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PACW > SEC Filings for PACW > Form 10-Q on 8-Nov-2013All Recent SEC Filings

Show all filings for PACWEST BANCORP

Form 10-Q for PACWEST BANCORP


8-Nov-2013

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, including the CapitalSource merger, and to successfully integrate such acquired entities or achieve expected benefits, synergies and/or operating efficiencies within expected time frames or at all;


the Company's ability to obtain regulatory approvals and meet other closing conditions to the CapitalSource merger, including approval by the Company and CapitalSource stockholders, on the expected terms and schedule;


delay in closing the CapitalSource merger;


business disruption following the proposed CapitalSource merger;


changes in the Company's stock price before completion of the CapitalSource merger, including as a result of the financial performance of the Company or CapitalSource prior to closing;


the reaction to the CapitalSource merger of the companies' customers, employees and counterparties;


if the CapitalSource merger is completed, additional regulatory requirements associated with being a bank and bank holding company with assets in excess of $10 billion;


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;


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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 Los Angeles-based wholly-owned 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 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 San Diego County to California's Central Coast; 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; net interest income, on a year-to-date basis, accounted for 96.3% of our net revenues (net interest income plus noninterest income).

Total assets decreased $92.2 million during the third quarter of 2013 to $6.6 billion due mainly to decreases in cash and cash equivalents, covered loans, and the FDIC loss sharing asset, offset by increases in investment securities available-for-sale and non-covered loans. At September 30, 2013 gross loans and leases totaled $4.4 billion, a decrease of $36.3 million since June 30, 2013. The gross non-covered loan and lease portfolio totaled $3.9 billion, an increase of $34.2 million during the third quarter reflecting $195.8 million in originations, $45.0 million in purchases, and $206.6 million in net paydowns. The covered loan portfolio totaled $510.9 million, down $70.5 million during the third quarter due to repayments and resolution activities. Securities available-for-sale increased $38.6 million to $1.5 billion due to purchases.

Total liabilities decreased $106.8 million during the third quarter to $5.8 billion due to lower total deposits and liabilities of discontinued operations. Total deposits decreased $89.9 million during the third quarter to $5.4 billion at September 30, 2013, due to a decrease in time deposits of $98.6 million, offset by an increase in core deposits of $8.7 million. The increase in core deposits was due to increases of $37.4 million, $7.6 million, and $5.5 million in noninterest-bearing demand deposits, interest checking deposits, and savings deposits, respectively, offset by a decline of $41.8 million in money market deposits. At September 30, 2013, core deposits totaled $4.7 billion, or 87% of total deposits, and noninterest-bearing demand deposits, which totaled $2.3 billion, were 43% of total deposits at that date.


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PacWest and CapitalSource Merger Announcement

On July 22, 2013, PacWest announced the signing of a definitive agreement and plan of merger (the "Agreement") whereby PacWest and CapitalSource, Inc. ("CSE") will merge in a transaction valued at approximately $2.4 billion. The combined company will be called PacWest Bancorp and the combined subsidiary bank will be called Pacific Western Bank. The CSE national lending operation will continue to do business under the name CapitalSource as a division of Pacific Western Bank.

Under the terms of the Agreement, CSE shareholders will receive $2.47 in cash and 0.2837 shares of PacWest common stock for each share of CSE common stock. Based on the closing price of PacWest shares on November 4, 2013 of $38.21, the total value of the CSE per share merger consideration was $13.31.

As of September 30, 2013, on a pro forma consolidated basis, the combined company would have had approximately $15.4 billion in assets with 95 branches throughout California. The combined institution would be the 6th largest publicly-owned bank headquartered in California, and the 8th largest commercial bank headquartered in California (out of more than 214 financial institutions in the state).

The transaction, currently expected to close in the first quarter of 2014, is subject to customary conditions, including the approval of bank regulatory authorities and the stockholders of both companies.

First California Financial Group Acquisition

On May 31, 2013, PacWest Bancorp ("PacWest") completed the acquisition of First California Financial Group, Inc. ("FCAL"). As part of the acquisition, First California Bank ("FCB"), a wholly-owned subsidiary of FCAL, merged with and into Pacific Western. For further information, see Note 3, Acquisitions, in the Notes to Condensed Consolidated Financial Statements (Unaudited) contained in "Item 1. Condensed Consolidated Financial Statements (Unaudited)."

