2023-07-17 09:12:27 ET
Summary
- Western Alliance Bancorporation is set to release its Q2 earnings report on July 18th, with key metrics to watch including deposits, asset rebalancing, and net interest margin (NIM).
- Analysts' projections for WAL's Q2 2023 results suggest a contraction in sales by about 4.3%, and in EPS by about 18%.
- Heading into Q2, I expect no negative surprises concerning the company's liquidity and solvency. However, there might be challenges in terms of NIM and earnings.
- Despite this, I believe that WAL remains undervalued compared to its earnings, especially with a consensus FWD P/E ratio of close to 5x for 2024.
The July quarter was certainly not an easy period for banks, reflecting on the collapse of SVB, Signature Bank, and Credit Suisse, as well as the First Republic emergency takeover by J.P. Morgan (JPM). With that frame of reference, Western Alliance Bancorporation (WAL) was -- like other regional banks -- at the center of an aggressive market sell-off.
With investor confidence gradually returning, all eyes are now set on WAL's Q2 earnings report, which is set to be released on July 18th, post market. In that context, I highlight three key metrics to watch: (i) Deposits, (ii) Asset Rebalancing, and (iii) Net Interest Margin ((NIM)).
Overall, I expect no downside surprises on WAL's liquidity and solvency. And, although I see NIM/ earnings challenges due to higher funding costs, I argue that at with a consensus FWD of close to 5x for 2024, WAL stock continues to be undervalued as compared to earnings.
WAL's Q2 - Key Metrics To Watch
Deposits - WAL management has previously guided $2 billion deposit growth per quarter through the rest of the FY 2023. As of the most recent data available on May 12th, deposits had already increased by more than $2 billion vs. EOP Q1 . That said, the key question here is how much of this deposit growth comes from new money being deposited from clients, or in other words, from funds that are returning to the company, vs. wholesale borrowing from the Fed or other banks. The distinction is important not only because there are implications for WAL's franchise value for customers, but also for funding costs -- as commercial deposits are quite a bit cheaper than wholesale borrowings.
Deposit cost are difficult to model, because not only do they depend on the Fed rate, but also on WAL's change in funding structure -- both metrics are very dynamic these days. For reference, in Q1 WAL's deposit costs amounted to $87 million.
Asset Rebalancing - According to management commentary, WAL is in the process of selling $6 billion worth of loans classified as "held for sale" (HFS). As of May 12th, they have already completed sales amounting to $2.3 billion, and they expect to reach $3 billion in sales by the end of this quarter, with the remaining $3 billion of sales are projected to be finalized in the second half of 2023.
Personally, I am interested to learn about potential markdowns in related asset values, given that these loans were written in a cheaper interest rate environment as compared to the current Fed benchmark.
Additional Context: As of EOP Q1, WAL disclosed approximately $7 billion in "held for sale" loans, which included $1 billion in AmeriHome loans. The average yield on these mortgage loans was 5.9%, vs. the current spot rate at 6.3%.
Moreover, I am also eager to learn how management now thinks about liquidity/ asset management -- specifically if WAL expects to increase its cash balances at lower yields, vs. deploying funds to write loans or paying off borrowings.
NIM - this one will be super interesting to watch, not only for Q2, but also for 2023/ 2024 guidance. Historically, WAL has achieved quite a strong NIM, anchored on the range 3.55% - 3.85%. However, given WAL's updated funding structure, paired with asset rebalancing, I expect this range to drop. But to where? To reasonably model the new NIM range, investors should extract management commentary regarding the (i) cost wholesale borrowings, (ii) changes in deposit balances, (iii) the NII effect of selling loans, (iv) change in management's attitude towards risk, and finally, (v) considerations about the Fed funds rate.
Analyst Estimates (Correctly) Imply NIM Pressure
Now, let's have a look on what analysts expect for WAL's Q2 reporting: Based on information collected by Seeking Alpha, 13 analysts have submitted their projections for WAL's Q2 2023 results, as of July 17th. These projections anticipate that the bank corp.'s total sales for the second quarter of 2023 will likely fall between $629 million and $683 million, with the average estimate being $655 million. Using the average analyst consensus estimate as a reference point, it is suggested that WAL's Q1Q2 sales may contract by about 4.3% YoY, as compared to the same period in 2022 - not a very notable drop considering the banking crisis in early Q2.
Fiscal Period Ending | Revenue Estimate | YoY Growth | Low | High | # of Analysts |
---|---|---|---|---|---|
FQ2 2023 (Jun 2023) | 655.47M | 4.34% | 628.90M | 683.60M | 9 |
Source: Seeking Alpha
With regard to profitability, however, the picture looks quite less optimistic: According to analysts estimates, WAL's Q2 2023 EPS projections vary from $1.77 to $2.29, with the average being $1.95. Assuming that the average estimate is the most reasonable forecast, it is suggested that WAL's Q2 profitability may drop close to 18% YoY vs the same period in 2021.
Fiscal Period Ending | EPS Estimate | YoY Growth | Low | High | # of Analysts |
---|---|---|---|---|---|
FQ2 2023 (Jun 2023) | 1.95 | -18.46% | 1.77 | 2.29 | 13 |
Source: Seeking Alpha
That said, while topline projections havn't been materially impacted by the banking turmoil ...
EPS estimates dropped like a stone, implying that funding costs pressure the bank's net interest margin.
High Risk!
Overall, WAL stock continues to be associated with a "high risk tag"; however, I do not see a reason to change what I written previously. In fact, reflecting on the encouraging FED stress test , paired with WAL's positive deposit update , I argue that the risk levels for WAL have contracted.
In my view, the market is currently displaying excessive caution towards some bank stocks, and I am confident that taking calculated risks will eventually yield handsome rewards. However, it's important for investors to recognize that due to balance sheet leverage, banks, including WAL, indeed carry a higher level of tail risk compared to non-banking businesses. In light of recent events, there is a possibility that equity holders in Western Alliance Bank may lose their entire investment. It is up to individual investors to assess whether they are comfortable with such a risk.
Conclusion
Western Alliance Bancorporation is set to release its Q2 earnings report on July 18th, with key metrics to watch including deposits, asset rebalancing, and net interest margin ((NIM)). Analysts' projections for WAL's Q2 2023 results suggest a contraction in sales by about 4.3%, and in EPS by about 18%.
Heading into Q2, I expect no negative surprises concerning the company's liquidity and solvency. However, there might be challenges in terms of Net Interest Margin and earnings due to increased funding costs. Despite this, I believe that WAL remains undervalued compared to its earnings, considering a consensus FWD P/E ratio of close to 5x for 2024.
For further details see:
Western Alliance Bancorp: All Eyes On Q2 - Key Metrics To Watch