Western Alliance Bancorporation (NYSE:WAL) Q4 2022 Earnings Call Transcript

Western Alliance Bancorporation (NYSE:WAL) Q4 2022 Earnings Call Transcript January 25, 2023

Operator: Good day, everyone. Welcome to Western Alliance Bancorporation’s Fourth Quarter 2020 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. Go ahead.

Miles Pondelik: Welcome to Western Alliance Bancorporation’s Fourth Quarter 2020 Conference Call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; and Dale Gibbons, Chief Financial 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: Thanks, Miles. Good morning, everyone. I’d like to provide an overview of our 2022 performance and then preface our approach to 2023 before Dale reviews the bank’s financial performance. I should also mention that Tim Bruckner, our Chief Credit Officer, is also in the room with us today. Western Alliance had a strong year in 2022. Our diversified national commercial bank grew loans 28%, deposits by nearly 13% and posted record net revenue and net income growth of 30% and 17.6%, respectively. We accomplished all this while maintaining strong and stable asset quality as net charge-offs to average loans were approximately 0% for the year, while non-performing assets to total assets improved to 14 basis points. Balance sheet is well positioned to weather an evolving environment as 27% of the loan portfolio is credit-protected and 53% of the loans can be classified as insured or economically resistant.

Our goal is to emerge on this slowing or recessionary environment as the top-performing asset quality bank in our peer group, a position we currently occupy. For 2023, the higher interest rate environment and slowing economy will generate headwinds for the banking industry. As I mentioned on our Q3 earnings call, WAL is focused on bolstering CET1 levels, restraining loan originations with deposit growth, outpacing loan growth while maintaining leading asset quality and growing year-over-year earnings. We are pleased with the substantial progress made towards this goal. Our CET1 ratio ended the year at 9.32%, which was over 60 basis points higher than the previous quarter. The rise in capital was driven by a purposeful facility, reducing approximately $1.8 billion in certain low-margin, low deposit categories such as capital call and subscription lines and corporate finance indications.

Without these actions, quarterly held for investment loans would have grown $1.5 billion and generated incremental interest income. Our ongoing investments in diversified deposit businesses should provide liquidity in excess of loan growth. Q4 ending deposits declined $1.9 billion from last quarter, while average deposits declined by only $295 million quarter-over-quarter. This decline was primarily driven by short-term seasonal tax and insurance escrow deposit outflows in the mortgage warehouse group, which has since recovered, with Q1 quarter-to-date average deposit balances up more than $2.4 billion from year-end. Previous investments in our settlement services, business escrow and HOA deposit businesses as well as the soon-to-be launched corporate trust platform, combined with several other initiatives we look to roll out, provide meaningful opportunities to gather incremental deposits this year.

We look for predictable balance sheet growth to improve NIM and grow net interest income in 2023. After Dale’s comments, I will discuss our 2023 outlook in more detail.

Dale Gibbons: Thanks, Ken. For the year, Western Alliance produced record net revenues of $2.5 billion, net income over $1 billion and EPS of $9.70, the 14th consecutive year of rising earnings. We maintained interest leading performance with return on average assets and return on average tangible common equity of 162% and 25%, respectively. Grew tangible book value per share to $40.25, 6.4% higher year-over-year. As Ken mentioned, we previously identified a near-term priority of bolstering our key capital ratios. We’re pleased with the substantial progress made towards this call with our CET1 ratio increasing over 60 basis points to 9.3% in Q4. This strategy led us to proactively restrain balance sheet growth without inhibiting record net interest income and earnings.

The year, net interest income increased 43% to $2.2 billion. Our diversified deposit franchises are focused on generating attractive core funding that drives net interest income and EPS higher rather than purely minimizing deposit betas to maximize the interest margin. Non-interest income declined $80 million to $325 million as a result of ongoing softness in the mortgage industry. However, improved mortgage-related revenue in Q4 and the pending withdrawal of a large money center bank from the correspondent mortgage business as gain on sale margins and core servicing income could be in the very early stages of stabilizing. Finally, asset quality remains stable and strong as classified and non-performing assets as a percentage of total assets are still lower than pre-pandemic levels.

