low of 5 years to a high of 30 years. The covered loan portfolio declined $41.6 million due to repayments and resolution activities.

Total liabilities increased $198.4 million during the third quarter due to the addition of deposits from the APB acquisition, offset by the deposit decline from the branch sale. Total deposits increased $196.0 million (including a $120 million noninterest-bearing deposit received at quarter-end that was withdrawn in October 2012) during the third quarter to $4.8 billion at September 30, 2012. Core deposits increased $198.7 million during the third quarter due mostly to increases of $134.5 million in noninterest-bearing demand deposits and $87.5 million in money market deposits. Time deposits decreased $2.7 million during the third quarter to $862.3 million at September 30, 2012. At September 30, 2012, core deposits totaled $3.9 billion, or 82% of total deposits at that date. Noninterest-bearing demand deposits were $2.0 billion at September 30, 2012 and represented 42% of total deposits at that date. See "Balance Sheet Analysis-Deposits" for a table showing the changes in deposits for the third quarter reflecting the APB acquisition and sale of branches.

American Perspective Bank Acquisition

On August 1, 2012, Pacific Western Bank completed the acquisition of American Perspective Bank, or APB, located in San Luis Obispo, California. Pacific Western Bank acquired all of the outstanding common stock of APB for $58.1 million in cash. APB had two operating branches located in San Luis Obispo and Santa Maria, California, and a loan production office located in Paso Robles, California. This acquisition is expected to strengthen the Company's presence in the Central Coast region. The loan production office has been approved to open as a branch in the fourth quarter of 2012 and is expected to provide opportunity for expansion and additional growth in that region. At August 1, 2012, APB had $197.3 million in gross loans outstanding, $48.9 million in investment securities available-for-sale, and $219.6 million in deposits. In August 2012, we sold $45.6 million of APB's government-sponsored enterprise mortgage backed securities and collateralized mortgage obligations.


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We retained APB's municipal securities portfolio. Immediately following the completion of the acquisition, APB was merged with and into Pacific Western Bank.

Sale of Branches

On September 21, 2012, Pacific Western Bank completed the sale of 10 branches. The branches are located in Los Angeles, San Bernardino, Riverside, and San Diego Counties. The transaction resulted in the transfer of deposits to the buyer in exchange for a blended deposit premium of 2.5% applied to the deposit balances transferred at closing. The deposits of the offices sold totaled $125.2 million and we recognized a net gain of $297,000 on this transaction. Although certain other immaterial assets related to the branches were included in the transaction, no loans were transferred. The annual cost savings from this transaction, representing noninterest expense less noninterest income, are estimated to be $2.0 million after tax.

Key Performance Indicators

Among other factors, our operating results depend generally on the following key performance indicators:

The Level of Our Net Interest Income

Net interest income is the excess of interest earned on our interest-earning assets over the interest paid on our interest-bearing liabilities. Net interest margin is net interest income expressed as a percentage of average interest- earning assets. A sustained low interest rate environment combined with low loan growth and high levels of marketplace liquidity may lower both our net interest income and net interest margin going forward.

Our primary interest-earning assets are loans and investments. Our primary interest-bearing liabilities are deposits. We attribute our high net interest margin to our high level of noninterest-bearing deposits and low cost of deposits. While our deposit balances will fluctuate depending on deposit holders' perceptions of alternative yields available in the market, we attempt to minimize these variances by attracting a high percentage of noninterest-bearing deposits, which have no expectation of yield.

Loan and Lease Growth

We generally seek new lending opportunities in the $500,000 to $15 million range, try to limit loan maturities for commercial loans to one year, for construction loans up to 18 months, and for commercial real estate loans up to ten years, and to price lending products so as to preserve our interest spread and net interest margin. We sometimes encounter strong competition in pursuing lending opportunities such that potential borrowers obtain loans elsewhere at lower rates than those we offer. Our ability to make new loans is dependent on economic factors in our market area, borrower qualifications, competition, and liquidity, among other items. Loan growth remains tepid, as new loan volume is not replacing maturities. We attribute this to the competition for new and maturing loans from money center banks, regional banks and community banks that operate in our market areas. Such competition centers on unreasonably low interest rates and unrestrictive loan terms. Excluding acquired loans, during the third quarter gross loans and leases increased $8.9 million. We continue to retain maturing lending relationships that contribute positively to our profitability and net interest margin, and selectively add new loans that meet our credit and pricing standards.

