Many banks, including JPMorgan Chase , Wells Fargo , PNC Financial , and U.S. Bancorp have snapped up failed institutions with the help of the Federal Deposit Insurance Corp. in the past year, but it's hard to find one that's benefited as much as East West Bancorp , a Pasadena, Calif.-based bank serving a largely Chinese American clientele.
East West's shares soared 55 per cent on Nov. 9, the first trading day after it bought UCBH Holdings following UCBH's seizure by regulators.
The pop was so dramatic in part because observers such as Sandler O'Neill analyst Aaron James Deer, who had a "sell" on the stock before the deal, suspected East West was too weak from a capital perspective to enable it to buy UCBH. But East West got some help from Corsair Capital, a private equity firm run by several former JPMorgan investment bankers that specializes in financial sector investments.
Private equity has been chomping at the bit to take advantage of the distressed investing opportunities in the U.S. banking sector, but has met with significant regulatory obstacles. One of the successful models that is emerging for private equity is to take a minority stake in a regional bank and then help it acquire failed institutions from the FDIC.
Warburg Pincus was thought to have a similar strategy in mind when it invested $115 million (U.S.) in Webster Financial in July, though Webster has not done a deal so far. For East West, the UCBH acquisition nearly doubled its size, bringing total assets to $19 billion from $12.5 billion.
East West picked up 63 U.S. branches of UCBH, plus a Hong Kong branch and a Chinese subsidiary headquartered in Shanghai. East West is now the largest bank in the United States focused on Asian Americans, according to Sandler O'Neill's research.
East West's stock has continued to run since the transaction took place. It gained more than 11 per cent on Dec. 18, possibly due in part to a report from Sterne Agee, which initiated coverage of the company with a "buy" rating in a report released that morning. However, the report was released in the morning and the big run-up occurred late in the day.
That suggests investors might have been speculating East West was ripe to pick up yet another failed bank. If they were, one would expect a selloff to have occurred the following Monday, Dec. 21, when such a deal did not materialize. But East West continued its gains.
Another possibility for the run-up may be that, as the list of regional banks that see share price pops following acquisitions continues to grow, it only attracts more attention to East West. Monday's big winner was City National shares of which spiked more than 15 per cent following its purchase of failed lender Imperial Capital Bank.
The reason for the bullishness around such deals is clear. In the case of East West, not only does it double in size, it gets significant downside protection from the FDIC. On $7.4 billion worth of loans East West is only responsible for 20 per cent of potential losses up to $2.05 billion, and just 5 per cent of losses beyond that, with the FDIC taking the rest of the downside.
In other words, even if UCBH's whole loan portfolio (which totals $7.7 billion) ends up worthless, the maximum loss potential for East West is $692 million, according to Sterne Agee research. Sterne Agee further notes that such a scenario is "unrealistic." Another reason to like East West is that it's a way to invest in Chinese growth without taking on quite as much risk as is inherent in companies doing business mainly in China.
While a Chinese crash, as noted short-seller Jim Chanos is predicting, would be devastating to UCBH, its strong U.S. presence would seem to give it a good shot at surviving. Still, when a bank stock has nearly doubled in 31 trading days, one has to wonder how much further it can fly. There are still questions about potential losses from East West's legacy commercial real estate portfolio.
And any time you have a big merger, there's always the potential for integration problems. But for bank sector investors that have never heard of East West, they should at least have it on their radar screens.
East West shares were up 11 cents to $17.14 in morning action. The session-high of $17.25 was just shy of its 52-week high of $17.28, set on Tuesday. It most recent trading it was down 5 cents to $16.98.