WAL - Western Alliance Bancorporation: An Update

2023-05-05 16:27:42 ET

Summary

• Western Alliance Bancorporation has fallen victim to a renewed wave of speculation.
• Western Alliance Bancorporation shares have fallen to low levels, with uncertainty being very high.
• Legitimate banks are falling victim to a new round of speculation, as some kind of government, Fed, or regulatory intervention seems appropriate.

When the regional banking sector turmoil broke loose in mid-March, I covered Western Alliance Bancorporation ( WAL ) as its shares took a massive hit in the wake of the Silicon Valley Bank failure. With investors and speculators believing that the contagion would spread, Western Alliance's shares quickly emerged in the wrong spotlight, leaving me to conclude that speculation was prevailing.

A Quick Recap

Western Alliance Bancorporation is a Phoenix-based bank which has seen rapid growth in recent years. The company has grown to employ more than 3,000 workers across more than 50 offices. Founded as the Bank of West Nevada in the 1990s, the bank went public in 2005 and grew above the $50 billion asset mark in 2021, aided by the purchase of AmeriHome.

The company itself describes its operation as a national banking platform, although that the bank is physically overrepresented in the Western part of the country. The bank has ten folded its asset base over the past decade, which has provided more diversification in the loan book, but still California was overrepresented with over a third of a share of the loan book.

This background, notably of higher growth, is important. After all, client relationships are relatively new and not as much as set-in-stone, as loyal clients are welcomed in such an environment.

2022 Numbers

The bank continued its growth trajectory in 2022, a year in which assets rose by 21% to $68 billion, financed by a $53 billion deposit base. The bank has seen deposits outflows to the tune of two billion in the final quarter of 2022, resorting to borrowings instead. Besides a decline in deposits, customers moved from non-interest bearing deposits to deposits which bear interest expenses, increasing the funding costs as well.

Fourth quarter gross interest income rose 84% to $888 million, driven by a greater loan books, but mostly higher rates. Interest expenses rose from $33 million in the fourth quarter of 2021 to $249 million, due to higher rates but also the shift in the funding mix of the bank. Deposit interest being paid of $158 million came in at an annual 120 basis points (blended) on a $53 billion deposit base.

The bank still earned $365 million in operating earnings, at a rate of $1.5 billion per annum, suggesting that the bank could raise interest rates being paid on deposits by nearly 3 percentage points before turning into loss-making territory!

The asset side of the balance sheet revealed $52 billion in loans. The company had an $8 billion in available-for-securities portfolio, on which the company reported an unrealized loss of $675 million. That loss was substantial, certainly if the loan book might be impacted as well, as the bank held just $5.4 billion in equity on $67 billion in assets.

A $100 stock in 2021 fell to an intraday low of $30 in the first panicky move in March but quickly recovered to the $50 mark, trading above book value again.

While there were few incentives for depositors to say with the bank given the uncertainty, I unfortunately, had to draw the same conclusion for equity holders as well, as the situation was simply too uncertain and too asymmetric in terms of risk and return.

Coming Down

After the initial turmoil in March, the situation appeared to stabilize a bit as Western Alliance Bancorporation shares traded around the $30 mark, with investors in the entire regional banking sector waiting for more clues about the destiny for the sector at large. Shares actually rallied to the $40 mark by April after the company posted relatively strong first quarter results.

Despite the turmoil in the sector, the company actually grew the balance sheet from $67.7 billion by year-end 2022 to $71.0 billion by the end of the first quarter. This came in part as cash holdings rose to $3.6 billion, while loan (including loans available for sale) and investment securities were pretty stable. Important was that the deposit base fell from $53.6 billion to $47.6 billion, down six billion in the time frame of a quarter. This was entirely offset by an increase in borrowings.

Total gross income rose a bit amidst rising interest rates, but the funding costs rose more amidst more competitive deposit rates to be offered, as well as a change in the funding mix, as borrowings are more expensive than deposits as well of course.

While the company saw some deposit outflows, the results were well-received by investors as profitability remained sound, even as the bank started to pay more competitive deposit rates, as the sector appears to enjoy a few weeks of relatively quiet conditions. That changed at the start of May as shares of First Republic Bank (FRCB) imploded, and a rescue was orchestrated by the authorities, with JPMorgan Chase & Co. ( JPM ) emerging as the winner.

Western Alliance provided an update on the 3rd of May in an effort to calm the markets, as the content of the update quite frankly was quite upbeat. The bank reported deposits of $48.8 billion as of the 2nd of May, actually up by $1.2 billion since the end of the first quarter, despite tax season in April, typically resulting in some outflows, while the company reaffirmed its $2 billion quarter-on-quarter deposit growth guidance.

The bank furthermore reported an improvement in the insured portion of the deposit base as the divestment of $6 billion in asset disposition was on track. The company, among some other items, furthermore confirmed the quarterly dividend at a rate of $0.36 per share.

A day later, the bank issued a press release disputing a Financial Times article which claimed that the bank was considering a potential sale for parts or all of the business.

In the meantime, Western Alliance Bancorporation shares fell from levels in the high-thirties towards the $30 mark as news broke of the takeover of First Republic Bank by JPMorgan Chase, as shares hit a low of $11 and change on Thursday amidst the speculation of a potential sale and general uncertainty. The strong reaction of the bank to this news triggered an intraday rally towards the $20 mark in pre-market trading on Friday, as market trading remains highly uncertain.

Perhaps regional banking investors are furthermore not pleased by the Fed announcement on Wednesday, as relatively little was said on their situation of regional banks. This might fuel speculation that the Fed might not come to the rescue.

And Now?

Right now it seems as if we are in the second inning of the game, after turmoil started in mid-March. While the first banks to go belly up really had self-inflicted (strategy) wounds, this time it feels different. It really feels as if this round of uncertainty is driven by speculation and short-selling, as these are generally decent banks with solid profitability. Hence, I really feel as if this is a speculation event, rather than a credit event, or even liquidity event (although this changes over time).

While depositors in all likelihood will be fine in any outcome, there are many stakeholders getting hurt right now in the process, and with that, I do not mean just employees or equity holders. Smaller and regional banks are key to local communities, not just with their physical presence, but because they are overrepresented in certain lending categories as well.

Right now we are heading into the weekend in again a highly uncertain situation, as the hand-off approach by the regulators, authorities, and the Federal Reserve has received scrutiny (for the right reasons). Continuing on this strategic route will make that more regional banks might suffer a similar fate to the banks which have failed by now, as uncertainty and speculation makes that perfectly fine functioning banks might become victim of this.

Perhaps an increase in the deposit insurance limit might help, but the FDIC has taken some hits already from the failures seen already, as such as move creates moral hazard issues as well. That being said, continued consolidation of the banking industry is not desirable, as the implicit subsidies provided to big banks are unfair as well. This is not just from a competitive point of view from the regional banks, but also the impact on society, certainly given the overrepresentation to certain lending categories.

Unfortunately, all options are on the table here, with Western Alliance Bancorporation bank no longer controlling its destiny itself, creating a real concern for equity holders and all other stakeholders. This is a very sad conclusion as the current stage of the crisis involves many banks whose wounds are not self-inflicted.

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