Western Alliance Bancorporation (NYSE:WAL) Q1 2024 Earnings Call Transcript

Western Alliance Bancorporation (NYSE:WAL) Q1 2024 Earnings Call Transcript April 19, 2024

Western Alliance Bancorporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, everyone. Welcome to Western Alliance Bancorporation’s First Quarter 2024 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 Bank’s first quarter 2024 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; Dale Gibbons, Chief Financial Officer; and Tim Bruckner, our Chief Banking Officer for Regional Banking will join for Q&A. 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 a 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.

Kenneth Vecchione: Good morning, everyone. I’ll make some brief comments about our first quarter earnings before turning the call over to Dale, he will review the financial results in more detail. I’ll come back and discuss the ’24 outlook, and then Tim Bruckner, our Chief Banking Officer, will join us for Q&A. For the last three quarters, the mission of the company has been to reposition the balance sheet and optimize our funding structure to establish an unassailable foundation of higher capital, liquidity and insured and collateralized deposits and further distance us from last launch. Together, these factors should provide a hallmark to better inflate the bank from future industry and market volatility, as well as support more predictable, superior long-term returns.

This quarter, we generated exceptional deposit growth of $6.9 billion that accelerated our repositioning plan at a faster pace than anticipated. We reached our CET1 capital target of 11%, lowered our HFI loan-to-deposit ratio by 10 points to 81%, and increased our already leading insured deposit ratio to 81%. Our liquidity profile was also enhanced by a $6.5 billion increase in unencumbered securities and cash from year end, which also will allow us to pay down — which also allow us to pay down borrowings by $1 billion. In summary, our repositioning goals have largely been accomplished. I’m pleased that during the quarter of outsized liquidity growth, Western Alliance earned $1.72 per share, excluding the increased special assessment from the FDIC, and tangible book value continued to climb despite rate headwinds.

Asset quality remained steady with special mention loans and classified assets declining $139 million in aggregate from Q4. Net charge-offs remained low at only 8 basis points of average loans. Our excellent liquidity positions us to drive stronger loan growth starting in Q2. Loan growth should track proportionately with deposits to maintain our improved loan-to-deposit ratio and allow us to exit 2024 in line with market expectations. Dale will now take you through the financial results.

Dale Gibbons: Thanks, Ken. During the first quarter, Western Alliance generated reported pre-provision net revenue of $247 million, net income of $177 million and earnings per share of $1.60. Excluding the $18 million FDIC special assessment charge, PPNR was $265 million, net income of $191 million and earnings per share was $1.72. Net interest income increased $7 million from Q4 to $599 million from higher average earning asset balances as well as lower average borrowings. Non-interest income of $130 million increased $39 million quarter-over-quarter from consistent performance in mortgage banking, including an improved MSR valuation from a higher balance of servicing rights owned. We look at mortgage revenue holistically because our conservative valuation process when servicing rights are created often results in understated MSR values, which dampened gain on sale revenue.

GAAP non-interest expense was $482 million or $464 million excluding the FDIC special assessment. Deposit costs of $137 million or $6 million above Q4 levels, essentially offsetting the net interest income growth during the quarter and driven by strong deposit growth from both existing and new clients in our HOA and Juris Banking businesses, along with the continued rebound in mortgage warehouse from seasonal lows. Typical seasonal factors as well as the reset of incentive compensation accruals, which were discounted in 2023 were the primary reasons for the increase in salaries and employee benefits in Q1. Provision expense of $15 million resulted from loan growth as well as $9.8 million in net charge-offs, while our economic outlook remains stable.

Lastly, our effective tax rate fell to 23.5% from a temporarily elevated rate last quarter. Loans held for investment grew $403 million to $50.7 billion, while deposits increased $6.9 billion to $62.2 billion at quarter end. As a result, our held-for-investment loan-to-deposit ratio fell to 81% from 91% last quarter. Outsized deposit growth accelerated our liquidity building efforts. Securities and cash increased by $0.4 billion (ph) quarter-over-quarter and allowed for a further $1 billion reduction in borrowings. Finally, tangible book value per share expanded $0.58 for the quarter to $47.30 from retained earnings, which more than offset a modest rate driven increase in our negative AOCI position. Held-for-investment loan growth of $403 million occurred predominantly in C&I categories.

