There is a lot going on in this post, so please bear with me. First, I think that it is time for Banc of California (NYSE:BANC) to sell itself, not because of the recent disclosure of losses related to a fraudulent loan, but because of the bigger issue of whether they can execute on their planned transformation. Second, I think that someone should make a public, unsolicited bid for Banc of California.
Banc of California has been a pretty controversial name for a while: among other things, it has experienced disagreements with activist investors, eyebrow raising stadium naming deals, scurrilous blog posts, an SEC probe and CEO resignation, more agitation by activist investors and even “palace intrigue.” The end result of all this is a new CEO, a revamped board and enhanced corporate governance policies and a comprehensive new business strategy—all great stuff that makes a lot of sense in theory, if not totally in practice. One of the big knocks on Banc of California under Steve Sugarman’s leadership was that he ran it kind of like a hedge fund—he bought and sold loan pools, etc. and had a big and pretty opaque securities book—and the current strategy, designed to continue the transformation to a commercial bank that had actually begun under Sugarman, seems intended (to some degree) to be a direct repudiation of the perceived risk taking of prior leadership. Instead, the plan going forward seems to be to transform Banc of California into a regular way, nuts and bolts commercial bank focused on business loans and funded by core deposits. I get it—I generally like those models, though I don’t understand why, given Doug Bowers’ previous leadership at Square 1, they are not trying to build out a technology bank, which are great sources of cheap deposits—I just think it is really hard to do.
Even when a major change in a bank’s strategy is well thought out, which Banc of California’s seems to be, there are obvious challenges. Execution risk is always an issue. Fraud can, and does, occur at any bank, and I don’t think the loss they just disclosed on a fraudulent loan necessarily reflects systemic weakness in its underwriting processes, but it is also pretty easy to come to the conclusion that mistakes can be made in attempting to rapidly grow commercial loans (if that is what it was—I don’t think the nature of the fraudulent credit has been disclosed).
Aside from execution risk, I think the biggest challenge in with a major revamp to a bank’s strategy is the near term replacement of earnings. When a bank exits a business line (in this case by exiting lease finance and selling associated assets, selling loan pools, exiting mortgage and selling related assets and remixing the securities portfolio), they give up the earnings associated with those businesses. They may get cash in return for whatever is sold and may be justifiably confident in the future earnings stream from whatever businesses they are going to enter or emphasize as part of the strategy shift, but they are still likely to have to deal with an earnings shortfall in the near term. Compounding the earnings shortfall is added expense of adding new bankers, etc. to implement the new strategy.
I would also distinguish between the type of major strategy shift that is gradual in nature and may have some type of short term earnings bridge built into the plan and the type that is being executed by Banc of California. As I said, I understand what Banc of California is trying to accomplish, but I am generally skeptical when a bank tries to dramatically and suddenly shift its strategy in reaction to some failure (in this case, broadly speaking, the perceived failure of Steve Sugarman’s leadership and vision) of the previous business model. In the latter case, I think it is best to just stabilize the bank as best as the board can, look for a buyer who can take out costs and take advantage of whatever desirable attributes (deposits, markets, whatever) that remain, and try to avoid being anchored by any pre-business model failure stock price. I don’t think this is unique to Banc of California. There are a number of banks in similar situations—MidSouth (NYSE:MSL) comes immediately to mind—who should look for a partner rather than taking on the challenge of replacing potential earnings lost to due to a change in strategy on their own. One additional advantage to dealing with these issues through a sale is that an acquirer may be more likely to take one large restructuring charge at the time of a transaction and eat all the costs of the transformation at once and in a way that might get more of a pass from analysts and investors.
Nonetheless, Banc of California seems to be moving aggressively to execute on their shift in business model. Just by taking a look at their investor deck outlining their strategy change and steps taken to date, you can see that they have made a lot of new hires and have a lot of new initiatives underway. While it is great that the new management team and revamped board are not letting the moss grow beneath their feet, these actions likely diminish the prospect of a near term sale.
