Margin Expansion From Loan Repricing And Deposit Mix Will Support Modest Long Term Upside

Catalysts

About Banc of California

Banc of California is a regional bank focused on relationship driven commercial lending and core deposit gathering across California and select national niches.

What are the underlying business or industry changes driving this perspective?

• Although strong loan production at yields above 7 percent supports ongoing remixing of the balance sheet, elevated payoffs and deliberate exits in areas like office and criticized credits could cap net loan growth and slow the pace of net interest income and earnings expansion.
• While the large multifamily portfolio repricing from roughly 4 percent coupons to higher rates offers margin upside, competitive agency pricing and potential refinancing pressure on borrowers may limit repricing gains and constrain future net interest margin and return on equity.
• Although the bank is capitalizing on industry dislocation in California by adding talent and winning new commercial and HOA deposit relationships, system wide liquidity tightening and higher competition for quality deposits may restrain low cost funding growth and weigh on net interest income.
• Despite disciplined expense control and technology investment that have driven a sub 60 percent efficiency ratio, wage inflation, project amortization and the need to support specialized businesses such as venture banking and warehouse lending could push core costs higher and slow operating leverage improvement.
• While expanded lending in niches like lender finance, mortgage warehouse and venture offers diversified revenue streams, any normalization of exceptionally low loss experience or tighter underwriting matrices in these portfolios could dampen growth and pressure net margins and earnings volatility.

Assumptions

This narrative explores a more pessimistic perspective on Banc of California compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Banc of California's revenue will grow by 11.1% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 16.5% today to 25.7% in 3 years time.
• The bearish analysts expect earnings to reach $359.4 million (and earnings per share of $2.44) by about December 2028, up from $168.7 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $400.7 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 8.7x on those 2028 earnings, down from 18.1x today. This future PE is lower than the current PE for the US Banks industry at 12.0x.
• The bearish analysts expect the number of shares outstanding to decline by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.75%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistent double digit earnings per share growth, supported by expanding net interest margin from remixing the loan book into higher yielding C&I, warehouse and lender finance assets, could lead to sustained upside surprises in earnings and drive a re rating of the share price, impacting both earnings and the valuation multiple applied to those earnings.
• Large embedded repricing upside in the multifamily and other fixed rate portfolios, with billions of loans currently near 4 percent coupons expected to reset toward 6 percent levels over the next several years, may structurally lift net interest income and net margins above market expectations, creating long term earnings growth that pushes the share price higher.
• Strategic share repurchases at prices below tangible book value, combined with CET1 capital accreting faster than reported profits due to deferred tax asset utilization, can magnify earnings per share growth and tangible book value per share, increasing return on equity and supporting a higher long term valuation for the stock.
• Secular growth in California and continued industry dislocation in the regional banking landscape may enable Banc of California to win high quality commercial and HOA deposit relationships and attractive lending opportunities, improving funding mix, lowering cost of deposits and lifting revenue and net interest margins over time.
• Disciplined expense control alongside ongoing technology and process investments, including automation and bank wide efficiency initiatives, could sustain positive operating leverage and keep the efficiency ratio trending lower, enhancing long run profitability, return on tangible common equity and ultimately the company’s earnings power.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Banc of California is $20.0, which represents up to two standard deviations below the consensus price target of $21.05. This valuation is based on what can be assumed as the expectations of Banc of California's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $24.0, and the most bearish reporting a price target of just $20.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $1.4 billion, earnings will come to $359.4 million, and it would be trading on a PE ratio of 8.7x, assuming you use a discount rate of 7.8%.
  
• Given the current share price of $19.69, the analyst price target of $20.0 is 1.5% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.