2012 Acquisitions

We completed the following three acquisitions in 2012: (1) American Perspective Bank, or APB, acquired on August 1, 2012, (2) Celtic Capital Corporation, or Celtic, acquired on April 3, 2012, and (3) Pacific Western Equipment Finance (formerly known as Marquette Equipment Finance), or EQF, acquired on January 3, 2012. For further information regarding these acquisitions, see Note 3, Acquisitions, in the Notes to Condensed Consolidated Financial Statements (Unaudited) contained in "Item 1. Condensed Consolidated Financial Statements (Unaudited)."

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


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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 to one year for commercial loans, up to 18 months for construction loans, and up to ten years for commercial real estate loans; and price lending products so as to preserve our interest spread and net interest margin. Achieving robust loan growth has been challenging due to:
(a) under-pricing by our competitors in many cases at margins that are not significantly above our securities portfolio yield, and (b) our unwillingness to incur unacceptable interest rate risk. We continue to selectively make or renew quality loans that contribute positively to our profitability and net interest margin and we are focused on building relationships rather than attracting customers at low prices. Our loan pipeline has built-up nicely due to slowly improving economic conditions in our markets, our focus on existing customers for new business referrals, and the service levels we provide that enable us to attract and retain business from the larger banks.

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-purchased credit impaired ("Non-PCI") 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-PCI loan and lease portfolio was based on our allowance methodology and reflected historical and current net charge-offs, the levels and trends of nonaccrual and classified loans and leases, the migration of loans and leases into various risk classifications, and the level of outstanding loans and leases. A provision for credit losses on the purchased credit impaired ("PCI") loan portfolio may be recorded to reflect decreases in expected cash flows on PCI loans compared to those previously estimated.

We regularly review our loans and leases to determine whether there has been any deterioration in credit quality stemming from economic conditions or other factors which may affect collectability of our loans and leases. 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 leases and increase portfolio loss factors. An increase in classified loans and leases 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 (a) noninterest income is reduced by FDIC loss sharing income and securities gains and losses, and (b) 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, 2013          64.3 %        57.3 %
                   June 30, 2013               93.5 %        62.4 %
                   March 31, 2013              64.5 %        61.7 %
                   December 31, 2012           60.7 %        55.7 %
                   September 30, 2012          67.6 %        56.5 %

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.

Adjusted Net Earnings

Our reported net earnings for the third quarter of 2013 were $24.2 million. Another measure of earnings used as an indicator of earnings generating capability and ability to absorb credit losses is adjusted net earnings. We calculate adjusted net earnings by excluding credit loss provisions, OREO expenses, FDIC loss sharing income or expense, securities gains and losses, and acquisition and integration costs. On a pre-tax basis, before loss from discontinued operations, this amounted to $38.1 million for the third quarter of 2013 and after applying our effective tax rate, our adjusted net earnings were $26.0 million.

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, 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, 2012.

Non-GAAP Measurements

Certain discussion in this Form 10-Q contains non-GAAP financial disclosures for adjusted earnings from continuing operations before income taxes, adjusted efficiency ratio, return on average tangible equity, tangible common equity, and adjusted allowance for credit losses to loans and leases. 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. As analysts and investors view adjusted earnings from continuing operations before income taxes as an indicator of the Company's ability to both generate earnings and absorb credit losses, we disclose this amount in addition to pre-tax earnings. We disclose the adjusted efficiency ratio as it shows the trend in recurring overhead related noninterest expense relative to recurring net revenues. Given the use of return on average tangible equity and tangible common equity amounts and ratios is prevalent among banking regulators, investors and analysts, we disclose our return on average tangible equity in addition to return on average equity and our tangible common equity ratio in addition to the equity-to-assets ratio. As the allowance for credit losses takes into account credit deterioration on acquired loans and leases, which include an estimate of credit losses in their initial fair values, we disclose the adjusted allowance for credit losses to loans and leases


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in addition to the allowance for credit losses to loans and leases. The adjusted allowance for credit losses to loans and leases excludes acquired loans and leases and the related allowance. The methodology of determining adjusted earnings from continuing operations before income taxes, the adjusted efficiency ratio, return on average tangible equity, tangible common equity, and the adjusted allowance for credit losses to loans and leases may differ among companies.