WAL has dramatically transformed its business over the last decade to become a national commercial bank focused on deep segment expertise, underwriting specialization and greater business diversification. For the year, Western Alliance reported net charge-offs of just $1.5 million or less than 1 basis point of average loans. During the fourth quarter trends and business drivers, Western Alliance generated net income of $293 million, EPS of $2.67 and pre-provision net revenue of $368 million. Operating EPS was $2.74 or $9.95 for all of 2022. Total net revenue was $701 million, an increase of $37 million during the quarter or 25% year-over-year. Net interest income increased 6% from Q3 to $640 million was primarily driven by NIM expansion, but also benefited from higher average earning asset balances.

During the quarter, the company completed a credit-linked note transaction, bringing 2022 issuances to total $579 million. As of year-end, the company is protected from adverse credit losses on reference pools of loans totaling $12 billion. Overall, non-interest income remained essentially flat from the prior quarter at $61.5 million as mortgage banking-related revenue increased $9 million to approximately $47 million. This increase was partially offset by a $9.2 million mark-to-market charge included in other income. Non-interest expense included — increased 9% or $27 million, resulting in an efficiency ratio of approximately 47%, primarily due to higher deposit costs related to earnings credits. The efficiency ratio was adjusted to classify deposit cost as interest expense and 40% as remaining operating expenses were essentially flat.

Turning now to net interest drivers. Our asset-sensitive balance sheet benefited from the rising rate environment. Risk investment yields increased 79 basis points from the prior quarter to 4.45% as variable rate securities reprice higher. On a linked-quarter basis, loan yields increased 86 basis points to 570 with an end-of-quarter spot rate of 6.26. Loans held for sale benefited from rising mortgage rates had increased 76 basis points to 5.63%. Irrespective of the Federal Reserve’s rate trajectory, our net interest income will continue to benefit from an average of $2.5 billion of loans maturing or repricing higher each quarter in 2023. During fixed rate loans are being replaced by these loans to yield over 2% higher while variable rate loans are repricing on the spreads 50 basis points wider on average.

Total funding costs, including borrowings and deposits increased 69 basis points to 1.57% as the use of CDs and short-term borrowings increased since the proportion of average interest-bearing liabilities. Net interest income growth of $38 million or 6% on a linked-quarter basis was powered by a 20 basis point NIM expansion and a modest increase in average interest-earning assets. Increase in total interest income continues to be greater than the change in total funding costs, including ECR expenses, demonstrating our continued asset sensitivity. The rate shock analysis shows that with the plus 100 basis point shock on a static balance sheet, net interest income is expected to lift over 3%. Using the same scenario on a growth balance sheet, we would expect net interest income to grow over 20%.

Fed rates declined, as some are projecting that might happen later this year. Growth balance sheet, net interest income still rises to incident with our decreasing asset sensitivity profile. Our efficiency ratio increased 140 basis points to approximately 47% after reclassifying deposit costs interest expense. Adjusted efficiency was essentially flat at 40%, again demonstrating the high operating leverage of the company. Deposit costs increased $26 million from the prior quarter due to higher earnings credit rates on deposits, but at a slower rate than Q3 as earnings credit rate paying demand deposits declined. Pre-provision net revenue climbed 3% to a record $368 million or 14% increase year-over-year, resulted in return on average tangible common equity, excluding all other comprehensive income, 23% for the quarter or 80 basis points higher than last quarter.

Western Alliance’s leading organic capital generation and continued strong performance provides significant flexibility to fund balance sheet growth, bill capital ratios and meet credit demands. Loans held for investment decreased $339 million to $51.2 billion, and deposits declined $1.9 million to $53.6 million at year-end, primarily driven by short-term seasonal mortgage warehouse factors. Total borrowings fell $16 million over the prior quarter, primarily from a decline in short-term borrowings, offset by issuance of $95 million in credit linked notes on a reference pool of residential loans. Finally, tangible book value per share increased $3.09 or 8% over the prior quarter and 6% year-over-year to $40.25 due to strong organic earnings, along with reduced drag from available-for-sale securities marks recorded in AOCI.

This quarter, net loan growth was impacted by our purposeful decision to temper certain C&I loan categories, such as equity fund resources and, to a lesser extent, corporate finance by approximately $1.8 billion in total. These reductions, C&I loans would have grown $220 million with total loans held for investment growth of $1.5 billion on a linked quarter basis. On C&I growth was driven by $651 million from sponsor-backed commercial real estate, $390 million from construction and $250 million from residential. Additionally, the breadth of our business lines generated healthy loan demand in regional banking, which was $696 million higher than Q3. Hotel Franchise Finance rose $315 million, and tech and innovation was up $140 million. We are well positioned to maintain prudent growth through a more uncertain economic environment given our diversified loan mix between national business lines, residential real estate and regional banking.