We have expanded our commercial loan and lease portfolio through the January 3, 2012 acquisition of Pacific Western Equipment Finance, an equipment leasing provider, and the April 3, 2012 acquisition of Celtic, an asset-based lender. As of September 30, 2012, Equipment Finance had


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$161.9 million of leases and $15.1 million of leases in process, and Celtic had $57.5 million in gross loans.

The Magnitude of Credit Losses

We stress credit quality in originating and monitoring the loans we make and measure our success by the levels of our nonperforming assets, net charge-offs and allowance for credit losses. We maintain an allowance for credit losses on non-covered loans and leases which is the sum of our allowance for loan and lease losses and our reserve for unfunded loan commitments. Provisions for credit losses are charged to operations as and when needed for both on and off balance sheet credit exposure. Loans and leases which are deemed uncollectible are charged off and deducted from the allowance for loan and lease losses. Recoveries on loans and leases previously charged off are added to the allowance for loan and lease losses. The provision for credit losses on the non-covered loan and lease portfolio was based on our allowance methodology and reflected net charge-offs, the levels and trends of nonaccrual and classified loans, and the migration of loans into various risk classifications. A provision for credit losses on the covered loan portfolio may be recorded to reflect decreases in expected cash flows on covered loans compared to those previously estimated.

We regularly review our loans to determine whether there has been any deterioration in credit quality stemming from economic conditions or other factors which may affect collectibility of our loans. Changes in economic conditions, such as inflation, unemployment, increases in the general level of interest rates, declines in real estate values and negative conditions in borrowers' businesses could negatively impact our customers and cause us to adversely classify loans and increase portfolio loss factors. An increase in classified loans generally results in increased provisions for credit losses. Any deterioration in the real estate market may lead to increased provisions for credit losses because of our concentration in real estate loans.

The Level of Our Noninterest Expense

Our noninterest expense includes fixed and controllable overhead, the major components of which are compensation, occupancy, data processing, and other professional services. It also includes costs that tend to vary based on the volume of activity, such as OREO expense. We measure success in controlling both fixed and variable costs through monitoring of the efficiency ratio. We calculate the base efficiency ratio by dividing noninterest expense by net revenues (the sum of net interest income plus noninterest income). We also calculate a non-GAAP measure called the "adjusted efficiency ratio." The adjusted efficiency ratio is calculated in the same manner as the base efficiency ratio except that noninterest income is reduced by FDIC loss sharing income and other-than-temporary loss on a covered security and noninterest expense is reduced by OREO expenses, acquisition and integration costs, and debt termination expense.


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The consolidated base and adjusted efficiency ratios have been as follows:

                                           Base        Adjusted
                                        Efficiency    Efficiency
                   Three Months Ended      Ratio         Ratio
                   September 30, 2012          67.6 %        56.5 %
                   June 30, 2012               64.9 %        59.7 %
                   March 31, 2012              97.1 %        58.6 %
                   December 31, 2011           60.4 %        59.9 %
                   September 30, 2011          67.9 %        58.7 %

We disclose the adjusted efficiency ratio as it shows the trend in recurring overhead-related noninterest expense relative to recurring net revenues. See "Results of Operations-Non-GAAP Measurements" for the calculations of the base and adjusted efficiency ratios.

Critical Accounting Policies

The Company's accounting policies are fundamental to understanding management's discussion and analysis of results of operations and financial condition. The Company has identified several policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for credit losses and the carrying values of intangible assets and deferred income tax assets. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2011.

