Western Alliance Bancorporation
Q3 2013 Earnings Call Transcript

Published: 18 Oct 2013

[Operator:]

Good day, everyone. Welcome to the earnings call for Western Alliance Bancorporation for the third quarter 2013. Our speakers today are Robert Sarver, Chairman and Chief Executive Officer; and Dale Gibbons, Chief Financial Officer. You may also view the presentation today via webcast through the company's website at www.westernalliancebancorp.com. The call will be recorded and made available for replay after 2

[Robert Gary Sarver:]

Thank you. Welcome to the Western Alliance Third Quarter 2013 Earnings Call. First, I'd like to spend a few minutes reviewing our performance highlights. Then I'll turn the time over to Dale for a more detailed report. We'll open it up for some questions. This was certainly another strong quarter for Western Alliance, as a number of core elements of our strong financial performance have come together. We had strong growth and improved margin in operating efficiency and swung to a net loan recovery position. Together, this has driven record top line revenue and net income. Net income was $28.2 million, up 80% from the $15.5 million we earned in the third quarter of last year. Reported EPS was $0.32, and although we had a few offsetting items, we believe this is indicative of our operating performance as well. That compared to the $0.30 operating EPS we had last quarter and $0.18 from the same quarter last year. Our net interest margin was up $0.05 from last quarter to 4.41%. We had an ROA of 1.3% and a 17% return on equity. For the quarter, loan growth was $104 million, and deposits were up $274 million. Each were up over $1 billion year-over-year. Asset quality continued to improve with our first net loan recovery quarter since 2006. Despite over $300 million in asset growth during the quarter, our strong capital ratios increased and pushed our tangible book value per share to $7.57. Dale?

[Dale M. Gibbons:]

