Western Alliance Bancorporation — Q2 2018 Form 10-Q
Business context and period. Western Alliance Bancorporation is a Phoenix-based bank holding company operating Western Alliance Bank and specialized banking businesses. This filing covers the quarter and six months ended June 30, 2018; income and cash-flow comparisons are to the corresponding 2017 periods, while balance-sheet comparisons are generally to December 31, 2017. Amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $224.1 million | $192.7 million | $438.3 million | $372.1 million |
| Provision for credit losses | $5.0 million | $3.0 million | $11.0 million | $7.3 million |
| Non-interest income | $13.4 million | $10.6 million | $25.1 million | $21.2 million |
| Non-interest expense | $102.5 million | $88.4 million | $200.7 million | $176.2 million |
| Net income | $104.7 million | $80.0 million | $205.6 million | $153.3 million |
| Diluted EPS | $0.99 | $0.76 | $1.95 | $1.46 |
- Margins and operating measures: Net interest margin was 4.70% in Q2, versus 4.61% a year earlier, and 4.65% for the first half, versus 4.62%. Management-reported operating PPNR was $135.5 million in Q2, up 17.6%; the operating efficiency ratio was 42.1%, compared with 41.2% a year earlier.
- Growth and balance sheet: At June 30, total assets were $21.37 billion, net loans $15.99 billion, deposits $18.09 billion, and stockholders’ equity $2.39 billion. Gross loans grew 6.9% and deposits 6.6% from year-end 2017. Loan growth was led by commercial and industrial and construction and land development lending.
- Credit quality: Nonperforming loans were $76.4 million, down from $86.4 million at year-end; nonperforming assets were $104.0 million, or 0.29% of assets. Non-accrual loans were $34.0 million, or 0.21% of gross loans. Q2 annualized net charge-offs were 0.07% of average loans, versus net recoveries of 0.03% a year earlier. The allowance for credit losses was $147.1 million, 0.91% of gross loans.
- Cash flow and liquidity: For the first half, operating activities provided $247.4 million; investing activities used $939.0 million, primarily reflecting net loan funding; financing activities provided $781.7 million, including a $1.11 billion net increase in deposits. Cash, cash equivalents, and restricted cash ended at $506.8 million. Management reported $2.98 billion of liquid assets and stated liquidity was adequate for expected cash needs over the next 90–120 days. Available credit included $2.66 billion from the FHLB, $1.28 billion from the FRB, and $180 million in correspondent-bank lines; these facilities were largely undrawn.
- Debt and capital: Short-term FHLB advances were $75.0 million, customer repurchase agreements $18.0 million, and qualifying debt $361.1 million. The company reported a 10.7% Common Equity Tier 1 ratio, 13.4% total capital ratio, and 10.8% Tier 1 leverage ratio; both the company and bank exceeded regulatory well-capitalized thresholds.
Material changes versus comparable periods
- Q2 net income increased 30.9% year over year, while net interest income rose 16.3%. Management attributed interest-income growth mainly to larger average loan balances and higher rates.
- Funding costs rose: Q2 interest expense increased 93.5%, including higher deposit costs and use of FHLB overnight advances. Average cost of interest-bearing deposits rose to 0.82% from 0.42%.
- Q2 non-interest expense increased 16.0%, primarily from salaries and benefits, deposit costs, data processing, and other expense. Staffing increased 8.9% year over year to 1,773 full-time equivalent employees.
- The effective tax rate fell to 19.48% in Q2 from 28.56%, primarily reflecting the lower federal statutory tax rate effective in 2018.
- Unrealized AFS securities losses reduced first-half other comprehensive income by $49.3 million, contributing to accumulated other comprehensive loss of $51.3 million at June 30. Management attributed securities’ unrealized losses primarily to market interest-rate increases and reported no other-than-temporary impairment.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific earnings, loan-growth, or margin guidance. Management notes that interim results are not necessarily indicative of full-year results.
- Interest-rate sensitivity modeling showed a 7.0% decline in projected 12-month net interest income under an immediate 100-basis-point rate decrease, outside the company’s stated negative 5.0% guideline. The board and ALCO accepted the breach; management expects deposit costs to become more sensitive to falling rates over time. The filing cautions that model results depend on assumptions and may differ from actual outcomes.
- Credit risk remains concentrated in real estate and commercial and industrial lending, with CRE-related loans about 51% of total loans. The company identifies exposure to local economic and real estate conditions in Arizona, Nevada, and California as key risks.
- Off-balance-sheet commitments to extend credit, credit-card commitments and guarantees, and standby letters of credit totaled $6.93 billion. The related loss contingency was $7.6 million. Management said many commitments may expire undrawn.
- The company reported $439.2 million of wholesale brokered deposits, which it identifies as a potential liquidity risk because such funds may be more rate-sensitive. It also reported $355.9 million of CDARS deposits and $615.0 million of ICS deposits.
- Management said routine litigation is not expected to have a material effect; the filing reports no material pending legal proceedings and no material changes to previously disclosed risk factors.
- Adoption of new equity-security accounting resulted in $1.8 million of first-half unrealized losses recognized in earnings. The company is implementing the expected-credit-loss standard (CECL), effective for it in 2020, and was developing models, data, policies, and controls.
Most important facts for investors to verify
- Whether loan and deposit growth can continue while deposit and borrowing costs rise, and whether net interest margin holds up.
- Credit trends in CRE, C&I, and construction lending, including charge-offs, criticized loans, impaired loans, and reserve adequacy.
- Liquidity and deposit mix, especially the growth and renewal behavior of brokered and other rate-sensitive deposits.
- The implications of the modeled down-rate sensitivity breach and the assumptions underlying interest-rate and securities valuations.
- Whether expense growth, CECL implementation, and the tax benefits reflected in current results affect future earnings comparability.