WAL - Western Alliance: Major Recovery Ahead

2023-04-19 12:04:43 ET

Summary

• Western Alliance announced that it received $2.0B in additional deposit inflows after the end of the quarter until 4/14/2023.
• The bank's deposit situation has clearly stabilized while deposit risks as a whole having decreased.
• The excessive discount to book value is not warranted and I believe a full re-rating is possible within a 1-year time period.

Just a short while ago, I recommended shares of community bank Western Alliance Bancorporation ( WAL ) on the drop as I thought the market was overreacting to the amount of deposit outflows the bank was seeing. On Tuesday, Western Alliance reported first-quarter earnings and the bank's stock soared 17% after the bell. Western Alliance's shares soared chiefly because the bank reported that deposits were flowing back to the community bank, removing a major obstacle to price appreciation. I believe Western Alliance has continued rebound potential and I still recommend the bank's shares as a strong buy as deposit risks have fundamentally decreased!

Western Alliance lost just $4B in deposits since the end of FY 2022

As I pointed out in my last work on Western Alliance -- The Market Is Too Fearful -- deposits have been flowing back to the bank lately which I thought stood in stark contrast to the general perception of Western Alliance being an "at-risk" community bank. According to Western Alliance Q1'23 earnings update, the bank is actually seeing a rather significant inflow of cash, a development I predicted in my original work on Western Alliance as well.

While the deposit trend was profoundly negative in the first week of March, Western Alliance has seen $2.9B in new deposit inflows since March 20, 2023 and $2.0B since the end of the quarter. In other words, Western Alliance, which was punished chiefly because of its exposure to the tech sector and high number of insured deposits on its balance sheet, has now a deposit base that is just 7.5% below the December 2022 deposit amount. In total, the bank lost just $4B in deposits, on a net basis, throughout the March financial crisis which is a rather small amount given the severity of the valuation draw-down. I believe the confidence crisis that was created through the implosion of Silicon Valley Bank is in the process of dissolving and I expect more deposits to return to Western Alliance in the coming month.

Additionally, Western Alliance's deposit base has much less risk now than it had just a quarter ago. The bank suffered a large valuation draw-down chiefly because it had a large percentage of uninsured deposits on its balance sheet which were especially vulnerable to withdrawals after Silicon Valley Bank was struggling. At the end of FY 2022, only 45% of the bank's deposits were insured, therefore leaving the company with a significant percentage (55%) of deposits that were vulnerable to withdrawals in times of crisis. This percentage has now, as of 4/14/23, risen to 73%, meaning the deposits remaining on Western Alliance's balance sheet are less risky. The uninsured deposit liquidity coverage ratio -- which tells investors how easily a bank could fund deposit withdrawals with immediately available liquidity -- rose to 158% in mid-April, showing an almost 4X factor increase since the end of the previous quarter. This means that every uninsured deposit could be withdrawn from Western Alliance at once and the bank would not need any additional liquidity to fund those withdrawals.

What this all means is that depositors are no longer fearful about putting their funds with Western Alliance… which I believe is a necessary precursor for the stock to see a major valuation re-rating.

Western Alliance's book value discount is still excessive

Western Alliance's shares are still selling for an unrealistically high discount to book value although the bank just demonstrated that its fundamental deposit situation is improving progressively. Currently, Western Alliance is selling for the third-largest discount to book value in the community bank sector, after First Republic Bank ( FRC ) and PacWest Bancorp ( PACW ). Both of these banks also suffered major deposit outflows during the crisis and the release of Western Alliance's Q1'23 results, especially with respect to the deposit situation, could also bode well for the earnings releases of First Republic Bank and PacWest later this month. Both banks are high risk, as clearly indicated by the enormous book value discounts we are still seeing, but they also have significant re-rating potential.

Western Alliance is currently trading at a 30% discount to book value and my expectation is that the share price could return to book value within a 1-year time period... if WAL sees a full restoration of its pre-crisis deposit base. For Western Alliance this means the stock price could re-rate approximately 42% higher from the current valuation level.

Risks with Western Alliance

The biggest risk for Western Alliance is if all of a sudden deposits started to flow out of the community bank again and the financial crisis of March 2023, for some reason, were to get a reboot. I consider this likelihood to be very low, however, and believe that the community banking market as a whole, due to the rescue actions of the US government and the Fed in March, is in a recovery setup.

Final thoughts

The most important piece of information in Western Alliance's Q1'23 earnings report was that the bank yet again affirmed that deposits are flowing back to the community bank. Because deposits are flowing back, shares of Western Alliance saw a major re-rating yesterday, but I believe this re-rating is not completed and the stock price has much more upside. I see no reason why shares of WAL could not fully revalue to book value, especially if the deposit situation continues to stabilize. Although shares of Western Alliance already soared yesterday, the setup, at least for me, remains attractive and promising!

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