Thanks, Robert. Loan growth for the quarter was $104 million. It's seasonally the slowest quarter of the year for us. And by category, C&I municipal loans had the largest growth with a notable increase in demand for construction. Residential is the only category which declined as we no longer offer this product. Deposit growth was $274 million during the quarter with increases in all categories, driven by growth in Arizona and in California. Deposits from the Centennial acquisition, which closed in April, fell $5 million during the quarter as our retention of these accounts continues to be higher than originally expected. Looking at our adversely graded loans on the graph on the left, nonperforming assets from our own originations improved to $324 million in the third quarter from $337 million at June 30 and are down 22% from 1 year ago at $417 million. Less than half of our $77 million in nonaccrual loans remain current with regard to contractual principal and interest payments. For the acquired adversely graded assets on the right, at September 30 the book balance was $111 million. However, we continue to believe there is minimal risk of loss of these loans as they are already net of $56 million in credit and rate marks from the purchase accounting entries. Our continued strong loan and deposit growth resulted in a 20% increase in total assets during the past year to $8.9 billion. This growth was matched by our increase in equity from strong internal capital generation with a tangible common equity ratio of 7.4% to September 30. And as Robert mentioned, the tangible book value has risen at almost the same rate and now stands at $7.57. For the third quarter, net interest income was up $2.4 million over the second quarter to $82.2 million. Noninterest income included $800,000 in nonrecurring gain from life insurance policies, bringing total revenue to $90.4 million, which is up 17% from the year ago quarter and our fourth consecutive year of double-digit top line revenue growth. Meanwhile, operating expenses, up 10% to $48.3 million during the same period as we continue to improve our operating leverage, resulting in pretax, pre-provision income of $42 million, which was up 26% from last year. We had no credit loss provision for the quarter as we have net loan recoveries of $1.5 million. A year ago, the provision was $8.9 million compared to net losses of $9 million. There was a modest loss on dispositions of other real estate, and we took a $1.7 million securities loss as we swapped lower-yielding Penny and Freddie paper for other higher-yielding GSE obligations. Merger and restructure expense included residual costs from the Centennial Bank conversion as well as IT consolidation expenses. Pretax income was $37 million. Tax liability was about 25% of pre-income, resulting in net income of $28 million and EPS of $0.32. As Robert mentioned, we view our operating EPS as $0.32, as well as we have a few offsetting items. To normalize our numbers, I took the $800,000 taxes and BOLI gain as essentially canceling the $1 million restructuring charge. The securities loss we took offset a normalized provision of $1.3 million based upon the $104 million of loan growth that we had. Finally, the $400,000 OREO loss offset a debt valuation gain of approximately the same amount. On a consolidated basis, our margin ticked up to 4.41% as NIM pressure stabilized in all of our affiliates and we benefited from a full quarter of Centennial Bank acquisition. Bank of Nevada's margin expanded as it was the recipient of inter-affiliate loan sales we mentioned last quarter as well as having an improved asset mix. Deposit growth in excess of loan growth this quarter pushed our cash position up, giving us an opportunity to increase net interest income as we deploy the $381 million. Investment yield improved as amortization of premiums declined, as well as MBS prepayments slowed as rates rose. Loan yields rose, benefiting from a full quarter of the acquired Centennial loans, which offset what would have been a modest contraction as the rate for new originations held at about 40 basis points lower than the average yield on the portfolio. Funding costs held steady as we expect our deposit rates are at the bottom. With revenue growth continuing to outpace expense growth, our operating efficiency ratio again improved to 51.6%. Compensation expense rose as FTE increased by 8 and we opened another office in Scottsdale. As asset quality continues to improve, we expect related legal, appraisal and loan collection costs to continue to decline over time. Our pretax, pre-provision ROA was 1.94% for the third quarter, as pre-pre income rose to $42 million, which is up 5% on a linked-quarter basis. We still expect to achieve our interim goal of 2% of pre-pre ROA as revenue growth continues to exceed that of expense. Return on assets climbed to 1.3% for the quarter on a consolidated basis, in part benefiting from no loan loss provision. Among the subsidiaries, however, Western Alliance Bank and Torrey Pines Bank incurred provision expense to support their loan growth, while Bank of Nevada booked a negative provision in recognition of their improved asset quality. Both Bank of Nevada and Torrey Pines Bank had net loan recoveries during the quarter. This page tracks the improvement in our asset quality while we were also generating strong loan growth. At September 30, 2012, high pass loans were $1.4 billion, or 25% of our portfolio, while other pass loans were another $3.6 billion or 68%. During the past year, 42% of the portfolio, or $329 million of the $781 million in organic loan growth, was high pass, and the rest was pass. Although the acquired loans were of lower quality than our existing book, we believe the potential loss in these credits is covered by the purchase discounts we obtained on these loans. In an aggregate, this has resulted in a better average loan grade on the portfolio than 1 year ago. Gross loan charge-offs fell by half during the quarter, from $5.8 million to $2.6 million, and are down 75% from the $10.9 million incurred in the third quarter of 2012. On the other hand, gross loan recoveries have doubled from $1.9 million 1 year ago to $4.1 million in the third quarter of 2013, resulting in net recoveries of $1.5 million or 10 basis points of average loans annualized. Looking at the lower graph, using our loan loss reserve allocation methodology on the $104 million of net loan growth we had during the quarter would have resulted in a provision of $1.3 million or 1.3% of new loans originated. However, this was offset by loan recoveries, and, consequently, no credit loss provision was recognized. These 2 tables show how our allowance is different as a result of the acquisitions we've conducted. At September 30, 2013, we report a loan loss reserve of $98 million, total loans of $6.5 billion and a ratio of the reserve to loss of 1.5%. However, included in the total number is $402 million of acquired loans. No reserve was provided for these loans as they've already been written down to fair value. So in the column titled, Less

[Robert Gary Sarver:]

