Pacific Mercantile Bank, the county’s largest homegrown bank and an oft-cited takeover target, is biding its time.
The Costa Mesa bank appears healthy amid the downturn, which has crimped lending and caused loans to go bad at local lenders.
But, for now, Pacific Mercantile’s chief executive said he isn’t actively shopping—either for a buyer or for acquisitions of its own.
“We’re focusing on growing organically through expanding our own products and services,” said Raymond Dellerba, who’s led the bank since its 1998 founding.
Pacific Mercantile has been watched as a takeover target since breaking the $1 billion mark in assets two years ago. It had $1.1 billion in assets as of Sept. 30.
A billion in assets seems to grab the attention of acquirers. The last local bank in the county to grow to more than $1 billion in assets was Eldorado Bank, where Dellerba was president up until it was bought in 2001 by California Bank & Trust, a unit of Utah’s Zions Bancorp.
Some contend Pacific Mercantile could be had at a bargain.
Banks historically have sold for around two times book value. In the boom years of 2005 and 2006, that jumped to three to four times in some cases, according to investment bankers.
Pacific Mercantile’s lightly traded stock had a recent market value of about $30 million, or less than half its book value.
An acquisition of Pacific Mercantile hasn’t realized amid the soft economy and upheaval among big banks in the past couple of years.
“The problem someone like Pacific Mercantile is going to have is that they’re healthy and the big boys aren’t at this point,” said Randy Krauthamer, an analyst at Irvine-based investment bank Waveland Capital Group LLC.
Nationally, 48 bank acquisitions took place in 2009, down from 71 a year earlier and 169 two years ago, according to McGraw-Hill Cos.’ Capital IQ.
“It’s important to keep in mind that the M&A market in banking is primarily being driven at this point by considerations over liquidity,” said Greg Presson, senior managing partner at the Newport Beach office of Los Angeles-based B. Riley & Co.
Pacific Mercantile could end up on the buying side, according to Krauthamer.
“It’s really the small- and mid-tier bankers who are growing in numbers and looking to finance M&A transactions now,” he said. “That’s sort of a sea change we’re seeing.”
Consolidation is likely to continue, said David Haithcock, executive director of the California Independent Bankers, a trade group based in Newport Beach. But he said he’s not looking for a big jump in activity locally for at least another several quarters.
By his estimates, 16 of the 27 homegrown banks in the county are unprofitable.
“Merger opportunities are certainly out there,” Haithcock said. “But right now, capital is pretty scarce, especially with the bigger players. Bankers are still in the mode of trying to hang on to as much as they can for as long as possible.”
Pacific Mercantile has its issues. Like most local lenders, it holds millions of dollars in bad loans. In the third quarter, the bank had $59.6 million in bad loans, or about 7% of its $835 million in total loans.
Pacific Mercantile had a total capital ratio—measuring the amount of cushion a bank has against loan losses—of 10.7%, within the “well capitalized” category of regulators.
The amount the bank has been setting aside to cover loan losses has fallen in the past year, which investment banker Presson called a “very healthy sign.”
In the third quarter of 2008, Pacific Mercantile set aside $1.6 million for bad loans. During last year’s third quarter, it set aside $470,000.
In all, Pacific Mercantile’s reserve for bad loans is $17 million, or equal to 2% of its loans.
“It appears they’re managing that area of their business very strongly,” Presson said.
A bank’s loans are judged by dealmakers on their diversity and exposure to troubled corners of the economy, according to Presson.
“Heavy weights in construction, real estate and other troubled sectors are red flags in these times,” he said.
Pacific Mercantile has pulled back from troubled sectors.
As of Sept. 30, about a third of its lending was commercial loans to businesses. Mortgages made to business owners to acquire buildings for their businesses were the next biggest at 22%.
Construction loans made up about 2%, or $23 million, of Pacific Mercantile’s loans as of Sept. 30, down from nearly $100 million during the real estate market’s 2006 peak.
“Even though we believe our pullback in most areas came early, it takes time to wind down a portfolio’s loans,” Dellerba said. “So there continues to be some ramifications on our books.”
Dellerba said he blames most of the bank’s recent loan losses on “about a half dozen of our construction loans.”
Meanwhile, the bank has moved into stronger sectors, he said.
“The bulk of our loan portfolio is now going to companies involved in manufacturing, distribution, wholesale and professional services,” Dellerba said.
