WAL - Western Alliance: 5.1x FWD P/E Strong Deposit Trends Upside Potential

2023-07-20 06:13:00 ET

Summary

• Western Alliance Bancorporation has seen a significant increase in new deposits in Q2, indicating a continual recovery from the March financial crisis.
• The Company has attracted $3.5B in new deposits in Q2'23.
• Exposure to commercial real estate loans remains very limited.
• Despite a negative trend in EPS and NIM, WAL's low valuation based on earnings and a significant discount to book value suggest an attractive investment opportunity.

Western Alliance Bancorporation ( WAL ), like the broader regional banking sector, has struggled to recover valuation losses sustained during the March financial crisis. However, given the bank's success in attracting new deposits in the second-quarter, I believe Western Alliance is one of the most attractive regional bank franchises that investors can buy.

Western Alliance submitted a solid Q2'23 earnings sheet on Tuesday that showed a large amount of deposits flowed back to the regional bank throughout the second-quarter, continuing very encouraging trends from the first-quarter and immediately thereafter. In my opinion, Western Alliance has strong revaluation potential as its deposit base is growing again and shares continue to trade at a significant discount to book value!

Expected Q2 NIM decline

Western Alliance's net interest margin expectedly declined in Q2'23. The bank generated a net interest margin of 3.42% which declined 37 basis points compared to the previous quarter, chiefly due to higher short term borrowings. However, the real story for Western Alliance, in my opinion, is the company's deposit trend.

Western Alliance makes progress restoring its deposit base

The possibility of deposits flowing back to Western Alliance after the bank's deposit base shrunk during the March meltdown was one of the key reasons why I recommended the bank's shares as a recovery investment. And the regional banking is indeed making rapid progress restoring its deposit base, adding billions of deposits to its balance sheets since March 20, 2023.

In the second-quarter, Western Alliance attracted $3.5B in new deposits which brought the bank's total bank deposit balance at the end of Q2'23 to $51.0B. In total, $1.0B in deposits returned from previous clients to the bank during Q2, funds that were partially withdrawn during the confidence crisis that erupted after Silicon Valley Bank failed in March. Quarter over quarter, Western Alliance reported 7% deposit growth which proves, in my opinion, that deposit flows for regional banks have not only stabilized, but are growing quite rapidly.

What is especially encouraging to me is that Western Alliance could be on track to fully restore its deposit base in the next few quarters. Since Q4'22, Western Alliance has lost about 5% of its deposits -- deposits were down about 11% in Q1'23 -- and the bank could see a full restoration of its deposit base by the end of the year, if not sooner... if deposits keep flowing back to the regional bank at the same pace as they did in the second-quarter.

Western Alliance said that it reclassified $6.0B of loans from held-for-investment to held-for-sale and sold non-core loans in order to aid its balance sheet restructuring. In the second-quarter, Western Alliance also sold $4.0B of assets, mostly commercial real estate loans that the bank decided to offload in order to improve its liquidity.

Limited commercial real estate exposure

Ever since Silicon Valley Bank went out of business, investors have been concerned about the commercial real estate exposure of regional banks such as Western Alliance. At the end of Q2'23, only 5% of Western Alliance's loans were tied to the office sector, limiting the potential fallout from a broader and longer down-turn in the office market.

Western Alliance's shares are still cheap based off of book value and earnings

Western Alliance has suffered a steep correction in its valuation since March 9, 2023, and although the bank has benefited from some recovery momentum, a huge discount to the bank's book value is still applied… which opens up a buying opportunity for investors. Currently, Western Alliance has the third-largest discount to book value in the regional banking industry, after PacWest Bancorp ( PACW ) and KeyCorp ( KEY ), a discount I believe is not deserved considering the massive progress that the bank has made in restoring its deposit base since March.

Western Alliance is currently trading at a price-to-book ratio of 0.9X. The 1-year average P/B ratio is 1.25X and I believe Western Alliance has a reasonable change of returning to its pre-crisis valuation over the next twelve months... if deposit trends continue to favor the bank. Considering that WAL is trading at a 28% discount to its historical P/B ratio and the bank just submitted a decent earnings report, I believe the risk profile remains attractive for investors.

Analysts currently project $8.12 per-share in earnings for Western Alliance in FY 2024 which calculates to a ridiculously low FWD P/E ratio of 5.3X. While the EPS trend is negative (due to expected declines in the bank's NIM), the low valuation based off of earnings may indicate that investors are still too fearful of touching this regional bank.

Western Alliance still has risks , but they are decreasing

Western Alliance is making progress in restoring its deposit base, but there is a risk that comes with higher interest rates: deposits have become more costly for the banking sector in general and there is clear pressure on the bank's net interest margin... both of which can be expected to lead to weakening profitability for Western Alliance in the short term.

Closing thoughts

Western Alliance has had great success in attracting new deposits since March 20, 2023 and the bank's deposit fundamentals are improving: the regional bank attracted $3.5B in net new deposits during the second-quarter, indicating that depositors and savers may not be as fearful as investors. Since the regional bank's deposit trend is highly favorable and considering that shares are still trading well below their 1-year average P/B ratio, I believe Western Alliance is one of the best regional bank recovery bets that investors can buy!

For further details see: