Western Alliance Bancorporation Common Stock (DE)

Good day everyone and welcome to the earnings call for Western Alliance Bancorporation for the third 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. Eastern Time October 23, 2020 through November 23, 2020 at 9 a.m. Eastern Time by dialing 1-877-344-7529 and entering passcode 101-48637. 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 than those expressed in any forward-looking statement. Some factors that could cause actual results to differ materially from historical or expected results include those listed in the 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 now like to turn the call over to Ken Vecchione. Please go ahead.

Thanks, operator. Good afternoon and welcome to Western Alliance's third quarter earnings call. Joining me on the call today are Dale Gibbons and Tim Bruckner, our chief financial officer and chief credit officer. I will 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 define our third quarter results and will continue into the future. Robust balance sheet growth, provision reflecting asset quality and consensus outlook, and strong net interest income and PPNR that continue to build capital. The combination of these variables generated record net income of $135.8 million and EPS of $1.36, each up more than 45% versus the prior quarter and exceeding our pre-pandemic performance in 2019. The flexibility of Western Alliance's diversified business model was again demonstrated this quarter as our deep segment and product expertise enable us to actively adapt our business in response to the changing environment and continue to achieve industry-leading profitability and growth while maintaining prudent credit risk management. Total loans grew $985 million for the quarter to $26 billion and deposits increased $1.3 billion to $29 billion, reducing our loan-to-deposit ratio to 90.2%. Our loan growth continues to be concentrated in low-loss asset classes such as warehouse lending, which accounted for over 100% of the loan growth and 56% of the deposit growth. and $267 million in capital call lines where the risk-reward equation is heavily skewed in our favor. The impact of this strategy will be seen near-term in our reduced provisioning expense and longer-term in lower net charge-offs. We are encouraged by our expanding pipeline as clients have applied lessons learned from prior recessions to right-size cost structures and to begin to plan for future opportunities. In the quarter, high average interest earning assets of $1.9 billion were offset by lower rates, substantial liquidity build and a one-time adjustment to Triple P loan fee recognition to reflect modification and extension of the CARES Act forgiveness timeframe which pushed our net interest margin downward to 3.71% as net interest income declined 13.7 million from the second quarter to $285 million, but improved 18.3 million from a year ago period. Excluding the impact of Triple P loans, net interest income would have only fallen by $4 million, which is largely the impact of interest expense on our new subordinated debt issued in middle of the second quarter. We believe approximately 21 basis points of this compression is transitory in nature, and NIM is expected to rise as excess liquidity is put to work through balance sheet growth, deposit seasonality and warehouse lending driving balances lower, and Triple P loan forgiveness assumptions normalize. Given these margin trends and balance sheet growth, We believe Q4's net interest income performance returns to Q2 levels and PPNR rises above Q3. Provision for credit losses was $14.7 million in the third quarter, considerably less than the $92 million in the second quarter, which was primarily attributable to stable to modest improvements in macroeconomic forecast assumptions, loan growth in low-risk asset classes, and limited net charge-offs of $8.2 million or 13 basis points of average assets. Dale will go into more detail on the specific drivers of our provision, but our total loan ACL to funded loans ratio now stands at 1.37% or $355 million and 1.46% excluding Triple P loans, which are guaranteed by the CARES Act. If macroeconomic trends remain stable or begin to improve, future provision expense will likely mirror net charge-offs and reserve levels could decline. Loan deferrals trended lower for the quarter as many of our clients have returned to paying as agreed following their deferral period. As of Q3, $1.3 billion of loans are on deferral or 5% of the total portfolio. which represents a 55% decline from Q2. We expect $1.1 billion of loan deferrals will expire next quarter, which will continue to drive down our outstanding modifications. Our quarterly efficiency ratio improved to 39.7% compared to 43.2% from the year-ago period. Becoming more efficient during the economic uncertainty provides the incremental flexibility to maintain PPNR. Finally, Western Alliance continues to generate significant excess capital, which grew tangible book value per share to $29.03, or 4.3%, over the previous quarter, and 13.4% year over year. Supported by our robust PPNR generation, Capital rose $121.6 million with a CET1 ratio of 10% supporting 15.6% annualized loan growth. Dale will now take you through our financial performance.

