BANC: Higher Merger Costs & Efficiency Efforts in 3Q13 Result in Lower EPS, but 2014 Still On Track To Achieve Core EPS: “Outperform”.

BANC Update 9.27.13

We are revising our EPS estimates for BANC to adjust for the pre-announcement of larger than expected one-time noninterest expenses totaling slightly more than $10 Million (pre-tax) to be incurred during the second half of 2013, primarily in the 3Q13. Our revised 3Q13 EPS now includes 90% of these expenses, which reduces our estimate to $0.09 from our previous estimate of $0.32.

On September 18, 2013 the company pre-announced that the combined expenses related to several corporate strategic initiatives as well as the closing of the Private Bank of California deal in July will result in one-time expenses over the second half of the year that were approximately twice the amount we had modeled for. These include closing of the Palisades Group, integration of the bank charters into a single OCC National Bank charter, renaming the Holding Company, rebranding of all banking operations, systems conversions, a “platform initiative” to align financial reporting and operations systems (previously announced to cost approximately $5 Mil.) and the previously announced sale of eight legacy thrift branches to AmericanWest Bank. The timing of expenses happens to fall almost entirely in the 3Q13.

Management indicated to us that approximately 60% of the synergies to be realized from the combined operations of Beach and Private Bank will come after the charter conversion, which is expected to occur on October 14th. Moreover, expenses related to the branch sale occur in 3Q while the deal closes (and the approximate $11.5 Mil. pre-tax gain is recognized) on October 4th. By extension, the cost savings to be incurred by the branch sale such as overhead and lower deposit costs cannot be realized until after the deal closes. Meanwhile management points out that mortgage production is on track to exceed 2Q13 levels and while NIM-Net Interest Margin is seeing some compression due to the excess liquidity required in the branch sale, deposit growth continues to be robust.

We have not changed our 2014 EPS estimate of $1.74 because our assumptions are largely unchanged – clarity on core earnings begin in 2014 with a 4.00% NIM, mortgage business revenues of $20 Mil. or more per quarter, and modest increases in expenses. While management still has confidence that it will meet its previously stated goal of a 65% efficiency ratio run rate by year-end 2013, or model suggests around a 70% efficiency for next year using modest sequential quarter increases. To the degree the company reduces costs or improves NIM beyond our expectations (NIM hits 4.12% by 4Q14), our estimate could be conservative. We are also lowering our 2015 estimate from $2.13 to $1.95 based on more realistic expense growth assumptions. We also expect the company will provision enough to maintain a 1.30-1.40% reserve ratio on originate loans through 2015.

It is easy to argue that cloudy earnings are getting to be the rule more than the exception at BANC, but we think that the pessimism surrounding these clearly identifiable expenses in the near-term provides a buying opportunity for investors. BANC is soon to become a well-capitalized, well run $3.5+ Billion institution with as-yet unrecognized synergies from its bank operations alignment and revenue diversification efforts. See the chart on Page 4 of management’s pro-forma capital estimates.

Our price target remains $17.50, which is equivalent to 10.0x our 2014 EPS estimate and 128% of the year-end tangible book estimate of $13.67. This is equivalent to a 26% increase over the current price. Likewise, our 2015 EPS estimate at only a 10x multiple discounted back at 10% for one year yields a future price of $17.50 one-year out. Hence we reiterate our “Outperform” rating.