First PacTrust Bancorp is betting the ranch on houses. It wasn't the original plan.

When First PacTrust raised $60 million late last year for acquisitions, commercial loans were looking a lot more promising than mortgages. But with many competitors eschewing the interest rate-sensitive housing market, First PacTrust took the opposite tack Monday, agreeing to buy Gateway Bancorp for $17 million with the goal of diversifying and improving fee income using the target's 22 loan production offices.

"If interest rates go up, then maybe the business isn't as attractive as it appears right now," said Andrew Liesch, an analyst at Sandler O'Neill & Partners LP. Still, he said, there should be a window of opportunity, given low interest rates. The deal works, he said, "in that they were looking for ways to increase fee income."

First PacTrust expects the acquisition to add more than $3 million a year in earnings, mostly through added revenue from loan production offices at Gateway's Mission Hills Mortgage Bankers. The division generated a respectable $6.5 million in gains on loan sales in the first quarter, though that was down from previous quarters.

Analysts said it is rare to see so many loan production offices change hands, particularly just a few years removed from the near-implosion of the mortgage industry in states such as California and Arizona.

"What First PacTrust got with Gateway is a professional mortgage bank, where they generate a lot of volume and turn around and sell it to the secondary market," said Tim Coffey, an analyst at FIG Partners LLC.

Gregory Mitchell, the president and chief executive at First PacTrust, in Chula Vista, Calif., said in an interview Tuesday that loan production offices would typically struggle in the current economic and interest rate environment. But Mitchell said new mortgage regulations and extensive protections in the deal's terms altered his outlook.

"I was not terribly bullish on mortgage originations," Mitchell said. But "new mortgage licensing requirements [should] … keep the less-desired mortgage originators out."

The buyer is tackling the addition of the loan production offices unconventionally. Rather than convert the offices into full-service branches, Mitchell said the company will add some of its own mortgage products.

Customers who visit the loan production offices will be able to make deposits into First PacTrust because the former credit union is still a member of the Credit Union Service Network. As a result, the company does not need to transform the offices into full-service branches.

First PacTrust also plans to improve compliance at the Mission Hills division. Gateway, based in Cerritos, Calif., also has credit-quality challenges.

Mitchell said the deal was structured to protect the buyer from certain losses, including a $2.5 million escrow account for up to 36 months to cover potential mortgage repurchase risk. Gateway bolstered its reserves to $3.8 million, or 3.8% of total loans. The offer price, at 61% of Gateway's tangible book value, allows the deal to boost First PacTrust's earnings immediately.

Community bank consolidation has not picked up as quickly as some industry observers expected earlier this year, and California was dormant until March, according to data from SNL Financial.

But there is some action, particularly in Southern California. Four deals in the area in the past four weeks include Monday's announcement that the $708 million-asset Opus Bank in Irvine had agreed to buy RMG Capital Corp. in Fullerton.

Pacific Trust Bank, a unit of First PacTrust, launched a four-branch expansion this year, most recently signing leases on two offices in Los Angeles in May.

"Certainly, Los Angeles is the bigger engine of business and growth in Southern California," said Joe Gladue, an analyst at B. Riley & Co. "If you're going to be a significant player in California, you need to have presence in the Los Angeles market."

Mitchell said that the Gateway deal is "one of many" the company plans to make beginning this year. After the deal, which the buyer expects to complete during the fourth quarter, the $837 million-asset First PacTrust would have assets of more than $1 billion. "We fully expect First PacTrust to be a consolidator of choice in California," Mitchell said.

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