Thanks, Ken. Over the last three months, Western Alliance generated record net income of $135.8 million or $1.36 per share, which is up 46% on a link quarter basis. As Ken mentioned, net income benefit reduction and provision expense for credit losses to 14.7 million primarily driven by stability in the economic outlook during the quarter and a release of specific reserves associated with the fully resolved credit. Net interest income grew 18.3 million year-over-year to 284.7 million but declined to 13.7 million during the quarter primarily a result of changes in The SBA's interim final rule, published in August, more than doubled the amount of time that people have to receive forgiveness on their loans. And coupled with a systems delay in forgiveness request processing, we now expect that forgiveness processes to be elongated and the average time the loans will be outstanding is projected to double as well. As a result, using the effective interest method, we reversed out $6.4 million of the fees recognized in Q2, and overall Triple P fee recognition has been extended. This is purely a change in timing, impacting them but with no change to cumulative fee revenue ultimately recognized from this program. The $43 million we are to receive will simply be booked to income more slowly than our original expectations. Net interest income was impacted in Q3 as a result of this timing change by $10.6 million. Non-interest income fell $700,000 to $20.6 million from the prior quarter. We benefited from a recovery of an additional $5 million in mark-to-market loss on preferred stocks that we recognized in the first quarter. Over the last two quarters, we've recovered 80% of that $11 million original loss. Finally, non-interest expense increased $9.3 million as the deferral of loan origination costs fell as PPP loan originations dropped, as well as an increase in incentive accruals as our third quarter performance exceeded our original third quarter budget, which was established before the pandemic. Strong ongoing balance sheet momentum coupled with diligent expense management drove pre-provision net revenue to $181.3 million, of 13.5% year-over-year and consistent with our overall growth trend from the first quarter as the second quarter benefited from one-time PPP recognition, a BOLI restructuring, and FAS91 loan cost deferrals. Turning now to net interest drivers, investment yields decreased 23 basis points from the prior quarter to 2.79% and fell 29 basis points from the prior year due to the lower rate environment. Loan yields decreased 35 basis points following declines across most loan types, mainly driven by changing loan mix and in the reduction of PPP loan fees, resulting in lower PPP loan yield during the quarter. Notably, for both investments and loans, spot rates as of September 30th are higher than the third quarter average yields. Cost of interest-bearing deposits was reduced by nine basis points in Q3, to 31 basis points with an end of quarter spot rate of 27 as we continue to lower posted deposit rates and push out higher cost exception price funds. The spot rate for total deposits which includes non-interest bearing deposits was 15 basis points. When all of the company's funding sources are considered, total funding costs declined by two basis points with an end of quarter spot rate of 25. Unlike last quarter, where spot rates indicated a likely margin compression in the third quarter, these rates appear to demonstrate that the margin will improve as both earning asset yields will rise and funding costs will fall in the fourth quarter. Additionally, in October, we called $75 million of subordinated debt that has diminishing capital treatment with a current rate of 3.4%. Despite the transition to a substantially lower rate environment during 2020, net interest income increased 6.9% year-over-year to $284.7 million. As mentioned earlier, during Q3, our extraordinary build in liquidity and adjustments to Triple P loan fee recognition compressed our net interest margin to 3.71% as net interest income declined to $13.7 million. However, the majority of these reduction drivers are transitory. Triple P loans reduced our NIM during the quarter by 13 basis points. This changes to prepayment assumptions reduced SBA fees recognized, resulting in PPP loan yields of 1.76%. Excluding this timing difference, net interest income declined only $4 million quarter over quarter, primarily due to interest expense on the new subordinated debt that we issued last May, resulting in a net interest margin of $384. Referring to the bar chart on the lower left section of the page, of the $43 million in total Triple P loan fees, net origination costs that we received, only $3.3 million was recognized in the third quarter. We recognize reversal of Triple P of $6.4 million in Q3 and expect fee recognition to be approximately $6.9 million in the fourth quarter and taper off as prepayments and forgiveness are realized. In reality, these assumptions are dependent on actual forgiveness from the SBA. Additionally, average excess liquidity relative to loans increased $1.3 million in the quarter, the majority of which are held at the Federal Reserve Bank earning minimal returns, which impacted NIM by approximately 21 basis points in aggregate. Given our healthy loan pipeline and ability to deploy these funds to higher yielding earning assets, we expect this margin drag to dissipate in the coming quarters. Regarding efficiency, on a linked quarter basis, our efficiency ratio increased to 39.7% as we continue to invest in our business to support future growth opportunities. As described earlier, the non-interest expense increase is largely related to a net increase in compensation costs as we now have greater confidence in our ability to execute on our pre-pandemic budget and are no longer benefiting from deferred costs for PPP loan originations. Excluding PPP, net loan fees and interest, the efficiency ratio for the quarter would have been 40.7%, which, as we indicated last quarter, should be moving closer to our historical levels in the low 40s. Return on assets increased 44 basis points from the prior quarter to 1.66% while provisions fell. PPNR ROA decreased 47 basis points to 222 as it tracked the decline in margin from the prior quarter. This continued strong performance in capital generation provides us significant flexibility to fund ongoing balance sheet growth, capital management actions, or meet our credit demands. Our strong balance sheet momentum continued during the quarter as loans increased $985 million to $26 billion, and deposit growth of $1.3 billion brought our total deposit balance to $22.8 billion at