Western Alliance Bancorporation (NYSE:WAL) Q1 2023 Earnings Call Transcript April 19, 2023
Western Alliance Bancorporation beats earnings expectations. Reported EPS is $2.3, expectations were $2.04.
Operator Good day everyone. Welcome to Western Alliance Bancorporation’s First Quarter 2023 Earnings Call. You may also view the presentation today via webcast through the company’s website at www.westernalliancebancorporation.com.I would now like to turn the call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Please go ahead.Miles Pondelik Thank you and welcome to Western Alliance Bancorporation’s first quarter 2023 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; and Dale Gibbons, Chief Financial Officer; and Tim Bruckner, Chief Credit Officer.Before I hand the call over to Ken, please note that today’s presentation contains forward-looking statements, which are subject to risks, uncertainties, and assumptions.
Except as required by law, the company does not undertake any obligation to update any forward-looking statements.For more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, please refer to the company’s SEC filings, including the Form 8-K filed yesterday, which are available on the company’s website.Now, for opening remarks, I’d like to turn the call over to Ken Vecchione.Ken Vecchione Thank you Miles. I would like to start by thanking our clients for the trust they placed in Western Alliance and to the people of Western Alliance for their extraordinary efforts over the last month. Since the collapse of three competitor bankers in mid-March, our team has worked relentlessly to meet our clients’ banking needs.Flexibility of our diversified national commercial banking strategy with a broad range of value-added deposit and deep commercial customer relationships in a wide variety of sectors and geography, all contributed to our firm’s resilience in the face of recent turbulence in the banking industry.We believe our focus on sound financial fundamentals, stable asset quality, and rebuilding capital and liquidity levels over the past several quarters have all helped us navigate through this challenging time.As we move forward with a renewed perspective, we are well-positioned to expand our client relationships and continue to achieve strong return profile.
Balance sheet repositioning included surgical sales of assets and loan reclassifications resulted in after-tax net non-operating charges of $110 million, will have an immediate accretive impact, regulatory capital, and allow us to prioritize core client relationships with holistic lending, deposit, and treasury management needs.Company earned through these charges and achieved net income of $142 million and earnings per share of $1.28 for the quarter, increasing tangible book value per share, 3.3% to $41.56 from year end to the CET ratio of 9.4%.Immediately after the exogenous events of mid-March, WAL experienced elevated net deposit outflows that soon returned to normalized levels. Outflows were concentrated in a few key client groups that will inform our funding strategy going forward.Suffering from the taint of SVB’s failure, approximately $3.3 billion or 42% of our technology and innovation deposits were withdrawn, less than anticipated given that 50% also have lending relationships.Our mortgage warehouse business remained fairly stable on a net base, with only the loss of a single customer that we expect to return to Western Alliance with more stable deposits.While settlement services experienced some initial volatility from very recently acquired clients, lows normalized quickly.
Balances were stable quarter over quarter. Our regional divisions, the strong local brands and small, mid-sized metro business relationships acted as a core source of strength and saw only modest deposit attrition.Non-core regions, which included title companies and other fiduciaries, we acted more reflexively, stock market volatility, and withdrew approximately $2.6 billion. These are non-deposit that we are prioritizing going forward.Since March 20th, our deposit flow stabilized and returned to a healthy growth trajectory with deposits of $2.9 billion to $49.6 billion as of April 14th. Some business lines were never impacted, including HOA with deposits higher by $900 million since the beginning of the year to — excuse me, since beginning of the year to April 14th.Our flexible diversified business model proved its worth in Q1, while monoline banking models depended on single industries or concentrated customer types failed.
85% of our customers already have more than one product or service with us and we will continue to prioritize client segments with fulsome banking service needs that include credit and treasury management, while deemphasizing credit-only relationships.Overall, we’ll successfully retain deep-rooted relationships and those for which we offer proprietary integrated treasury management technology solutions like HOA and we’ll continue to do more of these. It is also worth mentioning that not a single deposit channel of ours represented greater than 16% of total deposits at the onset of the deposit crisis.We responded to our client’s desire for and the market scrutiny surrounding enhanced deposit protection. Since year end, we have taken concrete steps to dramatically grow our insured deposits of approximately 45% of total deposits to 73% as of April 14th.
