Western Alliance Bancorporation — Q2 2019 Form 10-Q
Business and period. Western Alliance Bancorporation is a Phoenix-based bank holding company operating through Western Alliance Bank and regional banking divisions and specialized national business lines. This unaudited report covers the quarter and six months ended June 30, 2019; income comparisons are against 2018, and balance-sheet comparisons are against December 31, 2018. Dollar amounts below are in U.S. dollars.
Financial performance and condition
- Q2 earnings: Net interest income was $254.7 million, up 13.6% year over year; net income was $122.9 million, up 17.4%. Diluted EPS was $1.19 versus $0.99.
- First-half earnings: Net interest income was $502.0 million, up 14.5%; net income was $243.7 million, up 18.6%. Diluted EPS was $2.34 versus $1.95.
- Margins and costs: Q2 net interest margin was 4.59%, down 12 basis points from Q2 2018; first-half margin was 4.65%, down 4 basis points. Q2 interest expense rose 75.2% year over year, driven mainly by higher deposit balances and rates. The Q2 efficiency ratio was 41.5%; the company’s non-GAAP operating efficiency ratio was 42.0% versus 42.1%.
- Other income and expenses: Q2 non-interest income was $14.2 million, up 5.8%; non-interest expense was $114.2 million, up 11.4%. Higher salaries, deposit costs, and legal and professional fees contributed to expense growth. First-half non-interest income was $29.6 million, up 18.1%, while expense was $227.1 million, up 13.2%.
- Loans and deposits: Total assets were $25.31 billion, up 9.5% from year-end. Loans were $19.25 billion, up 8.7%; deposits were $21.44 billion, up 11.8%. Commercial and industrial, non-owner-occupied commercial real estate, and residential real estate were major contributors to loan growth.
- Credit quality: The allowance for credit losses was $160.4 million, or 0.83% of gross loans, compared with $152.7 million, or 0.91%, at year-end. Q2 net charge-offs were 0.03% of average loans on an annualized basis, versus 0.07% in Q2 2018. Nonperforming loans increased to $104.0 million from $64.8 million at year-end; nonaccrual loans rose to $51.8 million from $27.7 million.
- Liquidity and funding: Cash, cash equivalents, and federal funds sold totaled $1.07 billion. Management reported $3.46 billion of liquid assets, including $2.39 billion of unpledged marketable securities, and said liquidity was adequate for forecast needs. Available credit included $3.03 billion from the FHLB, $1.33 billion from the Federal Reserve, and $1.01 billion of correspondent-bank federal funds lines; none of those lines was drawn at quarter-end.
- Debt and capital: There were no short-term borrowings at June 30, versus $491.0 million at year-end; customer repurchase agreements were $13.9 million. Qualifying debt was $387.2 million. The company reported a 10.6% Common Equity Tier 1 ratio and 12.9% total capital ratio; the bank’s corresponding ratios were 10.4% and 11.8%. Both exceeded stated well-capitalized thresholds. Tangible common equity ratio was 10.2%.
- Cash flow, six months: Operating activities provided $330.3 million; investing activities used $1.44 billion, mainly reflecting net loan funding; financing activities provided $1.68 billion, principally from $2.26 billion of deposit growth. The company repurchased $71.9 million of common stock.
Material changes and notable items
- Loan growth and higher asset yields increased interest income, but faster growth in deposit and funding costs compressed the Q2 net interest margin.
- Nonperforming loans and total nonperforming loans increased from year-end, while reported annualized net charge-offs remained low. Commercial real estate-related loans represented approximately 48% of total loans; lending is concentrated in Arizona, Nevada, and California.
- Unrealized gains on available-for-sale securities lifted first-half other comprehensive income by $67.3 million, contributing to the increase in stockholders’ equity. Management reported no securities impairment charges for the period.
- The effective tax rate declined to 16.76% for Q2 and 17.10% for the first half, primarily due to solar tax credits and lower state tax accruals.
- The company adopted lease accounting on January 1, 2019, recording an operating lease right-of-use asset of $71.1 million and lease liability of $76.2 million at quarter-end. Management said the new standard did not materially affect earnings or cash flows.
- The company sold one $10.0 million par-value held-to-maturity security following a significant change in the issuer’s creditworthiness; no gain or loss was recorded. It reported no other-than-temporary impairment in its securities portfolio.
Outlook, risks, and contingencies
The filing provides no specific earnings or balance-sheet guidance. Management described continued loan and deposit growth and stated that liquidity was adequate. Interest-rate sensitivity modeling showed projected net interest income down 6.6% in an immediate 100-basis-point rate decline, outside the company’s stated negative 5.0% guideline; the Board and ALCO accepted the modeled breach, citing assumptions about deposit-rate sensitivity and repricing lags. Modeled net interest income increased in rate-up scenarios, but management cautioned that actual results may differ from model assumptions.
Key risks include credit losses exceeding estimates; exposure to commercial real estate and regional economic conditions; deposit pricing and retention; interest-rate and LIBOR transition risks; and operational, technology, cybersecurity, regulatory, and execution risks. The company had $9.08 billion of unfunded commitments and letters of credit, which are not equivalent to expected cash outflows. Management said routine lawsuits were not expected to have a material effect; no material legal proceedings or material changes to previously disclosed risk factors were reported. The company was preparing for CECL adoption on January 1, 2020, with model validation and implementation work ongoing.
Investor verification points
- Track the rise in nonaccrual and nonperforming loans, impaired loans, and TDR balances, particularly within commercial real estate, and assess allowance adequacy as CECL adoption approaches.
- Assess whether deposit costs continue to rise faster than loan yields and whether margin pressure persists.
- Review geographic and commercial real estate concentration, collateral values, and the quality and pace of loan growth.
- Check the assumptions behind the down-rate net interest income sensitivity breach and the effect of changing deposit betas and repricing lags.
- Separate recurring earnings from fair-value gains, tax-credit benefits, and other items; also monitor operating expense growth and share repurchases.
- Confirm capital and liquidity remain adequate as lending commitments are funded, deposits fluctuate, and the company implements CECL.