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 tables present performance amounts and ratios in accordance with GAAP and a reconciliation of the non-GAAP financial measurements to the GAAP financial measurements:

                                                            Three Months Ended                   Nine Months Ended
                                                                                                   September 30,
Adjusted Earnings From Continuing Operations    September 30,    June 30,     September 30,
Before Income Taxes                                 2013           2013           2012            2013        2012
                                                                          (In thousands)
Earnings from continuing operations before
income taxes                                    $       35,383    $  6,302    $       26,937    $  62,898   $ 61,028
Plus: Provision (negative provision) for
credit losses                                           (4,167 )    (1,842 )          (2,141 )     (2,872 )   (8,486 )
Non-covered OREO (income) expense, net                     (88 )        80             1,883          305      3,834
Covered OREO (income) expense, net                        (332 )       (94 )           4,290       (1,239 )    7,242
Other-than-temporary impairment loss on
covered security                                             -           -                 -            -      1,115
Acquisition and integration costs                        5,450      17,997             2,101       24,139      2,997
Debt termination expense                                     -           -                 -            -     22,598
Less: FDIC loss sharing income (expense),
net                                                     (7,032 )    (5,410 )            (367 )    (15,579 )   (4,048 )
Gain on sale of securities                                   -           -                 -          409          -
Acquisition-related securities gain                      5,222           -                 -        5,222          -

Adjusted earnings from continuing operations
before income taxes                             $       38,056    $ 27,853    $       33,437    $  93,179   $ 94,376


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                                         Three Months Ended                   Nine Months Ended
                             September 30,    June 30,     September 30,        September 30,
Adjusted Efficiency Ratio        2013           2013           2012           2013        2012
                                                   (Dollars in thousands)
Noninterest expense          $       56,200    $ 64,216    $       51,657   $ 164,599   $ 168,137
Less: Non-covered OREO
(income) expense, net                   (88 )        80             1,883         305       3,834
Covered OREO (income)
expense, net                           (332 )       (94 )           4,290      (1,239 )     7,242
Acquisition and
integration costs                     5,450      17,997             2,101      24,139       2,997
Debt termination expense                  -           -                 -           -      22,598

Adjusted noninterest
expense                      $       51,170    $ 46,233    $       43,383   $ 141,394   $ 131,466

Net interest income          $       82,289    $ 68,473    $       70,771   $ 216,455   $ 206,864
Noninterest income                    5,127         203             5,682       8,170      13,815

Net revenues                         87,416      68,676            76,453     224,625     220,679
Less: FDIC loss sharing
income (expense), net                (7,032 )    (5,410 )            (367 )   (15,579 )    (4,048 )
Gain on sale of
securities                                -           -                 -         409           -
Acquisition-related
securities gain                       5,222           -                 -       5,222           -
Other-than-temporary
impairment loss on
covered security                          -           -                 -           -      (1,115 )

Adjusted net revenues        $       89,226    $ 74,086    $       76,820   $ 234,573   $ 225,842

Base efficiency ratio(1)               64.3 %      93.5 %            67.6 %      73.3 %      76.2 %
Adjusted efficiency
ratio(2)                               57.3 %      62.4 %            56.5 %      60.3 %      58.2 %


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


Noninterest expense divided by net revenues.

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

                                                 Three Months Ended                   Nine Months Ended
                                     September 30,    June 30,     September 30,        September 30,
Return on Average Tangible Equity        2013           2013           2012           2013        2012
                                                           (Dollars in thousands)
PacWest Bancorp Consolidated:
Net earnings                         $       24,163   $   4,349    $       16,088   $  42,006   $  36,909

Average stockholders' equity         $      797,725   $ 666,425    $      573,609   $ 685,216   $ 561,237
Less: Average intangible assets             228,947     129,863            88,258     151,360      81,168

Average tangible common equity       $      568,778   $ 536,562    $      485,351   $ 533,856   $ 480,069

Annualized return on average
equity(1)                                     12.02 %      2.62 %           11.16 %      8.20 %      8.78 %
Annualized return on average
tangible equity(2)                            16.85 %      3.25 %           13.19 %     10.52 %     10.27 %


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


Calculated as annualized net earnings divided by average stockholders' equity.

(2)
Calculated as annualized net earnings divided by average tangible common equity.


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                                       September 30,      June 30,     December 31,
    Tangible Common Equity                 2013             2013           2012
                                                  (Dollars in thousands)
    PacWest Bancorp Consolidated:
    Stockholders' equity               $      816,289   $    801,699    $    589,121
    Less: Intangible assets                   234,540        229,380          94,589

    Tangible common equity             $      581,749   $    572,319    $    494,532

    Total assets                       $    6,616,855   $  6,709,102    $  5,463,658
    Less: Intangible assets                   234,540        229,380          94,589

    Tangible assets                    $    6,382,315   $  6,479,722    $  5,369,069

    Equity to assets ratio                      12.34 %        11.95 %         10.78 %
    Tangible common equity ratio(1)              9.12 %         8.83 %          9.21 %
    Book value per share               $        17.71   $      17.40    $      15.74
    Tangible book value per share      $        12.62   $      12.42    $      13.22
    Shares outstanding                     46,090,742     46,080,731      37,420,909
    Pacific Western Bank:
. . .
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