Western Alliance Bancorporation — Q2 2012 Form 10-Q
Business context and period: The company is a bank holding company operating Bank of Nevada, Western Alliance Bank and Torrey Pines Bank, with additional equipment-finance and investment-advisory businesses. This unaudited report covers the quarter and six months ended June 30, 2012; comparisons are with 2011 unless otherwise noted. Financial statement amounts below are in millions of dollars unless stated otherwise.
Financial performance and condition
- Profit: Q2 net income was $14.0 million, versus $6.2 million; net income available to common shareholders was $12.6 million versus $3.7 million. Diluted EPS was $0.15 versus $0.05. For the six months, net income was $25.3 million versus $11.4 million, and diluted EPS was $0.27 versus $0.08.
- Interest income and margin: Q2 net interest income rose 11.8% to $70.8 million; net interest margin increased to 4.46% from 4.34%. For six months, net interest income rose 13.3% to $140.9 million and margin was 4.49% versus 4.34%. Lower deposit funding costs supported the improvement.
- Credit costs and operating expenses: Q2 provision for credit losses increased to $13.3 million from $11.9 million; six-month provision increased to $26.4 million from $21.9 million. Q2 noninterest expense declined to $45.4 million from $51.0 million, largely because of lower foreclosed-asset valuation and disposition losses; six-month expense declined to $92.3 million from $99.2 million. Salary and benefit expense increased in both periods.
- Noninterest income: Q2 declined to $7.4 million from $9.6 million, mainly reflecting lower securities-sale gains and lower bank-owned life insurance income. Six-month noninterest income was $13.3 million versus $16.4 million. No securities impairment charge was recorded in 2012; $0.2 million was recorded in 2011.
- Loans, deposits and assets: At June 30, total assets were $7.16 billion, up from $6.84 billion at year-end 2011. Gross loans were $5.16 billion, up $384.8 million from year-end; management reported $239 million of net loan growth in Q2. Deposits were $6.00 billion, up $342.9 million from year-end. Noninterest-bearing demand deposits rose $283.9 million. Commercial real estate-related loans were about 60% of total loans.
- Asset quality: Nonaccrual loans were $104.3 million, up from $90.4 million at year-end; nonaccrual loans were 2.02% of gross loans. Total nonperforming assets were $297.1 million versus $294.6 million. Impaired loans increased to $225.4 million from $209.5 million. Annualized net charge-offs to average loans improved to 1.11% from 1.26% in Q2 2011. The allowance was $97.5 million, or 1.89% of gross loans, versus 2.07% at year-end.
- Cash flow and liquidity: For the first six months, operating cash flow was $83.7 million; investing activities used $313.4 million, principally reflecting net loan growth; financing activities provided $253.6 million, including $342.9 million of deposit growth. Cash and cash equivalents ended at $178.9 million. Management reported $712.9 million of liquid assets and considered liquidity adequate for expected cash needs over the next 90–120 days. Available borrowing capacity was approximately $992.5 million at the FHLB and $730.1 million at the FRB.
- Debt and capital: June 30 liabilities totaled $6.49 billion and stockholders’ equity was $672.1 million. Short-term funding included $230 million of FHLB advances and $86.9 million of customer repurchase agreements; the company also had $75 million principal amount of 10% senior notes due 2015. The company reported capital ratios of 12.3% total risk-based, 11.0% Tier 1 risk-based and 9.7% leverage, meeting well-capitalized thresholds. No common dividends were declared.
Material changes and management commentary
- Earnings improved substantially year over year, driven mainly by higher net interest income, reduced funding costs and lower foreclosed-asset losses. Lower securities-sale gains and higher credit-loss provisions partly offset these gains.
- Management attributed provision growth primarily to portfolio expansion, partly offset by improved asset quality. The allowance methodology was modified in Q1 2012; the company estimated the changes reduced provision and allowance by about $2.6 million versus the prior method.
- Foreclosed assets declined to $77.0 million from $89.1 million at year-end. Separately, nonaccrual and impaired loan balances increased, making credit trends mixed.
- The net deferred tax asset was $48.2 million. Despite a three-year cumulative pretax loss position, management concluded realization was more likely than not and forecast use of net operating losses by the end of 2013, based on current projections. Management cautioned that weaker-than-forecast taxable income could reduce the amount considered realizable.
- The filing provides no general earnings or operating guidance. The NOL utilization expectation is a tax-related forecast, not full-year earnings guidance.
Risks, contingencies and unusual items
- Credit and collateral risks remain material given the concentration in commercial real estate and lending in Nevada, Arizona and California; management noted that collateral values depend on regional real estate conditions. The filing also identifies risks from interest rates, funding costs, deposit withdrawals, regulation, competition, cyber security and cost control.
- Bank of Nevada remained under a regulatory memorandum of understanding requiring enhanced oversight, higher Tier 1 capital and prior regulatory approval for dividends to the parent. The company stated the bank was in compliance.
- An IRS review of a 2008 tax deduction involving CDOs related to an approximately $40 million tax refund claim was not yet closed. The appeals conferee had conceded the deduction and proposed no further adjustment, but Joint Committee on Taxation approval remained outstanding; no reserve was accrued.
- Unfunded lending commitments and letters of credit totaled $1.31 billion; these contractual amounts do not necessarily represent future cash requirements. The related loss contingency liability was $1.2 million. Management said routine litigation was not expected to materially affect results.
- Market-risk models showed projected net interest income declines of about 2.0% under +100 and +200 basis-point shocks. Management reported exposures within board-approved limits and cautioned that model assumptions may differ from actual outcomes.
Most important facts for investors to verify
- Whether rising nonaccrual and impaired loans lead to further charge-offs, provisions or collateral write-downs, particularly in commercial real estate.
- Whether the $48.2 million deferred tax asset remains supportable and whether the projected NOL utilization by the end of 2013 is achieved.
- Whether Bank of Nevada satisfies its regulatory memorandum requirements and any effect on subsidiary dividends or capital flexibility.
- Whether deposit growth and available secured borrowing capacity remain sufficient to fund loan growth and potential withdrawals.
- Resolution of the IRS review and approval process for the CDO-related tax refund claim.