This place us well in the top decile among the 50 largest US banks.Also as of April 14th, uninsured deposit coverage now stands at 158%. This results resulted from the shift towards insured deposits to accommodate depositors’ desires to have their funds safe and protected.We will continue to provide client deposit alternatives that accentuate safety in these uneasy times. I think it’s important to offer some thoughts on the volatility experienced in our industry since mid-March. WAL navigate through these developments through strategies initiated in 2022 and initially described in our Q3 and Q4 earnings calls, such as deemphasizing loan growth in advance of an economic slowdown, growing deposits on liquidity faster than loan growth, and achieving a greater than 10% CET1 ratio.Formed [ph] by lessons learned in the recent stress of the banking system, we have moved up our medium term CET1 goal to 11% and we are targeting a mid-80s loan to deposit ratio.At the onset of this turmoil, we acted decisively to tap various source to enhance our liquidity position engaged with stakeholders through measured, but impactful financial updates and maintained normal business operations.Looking forward, we will remain focused on building additional liquidity and capital while reaffirming our deposit-led growth strategy.
[Indiscernible] increased diversification and additional deposit streams are also our top strategic goals.To ensure adequate liquidity over the medium term, we will aim to drive our loan to deposit ratio to the mid-80s by cultivating deeper client relationships. We look to organically, but expeditiously rebuild capital with greater than 10% before the end of the second quarter. Our medium term CET1 target is 11%.Emulating larger banks that typically have larger capital efficiency will be an important step to drive sustained core deposit growth in the regulatory environment that will likely become stricter in response to recent industry turmoil.Higher capital, higher liquidity, and lower dependence on moderate rate funding should attract more core deposits and hopefully lead to higher investment-grade ratings.Accelerating HQLA growth in securities book, also something that we planned.
WAL total liquidity and capital, we chose to reposition our balance sheet through very targeted reclassification of certain loans and assets from held for investment to held for sale and specific non-core assets sales.We reclassified approximately $6 billion of HFI loans, recognizing an approximately 2% fair value adjustment of $92.2 million after-tax that includes expected future P&L and capital impacts.After-tax charge will be immediately accretive to regulatory capital as the loans are liquidated and allows us to develop efforts to full client relationships with lending, deposit, and treasury management needs.We already made significant progress in executing this strategy with actions that adds 51 basis points to CET1. Q1 $920 million of loan sales were executed before quarter end with another $3 billion already under contract, but not close by 3/31.MSR sales of $360 million, select security sales of $460 million, and the unwind of high cost mortgage warehouse equity fund resource CLMs all contributed to help offset the HFI reclassification on time charge.In addition, we are moving expeditiously to execute the remaining $3 billion of HFS loan sales.
jan-huber-J51Wt_AvKbc-unsplash
Such sales realized smaller losses than we expected. Note [Technical Difficulty] on the remaining HFS loans are incorporated into our Q1 numbers.These actions reaffirmed our plans to surpass 10% CET1 capital by June 30th. Even with the mark-to-market adjustments from balance sheet repositioning, we still advanced our CET1 ratio 6 basis points to 9.38%.When considering the contracted loan sales for this month and the unwind of our EFR, CLM, [Technical Difficulty] and subscription lines, we’ve already locked in CET1 ratio above 9.71% before considering our organic capital generation or completing sales of the remainder of the HFS loans, which should ultimately push CET1 above 10%.Finally, Western Alliance has significantly accessed to more than $21 billion in contingent sources of liquidity, to be customer and operating needs.
Access to loan balancing cash and unused borrowing capacity increases to greater than $26 billion with the near-term completion of HFS asset sales, $3 billion of which are contractually agreed to and will be used to pay down higher cost BTFP and FHLB short-term borrowings and return to more normal sources of financing. We continue to evaluate additional opportunities to establish secured borrowing facilities from other sources.At this time, I’ll let Dale take you through the financial results.Dale Gibbons Thanks Ken. Turning to the first quarter results, Western Alliance earned total adjusted net revenue of $712 million excluding non-operating charges. Net income was $142 million, while adjusted net income was $252 million.Earnings per share was $1.28 with an adjusted EPS of $2.3. Quarterly loans decreased $5.4 million as $6 billion was transferred to HFS matching the deposit decline of $6 billion.Total adversely [ph] graded assets increased $35 million and quarterly net loan charge-offs were $6 million or five basis points annualized.
Operating return on average assets and return on average tangible common equity of 1.43% and 21.9% provides sustainable go-forward earnings.In the quarter, Western Alliance generated pre-provision net revenue of $352 million. Total adjusted group net revenue was $712 million, was an increase of 28% year-over-year and an increase of $1.9 million for the quarter.Net interest income decreased during the quarter to $610 million. Average earning assets increased $1.5 billion, while lower yielding cash grew 5% from 2.1% of interest earning assets, creating a drag on the new.GAAP non-interest income decreased $120 million to the negative $58 million, while adjusted non-interest income grew $31.7 million from the prior quarter. Mortgage banking revenue increased $26 million quarterly to $73.3 million as AmeriHome continues to see green shoots in its operating environment.Production margins have widened to more historically normalized levels of 26 basis points and the industry capacity has been rationalized.