Over the last three years, 68% of our robust loan growth has come from low to no loss categories, which now account for 53% of our entire portfolio. Furthermore, we have structured additional loss prevention as 27% of loans are credit protected, which should fortify our industry-leading asset quality. The range in deposits, competition for funding picked up during the quarter and larger-than-expected seasonal factors combined to temporarily reduced deposit balances. Early deposits declined $1.9 billion, primarily driven by short-term seasonal escrow deposit outflows in our mortgage warehouse group, which are included in non-interest-bearing deposits, but subject to earnings credit rates. As Ken mentioned, these seasonal factors have reversed since year-end, with mortgage warehouse Q1 quarter-to-date average balances already up more than $2 billion from year-end or 15% higher from the same period year-over-year.

Additionally, quarter-to-date average balances for total deposits are up more than $2.4 billion from 12/31 and approximately $660 million greater than 4Q’s average balance. Western Alliance’s warehouse comprised 65% of the reduction in noninterest-bearing DDA. End of year seasonality is evident in the linked quarter decline in average deposits of only $295 million versus the more pronounced decline on a period-end basis. Increased competition for liquidity in a higher rate environment drove an 11% increase in total interest-bearing deposits, including a $1.9 billion growth in CDs Interest-bearing demand deposits grew $1.2 billion from last quarter, in part from migration from noninterest-bearing DDA. Diversified deposit franchise continues to provide meaningful opportunities to attract — to generate attractive funding to support loan growth.

Among our scalable national business lines, we are pleased with the continuing momentum in settlement services and homeowners’ associations. We produced linked quarter growth of $680 million and nearly $300 million, respectively. Going forward, we expect continued growth from our deposit business lines, including business escrow services to continue to generate attractive deposits, fund ongoing balance sheet growth and soften the impact of elevated rates on overall funding costs. Our asset quality remains strong and stable. Classified assets and non-performing assets as a percentage of the total are still lower than pre-pandemic levels. Total assets increased — total classified assets increased $8 million in Q4 to 58 basis points of total assets, only 2 basis points higher than Q3.

Total non-performing assets to total assets were down 1 basis point from last quarter to 14. The prospects for greater economic volatility continues to evolve. We believe our underwriting discipline borne out through our national business line strategies has prepared us well for additional credit stress that may accompany greater macro headwinds. However, we have not observed any preliminary signs of material uptick and credit migration trends, and we also expect to instead of to reduce our exposure to the more sensitive loan categories this year. Sound asset quality decisions will dictate our thoughtful loan growth trajectory and enable us to maintain profitability despite heightened economic uncertainty. Quarterly net charge-offs of $1.8 million in the quarter or 1 basis point of average loans of the full year 2022 net charge-offs to $1.5 million.

Those quarterly charge-offs have been stable at approximately $2 million per quarter for the past year, while net charge-off variances result from volatility and recoveries. Provision expense for credit losses was $3.1 million, primarily due to uncertainty surrounding a percentage recession, offset by risk-weighted asset optimization efforts, sale of corporate finance indications and reducing capital call and subscription line exposure. Base cases for a mild recession listed allowance for credit loss assumptions weighted towards Neo’s consensus forecast, which has shifted toward increasing the recessionary and more conservative scenario. Total loan ACL to funded loans was 69 basis points, while our ACL to non-accrual loans was 420% at year-end.

Testing for the $12 million of loans covered by credit linked notes, where ample first loss coverage is assumed by a third party, the ACL coverage rises to 89 basis points. We believe these superior asset quality trends are sustainable throughout economic cycles due to Western Alliance’s deliberate post-GFC business transformation strategy. Coming back to that time period, nearly 70% of losses Western Alliance incurred during rate financial prices came from loan categories comprising 44% of the loan portfolio. Those categories make up less than 6% of total loans. Contrast, 87% of the current portfolio is insured and resilient categories. The insured category consists of credit protected, government guarantees and cash secured loans. Resistant loans are categories which have historically no or low losses.