Thanks, Dale. At September 30, 2013, our regulatory capital ratios essentially rebounded from the dip during the second quarter that occurred when we closed the Centennial Bank acquisition for cash as our strong internal capital generation fully supports our robust balance sheet growth. The table on the right walks through our Basel III capital ratios, starting with tangible common equity, as shown on Page 16 of our earnings release. Disallowed trust preferred and deferred taxes haircuts our Tier 1 common capital to $645 million, while risk-weighted assets increase due to higher weightings for nonperforming assets and unfunded commitments. In total, each of our capital ratios under this new paradigm falls between 0.3% and 0.5% relative to the current standard, which, coincidentally, is about the same capital recovery we had during the third quarter. These new capital ratios are significantly above the new required levels even after full phasing in 2019. Largely from our strong earnings performance, our tangible book value per share is up $1.22 during the past year to $7.57, while our return on tangible common equity has steadily increased to just over 17%. Looking ahead, although we achieved our stated goal of $100 million in quarterly growth in loans and deposits, we expect organic balance sheet growth to accelerate during the fourth quarter from a seasonally slow third quarter. In particular, our deposit pipeline appears very strong. We closed the sale of PartnersFirst, our affinity credit card operation, on October 1, which will reduce our loans held for sale by $25 million in the fourth quarter. The margin increased modestly during the third quarter, but will likely slip in the fourth quarter as new loan yields still track lower than the existing book. Offsetting this potential development could be the continued deployment of current excess liquidity. However, this may be difficult if fourth quarter growth is robust as there may be some delay in fully implementing new deposit funding. In any event, we expect and continue to earn through margin compression and continue to report higher net interest income. We're looking for continued efficiency improvement as legacy credit costs fall and revenue growth continues. We are in the process of merging our 3 bank charters. We believe this will facilitate a stronger risk management infrastructure for the company and will also save us dollars for the duplication of doing things 3 times. These additional savings will be used to help fund new products we're working on as well as improved enhancement in our IT infrastructure. It would also allow senior management to have more time available to help with customer calls and focus on continuing to develop business and continue to grow this franchise, which has really been our hallmark since our beginning. Although predicting loan loss recoveries is very difficult, we do not see gross credit losses climbing above the low level that has been incurred so far this year as the economic recovery in our markets continue and we look for lower levels of problem assets over time despite the potential for some quarter-to-quarter volatility. At this point, we'd like to open it up to any of your questions.

[Operator:]

[Operator Instructions] And our first question comes from Joe Morford at RBC Capital Markets

[Unknown Analyst:]

This is actually Joe Walstrong [ph] in for Joe. Can you talk a little bit about the loan growth this quarter? You mentioned it was a seasonally slow quarter. And kind of how the pipeline is shaping up for 4Q?

[Dale M. Gibbons:]

Sure, yes. Particularly in Arizona and Nevada, the summer is kind of a time where a lot of the folks are on vacation. So it tends to be a little slower. Our loan pipelines are a little more full for the fourth quarter. And the reason we throw that $100 million a quarter is some quarters, we do have $100 million. Other quarters, like the quarter before, we have a couple of hundred million. But I -- we anticipate that the growth for the fourth quarter will be more than the growth we had this quarter.

[Unknown Analyst:]

Okay, great. And you also mentioned deploying some excess liquidity. I saw your cash balances were up this quarter. How are you kind of looking at what a normalized cash balance would be and deployment of that liquidity.

[Dale M. Gibbons:]

Yes, I mean, what we're looking for is probably, we're going to put this in the securities book in an expectation that over time, credits as well. We also mentioned that we think we're probably going to have a strong fourth quarter deposit number. So that will add to that, to some degree. But that number could be as low as, say, $200 million. So there could be $150 million, $180 million there that we could deploy and intend to over time.

[Operator:]

Our next question comes from Casey Haire at Jefferies.

[Casey Haire:]

So I wanted to ask about, I guess, first M&A opportunities. I know you guys have talked about potentially getting back into the market next year in L.A., Orange County. Just curious, any updated thoughts on the opportunity set there and also, your appetite to -- or how well -- protect tangible book, EPSs, accretion targets, stuff like that?