Commercial and industrial growth of $646 million demonstrated noteworthy progress in our regional commercial banking strategy as well as success in both mortgage warehouse and tech and innovation. C&I growth also mitigated a purposeful reduction in commercial real estate. On a year-over-year basis, total loans increased $4.3 billion, almost entirely from C&I production, which has been a point of emphasis for the bank. Outstanding deposit growth of $6.9 billion resulted from broad-based growth and market share gains from our regions, commercial deposit businesses and digital consumer channels. More specifically, our regions contributed approximately $1 billion HOA and digital consumer each over $800 million; Juris Banking over $400 million; and Corporate Trust added $160 million.

Mortgage warehouse deposits reacquired the $3.5 billion and fully replace Q4 outflows as our DDA deposit balance at March 31 surpassed where we were at September 30. Overall, in a more stable rate environment, we are experiencing minimal mix shift of existing client funds into higher cost deposits. Turning now to our net interest drivers. Held-for-investment loan yields increased 12 basis points due to the higher rate environment. Loan growth was weighted towards the end of the quarter as demonstrated by period-end loan balances exceeding average balances by $1 billion. The yield on total securities decreased 33 basis points to 4.66% from our efforts to significantly enhance our liquidity profile, which resulted in a total high-quality liquid securities increasing $4.8 billion from Q4.

In addition, the proportion of average interest earning assets invested in securities and cash increased 23% from 21% in the fourth quarter as a result of these repositioning efforts, which have largely been completed. These efforts position us well to deploy incremental funds to higher-yielding commercial loans earlier than initially expected as well as to manage the cost of deposits lower ahead of the Fed rate cut. The cost of total interest-bearing deposits expanded 11 basis points, while the total cost of funds was flat at 2.82% as average short-term borrowings declined $1.8 billion to 8% of average interest-bearing liabilities. In aggregate, net interest income increased approximately $7 million, while net interest margin of 3.60% compressed 5 basis points due to the earning asset mix shift and securities we discussed.

Additionally, adjusting for the increased FDIC special assessment and deposit costs, our adjusted efficiency ratio for the quarter was 54.4%, which also reflected higher seasonal costs. Deposit costs moved up only $6 million or 4.6% quarter-over-quarter, even though average balances of ECR-related deposits grew $1.4 billion or 7%. Asset quality metrics continue to remain steady and are reflective of our ongoing forward-looking portfolio monitoring and proactive credit mitigation strategy, which produced low realized losses. In aggregate, special mention loans and classified assets declined $139 million from Q4. Non-performing assets increased $126 million to $407 million or 53 basis points of total assets, as we execute our strategy to accelerate resolution for this subset of loans and proactively address them before reaching maturity.

Notably, about two-thirds of our NPLs are paying as agreed with regard to debt service obligations. As stated previously, we’ve largely avoided the largest urban centers for commercial real estate lending that have experienced more value contraction in the nation at large. We see that in our submarkets, which we watch closely, our borrowers projections continue to perform better with more stable appraisals than other markets. Quarterly net loan charge-offs were $9.8 million or 8 basis points of average loans provision expense of $15.2 million covered net charge-offs and provided reserves in concert with loan growth. Our allowance for funded loans increased $4 million from the prior quarter to $340 million and the allowance for credit loss ratio to funded loans of 74 basis points was stable, covering 94% of non-performing loans.

The valuation of NPLs, which primarily consists of real estate secured credits are confirmed by fair value appraisals and collateral. Our CET1 ratio again grew 20 points to 11% or 10% when adjusted for our negative AOCI position, which is 160 basis points higher year-over-year and 230 basis points above our Q3 2022 level when our repositioning efforts began. Our tangible common equity-to-total assets ratio moved down approximately 50 basis points from Q4 to 6.8%, as asset growth in low-risk categories exceeded organic capital accretion from higher earnings. Tangible book value per share increased $0.58 from December 31 to $47.30 for retained earnings growth outpacing the higher AOCI offset. Our consistent upward trajectory and tangible book value per share has outpaced peers by over 4 times since 2013, including strong growth in 2023.

I’ll now hand the call back to Ken.

