Banc of California, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 2/5

A California-based bank operating in a competitive market and focused on loans with specific risk segments, BANC is currently undergoing a merger with PacWest Bancorp.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Banc of California (BANC) is a holding company for Banc of California, N.A., operating as a commercial bank with a network of branches primarily in California. Post-merger with PacWest Bancorp, it’s set to become a larger entity, still centered around providing banking and financial services. The core business revolves around taking deposits and offering a wide range of loan products, including both commercial and consumer loans.

Business Overview BANC’s operations focus on both commercial and consumer banking. It generates income from the net interest margin on its loans and deposits, as well as fees from services like loan origination and wealth management. The bank has historically targeted specific loan niches, including real estate (both commercial and construction), business loans, and consumer loans. The bank also earns income from non-interest activities, such as deposit and wealth management fees. As a bank, BANC’s financial health is heavily intertwined with the broader economic environment, interest rates, and the regulatory landscape. This is why they are always striving to maintain high levels of liquidity, which are the total liquid assets/total liabilities of a bank.

The bank’s ability to generate sustainable profits depends on managing credit risk, interest rate risk, and liquidity risk effectively. Their focus on diverse loan categories helps them capture different needs within California’s economy, but also exposes them to more risks.

Competitive Landscape The banking sector in California is highly competitive. BANC faces competition from both large national banks with vast resources and smaller, local community banks which have closer relationships with clients. The industry is experiencing substantial disruption due to FinTech entrants, but for banks, the primary method of attracting customers is through better offers in terms of rates on savings and rates for loans, and also convenient/reliable service. In other words, the main advantage a bank has, is lower costs of operation. Banks that can control costs more efficiently, can offer better value to consumers and get clients to choose them more easily. A few other factors include: network effects, customer lock-in, and brand loyalty. These are not very strong for the bank to create and hold on to sustainable competitive advantage.

After the mergers with PacWest, there are potential disruptions for the bank. Integrating new employees and products, while improving operations and cost efficiency, would be a challenge for the combined bank.

Moat Analysis and Rating While the bank has certain unique features, they are not robust enough to constitute a wide economic moat in the context of this competitive banking sector.

Economies of Scale: While larger in size compared to other community banks, BANC does not enjoy a scale advantage over larger national banks. The market is very saturated and there is no clear evidence to show that the bank has economies of scale when competing with other large banks.
Customer Switching Costs: Customers are not necessarily sticky to a specific bank because they are only utilizing the service. There are many competing products and switching costs are quite low.
Intangible Assets: Brand recognition isn’t as strong for BANC, while brands are key to attracting and retaining customers. Further, most banks offer commodity services that don’t have strong differentiation. Some exceptions are brand image, patents, and regulation. BANC does have some regulatory approvals but it is still very hard to argue that these help them hold on to a formidable moat.
Network Effect: There is no clear network effect in the services that BANC provides. There is no reason for customers to want to stay at the same bank other than convenience, but they have no particular benefits by adding more customers to their bank.
Cost Advantages: While having some control on costs, BANC does not have unique access to resources or processes that can make it a cost leader.

Given these considerations, BANC has a weak, narrow moat at best, due to their somewhat diversified and well known name for local banks. It also gains the benefit of some regulatory approvals.

Moat Rating: 2/5

Risks to the Moat and Business Resilience

Interest Rate Risk: A significant fluctuation in interest rates would compress the bank’s net interest margin and affect its profitability. High interest rates make their loans more risky, and also their loan prices less attractive. This can severely damage their profitability.
Credit Risk: A rise in loan defaults due to economic downturns could lead to substantial loan losses, which directly decreases the bank’s profitability. The risk is heightened due to the specific high-risk categories they have chosen to focus on.
Competition: BANC operates in a very competitive landscape. Competition from large national banks, FinTech firms, and smaller community banks can erode BANC’s customer base and margins.
Regulatory Changes: New financial regulations or increased reporting requirements could significantly increase compliance costs. This is especially concerning, as regulatory risk can significantly lower profits.
Integration Risk: The integration of PacWest may not go smoothly, causing disruption in operations and a loss of customers. There are often unforeseen losses due to mergers. Furthermore, customers from both banks might not be interested in the combined company, and therefore they might leave.
Loan Concentration Risk: The bank is heavily concentrated in real estate lending, which exposes it to the ups and downs of this sector. Also, the bank’s business lending has shown higher risk recently.
Funding Pressure: Because of its weak balance sheet and large loan loss, BANC may experience issues in funding their loans, resulting in an inability to compete.