[Robert Gary Sarver:]

Well, I think, given our performance right now in our valuation, we're in a good position to look at a number of deals and to look at deals that are accretive, both to book value and earnings per share. And we, at this point, have got a fair amount of bait on the line and spending time -- I know I'm spending a fair amount of time right now focused on M&A and meeting banks. We're going to be disciplined in terms of the type of deals we can do because I think there is a potential for a number of sellers out there. And we're a pretty attractive currency for them, and we're also a pretty attractive business model for them, from a social standpoint, to want to be a part of. So I think we'll -- we should have a pretty good year next year on the M&A front.

[Casey Haire:]

And in terms of -- is there a particular size that you guys are targeting or is more willing to partner up at this stage?

[Robert Gary Sarver:]

Well, I wouldn't say we look at it so much by size. I think it boils down to economics, it boils down to management, people and synergies and things like that.

[Casey Haire:]

Okay. And then just lastly, on the charter consolidation, I appreciate that this is more of a risk management helper than anything else. But what kind of cost save opportunity could this eventually bring?

[Robert Gary Sarver:]

It will bring cost saves. But I think what we're trying to say is that a number of those cost saves are going to help us reinvest more in technology and products and people. And so we're not trying to lead you down the path of cutting our overhead so much.

[Dale M. Gibbons:]

Yes, it's just another example and we talked about in the past some of the costs that we have on legacy asset issues that are going to come down. We had a reduction in our deposit insurance from Bank of Nevada this quarter as well. It's another reason why we think we can continue to grow revenue in excess of the expense growth rate and push down our efficiency ratio. So you're going to see our expenses fall, but I think you're going to see them to continue to grow more muted than what we're going to see on the top line.

[Operator:]

Our next question comes from Matthew Clark at Credit Suisse.

[Matthew T. Clark:]

On the FDIC insurance relief, did you get the full quarter benefit there this quarter? Or are you going to -- should we see a...

[Robert Gary Sarver:]

Yes, we almost did. We -- not quite the full quarter. The reason why you didn't see a step down as much is because the deposit growth was strong, and we think the deposit growth is going to remain strong. So again, I'm not sure that you're going to see that expense line fall, but you will see an increased balance sheet with really no increase necessarily in deposit insurance premiums. So yes, we did get the benefit. We got most of it during the quarter, but not quite all of it.

[Matthew T. Clark:]

Okay. And then on the reserves and making the adjustment, if we think about that 2.06% or so, the 1.60%, 2.06% relative to the reported 1.51%, I mean, I got to believe that reported reserve is -- could easily drift into the 1.2s, I would assume. Is that kind of how you think things might shake out without any additional acquisitions?

[Dale M. Gibbons:]

Well, I mean, it's all a function of there's a kind of a relatively significant kind of mechanical process about determining the reserve based upon geography or loan type, historical loss, current levels of historical losses. At the end of the day, everyone wants to talk about kind of what that ratio is. I mentioned that if you looked at our loan originations for the quarter, that would have put the reserve at 1.3%, which you could argue that maybe we would drift down to that level, as you're going to proposing, Matt. Conversely, you do have some special allocations. If a loan kind of gets -- goes sideways on, you have with -- some particular allocation that would be additive to that 1.3% number. So I think there is room that, based upon our historical loss trends and what we see kind of going forward, that those ratios could continue to kind of ebb down. But I'm not looking for a significant further reduction in our reserve coverage.

[Robert Gary Sarver:]

We're trying as hard as we can to not take the reserve down.

[Matthew T. Clark:]

Okay. And then on the tax rate, as you guys continue to make more and more money, should we assume that tax rate continues to drift up to the 28% level or is it...

[Dale M. Gibbons:]

Well, we've -- I think we've been guiding to about 25%, which is kind of where it came in this quarter. It was lower last quarter because we had a big -- a significant gain from the bargain purchase of Centennial that was tax exempt. Going forward, we're trying to keep that in the mid-20s. Now each additional dollar we have in income really has a marginal tax rate associated with it of about 38%. That's a combination of the federated 35% in the various states in which we have operations. So it does require continued management to keep that number coming down because the new revenue dollars is at a significantly higher tax rate. We think that we can do this for a while, and it may drift up slightly. But I'm not looking for the tax rate to climb significantly within the -- over the next year.