Kenneth Vecchione: Okay. Thanks, Dale. We have transformed the bank several times in the company’s history. Starting as a Las Vegas Bank in 1994 and expanding into Arizona and California in 2003. In 2010, after the GFC, during which we were landlocked in some of the most stressed markets nationally, we began our diversification strategy into national business lines, with HOA and mortgage warehouse that created diversity, growth and sustainable earnings without undue risk. In 2015 and 2016, we added Bridge Bank to enter into the tech and innovation economy, and that purchased the hotel franchise finance business, which provides expertise and deep industry knowledge, enabling us to become a leader in that vertical. In 2018 and ’19, the bank entered, developed and launched three specialty deposit verticals: settlement services, business escrow services and corporate trust that expanded the business diversification strategy and produce access to new deposit sources.

In 2023, we launched a digital consumer deposit strategy to gain access to a granular deposit base. Now in 2024, the company has worked hard to reposition and fortify its balance sheet and liquidity. Informed by the events of last March, the management team continues to optimize funding, significantly improved capital and carry higher levels of insured and collateralized deposits to form a solid, sturdy balance sheet, which can be used as the foundation to reignite earnings, grow the balance sheet and generate organic capital while ensuring asset quality remains safe and protected. So what does WAL look like in the future? Well, using and reinforcing the disciplines I just mentioned, Western Alliance has and will continue to have risk management architecture that will enhance the company’s guardrails as we continue to develop new organic avenues for growth to deliver consistent upper teens return on tangible common equity and sustainable earnings growth that maintains historical capital accumulation at multiples higher than other banks.

We are excited that the repositioning strategy has been largely completed. We have fortified our balance sheet, which we will — which will allow the company to generate earnings velocity through the back half of 2024 and into 2025. To that end, from our first quarter results, we updated our 2024 guidance as follows: continued thoughtful balance sheet growth at a slightly higher level building on the momentum of Q1 and more focused on deploying incremental liquidity into sound, safe and thoughtful loans. Our current loan-to-deposit ratio provides flexibility to selectively make more loans as opportunities arise. For the full year, loans are expected to grow $4 billion up from $2 billion, given the new client wins in current pipelines. We also expect deposits to end the year up $11 billion, which is $3 billion above our previous consensus.

Turning to capital. We expect our CET1 ratio to remain steady at or near 11%, capturing the forecasted increase in loan volume. Regarding net interest income, we reaffirm our 5% to 10% growth expectation from Q4 2023’s annualized jumping off point and are tracking to the upper end of this range. Our rate outlook includes two 25 basis point cuts in the back half of the year and a higher for longer rate environment without rate cuts by the FRB, we would expect NIM to incrementally benefit by mid-single digit basis points from loans repricing in an elevated rate environment. Our expectation is that net interest margin will trough in Q2, but the full quarter effect of our liquidity build — I’m sorry, with the full effect of our liquidity build, while net interest income will continue to move higher from Q1 levels.

NIM should ascend due to repricing of existing loans and new loan originations, which all should generate a full year NIM in the low 350s. Non-interest income should increase 10% to 20% from an adjusted 2023 baseline level of $397 million. Mortgage banking-related income remains somewhat dependent on the rate environment and mortgage volume, but we are encouraged by the resilience of the Q1 results. Non-interest expense, inclusive of ECR-related deposit costs is now expected to rise 6% to 9% from an annualized adjusted Q4 baseline of $1.74 billion, primarily from the accelerated ECR-related deposit growth we achieved in Q1, which helped the company reach liquidity targets earlier than expected. In aggregate, these factors should enable Western Alliance to consistently grow PPNR throughout the year and establish a higher baseline headed into 2025.

Asset quality continues to remain steady and is performing as expected with continued sponsor support of projects. Our full year net charge-off guidance remains 10 basis points to 15 basis points of average loans. At this time, Dale, Tim and I look forward to answering your questions.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from the line of Jared Shaw with Barclays. Jared, please go ahead.

Jared Shaw: Hey. Good morning, guys.

Kenneth Vecchione: Good morning.

Jared Shaw: Thanks. Looking at the guidance with the expense growth primarily coming from the ECR. I guess, why? Why wouldn’t that also help drive a higher expectation for NII? You’re saying looking at the higher end of that, but if — with this big deposit growth and the opportunity for loan growth, I guess, what’s — are we giving up all of that spread early stages to the ECR?