Unlike a lot of bank boards, I doubt that the board at Banc of California has any commitment to independence for its own sake. Given its makeup--a private equity guy focused on banks, an activist investor focused on banks, a former bank CEO who successfully sold a bank, etc—I would assume that the board of Banc of California is particularly focused on maximizing stockholder value. However, given the expense and effort involved in selecting and hiring a new CEO, overhauling the rest of the management team, hiring new lenders and everything else associated with the change in strategy, I would assume that they are committed to the path they are currently on, unless something better comes along.
Before getting into why I think someone should make a public, unsolicited bid for Banc of California, it might make sense to consider why such things, which are not uncommon at all in the rest of the business world, are so rare in the banking industry. There are some possible reasons—the general opacity of bank assets, concerns about retaining management, regulatory issues, etc.—but I think, at the end of the day, it is because banking is a very clubby industry and almost no CEO that I know of wants to be on bad terms with the guy down the street, even if they are fierce competitors. A corollary of this is that acquisitive CEOs don’t want to prejudice themselves in the event that a bank later decides to sell itself. My sense is that most acquisitive CEOs just tend to let it be known, directly or indirectly, that they would be interested to the extent the target bank ever considers selling and do not force the issue. There are few examples of unsolicited overtures having a happy ending for the instigator and at least one where the ending was clearly not what the instigator intended.
As a total aside, I would not be surprised if, in this rising rate environment, there appeared a few unsolicited bids for banks with low deposit costs and liquid balance sheets, particularly where management has tried, but failed, to get their banks “loaned up” enough to make decent returns. I could pretty easily see some of the banks in California’s Central Valley become prey for faster growing asset generators with high multiples, whether from the California coast or elsewhere, who can better deploy excess liquidity.
Turning back to Banc of California, I think that a public, unsolicited bid could count as something better coming along and prompt serious consideration by its board. To be sure, a “low ball” bid would not be successful, but, at the same time, were an in-market player that could offer significant cost saves and effectively de-risk Banc of California’s strategy change make a bid with a modest premium, I don’t think that such a bid could be rejected out of hand.
As for why a public bid, rather than the discreet approach more widely favored in the banking industry, I think the answer is simple—a public bid is hard to ignore. I don’t think that the Banc of California board would take the ostrich like approach that some other boards might if confronted with a privately made unsolicited bid and reject it out of hand or after comparing it to expected future performance without taking into account the risks associated with attaining that future performance, but all the same, making the bid public would probably result in a more rigorous decision making process.
In addition, I think some of the circumstances that might otherwise give a potential bidder pause are not relevant here. First, as noted, I think the Banc of California board falls squarely in the “maximize stockholder value” camp (as opposed to the “independence for non-economic reasons” camp) and is comprised of sophisticated individuals who understand that unsolicited bids are part of business. They might not be overjoyed to be on the receiving end of a public, unsolicited bid but I have no doubt that they (i) would take advantage of such a bid to extract maximum value for Banc of California stockholders and (ii) not take it personally and attempt to find another suitor primarily to spite the original bidder or, to the extent the bid does not result in a transaction, exclude the original bidder from any potential sale process down the road.
In terms of some of the other factors that might give a potential bidder pause, asset quality should not be an issue as I would have expected a new CEO to diligence credit pretty thoroughly before taking the job, though the recent fraud certainly gives rise to questions about risk controls, etc. Also, with regard to management, while the new CEO has probably done a pretty good job with the hand he was dealt, I would not expect him to be such a critical part of the business (just because of his short tenure, not any shortfalls in his ability) that losing him or his senior team would materially jeopardize the value of the business to an acquirer.
Whether a bid emerges or not, who knows, but given the need for constant earnings growth, the unsolicited bid should become part of the playbook for acquisitive banks going forward.
 I don’t know if it was the intent, but it wouldn’t be out of the question to argue that the former CEO Steve Sugarman had already begun the transformation Banc of California is now attempt to execute, but in a slower and more deliberate fashion and using the assets that the bank has since jettisoned as an earnings bridge.
 Based on a recent summary on the M&A market prepared by one of the top investment banking boutiques, there were 134 hostile M&A deals globally in 2017, representing $523bln in aggregate deal volume.