[Matthew T. Clark:]

Okay. But maybe, as we get into 2015, it's fair to assume maybe [indiscernible].

[Dale M. Gibbons:]

I can't project that far out. But I hope...

[Operator:]

Our next question comes from Brad Milsaps with Sandler O'Neill.

[Brad J. Milsaps:]

Robert, just I know you touched a little bit the coupons on new loans coming in lower than where loan yields are now. I was wondering if you'd maybe give a little bit of color, kind of a range of where they're coming in. And then secondly, just on the competitive environment in general on your markets as more and more banks get healthy and maybe can compete with you guys a little bit more.

[Robert Gary Sarver:]

Well, the -- again, one of the good things about our markets is there's not that many community banks to get healthy, because the bigger ones are out of business and the smaller ones don't have the capital to grow. So it's really the bigger banks now who are -- that we're continuing to compete against. Key for us is just having more potential deals in the pipeline, because as the business gets a little more competitive, even the deals that you underwrite that you want, you're going to lose a few of those due to pricing. And some of the pricing gets a little irrational. We lost a deal last week, and I felt like calling up the CEO and telling him, "Hey, you can undercut the market by 1% and still get your deal. You don't have to undercut it by 2%." And so we do find pockets where -- we're not going to loan money at 2% and 3% or LIBOR plus 100 basis points. Not that we can't. We could. We just think we offer more to our customers and we can pick and choose and get plenty of credits that make sense. Right now, our loan portfolio average yield is 5.44%. And I would say the deals we're doing right now are more in the 4.5% range in terms of the new credits we're originating. But our pipeline is big, and so even though there is a little more competition in the market for credit, we're able to get plenty because the pipeline's robust.

[Brad J. Milsaps:]

Okay, great. That's good color. And just to follow up on that, the growth at -- obviously, you had great growth at -- in Arizona. Torrey Pines is a little slower. Anything specific there? Or is it just -- is that just a kind of a third quarter anomaly?

[Robert Gary Sarver:]

No, I don't think -- I think sometimes, I -- they're scheduled for a pretty big fourth quarter. And so sometimes, it just -- it gets a little bit seasonal. But a number of our specialty groups are based at Western Alliance, so a lot of our municipal finance stuff is going into the bank here. We're doing really good there. We're able to generate floating-rate credit at about 3.25 to 3.50 over LIBOR on what would be kind of bottom-level investment-grade-type credits. That's been a nice niche for us. And the Arizona recovery is pretty robust. So I think we're getting probably more growth there. But having said that, the pipelines are pretty good in California. I was in L.A. Tuesday and sat down and went through their pipeline, and it looks pretty good. They got about $150 million in the hopper they're working on in L.A. And I think they'll -- their loan growth will start to pick up a little bit.

[Brad J. Milsaps:]

Okay, great. And just a final follow-up for Dale. I apologize if I missed it, but I think you mentioned last quarter that Centennial, there's about 8 bps of accretion income in the margin. What -- do you happen to have that number for this quarter?

[Dale M. Gibbons:]

Yes, it would have added a couple more bps to that as we picked up kind of 3 months over 2. So that -- it did push it up a little bit more as a result of that.

[Brad J. Milsaps:]

But stable, virtually stable, and it wasn't outsized this quarter?

[Dale M. Gibbons:]

No, it was not outsized. The delta was not outsized.

[Operator:]

Our next question comes from Herman Chan at Wells Fargo.

[Herman Chan:]

Just following up on California. I know that's been a focus for the bank. Can you provide some color on the build-out and hiring there outside of any potential acquisition?

