Western Alliance Bancorporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless noted. Western Alliance is a Phoenix-based bank holding company serving customers through regional banking divisions and specialized national business lines.
Financial results and condition
| Metric | Q3 2018 | Q3 2017 | Change |
|---|---|---|---|
| Net interest income | $234.0 million | $201.6 million | +16.1% |
| Net interest margin, taxable-equivalent basis | 4.72% | 4.65% | +7 basis points |
| Provision for credit losses | $6.0 million | $5.0 million | +$1.0 million |
| Non-interest income | $4.4 million | $10.5 million | -$6.0 million |
| Non-interest expense | $113.8 million | $89.3 million | +27.5% |
| Income before taxes | $118.6 million | $117.7 million | +$0.9 million |
| Net income | $111.1 million | $82.8 million | +34.1% |
| Diluted EPS | $1.05 | $0.79 | +$0.26 |
For the first nine months, net income was $316.7 million, up 34.1%; diluted EPS was $3.00 versus $2.25. Net interest income rose 17.2% to $672.4 million, while reported non-interest income declined 6.8% to $29.5 million and non-interest expense rose 18.5% to $314.5 million.
- Margins and operating performance: Q3 operating net revenue, a company-defined non-GAAP measure, increased 16.6% to $246.9 million. Operating pre-provision net revenue rose 15.6% to $141.9 million. The reported efficiency ratio increased to 46.6% from 40.1%; the operating efficiency ratio was 41.5% versus 40.0%.
- Balance sheet at September 30: Assets were $22.18 billion, loans $16.73 billion, deposits $18.91 billion, and stockholders’ equity $2.49 billion. Since year-end 2017, assets increased 9.1%, loans 10.9%, and deposits 11.4%. Loan growth included C&I, construction and land development, and residential real estate.
- Credit quality: Nonperforming assets were $99.5 million, down from $114.9 million at year-end; they equaled 0.26% of assets. Non-accrual loans were $36.9 million, or 0.22% of gross loans, versus $43.9 million and 0.29% at year-end. Q3 annualized net charge-offs were 0.08% of average loans, up from 0.01% a year earlier. The allowance was $150.0 million, or 0.90% of gross loans.
- Cash flow and liquidity: For the nine months, operating cash flow was $396.3 million, investing cash outflow $1.64 billion, and financing cash inflow $1.53 billion. Cash, cash equivalents, and restricted cash ended at $700.6 million. Management reported $3.10 billion of liquid assets, including $2.40 billion of unpledged marketable securities, and approximately $4.24 billion of available FHLB and FRB credit. It considered liquidity adequate for expected near-term needs.
- Debt and capital: No FHLB advances were outstanding at quarter-end; customer repurchase agreements were $21.0 million. Qualifying debt was $359.1 million. The company’s total capital ratio was 13.5%, CET1 ratio 10.9%, and Tier 1 leverage ratio 11.0%; the bank and holding company exceeded the stated well-capitalized thresholds.
Material changes and unusual items
- Higher loan balances and rising asset yields drove interest income growth, while higher deposit costs partially offset the benefit. Q3 interest expense nearly doubled year over year; the average cost of interest-bearing deposits rose to 0.97% from 0.49%.
- Reported Q3 non-interest income included a $7.2 million loss from selling lower-yielding securities for reinvestment in higher-yield, shorter-duration securities, and a $1.2 million fair-value loss on equity investments. The company said it did not consider its remaining securities in unrealized-loss positions other-than-temporarily impaired.
- Q3 non-interest expense included a $7.6 million charitable foundation contribution, largely a non-cash donation of foreclosed property. Salaries and benefits also rose with growth in staffing.
- The effective tax rate fell to 6.32% for Q3 and 14.48% for the nine months, versus 29.64% and 27.89%. Management attributed the decrease to the lower federal statutory rate and its decision to carry back 2017 federal net operating losses. This materially boosted reported net income relative to pre-tax income growth.
- Accumulated other comprehensive loss widened to $70.4 million from $3.1 million at year-end, primarily reflecting unrealized losses on available-for-sale securities amid higher market interest rates.
Outlook, risks, and contingencies
The filing provides no specific earnings, loan-growth, or margin guidance. Management described liquidity as adequate and reported that modeled net interest income exposure was within limits for rising-rate scenarios. The modeled decline under a 100-basis-point rate decrease was 6.1%, outside the company’s 5.0% downside guideline; the Board and ALCO accepted the breach. Management cautioned that simulation results depend on assumptions and may differ from actual outcomes.
- Key disclosed risks include concentration in commercial real estate and C&I lending, geographic exposure to Arizona, Nevada, and California, potential credit losses, real-estate market weakness, deposit competition and withdrawals, and sensitivity to interest rates.
- CRE-related loans were approximately 50% of total loans at quarter-end. The company also flagged risks involving cybersecurity, third-party providers, regulatory compliance, execution of growth strategies, and implementation of new credit-loss accounting requirements.
- Unfunded commitments and letters of credit totaled $7.23 billion; the related loss contingency was $7.6 million. Management said routine litigation was not expected to have a material impact and reported no material pending legal proceedings.
- The company was implementing the expected-credit-loss standard (CECL), with parallel testing of certain models expected to begin in early 2019. The filing notes that regulatory implementation of the 2018 EGRRCPA relieved the company and bank from annual company-run stress testing.
Important facts for investors to verify
- Whether loan growth and yields continue to outpace increases in deposit costs, and how that affects net interest margin.
- Whether the rise in quarterly charge-offs and impaired C&I loans signals a sustained deterioration in credit quality; review loan concentrations and allowance assumptions.
- How much of the unusually low 2018 effective tax rate is repeatable after the NOL carryback benefit and tax-law changes.
- Whether securities portfolio unrealized losses or future sales create further earnings or capital pressure as rates change.
- How the $7.23 billion of off-balance-sheet commitments, brokered deposits, and the accepted down-rate sensitivity breach affect funding and risk.
- Reconcile company-defined operating measures with GAAP results and review the full filing’s segment disclosures, capital requirements, and CECL implementation updates.