Retreat of a large money center bank from the corresponding lending market has paved the way for higher margins and win rates.The servicing rights assets continue to produce attractive returns, given the lower prepayment speeds, strong underlying asset quality and continue to attract interest from investors.Q1 sale of $360 million of MSRs at par provides flexibility and a long life path before we come to the market again. Held for Investment decreased $5.4 million to $46.4 million and deposits decreased $6 billion with our [Indiscernible] to $47.6 million at quarter end.MSR balances decreased $238 million in the quarter to $910 million. Total borrowings increased $9.6 billion over the prior quarter to $16.7 billion due to an increase in short-term borrowings of $9.8, partially offset by redemptions of credit lien notes of $265 million.Finally tangible book value per share increased $1.31 or 3.3% over the prior quarter to $41.56 and up nearly 12% over the prior year.
We announced the decomposition of our quarterly go-forward and go-forward debt interest drivers, our investment securities portfolio grew approximately $600 million to $9.1 billion as we sold $460 million of securities predominantly credit CLOs.Other investments increased approximately $900 million, which primarily consists of high quality liquid assets such as treasury bills, part of our strategy to further enhance our liquidity position.Investment yields increased 24 basis points from the third quarter to 4.69% with an end of quarter spot rate of 4.60%.Given the uncertain economic environment, we curtailed loan growth early in the first quarter. This slowdown in credit accelerated in March as we right-sized existing loan balances through reclassification to held for sale and targeted loan sales of approximately at least $7 billion, primarily from limited credit — relationship credits or with limited credit spreads.
These actions lowered our period end balance to $46.4 billion.Loan yields continue to benefit from repricing into the higher rate environment and wider overall spread with an end of quarter spot rate of 6.45% compared to an average rate of 6.28%. Our residential loan portfolio of $15 billion is match-funded with non-interest bearing deposits of 16.5%.Turning to a decomposition of our held for investment loan reclassification, loans transferred to HFS nearly half were syndicated credits and capital call and subscription lines. Areas we have previously mentioned we would be deemphasizing. $5.9 billion loan held for sale portfolio had a quarter end spot yield of 7.34%, which are now funded by FHLB borrowings with the current spot cost of 5.05%, resulting in a modest 2.3% margin.
Leading the sales transaction, lend support, and buoyancy to our net interest margin guide.Total cost of deposit spot rates increased 45 basis points to 1.85% at quarter end compared to an average of 1.72%. This was primarily driven by a $1.5 billion increase in CDs that now comprise 14% of deposits, while non-interest bearing DDAs comprised 35% of our total deposit mix of which 52% of no cash payment to earnings credits.Notably, the spot rate for interest bearing DDA is lower than the average for the quarter as migration from non-interest bearing checking was accomplished at lower rates than the average interest checking rate.But savings and money market rates were also lower as balance attrition tended to be from larger and higher cost accounts.
The interest bearing deposits increased 78 basis points for the quarter to 2.75% compared to the ending spot rate of 2.82%. $6 billion decline in deposits during the quarter was roughly evenly split between money market accounts and demand deposits.Overall, net interest income decreased $30 million or 4.7% over the prior quarter, nearly half due to two fewer days in the quarter and the remainder due to balance sheet repositioning actions in light of the deposit loss.Held for sale loans contributed $31 million, which will decline as we liquidate these assets. Net interest margin compression compressed 19 basis points to 3.79% due to increased borrowings, short-term excess cash on the balance sheet we had to ensure liquidity, and an incremental drag of 11 basis points.Going forward, we estimate that our balance sheet is fairly interest rate neutral with rate shock sensitivities either up or down, only changing net interest income by less than 1%.
Our adjusted efficiency ratio increased to 43% from 39% in the quarter and was flat year-over-year.Higher deposit cost of $5 million related to higher earnings credit rates and normal Q1 seasonality were the primary drivers of the increase from the fourth quarter. Pre-provision net revenue was $352 million during the quarter, a 15% increase in the same period last year, and a decrease of $25 million or 7% from the prior quarter. This resulted in PPNR return on assets of 2% for the quarter, a decrease of 15 basis points from Q4.The aggregate of adversely graded credits increased $35 million this quarter. We see nothing significant in this modest migration to indicate in our widespread deterioration is looming.Total non-performing assets increased $22 million, 17 basis points of total assets.