Results of Operations

Non-GAAP Measurements

Certain discussion in this Form 10-Q contains non-GAAP financial disclosures for tangible common equity, adjusted earnings before income taxes, and adjusted efficiency ratios. The Company uses certain non-GAAP financial measures to provide meaningful supplemental information regarding the Company's operational performance and to enhance investors' overall understanding of such financial performance. Given the use of tangible common equity amounts and ratio is prevalent among banking regulators, investors and analysts, we disclose our tangible common equity ratio in addition to the equity-to-assets ratio. Also, as analysts and investors view adjusted earnings before income taxes as an indicator of the Company's ability to absorb credit losses, we disclose this amount in addition to pre-tax earnings. The methodology of determining tangible common equity and adjusted earnings before income taxes may differ among companies. We disclose the adjusted efficiency ratio as it shows the trend in recurring overhead-related noninterest expense relative to recurring net revenues.

These non-GAAP financial measures are presented for supplemental informational purposes only for understanding the Company's operating results and should not be considered a substitute for financial information presented in accordance with United States generally accepted accounting principles ("GAAP"). The following table presents performance amounts and ratios in accordance with


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GAAP and a reconciliation of the non-GAAP financial measurements to the GAAP financial measurements.

                                                         Three Months Ended                   Nine Months Ended
                                             September 30,    June 30,     September 30,        September 30,
Adjusted Earnings Before Income Taxes            2012           2012           2011            2012        2011
                                                                       (In thousands)
Earnings before income taxes                 $       26,937    $ 25,970    $       22,649    $  61,028   $ 63,068
Plus:       Total provision for credit
            losses                                   (2,141 )      (271 )             348       (8,486 )   22,448
            Non-covered OREO expense, net             1,883         130             2,293        3,834      5,296
            Covered OREO expense, net                 4,290       2,130             4,813        7,242      3,440
            Other-than-temporary
            impairment loss on covered
            security                                      -       1,115                 -        1,115          -
            Acquisition and integration
            costs                                     2,101         871                 -        2,997          -
            Debt termination expense                      -           -                 -       22,598          -
Less:       FDIC loss sharing income
            (expense), net                             (367 )      (102 )             963       (4,048 )    5,109

            Adjusted earnings before
            income taxes                     $       33,437    $ 30,047    $       29,140    $  94,376   $ 89,143

                                            Three Months Ended                   Nine Months Ended
                                September 30,    June 30,     September 30,        September 30,
Adjusted Efficiency Ratio           2012           2012           2011           2012        2011
                                                      (Dollars in thousands)
Noninterest expense             $       51,657    $ 47,585    $       48,587   $ 168,137   $ 136,524
Less:   Non-covered OREO
        expense, net                     1,883         130             2,293       3,834       5,296
        Covered OREO
        expense, net                     4,290       2,130             4,813       7,242       3,440
        Acquisition and
        integration costs                2,101         871                 -       2,997           -
        Debt termination
        expense                              -           -                 -      22,598           -

        Adjusted noninterest
        expense                 $       43,383    $ 44,454    $       41,481   $ 131,466   $ 127,788

Net interest income             $       70,771    $ 68,413    $       64,441   $ 206,864   $ 198,868
Noninterest income                       5,682       4,871             7,143      13,815      23,172

        Net revenues                    76,453      73,284            71,584     220,679     222,040
Less:   FDIC loss sharing
        income (expense),
        net                               (367 )      (102 )             963      (4,048 )     5,109
        Other-than-temporary
        impairment loss on
        covered security                     -      (1,115 )               -      (1,115 )         -

          Adjusted net
        revenues                $       76,820    $ 74,501    $       70,621   $ 225,842   $ 216,931

Base efficiency ratio(1)                  67.6 %      64.9 %            67.9 %      76.2 %      61.5 %
Adjusted efficiency ratio(2)              56.5 %      59.7 %            58.7 %      58.2 %      58.9 %


--------------------------------------------------------------------------------
    (1)


Noninterest expense divided by net revenues.

(2)
Adjusted noninterest expense divided by adjusted net revenues.


