WAL - Western Alliance: Important Deposit And Liquidity Update

2023-05-04 12:20:00 ET

Summary

• The bank panic went into phase 2, experienced a reboot this week.
• Tuesday's massive sell-off in the community banking market creates March-like investment opportunities.
• The bank submitted an important update to calm investors Tuesday May 3.
• WAL is priced for disaster and investors can capture a huge discount to tangible (intrinsic) value.

A major, panic-driven sell-off in the community banking market this week has created unique investment opportunities for those investors that can handle high risk, but also look for high reward opportunities. I see one such opportunity with Western Alliance Bancorporation ( WAL ) again which only recently presented first-quarter results that were much better than the market thought, causing the bank's share price to soar. I don’t believe that the market has a really good reason to question Western Alliance’s underlying deposit trends and I believe the market is overreacting to First Republic Bank being rescued by JPMorgan Chase ( JPM ) earlier this week. With deposit trends intact, according to the bank's deposit update, a strong balance sheet and good liquidity, Western Alliance is a buy on the drop!

Deposit trends indicate a fundamentally sound business

The most recent event that contributed to the massive sell-off in community banks this week was that First Republic Bank was seized by regulators and immediately sold to JPMorgan Chase at the beginning of the week. First Republic Bank experienced higher than expected deposit outflows in the first-quarter, causing investors to doubt the bank's survival prospects.

The most likely outcome for the bank, as I indicated in my work -- First Republic Bank: Existential Risks Are Real -- was that a top tier bank was going to snatch up First Republic Bank at a fire-sale price. First Republic Bank was indeed sold to a larger, better-capitalized bank, JPMorgan Chase, on Monday but the rescue action has created new anxiety and fear in the market that other community banks might also have to get rescued.

Western Alliance, however, should not be such a bank. The bank's share price plummeted this week, but fear spread around the entire community banking sector, causing a bloodbath for bank names such as Western Alliance, PacWest Bancorp ( PACW ) and Zions Bancorporation ( ZION ).

Investors are irrational

As I indicated in my work on the community bank in April, Western Alliance saw a strong recovery in deposit flows after March 20, 2023 which is when market fear about potential bank failures peaked and depositors pulled their funds out of banks that were perceived as being risky due to a high percentage of uninsured deposits.

In the specific case of Western Alliance, the bank's insured deposit percentage rose from 45% at the end of FY 2022 to 68% at the end of Q1'23, and the percentage further grew to 73% as of April 14, 2023. The bank's deposit liquidity coverage ratio also saw a massive improvement and stood at 158% on April 14, 2023. This means that the bank's deposit base has been materially de-risked, materially mitigating deposit flight risks. Western Alliance has also seen $2.9B in net deposit growth since March 20, 2023 and deposit flows further stabilized in April… indicating that the market’s renewed pessimism with regards to the bank is misplaced.

The Fed's liquidity backstop has also worked, and is still working, should banks need new liquidity to fund deposit withdrawals. Considering that Western Alliance's deposit base only shrunk $6.1B quarter over quarter, I believe investors have no reason to panic.

This is especially true since Western Alliance's liquidity situation has dramatically improved last month, in part because of the Fed's unprecedented actions in March. The bank had $1.9B in cash on its balance sheet plus unused funding capacity of $26.6B. I don't see any liquidity issues for Western Alliance and since the deposit situation also improved, the current market sell-off really makes very little sense.

Important Deposit And Liquidity Update

In light of the current sell-off in the community banking market, Western Alliance presented an update on May 3, 2023. In this deposit update, Western Alliance reaffirmed a stable deposit base. According to Western Alliance, the bank had $48.8B in deposits as of May 2, 2023 and deposits increased $1.2B compared to quarter-end. Western Alliance also specifically stated that the bank is not seeing elevated deposit outflows after First Republic Bank was rescued by JPMorgan Chase.

Western Alliance also said that of its previously announced asset sale worth $3B, $2.1B of sales have settled already, meaning the bank is doing its part in proactively strengthening its balance sheet and raising additional liquidity.

What is also important is that Western Alliance’s capital ratio, as measured by the CET1 ratio, further improved after quarter-end… which is something that investors seem to dismiss considering that Western Alliance’s share price just dropped 30%. The CET1 ratio, which measures capital strength, increased from 9.4% at the end of Q1’23 to 9.7% as of May 2, 2023. The implication here is that Western Alliance’s deposit trends, liquidity situation and capital position have improved after quarter-end, strongly indicating that Western Alliance doesn’t need a First Republic Bank-like like rescue deal.

Western Alliance’s valuation

I prepared this report when shares of Western Alliance are now trading at approximately $24.55 per-share, materially below its tangible book value of $41.56 per-share... which was up 3.3% quarter over quarter despite massive fear and stress in the financial system in March.

Tangible book value neglects intangible assets such as goodwill which may result from corporate acquisitions. A bank’s tangible book value is therefore a conservative estimate of its intrinsic value and a good benchmark to evaluate a bank against: investors buying Tuesday's drop in WAL can get a 41% discount to the bank's Q1'23 tangible book value. I believe the valuation is very attractive here, but investors get this discount because the situation in the community banking market is very uncertain right now.

Risks with Western Alliance

Fear and anxiety came back with a vengeance this week and it is likely that the community banking market will continue to experience selling pressure and stress in the near term. However, Western Alliance’s deposit trends as well as liquidity situation are not very much affected by market volatility... and investors should focus on the underlying business trends. Western Alliance's business trends indicate deposit normalization and improving liquidity. What would change my mind about WAL is if the bank saw a reboot of the financial crisis and a large amount of deposit withdrawals.

Final thoughts

The bank panic is back after First Republic Bank was rescued by JPMorgan Chase at the beginning of the week. However, Western Alliance is not First Republic Bank and the bank has seen a rather small amount of deposit outflows, relative to its deposit base, in the first-quarter. Additionally, deposits have flowed back to the community bank lately and Western Alliance has seen a fundamental de-risking of its deposit base as its insured deposit share increased sharply in the first-quarter. The update from May 3, 2023 is encouraging as well. Given how panicky the market was Tuesday I believe that the market hopeless overreacts and that Western Alliance’s shares are a high-risk, high-reward buy!

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