Westamerica Bancorp (WABC) is a regional community bank serving the North Cal and South Cal markets. Operating through 79 branches and 21 counties in California, the bank underwrites commercial, CRE, residential mortgage, construction and consumer loans. The bank is known for its very conservative credit culture, which is manifested by a high level of securities balance and low historical loan losses. The bank also earns non-interest income through merchant processing services and traditional non-interest income such as service charges, debit card fees, trust fees, etc. Over the years, the bank has established itself as a strong, conservative and consistent regional partner bank providing various services to businesses and individuals.
One of the bank’s strengths is its strong position in low-cost deposits. The extremely low deposit cost of less than 10 basis points is probably the best in the country. Given the desirable deposit position, WABC can potentially be a very attractive acquisition target, allowing the acquirer to assess to attract low-cost financing.
From a profitability perspective, ROA and ROE are relatively on par with industry averages. The efficiency ratio has evolved favorably over time as the management team has focused on cost control.
The conservative credit culture is reflected in the low level of non-performing loans. Over the past five years, non-performing loans as a percentage of the total loan portfolio have consistently posted less than ~50 basis points. Additionally, with a total asset base of $7.5 billion, the bank reported securities of approximately $5.0 billion and net lending of $1.0 billion. This is a manifestation of an ultra-conservative credit culture, as management cannot or will not expose the bank to any risk. While no bank investor wants to see a loss of principal, a banker’s job is to deploy capital and generate returns on a risk-adjusted basis. Even though the bank has been able to increase the size of the balance sheet over time, WABC has not significantly increased its loan portfolio, and most of the additional assets are held as securities on the balance sheet. Although the securities earn interest, investors would like to see WABC take a more balanced approach to capital deployment and risk assessment. Ultimately, bank investors are not fixed income investors. Banks should provide a return on assets that investors cannot obtain through the local economy and generate returns that help diversify portfolio risk. WABC, although generating good profits, failed to do so.
As mentioned earlier, given the bank’s conservative credit culture, the bank’s loan portfolio has not grown significantly over time. The extremely low cost of borrowing is attractive, but to some extent the bank primarily benefits from its low source of funding and, in our view, underincome relative to its true potential. The bank should engage in transformative corporate transactions to create shareholder value.
The P/TBV and P/E are relatively rich, especially given the bank’s ability to grow. Shareholders view the bank as a safe haven for their capital and “essentially park their money.” Mergers and acquisitions can provide an advantage to the bank if the target has a strong lending practice and can successfully convince the existing management team to take a more balanced approach with the loan portfolio. WABC will be a good acquisition target in the meantime, although an acquirer should justify paying a reasonable premium on top of a 2.2x P/TBV for the bank at this stage.
From a risk perspective, a poorly executed transaction can derail the bank. The cultural difference between the acquirer and the target can cause social problems within the combined bank and derail operations. If the bank continues to operate autonomously, then it is subject to the typical risks to which a traditional regional bank is exposed.
From a compensation perspective, we continue to struggle with a clear and well-articulated growth plan. The current management team has not demonstrated the ability to balance risk and reward from a loan portfolio perspective and has relied primarily on reducing interest from its securities portfolio. A change in management and a merger and acquisition can potentially create some excitement around the growth plan, although the timing and execution may be uncertain.
Overall, WABC operates in relatively affluent areas of the country. The low cost of funding is a key advantage, but to some extent the “offensive side of the bank”, i.e. loan underwriting, is not as strong due to the credit culture form the bank. Being conservative is not bad; the return generation may be slower and the bank is less dynamic. For dividend-seeking investors, this will likely work very well, as growth in the equity portfolio and a well-managed cost structure will allow the bank to increase dividends over time. For investors looking for capital appreciation, it’s a slightly different story. We are investors who favor capital appreciation. As such, we will continue to monitor the bank’s operations and wait for catalysts to generate excitement around the name.