PACW - Western Alliance: A 30%-Discounted Regional Bank Bargain

2023-03-22 10:22:23 ET

Summary

• Western Alliance Bancorporation’s market cap has declined by about half in the last 9 trading days.
• The community bank attracted a 5.4% investment from hedge fund Citadel at the beginning of the crisis.
• The Western Alliance Bancorporation 8K disclosure shows sufficient liquidity.
• While credit down-grades pose a short-term risk, Western Alliance Bancorporation remains undervalued at a near-30% discount to book value.

The market panic in the community banking market has resulted in a near-30% discount to book value for Western Alliance Bancorporation (WAL), which I believe investors should take advantage of as long as they can. The community bank also attracted a 5.4% passive investment stake from hedge fund Citadel and its majority-owner Ken Griffin at the beginning of the current banking crisis, inspiring confidence that the bank will be able to survive the current market conditions. Considering that the community bank has lost about half of its market cap in the last 9 trading days, I believe the risk/reward relationship is very favorable, especially when considering that the bank made a confidence-inspiring disclosure about its liquidity situation. I see strong rebound potential for Western Alliance Bancorporation as bank fears ebb and the stock price revalues upward to book value!

The FED backstop is working, Western Alliance's 8K disclosure about its liquidity situation

The FED's new liquidity facility , announced at the height of the Silicon Valley Bank ("SVB") crisis, has had its desired effect. Although there were some concerning events in the community bank market with the rescue of First Republic Bank ( FRC ) and Credit Suisse Group AG (CS) in Switzerland lately, investors' nerves have clearly calmed. The Fed deserves the credit here, as it gave U.S. depository institutions effectively a deposit guarantee and made $25B available on short notice for banks to fund withdrawals. The emergency liquidity measure has had great effect: no new deposit runs have happened.

In an 8K disclosure filing on March 13, 2023, Western Alliance has tried to calm rattled investors and said that it has access to significant liquidity. The bank announced that it had $25B in immediate liquidity and that "deposit outflows have been moderate." Recently, U.S. government officials have said that deposit flows in the U.S. regional banking system have stabilized. Therefore, I believe that while Western Alliance has likely lost some deposits in the wake of SVB's bank failure, the community bank is not at risk of running out of cash.

Before the crisis, Western Alliance Bancorporation was a solid community bank that has seen consistent growth in its deposit base. The bank had total assets of $67.7B and deposits of $53.6B at the end of FY 2022. Western Alliance's deposits grew 13% year-over-year. Since FY 2019, Western Alliance has expanded its deposit base by a factor of 2.4 X.

Additionally, Western Alliance is well-capitalized and even under consideration of unrealized losses in its held-to-maturity and available-for-sale portfolios, the Tier 1 capital ratio, as of December 31, 2022,would be 7.9% (according to the bank's 8K disclosure). According to JPMorgan Chase & Co. ( JPM ), this would rank Western Alliance in the middle of its industry group.

Hedge fund Citadel buys into Western Alliance at height of market crisis

Hedge fund Citadel bought a passive 5.4% investment stake in Western Alliance at the beginning of the crisis, thereby expressing confidence that the regional bank will be able to persist through the current liquidity crisis.

Near-30% discount to book value

Western Alliance has suffered one of the steepest declines in market cap during this crisis, as the regional is being perceived as vulnerable with its California focus and a high percentage of deposits being uninsured (insured deposits exceeded 50% of total deposits as of March 13, 2023).

Western Alliance's discount to book value has narrowed in the last few days as the sector recovered from the bloodbath a week ago, but it is still relatively large: investors can still get a 27% discount to BV right now. Two weeks ago, WAL was trading at a 60% premium to book value and the 1-year average P/B ratio was 1.55 X. Given that Western Alliance's discount is large relative to other regional banks, I believe that WAL has larger upside potential if the financial crisis gets contained.

Risks with Western Alliance Bancorporation

Theoretically and practically, a meltdown of the U.S. financial system is possible, but not probable, in my opinion. The Fed has done the right thing by providing emergency liquidity for banks to withstand deposit runs which makes this crisis very different from the crisis in 2008. The biggest short term risk for community banks is not the flight of deposits, but higher interest rate costs in the context of credit down-grades. Western Alliance Bancorporation was downgraded by Fitch ( Rating Watch Negative ), as an example, which is set to affect the bank's profitability negatively in the short term. However, given the large discount to book value, I believe investors still face an asymmetric risk/reward profile.

Which community bank is right for you?

Investors have no shortage of investment opportunities right now in the community banking market, and I have covered a few of them. These include First Republic Bank ( Source ), PacWest Bancorp ([[PACW]], ( Source ), The Charles Schwab Corporation ([[SCHW]], Source ) and U.S. Bancorp ([[USB]], Source ).

In my opinion, U.S. Bancorp offers the safest way to play a rebound in the regional banking market because the bank is the fifth-largest bank in the country with a very strong and diversified deposit base. First Republic Bank and PacWest Bancorp remain much riskier turnaround bets as they have high exposure to the venture capital market and have likely seen the biggest deposit outflows in the early stages of the crisis. Western Alliance Bancorporation might be a promising investment for investors that have a medium- to high-level risk tolerance.

Final thoughts

I believe Western Alliance Bancorporation is not the riskiest community bank investors can buy for a rebound. The bank's shares are still, despite a 15% rebound yesterday, trading about 50% below their pre-crisis valuation. Did Western Alliance see deposit outflows last week? Likely. But the Fed's backstop, in my opinion, is working, and deposits could even be flowing back to community banks once confidence is restored.

According to the bank's 8K disclosure, Western Alliance Bancorporation has ample liquidity even without utilizing the Fed's liquidity facility. With a near-30% discount to book value still present in the market, investors that believe the Fed won't let any regional bank die should consider this Western Alliance Bancorporation situation a buying opportunity!

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