[Robert Gary Sarver:]

Yes, we opened an office in Beverly Hills a little while ago, and we're kind of getting that staffed up and getting that rolling. We're just getting ready to take out a little more space there and recruit some more folks into that market. So we got our toe in downtown, we got our toe in West L.A. There is about another 7 or 8 areas around L.A. that we should get to, but I think part of our strategy there is also going to be on the M&A front. So we're taking a good look at all of the good banks over in that market in terms of how to expand there. It's a little tougher when you're smaller in a real big city than it is when you have a little bigger presence. So the buildup of kind of name recognition in the market and referrals and all those kind of things that we get a lot of in San Diego just takes a little bit of time. You got to get a little bit of scale. And once you get the scale, you can be a lot more effective.

[Herman Chan:]

Understood. And Robert, you mentioned new products in your prepared remarks. Can you provide some color on expectations there?

[Robert Gary Sarver:]

Yes. And mainly, again, it's still going to center around the business clientele. So we're working on a number of enhancements on our Treasury management side to put us in a better position to keep the heat for larger operating accounts and larger checking accounts, which we're getting opportunities for on the credit side. And so I would say most of it is technology related, and it's related on the commercial side. We also now have just gotten set up to get into the foreign letters of credit, the...

[Dale M. Gibbons:]

Export, import.

[Robert Gary Sarver:]

Yes, export, import...

[Dale M. Gibbons:]

Bank finance.

[Robert Gary Sarver:]

Bank finance. And so we're going to be rolling that out over the next couple of months. And that's -- those are probably primarily our areas of focus.

[Operator:]

Our next question comes from Eric Goubleck [ph] at Highlander Capital.

[Unknown Analyst:]

Just a couple of things. One, the comment you made about the infrastructure spending, I guess, in light of being able to save by consolidating the charters into one, could you just elaborate a little bit more about what is it on the infrastructure that needs upgrading or improvement?

[Robert Gary Sarver:]

Yes, more on the technology side. If you think about it, 10 years ago, we were a $1 billion bank. So we're now a $9 billion bank. And we use a lot of outsourcing and different technology. But we have to make sure that our infrastructure on the technology side and the product side and all that keeps up with the size of the bank and keeps up with our competition and also keeps up with the regulatory environment, too. So it's -- the additional spending, I would say, would be more on the technology front and also continued spending on recruiting groups of people to the company that can develop business and bring in business. We continue to hire people and expand our operation like on our homeowner association banking front. We're now in 26 states there. We're pushing $700 million in deposit growth, which is coming in at about $10 million of growth a month. And so we're expanding that. So it's a little bit, in terms of people, bringing in business and a little bit in terms of technology and infrastructure.

[Unknown Analyst:]

Okay, good. And look, just a little clarification. One of the charts you rolled through, I think it was Page 6 or Slide 16 about the remaining balances by vintage, when you show that, I guess at what, $4.575 billion of outstandings after 2008, does that also include existing customers that have had a maturity in a rollover after 2008? Or is that like brand-new customers of the company?

[Dale M. Gibbons:]

No, this is all of the loan book of the company except for the acquisitions we -- the 2 acquisitions we've done because they're not going to show up as charge-offs anyway because we've got -- we've discounted those loans at purchase. So this traces back loans to when they were first -- so if you have a loan that rolls, it traces it back to when it was originally done. That doesn't mean that you don't have a customer. Maybe you've got a real estate development customer who now has a new project, and that project, they have the first project done in 2004 and they have another one started in 2010. The 2010 project is going to show up in 2010. So it's not really by customer. It's when loans were -- a credit was originally developed. But if you have a loan that rolls every year, so you've got a credit line that rolls, that's going to trace back to when it was originally done.

[Unknown Analyst:]

Okay. So it's a blend of new, new customers and maybe existing relationships where there's a new project or a rollover of an existing loan in that given year?

[Dale M. Gibbons:]

Yes.

[Unknown Analyst:]

Okay, that's what I thought.

[Operator:]

At this time, we show no further questions. Mr. Sarver, would you like to make any closing remarks?

[Robert Gary Sarver:]

Just thanks for tuning in, and appreciate your interest in our company. And we look forward to talking to you at the fourth quarter earnings call.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.