Really net loan charge offs were $6 million or five basis points of average loans compared to net loan charge-off $1.8 million or one basis points in the fourth quarter.Our total loan ACL decreased $7 million from the prior quarter to $350 million as loans were marked down in the ACL release if these credits were transferred to held for sale.Loan ACL to funded loans increased to 75 basis points compared to 69 in Q4 as some of the loans transferred had low loss rate assumptions, leaving capital call and subscription lines and mortgage warehouse credits. Additionally, the reserve associated with commercial real estate was increased as the economic outlook softened.Tangible common equity to total assets of 6.5% and common equity Tier 1 ratio of 9.4% were both bolstered by net income.
Like the increase we expect for CET1 in the second quarter, tangible common equity ratio should rise in tandem. Inclusive [ph] of our quarterly cash dividend payment of $0.36 per share, our tangible book value per share increased $1.31 in the quarter to $41.56..Tangible book value per share continued its long ascent as the earnings power of the company surpassed charges associated with the bank’s balance of repositioning. TBV also benefited from a reduced AOCI impact after crimping book value last year as bonds prices fell when rates rose.I will return the call back to Ken.Ken Vecchione Okay. Thanks Dale. Our guidance for the rest of 2023 continues to be driven by the strategies and priorities laid out in our Q3 and Q4 2022 earnings calls and informed by the recent banking disruptions.In order to best serve our sophisticated commercial clients, we will continue to aim to be more aligned with the country’s largest banks by rebuilding our capital levels, enhancing insured deposits and liquidity, lowering our loan to deposit ratio, and deepening our client relationships.
We want to be seen as equal to these bank — these peer banks from our depositors’ perspective.Eliminating these differences allows us to compete more on service, performance, and what I call, management intimacy, where C Suite relationships can drive deeper banking relationships.Organic earnings balance sheet repositioning, we’ll continue to grow capital as we reposition the company for slower growth ahead of a potential economic slowdown. So, let me tell you what this means going forward.Regarding capital, we discussed our imminent lift in CET1 to 9. 7% and that we expect to exceed 10% by the end of Q2 through planned loan HFS sales and organic capital growth.Over the medium term, we will target an 11% CET1 ratio, which will be driven by our continued strong return on average tangible common equity and capital generation.As we complete our planned HFS loan sales, we will payoff short-term borrowings and return to more traditional bank funding.
Deposits are expected to grow at approximately $2 billion a quarter and exceed more muted loan growth. This will lower our loan to deposit ratio over time towards a mid-80% target.Net interest margin is expected to slightly compress in 2023 to 3.65% to 3.75% given the anticipated flat rate environment, slower loan growth and increasing price competition for deposits. As our liquidity grows, we will look to accelerate HQI growth in our securities book to further enhance liquidity flexibility.Our efficiency ratio, excluding the impact of deposit costs, should increase slightly to the mid to high 40s given our smaller loan book, partially offset by the inherent operating leverage of our business.Asset quality remains well-positioned and steady as she goes.
And then on future economic environment, net charge offs could begin to normalize and we expect net charge offs to range between the first quarter’s five basis points maybe up to 15 basis.Overall, we expect PPNR for the full year of 2023 to be down 5% to 10% from 2022 levels due to small interest earning assets and higher borrowing costs. However, as we execute our balance sheet repositioning efforts and continue to reestablish our core deposit growth trajectory, we see Western Alliance as even a better institution and better well-positioned for the future.At this time, Dale, Tim, and I are happy to take your questions.
See also 35 Most Beautiful Places In The World and 8 Best Insider Trading Websites in 2023.
Question-and-Answer Session Operator Thank you. [Operator Instructions]
First question today comes from the line of Steven Alexopoulos with JPMorgan.
Steven, please go ahead.Steven Alexopoulos Hi, everyone. I wanted to start with the big picture question first. So, just following-up on the balance sheet repositioning in the quarter, a fair portion of your growth over the past few years has come from these non-core segments, right, which you’re now exiting. With you shrinking the company down to focus more on core relationships, one, when do you get there, right? When is the bank primarily done in terms of shrinking down to get to these more fuller relationships?And then even more important, what does Western Alliance look like after that? Do you focus on ROE, profitability? Are you still a growth bank? What is West Alliance 2.0?Ken Vecchione Okay. A couple of things there. Let me unpack them all.
