Western Alliance Bancorporation Common Stock (DE)

Good day, everyone. Welcome to the earnings call for Western Alliance Bancorporation for the second quarter 2020. Our speakers today are Ken Vecchione, President and Chief Executive Officer, and Dale Gibbons, Chief Financial Officer. You may also view the presentation today via webcast through the company's website at www.WesternAllianceBancorporation.com. The call will be recorded and made available for replay after 2 p.m. ET July 17, 2020 through August 17, 2020 at 9 a.m. ET by dialing 1-877-344-7529 using password 101-46019. The discussion during this call may contain forward-looking statements that relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts. The forward-looking statements contained herein reflect our current views about future events and financial performance and are subject to risks, uncertainties, assumptions, and changes in circumstances. that may cause our actual results to differ significantly from historical results and those expressed in any forward-looking statement. Factors that could cause actual results to differ materially from historical or expected results are included in this presentation, the related earnings release and our filings with the Securities and Exchange Commission. Except as required by law, the company does not undertake any obligation to update any forward-looking statements. Now for the opening remarks, I would like to turn the call over to Ken Vecchione. Please go ahead.

Good afternoon and welcome to Western Alliance's second quarter earnings call. Joining me on the call today are Gail Gibbons and Tim Bruckner, our Chief Financial Officer and Chief Credit Officer. I will first provide an overview of our quarterly results. and how we are managing the business in this current economic environment. And then Dale will walk you through the bank's financial performance. Afterwards, we will open the line to take your questions. I'd like to focus on three trends that were present this quarter and will continue throughout the year. PPNR strength, credit provisioning expense, and balance sheet growth. Combined, these trends will support earnings and capital growth and dividend distributions throughout 2020 and 2021. Starting with our second quarter results, Western Alliance generated net income of $93.3 million and EPS of $0.93, which was up 12% over the previous quarter. Tangible book value per share of $27.84 was an increase of 4.2% over the previous quarter, and 12.9% year-over-year. Driving these results was record operating pre-provision net revenue of $194.7 million, up 27.7% year-over-year and 19.1% quarter-over-quarter, with strong operating PPNR ROA growth of 18 basis points to 2.56%, which benefited from recognition of $13.9 million in payment protection program net fees. These results demonstrate that the long-term earnings power of West Alliance core business remains strong amid the current economic and market volatility and will support significant ongoing capital accumulation, provide financial flexibility to fund balance sheet growth, and accommodate changes to the allowance for credit losses for revisions to the economic outlook. In the quarter, we recorded provision for credit losses of $92 million versus $51.2 million in Q1, which was primarily attributable to changes in macroeconomic forecast assumptions and net charge-offs of $5.5 million. Dale will go into more detail in a bit on the specific drivers of our provisions, but our total loan ACL to funded loan ratio now stands at 1.39%, or $347 million. Continuing our strong balance sheet momentum from 2019, loans increased $1.9 billion this quarter to $25 billion and deposits grew $2.7 billion to $27.5. Without the inclusion of Triple P, loans grew a more modest $117 million and deposits demonstrated strong growth of approximately $1.6 billion. The lower adjusted loan growth reflects muted demand for which we held back on marketing activities and directed our focus to low loss, high quality loan segments in addition to assisting our clients with their Triple P applications. We are encouraged by our pipeline and our opportunity to continue to grow in low risk asset classes. Throughout the crisis, we have continued to attract new, high quality relationships to our bank Thank you very much. Looking ahead, we will continue to invest in new product offerings and infrastructure to maintain operational efficiency, but Q2 levels are temporary and will eventually rise back to a sustainable level in the low 40s. However, our branch-like business model and our national business line strategy continue to give us a competitive advantage. Finally, supported by our healthy PPNR generation, Western Alliance remains well capitalized with a CET1 ratio of 10.2%, which puts us in a position of strength, uniquely prepared to address what's ahead in this uncertain environment. Now let's take a moment to provide an update on Western Alliance's response to the COVID pandemic. First and foremost, I want to acknowledge the health and safety of our people. and clients are of our utmost concern. We continue to follow CDC protocol and state-by-state return to work guidance as our organization returns to the office. Our business continuity plans have been working as anticipated and I want to thank all of our people who continue to go above the call duty to get the job done and serve our clients in this unique environment. As I initially described on our Q1 earnings call, Wall's unique credit risk management strategy is focused on establishing individual borrower-level strategies and direct customer dialogue to develop long-term financial plans. Our approach to payment deferral requests is to look for resourceful ways to partner with our clients along with assessing their willingness and capacity to support their business interests. We ask our clients to work hand-in-hand with us whereby our clients contribute liquidity Thank you. Thank you. At quarter end, 2.9 billion or 11.5% of loans have been modified with the bulk of these loans receiving principal and interest deferrals. Excluding the hotel franchise finance segment in which we executed a unique sector deferral strategy, the bank-wide deferral rate is approximately 5%. The vast majority of our borrowers elect to utilize their own resources or PPP funds to bridge their business through the COVID crisis. I will provide an update on the portfolios most impacted by COVID later on, but I did want to highlight in our hotel franchise finance portfolio, our sophisticated hotel sponsors continue to see value in and support their properties with 92% of deferrals achieved by posting additional liquidity as a component of future payment deferrals. Our differentiated deferral strategy provides our customers the runway Thank you very much. Thank you. Today, 95% of our clients are open for business and are experiencing a strong rebound of demand. These facts and the daily conversations with our people and clients help me feel confident that our credit mitigation strategy and early approach to proactively managing our risk segments is bearing fruit and puts Western Alliance in a strong position to come out on the other side of the pandemic in better shape than our peers. Dale will now take you through our financial performance.