However, given these disadvantages, the bank can be resilient due to its large customer base, diverse loan segments, and brand loyalty in the California area. Also, this merger might give the bank a larger scale to better absorb losses and remain afloat. The bank has done well to navigate past crises, so a return to more profitability can be achieved. However, it has to be seen if their attempts to better themselves will succeed.

The recent bank crises have shown that even highly profitable companies can go bankrupt within a short time period. This can be extremely bad for the bank, even if they have great operations and strong management. The biggest risk for banks is therefore from unknown black swan events.

Financial Analysis The bank’s financial statements are difficult to assess. The high number of different charges, combined with special items, gives a very hazy picture of the earnings. Also, the merger is going to complicate this further. Some important information that can be extracted is as follows:

Income Statement: In Q3 2023, net interest margin and loan originations have dropped considerably, which has been a major cause of losses. There are significant expenses for non-performing assets. A major component of the income has been from non-recurring income. As a result, the operating income has been negative. This demonstrates the weakness of the bank.
Balance Sheet: The bank’s balance sheet has a very high level of debt which has been significantly increasing since 2021. It does have large cash holdings, however, a good portion of that cash is also used for operating losses. The levels of loans and mortgages held for investment have also been gradually increasing, which has led to more financial risk. Overall, their balance sheet is quite concerning with a mix of good and bad financial decisions.
Cash Flow Statement: Cash from operations has been very volatile, with years that have been good and bad. But in recent years, cash from operations has become negative. Cash from investing was also highly negative from 2019 to 2020 but has turned slightly positive recently, indicating more divestiture. Cash from financing has been generally positive due to increases in debt. But the cash flow statement doesn’t present a full picture due to a lack of more details.

Understandability Rating Despite its basic business model as a bank, several factors contribute to complexity of understanding. First is the many special factors and changes that affect their financial health. Second is the sheer size of the business, which makes following operations and numbers very difficult. Finally, the merger is going to create a lot of unknowns that affect both future and present operations. Therefore, understanding BANC is more difficult than many other businesses.

Understandability Rating: 2 / 5

Balance Sheet Health Rating The Bank’s balance sheet health has been concerning recently due to a combination of lower profitability, and higher nonperforming assets. There is also a considerable decrease in net interest margin and high leverage. Therefore the balance sheet is not in a good position and is likely to have a limited ability to deal with future problems.

Balance Sheet Health Rating: 2 / 5

Recent Problems

BANC’s recent history has included significant challenges. Their 2023 performance was disappointing, due to a combination of rising interest rates, increased funding costs, and credit losses. They have also announced a merger with PacWest Bancorp, which has been controversial with the market, mainly due to the issues both companies have. Also, the bank has faced an investigation from the SEC. A big component of the poor results of BANC was their high level of loan losses and a high interest rate environment. In the last earnings calls, there has been a focus from the management on a return to profitability, while also stating their main goals for the combined bank are revenue growth, reduced volatility, and lower expense ratio.

The recent market volatility has increased the number of short-term investments made by the bank, further increasing the risks.

To conclude, Banc of California is a complex and somewhat risky bank with no meaningful moat, in a difficult industry to operate in, and has high downside risks. I wouldn’t personally invest in this company because there are better alternatives with less risks and better prospects. Also, the recent merger further compounds the difficulty in evaluating their future prospects.