One, the EFR loans that we have exited in some syndication lines that we exited. Again, those were all non-core and they reflected our excess liquidity that we had in the company and let’s go back to the days of 2020 when we had $6 billion to $7 billion of cash sitting at the Fed earning 10 basis points, it was a good alternative to increase net interest income and there was excellent asset quality and that’s what we did there.We’re not as we continue to reemerge from this. First things first, I want to say, our focus near-term is on moving that deposit ratio down and also moving the capital levels up and we’re going to do that with a heavy focus and concentration on deposit growth and again a more muted growth in loans about $500 plus million.As we emerge from Q4 and position ourselves for 2024, we should be just about ready as we enter into 2024 to hit our CET1 ratios and hit our liquidity into the multi deposit ratios.Now, we’ve got plenty of opportunity here to grow.
I think you’ll see us go to some of our core strengths that have always been with us, that have always helped us grow in the past.C&I loans out of warehouse lending is still active. Now, Florida is going to be economically driven as well. Note financing is going to be there. We’ve been strong in CRE, especially in lot banking. We’ve always had good performance out of our hotel book.Again, I want to say very clearly it’s all dependent upon where the economy is at the end of 2023 moving into 2024. But in the big picture, we will go back to some of the things that we’ve done well. But also during the course of the remainder of this year, we have a number of different business lines that we are working on to developing. Some of those are on the deposit side and some of them are on the loan side.
And as we’ve done every year, year and a half, we’ve rolled out new business lines and opportunities to make sure we propel growth.But I will say, Steve, in the past, we’ve been — if you go back and look from 2022 backwards to 2014, you’ve seen we’ve grown loans and deposits on average both about 23% to 26% per year, right? We never got paid to that. And I think what we’re going to do is we’re going to be a little more cautious on that loan growth, but again accelerating on the deposit side.So, one, we never have to experience a disruption with some information that was put in the marketplace, which I think was inappropriate, but we can get to that point in another time. But I think we’re going to be a very steady grower. I think we should be able to grow above peer trend like we’ve always had.
I just don’t think we’re going to grow at the very top end of peer trend, I don’t think that’s necessary for us.Dale Gibbons I might add that we’re really taking a surgical strike here on these types of things. So, capital call, for example, I mean we got into that as Ken said when we had a lot of liquidity. Those are thinly priced fields and we did syndications where we received no deposits. We’re not exiting that space entirely, we’re still going to do bilateral deals where it’s a complete relationship. And that’s a way that we can kind of continue to be here, but really step away from the stuff really the marginal cost and marginal benefit from that is fairly muted.Steven Alexopoulos Got it. That’s helpful. Thank you. And maybe just one follow-up.
So, if I look at the deposit decline in the quarter, the $3.3 billion you’re calling out through March, the Tech & Innovation segment. We heard from many of the regional banks at this point that they were beneficiaries of the flight out of Silicon Valley Bank.What did you hear from your customers through this period, which drove them to take deposits out of your bank. I would have thought you could have been a beneficiary also, but they just watching your stock price and panicking. What was it? And did they close accounts or they just bring balances down to the insured level? Thanks.Ken Vecchione Okay. One, they didn’t close accounts, they moved deposits out. So, let’s kind of break down the deposit outflow. $3 billion of the deposit outflow, 50% came out of our Tech Innovation and Life Science area.
And Bridge Bank, which is our technology and innovation arm of the company, was always set up as a challenger to SVB.So, during the panic of Monday morning the 13th, I think people looked and said, what most looks like SVB. Well, here is Western Alliance. Now, what was interesting, only 14% of our deposits and about 11% of our total loans was in the tech and innovation sector, right? But still, there was a lot of pressure put on our stock price.And what you saw was a modern-day bank run, right? You saw heavy social media and commentary and social media, which got shareholders nervous, which drove the stock price down, we can talk about this a little later, too, which then forced some of the larger corporates that we had to through treasury management systems to move their mouse, click — point click and send the funds out, then we received a phone call that said, I’m sorry, I’m moving my money, but I see the stock price going down and better to be safe sorry.68% of our dollars that went out, went out to larger banks, the money center banks.
And everyone all said the same thing. When the crisis is over, we’re going to come back. And we’ll wait and see if that happens. And we’ll wait and see if they come back dollar-for-dollar. I doubt it, but they should come back because we haven’t lost touch with these folks, all right?On the second part of your question as it relates to Tech and Innovation, we were still fighting the fight, pulled on to deposits during the — on the 13th and the 14th of March. Now, that has begun to change a little bit and we are more optimistic that deposit growth will begin to happen in our Tech and Innovation, and that kind of informs us to say why we feel comfortable with growing $2 billion per quarter.Steven Alexopoulos Okay. I appreciate it. Go ahead Dale.Dale Gibbons In terms of kind of the stock situation — so really, I think the question starts with how did we get caught up in this?