The Categories have experienced de minimis losses since 2014. loans are supported by strong collateral and counterparties as well as our underwriting expertise. This category might experience some grade migration, realized losses are minimal due to limited recovery — uncovered collateral risk with average loss of only 2 basis points and a maximum quarterly annualized loss of just 16 basis points. 13% of the portfolio we blew is more sensitive to economic growth. Lending in this category has been focused on unique sub-segments that offer the highest risk-adjusted returns and where we leverage our sector knowledge and underwriting capabilities to maintain superior relative asset quality. In 2014, these loans have experienced a maximum quarterly annualized loss rate of only 71 basis points with average losses of five.

Exceptional post GFC asset quality has been highlighted by minimal net charge-offs of only $29 million since the beginning of 2014. Comparing the ARP performance to the 32 publicly held banks with assets between $25 billion and $150 billion based in the United States, we realized the lowest average net charge-offs and the lowest quarterly annualized maximum charge-offs as a percentage of total loans over the same time period. While the past decade has been a period of relatively low credit stress, our leading performance in low average losses and, more importantly, the lowest loss volatility among peers bodes well as to how Western Alliance will outperform peers if and when credit stress becomes more acute. On our last earnings call, we discussed our renewed focus to rebuild capital and have made strong progress so far.

Our tangible common equity to total assets ratio of 6.5% and common equity Tier 1 of 9.3% were both materially higher quarter-over-quarter. In our industry-leading return on equity and assets, we continue to generate significant capital to fund organic growth and to lift well-capitalized regulatory ratios. This strong capital generation during this quarter is the equivalent of issuing approximately 5.5 million shares. As previously mentioned, TBV per share increased $3 to $40.25 and since 2013 has grown 4.3 times faster than the peer group. We believe our business diversification, excellent asset quality and ability to generate solid operating leverage will continue in a softer economy and validate our franchise as a high-performing all-weather growth bank.

Back to Ken.

Ken Vecchione : Thanks, Dale. I was pleased with the management team’s ability to adapt to the changing interest rate economic environment to produce record operating results in 2022, a thoughtful balance sheet growth in conjunction with executional focus, position the bank to capitalize on matters income sensitivity while simultaneously growing both sides of the balance sheet with industry-leading performance as the quality remains solid and stable with those signs of elevated stress. Looking forward for the full year 2023, we expect continued careful balance sheet growth driven by our diversified business model with a flexible origination mix designed to maximize net interest income. We expect loans held for investment to grow between 10% and 15% and deposits to grow between 13% and 17%.

Our specialized deposit franchises generate funds for more economically agnostic and secularly strong sectors, which offer significant deposit growth opportunities in excess of loan growth. We also expect improved interest expense on the marginal deposits raised as we had fewer term deposits and favorable interest-bearing deposits. Net interest margin is expected to expand between 4% and 4.10% as it moves in concert with Fed fund actions. Favorable earning asset repricing dynamics per quarter will support NIM even if the Fed pauses hikes this year. Net interest income is expected to grow between 20% and 25% for the year in a rising rate environment and to exceed growth in ECR-related deposit costs. Growth and efficiency ratio for the year should remain in the low 40s as we will continue to invest in risk management, technology and new business lines to take advantage of the attractive growth opportunities we see in front of us.

In aggregate, we expect pre-provision net revenue growth of 11% to 15%. Excellent asset quality should remain intact, but we could return to more normalized losses if the economy enters into a recession. Our goal remains to prudently bolster key capital ratios in line with macro environment with a CET1 ratio of between 9.75% and 10%. Our bank’s industry-leading return on average tangible common equity produces significant organic capital of approximately 45 basis points of CET1 net of dividends per quarter, which provides us with significant flexibility to achieve our strategic objectives, grow capital ratios, on balance sheet growth or to take other capital actions. At this time, Dale, Tim and I are happy to take your questions.

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Q&A Session

Operator: The first question comes from the line of Casey Haire with Jefferies. Please proceed.

Casey Haire : Thanks. Good morning, guys. No way I cut all that guide, Ken. But I just — I did hear the NIM guide. I think you said 4% to 4.1%. I’m assuming that’s for the year. Can you just give us sort of the progression, how you see it trending throughout the year and exiting the year? And what Fed forecast are you guys assuming? Thank you.