Dale Gibbons: No. It will help drive NII. The issue is that, that growth came in kind of ratably over the first quarter. We haven’t [indiscernible] up to the degree we can, the origination of good quality credit to disperse those additional funds. That’s going to take a process within, say, the second quarter. So it will catch up. But the second quarter is a little bit of a pivot point whereby we’re going to look for higher asset growth than we had in Q1 and that’s going to hold the second quarter back a bit.

Kenneth Vecchione: The prior guide — let me just add, the prior guide included four rate cuts, which have now been revised to two cuts. To offset that, we’ve also increased our loan growth from $500 million a quarter to $1 billion a quarter and that’s what helps our net interest income throughout the rest of the year continue to grow quarter-to-quarter.

Jared Shaw: Okay. All right. Thanks for that. I guess maybe shifting a little to the capital and now that you’re at the target floor of 11%. How should we be thinking about the desire to grow that from here? And can you give an update on how the credit-linked notes impact that going forward and sort of the timing on that?

Kenneth Vecchione: Yeah. So we see capital remaining modestly at or above 11% for the remainder of the year. Increasing loan growth above trend will absorb the excess capital formation for the rest of the year. I will note that since we started our repositioning strategy on capital from Q3 of 2023, we’ve increased the CET1 ratio of 230 basis points without raising capital. We do have a couple of CLNs embedded into these numbers and the runoff of the CLN is very modest year-over-year.

Dale Gibbons: Yeah. As you recall, we collapsed two of our CLNs last year in mortgage warehouse and capital calls (ph). We’ve got a few residentials that are — that don’t have substitution credits in them. So they are just running off. We’re gaining about 40 basis points to 50 basis points in CET1 from that.

Operator: Thank you. The next question comes from the line of Casey Haire with Jefferies. Casey, please go ahead.

Casey Haire: Great. Thanks. Good morning, guys. Question on the loan and deposit growth. Just wondering how you guys got to those numbers. I mean you guys have demonstrated that you’re capable of putting up stronger growth than that. And just wondering, if it’s conservative or if you’re just looking to manage the growth and have an eye on, obviously, the $100 billion line, so just some color there?

Kenneth Vecchione: Yeah. So Casey, while we continue to remain cautious about the future economic activity, and we have deemphasized certain asset classes, we do believe that we can actively grow loans $1 billion per quarter. And we feel rather comfortable with that based on the pipeline that get reviewed on a weekly basis. So we are deemphasizing certain areas, as you would expect, CRE office, residential, general construction, a little cautious on multifamily, we also see better opportunities in warehouse lending group and the SAR (ph) lending, the regional C&I business is beginning to take hold, resource lending and maybe lot banking also give us the best risk reward dynamics on the loan side. So if we could do better than $1 billion we will, as long as it’s safe, sound, and thoughtful growth and the economic environment hasn’t changed.

But right now, we feel comfortable with $1 billion. As it relates to the deposit guide, we certainly had a monster quarter at $6.9 billion. A lot of that came in because of our, we think, because of our better service levels, and we had a number of market share wins as well as a number of our new deposit verticals have really begun to take hold. Settlement services had a good quarter. Corporate Trust is growing. HOA had its best quarter ever. It was monsters. Okay. And in fact, we think we are now the leader in HOA deposits in the industry. And then the region also had a very good quarter as well for $1 billion. So taking together, all that informs us that we think we’re comfortable growing positive $2 billion a quarter for the rest of the year.

I will say, something we’re proud of here, when you look back over a year, we’ve grown total deposits by $14.3 billion. If you take out $1 billion for broker deposits, we grew $13 billion in a year. And that kind of gives us the confidence level to say that $2 billion seems very reasonable and practical.

Casey Haire: Yeah. Okay. And then, just switching to the expense front. Just to clarify, does the expense guide do include the $17 million FDIC assessment for this year? And then, if I layer in your guide, it looks like it’s delivering an efficiency ratio in the low 60s. That’s obviously with the deposit costs, but it’s obviously running a little bit higher than what you’ve been guiding to in the past. I think it’s been around 50%. So just wondering what’s the new expectation on that front.