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                                            September 30,      June 30,     December 31,
Tangible Common Equity                          2012             2012           2011
                                                       (Dollars in thousands)
PacWest Bancorp Consolidated:
Stockholders' equity                        $      584,086   $    565,648    $    546,203
Less:      Intangible assets                        95,491         78,951          56,556

             Tangible common equity         $      488,595   $    486,697    $    489,647

Total assets                                $    5,538,502   $  5,321,622    $  5,528,237
Less:      Intangible assets                        95,491         78,951          56,556

           Tangible assets                  $    5,443,011   $  5,242,671    $  5,471,681

           Equity to assets ratio                    10.55 %        10.63 %          9.88 %
           Tangible common equity
           ratio(1)                                   8.98 %         9.28 %          8.95 %
Book value per share                        $        15.61   $      15.12    $      14.66
Tangible book value per share               $        13.06   $      13.01    $      13.14
Shares outstanding                              37,420,025     37,402,293      37,254,318
Pacific Western Bank:
Stockholders' equity                        $      660,693   $    642,553    $    625,494
Less:      Intangible assets                        95,491         78,951          56,556

           Tangible common equity           $      565,202   $    563,602    $    568,938

Total assets                                $    5,520,998   $  5,305,170    $  5,512,025
Less:      Intangible assets                        95,491         78,951          56,556

           Tangible assets                  $    5,425,507   $  5,226,219    $  5,455,469

           Equity to assets ratio                    11.97 %        12.11 %         11.35 %
           Tangible common equity
           ratio(1)                                  10.42 %        10.78 %         10.43 %


--------------------------------------------------------------------------------
    (1)


Calculated as tangible common equity divided by tangible assets.


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     Earnings Performance

    Summarized financial information for the periods indicated are as follows:

                                    Three Months Ended                    Nine Months Ended
                        September 30,    June 30,     September 30,         September 30,
                            2012           2012           2011            2012         2011
                                    (Dollars in thousands, except per share data)
Earnings Summary:
Interest income         $       75,123   $  72,890    $       72,518   $  222,413   $  224,371
Interest expense                (4,352 )    (4,477 )          (8,077 )    (15,549 )    (25,503 )

Net interest income             70,771      68,413            64,441      206,864      198,868

Provision for credit
losses:
Non-covered loans
and leases                      (2,000 )         -                 -      (12,000 )     13,300
Covered loans                     (141 )      (271 )             348        3,514        9,148

Total provision                 (2,141 )      (271 )             348       (8,486 )     22,448

FDIC loss sharing
income (expense),
net                               (367 )      (102 )             963       (4,048 )      5,109
Other-than-temporary
impairment loss on
covered security                     -      (1,115 )               -       (1,115 )          -
Other noninterest
income                           6,049       6,088             6,180       18,978       18,063

Total noninterest
income                           5,682       4,871             7,143       13,815       23,172

Non-covered OREO
expense, net                    (1,883 )      (130 )          (2,293 )     (3,834 )     (5,296 )
Covered OREO
expense, net                    (4,290 )    (2,130 )          (4,813 )     (7,242 )     (3,440 )
Acquisition and
integration costs               (2,101 )      (871 )               -       (2,997 )          -
Debt termination
expense                              -           -                 -      (22,598 )          -
Other noninterest
expense                        (43,383 )   (44,454 )         (41,481 )   (131,466 )   (127,788 )

Total noninterest
expense                        (51,657 )   (47,585 )         (48,587 )   (168,137 )   (136,524 )

Income tax expense             (10,849 )   (10,413 )          (9,345 )    (24,119 )    (26,247 )

Net earnings            $       16,088   $  15,557    $       13,304   $   36,909   $   36,821

Profitability
Measures:
Earnings per share:
Basic                   $         0.43   $    0.42    $         0.36   $     1.00   $     0.99
Diluted                 $         0.43   $    0.42    $         0.36   $     1.00   $     0.99
Annualized return
on:
Average assets                    1.16 %      1.16 %            0.97 %       0.90 %       0.90 %
Average equity                   11.16 %     11.23 %           10.11 %       8.78 %       9.81 %
Net interest margin               5.58 %      5.60 %            5.15 %       5.53 %       5.35 %
Base efficiency
ratio                             67.6 %      64.9 %            67.9 %       76.2 %       61.5 %
. . .
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