Thanks, Ken. Over the last three months, Western Alliance generated net income of $93.3 million, or 93 cents per share. As mentioned, net income was impacted by elevated provision expense for credit losses driven by the adoption of CECL in Q1 and changes in the economic outlook during the quarter. Net interest income increased $29.4 million, primarily as a result of loan growth and lower rates on liabilities as interest expense was cut in half. Operating non-interest income fell $5.2 million to $11.1 million from the prior quarter as lower levels of financial activity generated fewer fees. We also benefited from several non-operating items during the period, including a recovery of approximately 40% or $4.4 million of the mark-to-market loss on preferred stock holdings we recognized in Q1. Bancor Life Insurance was restructured resulting in an increase of $5.6 million as we surrendered and reinvested lower yielding policies. In addition to this gain, this should moderately increase Foley revenue prospectively. Finally, non-interest expense declined $5.7 million primarily from an increase in deferred compensation expense of $3.3 million related to Triple P loan originations, plus a 52% decrease in deposit costs and a 64% decline in business development and travel expenses. Strong ongoing balance sheet momentum coupled with diligent expense management drove operating pre-provision net revenue of $194.7 million, which was up 27.7% year over year. We believe it's the most relevant metric to evaluate the ongoing earnings power of the bank. Our strong PPNR covered an 80% increase in provision costs from Q1 to $92 million, while driving EPS up 12% to 93 cents on a linked quarter basis. Turning now to our interest drivers, investment yields increased four basis points from the prior quarter to 3.02. However, the overall quarterly portfolio yield decreased by 32 basis points from the prior year due to the lower rate environment. Loan yields decreased 45 basis points following declines across most loan types, mainly driven by the 83 basis point Thank you. Thank you. The FOMC cut rates twice in March. The spot rate of total deposits at quarter end was 20 basis points. Total funding costs declined by 34 basis points when all of the company's funding sources are considered, including non-interest-bearing deposits and borrowings. The spot rate on total funding costs at 31 basis points is higher than the quarterly average due to the issuance of subordinated debt mid-quarter at 5.25%. We expect funding costs to have stabilized at these levels as no further Fed actions are anticipated. Demonstrating the flexibility of our business model, despite a transition to a substantially lower rate environment during the quarter, net interest income rose 10.9% for $29 million during Q1 to $298.4 million, up 17% year over year. Our origination of PPP loans coupled with strong balance sheet growth and immediate steps taken to reduce the cost of interest-bearing deposits counteracted the decline in prime and LIBOR. Triple P lending supported our net interest margin during Q2 as SBA fees were recognized resulting in a loan yield of 5.02% in this sector. We estimate most of Triple P loans will be forgiven within eight months from origination. Of the 43 million in Triple P loan fees we received from the SBA net of origination costs, one-third, or 13.9 million, was recognized in the second quarter. Net interest margin contracted three basis points to 419 during the quarter as our earning asset yield fell 34 basis points, but was offset by an equal improvement in funding costs. Our outsized deposit growth and mounting cash reserves will continue to place downward pressure on the NIM until excess liquidity can be deployed, which we expect will take two to three quarters. With regards with our asset sensitivity, our rate risk profile has declined notably over the last year, and we are now asymmetrically positioned to benefit from any future rate increases as 70% of our loan portfolio is behaving as a fixed rate since floors on variable rate loans have largely been triggered. Our estimated net change of net interest income in a 100 basis point parallel shock higher is 4.2% over the next year, and we now project zero net interest income at risk if rates move lower. Turning now to operating efficiency, on a linked quarter basis, our efficiency ratio improved 550 basis points to 36.3%, which continues to demonstrate our industry-leading operating leverage. As mentioned earlier, the non-interest expense improvement is related to an increase in deferred compensation expense of $3.3 million on related PPP loan originations, plus a 52% reduction in deposit costs and a 64% decrease in development and travel costs. Normalizing for PPP net loan fees and interest, the efficiency ratio for Q2 would have been 38.4. Additionally, our branch-light model has given us the flexibility to identify two locations that we are transitioning from full service offices to loan production facilities. Our core underlying earning power remains strong as pre-provision net revenue ROA increased 18 basis points from the prior quarter to 2.56% and return on assets was flat at 1.22%. While we expect the 2.56 as a high watermark as elevated liquidity will hold down the margin, we believe we will continue to maintain industry-leading performance. This provides us significant flexibility to fund ongoing balance sheet growth, capital management actions, or any credit demand. Our balance sheet momentum continued during the quarter as loans increased $1.9 billion to $25 billion, and this deposit growth of $2.7 billion brought our deposit balances to $27.5 billion a quarter end. The loan deposit ratio fell to 90.9% from 93.3% in