WESTERN ALLIANCE BANCORPORATION annual report, FY2017

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Western Alliance Bancorporation — 2017 Form 10-K

Reporting period: Fiscal year ended December 31, 2017. Western Alliance is a Phoenix-based bank holding company operating Western Alliance Bank, regional banking divisions, and specialized national business lines. Unless otherwise noted, amounts are U.S. dollars.

Financial performance and condition

  • Earnings: Net income was $325.5 million, up $65.7 million (25.3%) from 2016. Diluted EPS increased to $3.10 from $2.50. Return on average assets was 1.72%, versus 1.61%.
  • Revenue and margins: Net interest income rose 19.4% to $784.7 million; net interest margin increased 7 basis points to 4.65%. Non-interest income was $45.3 million, up 5.7%. Operating pre-provision net revenue, a non-GAAP measure, increased to $466.6 million from $380.4 million. The operating efficiency ratio improved to 41.5% from 43.4%.
  • Expenses and taxes: Non-interest expense increased 9.1% to $360.9 million, including higher compensation, professional fees, and deposit costs; 2016 included $12.4 million of acquisition/restructuring expense, compared with none in 2017. Income tax expense was $126.3 million and the effective tax rate was 27.96%. The new tax law reduced the federal corporate rate and contributed to a substantial deferred-tax remeasurement; the company reported $88.5 million of deferred tax expense in 2017.
  • Loans and credit: Loans, net of deferred fees and costs, grew 14.3% to $15.09 billion. Commercial and industrial loans were 45.3% of the portfolio; commercial real estate and construction/land development together represented approximately 52%. The allowance for credit losses was $140.1 million, or 0.93% of gross loans. Provision expense rose to $17.3 million from $8.0 million, primarily reflecting loan growth. Net charge-offs were $1.9 million (0.01% of average loans), versus $2.4 million (0.02%) in 2016.
  • Asset quality: Non-accrual loans were $43.9 million, or 0.29% of gross organic loans. Non-accrual loans plus repossessed assets were $72.5 million, or 0.36% of assets, down from 0.51%. Total nonperforming loans, including accruing troubled debt restructurings, were $86.4 million; total nonperforming assets including repossessed assets were $114.9 million. These measures use different definitions.
  • Balance sheet and liquidity: Total assets increased 18.2% to $20.33 billion; deposits rose 16.7% to $16.97 billion, with non-interest-bearing deposits representing 43.9%. The loan-to-deposit ratio was 88.93%. Cash and cash equivalents were $416.8 million; management reported $2.89 billion in liquid assets, including unpledged marketable securities, and considered liquidity adequate for near-term needs. Operating cash flow was $383.8 million; investing activities used $2.96 billion and financing activities provided $2.70 billion. Cash increased $132.3 million.
  • Capital and debt: Stockholders’ equity was $2.23 billion and tangible common equity ratio was 9.6%. Western Alliance Bancorporation reported a 10.4% CET1 ratio, 10.8% Tier 1 capital ratio, 13.3% total capital ratio, and 10.3% Tier 1 leverage ratio; Western Alliance Bank’s total capital ratio was 12.3%. Both were above reported well-capitalized thresholds. Year-end FHLB advances were $390 million, up from $80 million; qualifying debt was $376.9 million. Debt included $175 million of parent subordinated debentures at 6.25% due 2056 and $150 million of bank subordinated notes at 5.00% fixed through June 2020, then floating, due 2025.

Fourth-quarter and prior-period comparison

Fourth-quarter 2017 net income available to common stockholders was $89.3 million and diluted EPS was $0.85, compared with $69.8 million and $0.67 in fourth-quarter 2016. Fourth-quarter 2017 net interest income was $211.0 million and provision for credit losses was $5.0 million. For the full year, growth reflected higher average loan balances, rising rates, and a full year of Hotel Franchise Finance results. Interest expense also rose as deposit costs and qualifying-debt expense increased. Deposits grew faster than loans, and nonperforming assets as a share of total assets declined.

Outlook, risks, and unusual items

  • The filing provides no numerical earnings, loan-growth, or deposit-growth guidance. Management described continued emphasis on business deposits, loan growth, and maintaining a low cost of funds.
  • Interest-rate modeling showed estimated 12-month net interest income up 6.5% under an immediate 100-basis-point increase and down 6.9% under a 100-basis-point decline. The downside scenario exceeded the company’s stated negative 5% guideline; the board and management accepted the breach. These are model scenarios, not forecasts.
  • Credit and concentration risks include substantial real-estate exposure, approximately 52% of loans in CRE-related categories, and geographic concentration in Arizona, California, and Nevada. Other stated risks include deposit competition and funding costs, interest-rate changes, cyber/fraud and third-party disruption, regulation, and economic or property-market deterioration.
  • The company expects CECL to require a one-time cumulative allowance adjustment when implemented, but said it could not yet estimate the impact. The standard was scheduled to apply beginning January 1, 2020.
  • The 2017 Tax Cuts and Jobs Act required estimates and remeasurement of deferred taxes; management noted that final effects could change with further interpretation or guidance. Management reported no material pending litigation and no securities impairment charges in 2017.
  • Management disclosed a planned leadership transition: Kenneth Vecchione was to become CEO on April 1, 2018, with Robert Sarver transitioning to Executive Chairman; James Haught was also scheduled to become company president that date.
  • The company had never paid a common cash dividend and said it had no current plans to do so. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.

Most important facts for investors to verify

  1. Whether loan and deposit growth can continue without materially increasing funding costs, credit provisions, or concentration risk.
  2. Credit quality trends behind the rise in non-accrual balances and provision expense, including criticized loans, TDRs, and CRE exposures by market and property type.
  3. The eventual CECL transition impact and any further tax-law adjustments, including changes to the reported deferred-tax position.
  4. Deposit retention, liquidity access, and the effect of the $390 million FHLB borrowing balance and higher rates on net interest margin.
  5. Execution of the announced executive succession and the effect of the disclosed downside interest-rate sensitivity breach.