quarter end. Inclusive of PPP, both loans and deposits grew approximately 29% year-over-year with our focus on low-loss segments in DDA. The loan-to-deposit ratio decreased to 90.2% from 90.9% in Q2 as our strong liquidity position continues to provide us with balance sheet capacity to meet funding needs. Our cash position remains elevated at $1.4 billion at quarter end compared to $2.1 billion quarterly average. as deposit growth continues to outpace loan originations. While this does impair margin near term, we believe it provides us inventory for selected credit growth as demand resumes. Finally, tangible book value per share increased $1.19 over the prior quarter to $29.03, an increase of $3.43 or 13.4% over the past 12 months. The vast majority of the $985 million in loan growth was driven by increases in CNI loans of $892 million, supplemented by construction loan increases of $103. Residential and consumer loans now comprise 9.3% of our portfolio, while construction loan concentration remains flat at 8.8% of total loans. Within the CNI growth of the quarter, and highlighting our focus on low-risk assets that Ken mentioned, Capital call lines grew 267 million, mortgage warehouse loans grew over 1 billion, and corporate finance loans decreased 141 million this quarter. Residential loan originations were offset by higher prepayment activity, leaving the balance fairly flat. 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-over-year deposit growth of $6.4 million is higher than the annual deposit growth in any previous calendar year. Deposits grew $1.3 billion or 4.7% in the third quarter, driven by increases in non-interest-bearing DDA of $777 million, which now comprise over 45% of our deposit base, plus growth in savings and money market accounts of $752 million. Marketshare gains in mortgage warehouse and robust activity in tech and innovation continue to be significant drivers of deposit growth. As we 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 with us hand-in-hand whereby our clients contribute liquidity, capital, or equity as an integral component to modified prepayment plans. Our approach collectively uses the resources of the borrower, government, and the bank's balance sheet to develop solutions that extend beyond the six-month window provided for in the CARES Act. By quarter end, deferrals had declined by $1.6 billion, or 55%, reducing total loan deferrals from an 11.5% at Q2 to 5%. Excluding the hotel franchise finance segment, in which we executed a unique sector-specific deferral strategy, the bank-wide deferral rate is approximately 1.6%. We have received minimal additional requests for further deferrals, and 98% of clients with expired deferrals are now current in payments. We expect $1.1 billion of loan deferrals will expire in the current quarter, which will substantially drive down outstanding modifications. Consistent with this trend, as of yesterday, deferrals are down $420 million in October, bringing the current total to $880 million. Regarding asset quality, our non-performing assets and OREO low ratio remain flat at 47 basis points to total assets. while total classified assets increased 28 million or four basis points to 98 basis points of total assets. Classified accruing loans rose by 21 million, explainable by a few loans 90 days past due as of September 30th. All of these loans are now current. Special mention loans increased 81 million during the quarter to 1.83% of funded loans, which is a result of our credit mitigation strategy to early identify, elevate, and apply heightened monitoring to loans and segments impacted by the current COVID environment. Over 60% of the increase in special mention loans are from previously identified segments uniquely impacted by the pandemic, such as the hotel portfolio and a component of our corporate finance division credits determined to have some level of repayment dependency on travel, leisure, or entertainment. As we've discussed in the past, special mention loans are not predictive of future migration to classified or loss, since over the past five years, less than 1% has moved through charge-offs. If borrowers do not have, through cycle liquidity and cash and capital plans, we downgrade to some standard immediately to remediate. Our total allowance for credit losses rose a modest $7 million from the prior quarter due to improvement in macroeconomic forecasts and loan growth in portfolio segments with low expected loss rates. Additionally, we covered 8.2 million of net charge-offs. The ending allowance related to loan losses was 355 million. For CECL, we are using a consensus economic forecast outlook of blue-chip forecasters as it tracks management's view of the recession and recovery. The economic forecast improved during the quarter, which would have implied a reserve release, However, given the still unknown time horizon of COVID impacts, political uncertainty, and the unknown status of further stimulus, we adjusted our scenario weightings to a less optimistic outlook. In all, total loan allowance for credit losses to funded loans declined a modest two basis points to 1.37% or 1.46% when excluding Triple P loans. On a more granular level, Our loan loss segments account for approximately one-third of our portfolio and include mortgage warehouse, residential and HOA lending, capital call lines, and resort lending. When we exclude these segments, the ACLs of funded loans on the remainder of the portfolio is 2%. Provision expense decreased to $14.7 million for Q3, driven by loan growth and lower loss segments and improved macroeconomic factors, while fully covering charge-offs. Net credit losses of 8.2 million or 13 basis points of average loans were recognized during the quarter compared to 5.5 million in Q2. Relative to other banking companies, our lower consumer exposure continues to result in much lower total loan losses. We continue to generate significant capital and maintain strong regulatory capital ratios with tangible common equity to total assets of 8.9%, and a common equity tier one ratio of 10, a decrease of 20 basis points during the quarter due to our strong loan growth. Excluding PPP loans, TCE to tangible assets is 9.3%, a modest decline of 10 basis points from the first quarter. Inclusive of our quarterly cash dividend payments of 25 cents per share, our tangible book value per share rose $1.19 in the quarter to 29.03, up 13.4% in the past year. We continue to grow our tangible book value per share rapidly as it has increased three times that of the peers over the last five and a half years. And I'll turn the call back to Ken to conclude with comments on a few of our specific portfolios.