Q1 as our strong liquidity position continues to provide us with balance sheet capacity to meet all funding needs. Our cash position increased to $1.5 billion as deposit growth continues to outpace credit expansion. While this impairs the margin near term, we believe it provides us with inventory for good credit growth as demand resumes. Of note during the quarter, we issued $225 million of bank-level subordinated debt to ensure ample capacity to support our growth trajectory by bolstering our total capital ratio. Finally, tangible book value per share increased $1.11 over the prior quarter to $27.84, an increase of $3.19 or 13% over the prior year. The vast majority of the $1.9 billion in loan growth was driven by increases in CNI loans of $1.6 billion, residential loans of $154 million, and construction loans of $138 million. Residential and consumer loans now comprise 9.8% of our loan portfolio, while our construction loan concentration continues to trend downward and is now at 8.8% of total loans. including PPP loans, loan growth was $117 million which was affected by line paydowns from draws during Q1 and offset by growth in residential and construction. Highlighting our continued focus on growth and low-risk assets, tech and innovation loans were flat in total while within the category, capital call and subscription lines grew $35 million, mortgage warehouse loans grew $325 million, and residential mortgages grew $165 million. Corporate finance loans decreased $233 million compared to the increase we saw in Q1 as borrowers repaid their line draws, reducing utilization rates down from 38% to 17%. And all loan growth was fully funded by deposit growth. We continue to believe our ability to profitably grow deposits is both a key differentiator and a core value driver to our firm's long-term value creation. Notably, year-to-date deposit growth of $6.1 billion is higher than the annual deposit growth of the company in any previous calendar year. Deposits grew $2.7 billion, or 10.9%, in the second quarter, driven by increases in non-interest-bearing DDAs of $2.3 billion which now comprise over 44% of our deposit base. Triple P loan-related deposits grew $1.1 billion and savings and money market accounts were up $845 million. HOAs contributed to total deposit growth by adding $136 million and Tech and Innovation increased $262 million as capital raising activity during the quarter was active. Excluding Triple P related deposits, growth would have been $1.6 billion or 6.5%. Regarding asset quality, special mention loans increased $292 million and non-performing loans rose $53 million during the quarter. One half of the increase in SM loans are from the hotel portfolio, generally consistent with our previously discussed tech and innovation rating guidelines. These loans were downgraded as we do not have clear line of sight to more than six months of remaining operating liquidity. These borrowers are current, however, as they made loan prepayments that were required for us to consent to a deferral modification. Our other borrowers in this segment are also paying as agreed or provided cash payments that when coupled with the payment deferral have no additional debt service requirement until sometime in 2021. Second, we've aggregated an event planning and leisure subsegment in which the business models are essentially dependent on social distancing relief, and in some cases, the resumption of group events. Of the $150 million total exposure to this sector, $60 million has been moved to special mention and $40 million to non-performing. While the portion moved to FM has over a year of current liquidity, it was downgraded as the revenue models have been sharply impaired. The loan move to non-performing now has limited remaining liquidity. The remainder of the migration to special mention is fairly granular from our client spread throughout our metropolitan markets where liquidity has been tightened. These loans are generally collateralized by an array of assets that include real property. Frequently, a loan may be downgraded to SM because of liquidity concerns, even though collateral coverage may be considerable. For this reason, migration to special mention has a low correlation to ultimate credit losses as over the past five years, less than 1% has moved through to charge-offs. Our allowance for credit losses rose $86 million during the quarter as the change in mix of the balance sheet released $4.2 million of reserves and changes to the outlook accounted for $96.2 million, including covering $5.5 million of net charge-offs. Revisions to the CECL macroeconomic outlook assumptions, which have declined since March 31st, but have generally stabilized since April, accounted for the entire net reserve bill. The funding allowance related to loan losses was $347 million, excluding health and maturity securities, or 1.39% of funds and loans, an increase of 25 basis points. The current reserve bill reflects our best estimate of the future economic environment as of quarter end, including the impact of government stimulus programs and credit migration actions. We have migrated to a consensus economic outlook of blue-chip economic forecasts as it tracks largely management's view of the recession and recovery. Net credit losses of $5.5 million were recognized during the quarter, which were mainly attributable to small business and C&I borrowers. In all, total loan ACL to funded loans increased 25 basis points to 1.39% in Q2 as provision expense for loan losses of 87.3 million significantly outpaced net loan charge-offs. Relative to most other banking companies, our lower consumer exposure continues to result in lower total loan losses. I'll now turn the call back to Ken.