WAL - Western Alliance Bancorporation: Uncertainty Prevails

2023-03-13 07:44:49 ET

Summary

• Western Alliance has seen rapid growth over the past couple of years.
• The bank sees deposit rates creeping up and had to make a shift to more borrowing by the bank itself to ensure funding.
• Lower deposits, lower equity and concerns on the asset book, as well as focus on California and technology companies is a concern.
• Given all this, uncertainty is prevailing, making it a tough situation for both investors and deposit holders, as there is no need to be a hero here.

Shares of the Western Alliance Bank ( WAL ) have fallen victim to the uncertainty which materialized at light breaking speed in the financial sector in the second half of last week. The bank has similarities to the troubled SVB Financial Group as these (perceived) similarities, (even if they are not applicable to the same extent) create massive uncertainty here. Consequently, investors are selling first and depositors withdrawing before asking questions.

A Quick Intro

Western Alliance Bank is a Phoenix-headquartered bank which employs over 3,000 workers across more than 50 offices. After a though time during the recession of 2009, the company has seen a solid recovery. Originally founded as the Bank of West Nevada in the 1990s the company went public in 2005 and subsequently has steadily grown, surpassing the $50 billion asset market in 2021.

The company describes itself as a national banking platform with (remote) offices located throughout the country, although many branches are located in the Western part of the country. The company has ten folded its asset base over the past decade, as that growth has come with greater diversification in the loan book (to borrower categories) as well. That said, 37% of the loan book is lent out in California and a substantial amount of loans is geared towards real estate.

Industry Challenges Are 2-Fold

Right now the industry at large is facing headwinds from two related items. Many banks pay depositors an average rate of a percent or less, trailing risk free rates by a huge margin. This rate difference, cash needs by clients, and concerns on the industry result in deposit outflows at this moment. That is no issue if the bank has sufficient liquidity, but here we touch on the second issue.

Banks have invested huge sums into Treasuries and agency securities which do not necessarily involve credit risk, but the duration risks of these investments in combination with the rapid increase in interest rates makes that these are underwater. That is no issue as many of these assets are classified as held-to-maturity securities, but the reality is that banks which are seeking liquidity are now forced to sell some of these investments at a loss, raising capital concerns.

2022 Results

For the year 2022 , the bank has seen rapid growth as total assets rose 21% to nearly $68 billion. These assets were largely financed by a more than $53 billion deposit base. The banks actually saw $2 billion in deposit outflows in the fourth quarter, itself resorting to borrowing instead. The composition of deposits was changing as well, with clients moving into certificates of deposits at the expense of non-interest bearing products, thereby increase the cost of deposits.

Fourth quarter gross interest income rose 84% on an annual basis to $888 million, with growth driven by a larger loan book, bust mostly higher rates. Interest expenses rose sharply, coming in at $249 million compared to just $33 million in the year before. About $91 million was paid on debt, which carries the highest rate of course. This comes as borrowings have gone up from $1.5 billion to $6 billion over the past year. Deposit payments rose to $158 million in the fourth quarter. This comes in around 120 basis points (blended) on the $53 billion deposit base, albeit that there is huge variety in the subsegments of deposits of course.

The bank still reported $365 million in operating earnings in the fourth quarter, which annualized works down to $1.5 billion. This is relatively large earnings power in relation to the $53 billion deposit base, indicating that the bank can raise these rates by nearly 3 percent while posting break-even results.

From that point of view liquidity is getting more expensive, but the company has earnings power to hike deposit rates, needed as it wants to stay away from more expensive borrowing sources.

On the asset side we see $8 billion in investment securities and about $52 billion in loans, for which just $310 million of loan loss allowances are reserved. This is risky as these loans are not mark-to-marketed, but of course the allowances focus on credit risk, not mark-to-market risks. Losses on AFS securities, were reported at $675 million by year end 2022 on a portfolio of around $8 billion.

Whilst this is less than 10%, it raises concerns if the same applies to the loan book as well as the $5.4 billion equity position on $67 billion in assets feels a bit soft.

An Update

On the 10th of March, the bank provided an update following the developments at SVB Financial Group ( SIVB ) . The company reported a deposit number of $61.5 billion, actually up nearly $8 billion from the end of 2022, which looks strong. Of these deposits include $8 billion from technology-related firms and equity fund resources and life science deposits.

The company claims to hold $2.5 billion cash and equivalents on the balance sheet, while holding many billions in collateralized credit facility with the Federal Home Loan Bank of San Francisco, the Federal Bank and many commercial banks. The question is of course what conditions are tied to these facilities.

And Now?

Shedding some perspective we have to understand that this was a $50 stock pre-pandemic, which saw a huge rally to more than $100 in 2021. Ever since, shares had fallen a bit last year, trading at $80 in recent weeks. Last week shares hit an intraday low of $30, to rebound at $50 now, still marking big losses. At these levels shares are flat compared to pre-pandemic levels, still trading largely around book value.

Fortunately the investment losses appear to be relatively modest in relation to the capital base, but this is not too great. The news on the deposit inflows year to date are encouraging, but investors are arguably fearing what happened to deposit flows on Friday and over the weekend, as moves happen at great speed. This is confirmed in the case of SVB, seeing a massive $42 billion in outflows in a single day!

Depositors have absolutely no incentive to stay with the bank here, as the uncertainty likely applies for equity holders as well. Unless there is big news flow over the weekend to reassure markets (but more so depositors) the situation is simply too uncertain and not compelling (giving the asymmetric risks) for depositors or investors to be involved.

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