Ken Vecchione: So, on the Fed forecast, we actually have only one rate increase at the beginning of the year. That’s about a week from now for 25 basis points on the upside. We also have 2 rate decreases, both 25 basis points placed into our Q4 forecast. We’re probably less confident about those rate declines, but we think it’s a good, prudent thing to do in order to manage our efficiency ratio and not have expenses run ahead of potential revenue increases. So that’s the rate forecast. On NIM, we expect it to grow slowly through the year between 4% and 4.10% is pretty tight for us. So probably crosses over 4%, a little more towards the end of Q1 into Q2 and then just grows generally from there.

Casey Haire: Okay. And within that deposit growth guide, which I think you said 13% to 17%, any sense — I’m assuming there’s a lot of negative mix shift baked into that. But any sense of where DDA as a percentage of total deposits can settle versus that, I think, we’re low 40s today?

Ken Vecchione: I’ll start, and I’ll let Dale answer that second half of the question, but deposit is between 13% and 17%. That’s $7 billion to $9 billion, right? And just to be clear, what we’re trying to do is grow deposits at a rate faster than loan growth, and that’s what we mentioned on Q3. In terms of growth areas for us, in terms of businesses, that may give you some confidence around the deposits, our HOA business in 2022 grew $1.3 billion, and we kind of see that still being the same. We also see growth coming from our settlement services and our business escrow services lines of business. And those, we invested in, in 2018 and ’19 with a stronger rollout as we got into 2020. And those businesses did rather well. Certainly, settlement services did rather well in 2022, and then the rest is — in terms of deposit growth will come from the regions.

Dale Gibbons: Okay. It’s pretty difficult in today’s environment to garner new non-interest bearing deposit relationships. But as we indicated, we have seen a recovery of approximately half of the DDA that declined in the fourth quarter, were primarily related to mortgage banking operations and the seasonal trough is 4Q. So I’m going to stick with that, that we think we can hold about half of what came down in the fourth quarter. But again, what we’re focused on from here is how do we sustaining our deposit growth trajectory and then putting on loans that have plus 300 more — or more spread between them, and that can drive net interest income kind of regardless of what the Fed does.

Casey Haire: Okay. Great. And just kind of tying this all together. You guys talked about the 9.80% number this year, you got there. The Street had you at 10.75% for ’23. Do you feel like — I can input all the components and work it through? But I’m just wondering, do you feel like that 10.75% is doable with this guide?

Ken Vecchione: So Casey, what I’d say is our PPNR guide is between 11% and 15%. And from there, you have to take a viewpoint on what you think is going to happen in the economy in terms of determining the provision. So the provision will naturally grow because of balance sheet growth. We’re not seeing any cracks in asset quality. We — it looks pretty good. But listening to a number of the talking heads, many people think towards the back half of 2023, we’ll see some weakening in asset quality. Again, we haven’t seen any of that, so you’re going to need to make your own assumptions regarding charge-offs on top of provisioning. But the PPNR guide is between 11% and 15% for next year.

Casey Haire: Understood. And last one for me, just the loan deposit growth, is that average or period end?

Dale Gibbons: So we talked about kind of both of those numbers. But from here, I expect this to recover about half of the DDA decline in the fourth quarter by period end.

Casey Haire: Okay. Thank you.

Operator: The next question comes from the line of Brad Milsaps with Piper Sandler. Please proceed.

Brad Milsaps: Good afternoon. Thanks for taking my questions. I appreciate all the color around guidance. Maybe — I wanted to maybe delve into credit a little bit more. Dale, you gave a lot of color, but just kind of curious with everything that’s going on, all the uncertainty. Just can you talk a little bit more about what were the drivers of the $3 million provision this quarter? I understand that a lot of movement within the risk-weighted assets, you didn’t have a lot of loan growth, but it would just seem that most outlooks have worsened in the $3 million provision. Might seem a little light, maybe relative to the environment. But just wanted to get some more color there, particularly maybe as it relates to 2023?

Ken Vecchione: Well, let’s start with — if you work backwards from the $3 million and add on to that the sale of the corporate finance applications, which we sold, plus the fact that this is a quarter where we didn’t grow and we took down our EFR balances, when you kind of reverse engineer it, we would have been closer to what we’ve posted in previous quarters. So the $3 million really represents net of those actions. Dale, you want to talk about the CECL stuff?