PacWest Bancorp just scooped up one of the venture capital industry’s leading lenders, which at first glance looks like another reverberation of the tech boom happening in Silicon Beach and beyond. But this deal was less about software than hard cash.

The Century City bank announced March 2 that it cut a deal to buy tech industry lender Square 1 Financial Inc. in Durham, N.C., for about $849 million in stock.

It’s a deal that would boost PacWest’s assets to nearly $20 billion and give it a big presence in venture capital-backed industries, which could prove to be a real asset given the growth of startups on the shores of Los Angeles. But more importantly, it gives the bank the reserves it needs to make more loans. PacWest has more loans than it does deposits, while Square 1’s deposits dwarf its loan portfolio.

Julianna Balicka, an analyst who covers PacWest for the San Francisco office of New York investment bank Keefe Bruyette & Woods Inc., said the deal was a great marriage for precisely that reason.

“Square 1 is kind of a perfect profile for PacWest,” she said. “They have a lot of ability to support PacWest loan growth.”

Regulators want banks to have loan-to-deposit ratios of less than 100 percent – that is, to have more deposits than loans. Today, PacWest’s ratio is 101 percent; combined with Square 1, that figure would fall to 91 percent.

PacWest executives did not respond to the Business Journal’s request for comment.

Buying Square 1 and its plentiful deposits also gives PacWest a chance to replace some of its more expensive ones, which it took on when it acquired downtown L.A. business lender CapitalSource Inc. for $3.1 billion last year.

CapitalSource was an industrial loan company, meaning it was legally barred from offering basic checking accounts – a source of cheap deposits for most banks. Instead of checking accounts, certificates of deposit, or CDs, made up the bulk of CapitalSource’s deposits, and now represent about 45 percent of PacWest’s.

Those CDs yield little interest today, but in the event of a rate increase, they would immediately reprice, forcing the bank to pay more interest to depositors and hurting profit margins. Square 1, though, has more than $2 billion in money-market deposits that pay a near-zero rate, and will remain cheap even if interest rates tick up.

Christopher Marinac, who covers PacWest for Atlanta brokerage FIG Partners, said Square 1’s low-cost deposits give PacWest some insurance against potential rate increases.

“We still operate with a fair amount of uncertainty about the Fed increasing rates,” Marinac said. “If that were to occur, PacWest would have an Achilles’ heel. They would have CDs that would reprice very quickly. Square 1 would give them a good counterpunch.”

He said that deposit base was the main reason PacWest decided to pay 2.6 times Square 1’s tangible book value – essentially the bank’s assets minus liabilities – which he called a fair price, if not a bargain.

That’s about the same ratio Royal Bank of Canada recently agreed to pay for downtown L.A.’s City National Bank, but it’s still much higher than ratios in other recent bank deals, including PacWest’s acquisition of CapitalSource, which was priced at about 1.7 times tangible book value.

Silicon lender

Square 1, which went public not quite a year ago, has made about 70 percent of its loans to venture capital-backed firms in the technology and life-sciences industries. Though headquartered in Durham, most of its offices are elsewhere, in tech and biotech hubs including New York, Boston and San Diego. Along with L.A. and Orange County offices, Square 1 has a San Francisco outpost and two in Silicon Valley.

But despite the fact that PacWest is one of the biggest banks in Los Angeles – a region in the midst of a venture capital boom – Balicka said Square 1’s focus on VCs wasn’t a big selling point for PacWest. She said the deal was about Square 1’s deposits.

But Marinac said PacWest establishing a deeper foothold in VC banking was a meaningful consideration, especially given where a lot of its borrowers are located.

“A lot of the customers of Square 1 are California based,” he said. “Because PacWest is so big in California, it can serve them.”

Nate Redmond, a partner at venture capital firms Rustic Canyon Partners and Basepoint Ventures in Santa Monica, has done business with Square 1 before. He said lenders serving VC-backed companies play an important role in the venture ecosystem.

“They’re strategic financing partners to the companies and they become partners to us as lead investors and board members in these companies,” he said.

Redmond thinks PacWest is hoping to capture the growth potential inherent in the tech and life-sciences space where Square 1 does the majority of its lending.

“These companies are high-growth drivers,” he said. “They have ever-increasing needs for capital, and if they’re very successful, they’re borrowing tens of millions of dollars. That’s significant for any bank.”

Next step

PacWest has been one of L.A.’s most active shoppers, and while Balicka and Marinac believe Square 1 should sate PacWest’s appetite for now, they’re not going to bet against more buying.

“Right now, this is a transaction they have to digest,” Marinac said. “In the big picture, they’re likely to do more deals.”

PacWest expects the acquisition to close late this year and plans to keep the Square 1 operations under the Square 1 name, a move that didn’t surprise analysts. Balicka said Square 1 has built a solid reputation in the industry, and there would be no upside in rebranding. Also, PacWest’s experience running CapitalSource as its own business has given the bank a blueprint in integrating an acquisition that complements, but doesn’t overlap with, its core banking practice.

“PacWest has done well operating CapitalSource as an independent entity,” Balicka said. “Why mess with success?”

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