Western Alliance Bancorp (WAL) 2016 Q3 法說會逐字稿

Good day, everyone. Welcome to the earnings call for Western Alliance Bancorporation for the third-quarter 2016. Our speakers today are Robert Sarver, Chairman and CEO; and Dale Gibbons, Chief Financial Officer. You may also view the presentation today via webcast through the Company's website at www.westernalliancebancorporation.com.

The call will be recorded and made available for replay after 2 p.m. Eastern Time on October 24, 2016 through Thursday, November 24, 2016 at 9:00 a.m. Eastern Time by dialing 1-877-344-7529 and entering 10093456.

The discussion during this call may contain forward-looking statements that relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical fact. The forward-looking statements contained herein reflect our current views about future events and financial performance and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from historical results and those expressed in any forward-looking statement. Some factors that could cause actual results to differ materially from historical or expected results include those listed in the filings with the Securities and Exchange Commission. Except as required by law, the Company does not undertake any obligation to update any forward-looking statements.

Now, for the opening remarks, I would like to turn the call over to Robert Sarver. Please go ahead, sir.

Thank you, good morning. Welcome to Western Alliance's third-quarter earnings call.

Dale and I are going to review the slide deck that's been posted on the website, and then we'll open it up for questions. We had another record quarter with net income of $67.1 million or $0.64 per share, inclusive of $0.02 per share in charges for acquisition and conversion costs. This compares to $61.6 million or $0.60 for the prior quarter, which also included a $0.02 charge for integration.

Excluding acquisition costs, EPS is up 20% from $0.55 in the year-ago quarter to $0.66. Loans grew $156 million during the quarter to a little over $13 billion, driven by C&I growth, while deposits climbed $242 million to $14.4 billion, entirely in non-interest-bearing accounts. Year over year, our loans are up $2.25 billion, $1 billion organic and $1.25 billion from the GE acquisition, and deposits are up $2.83 billion, all organically.

The net interest margin contracted 8 basis points from the second quarter to 455, largely due to recognizing a full-quarter interest cost for the June subordinated debt issuance. Our efficiency ratio was flat at 43%, as incentive compensation cost drove total expense to rise proportionately with revenue.

Non-performing assets and total assets were flat from the second quarter, at just over 1/2 of 1% but are down 30% from 76 basis points a year ago. Annualized net losses were just 0.04% of total loans, as they have hovered around zero all year. The tangible common equity ratio rose 9.1% at June 30 to 9.3% this quarter, while our tangible book value per share rose 4% to $14.84.

Turning to our consolidated results. Net interest income for Q3 increased $8.8 million or 5.4% from the second quarter to $172.5 million. It is up $35 million or 26% from a year ago.

Operating non-interest expense rose $2.1 million during the quarter to $10.7 million, due to higher warrant income and gain on sale of loans. Operating expenses climbed $4.6 million during the quarter to $82.4 million driven by compensation costs. Operating pre-provision net revenue exceeded $100 million for the first time in the Company's history, up 37% from $73.7 million a year ago.

The credit loss provision of $2 million exceeded the $1.2 million in incurred loan losses and the improving trend it credit -- in credit metrics continued. Acquisition and restructuring costs were $2.7 million reflecting the completion of our conversion in September from GE for hotel finance lending as well as conversion costs for our core banking platform, resulting from the Bridge Bank merger.

Income taxes increased $2.9 million to $29.2 million, primarily due to the $8.3 million increase in pretaxed income. The diluted share count climbed by $1.1 million, as our at-the-money equity offering was completed in the second quarter but not fully reflected in the average share count until the third quarter, resulting in reported EPS of $0.64 including the $0.02 of one-time mergers.

Our secure securities portfolio grew $500 million to $2.8 billion during the quarter as we deployed a portion of our excess liquidity; however the yield fell 5 basis points to 290 as re-investable yields remained low and premium amortization on mortgage-backed securities climbed, while prepayment speeds accelerated. Loan yield essentially held steady at 5.44% as did our cost of interest-bearing deposits at 36 basis points.

Average borrowing costs increased to 4.05% from 2.06% -- 2.86% as we've picked up a full quarter of our subordinated debt issuance cost that was completed in June. While net interest income rose to a record $172 million the margin fell 8 basis points during the quarter to 4.55%.

5 basis points of the margin decline were due to the full effect of the debt issuance and 3 basis points from accelerated mortgage bond prepayments and investment yields. Accretion from purchase loans was $8.8 million during the quarter, without which the margin would have been 433.

Scheduled acquisition loan accretion for the fourth quarter was $4.9 million and declining to $4.2 million by third quarter of next year. For most periods, realized accretion is likely to be higher than scheduled due to prepayments and refinancing in advance of contractual maturity, which accelerate recognition of remaining discounts.

All of the $4.6 million gain in operating expense is from the $4.8 million jump in comp costs. On a link-quarter basis, base salaries rose $1.1 million, half of which was from one additional payroll day during the quarter and the rest from salary increases for existing staff and five FTE employees hired during the quarter.

Incentive comp was up $3.7 million from the prior quarter as the accrual for companywide performance bonuses rose $2 million, since we are exceeding our targets in almost all performance metrics for 2016 that were laid out in our proxy in April. Additionally, individual business development incentives rose $1.8 million as growth in retention of clients has been strong, particularly for core deposits. In total, this 6% increase in expense from the second quarter matched the 6% increase in revenue, leaving the efficiency ratio unchanged at 43%.

The consistency of our performance shows up in our pretax pre-provision return on assets of 2.38% and ROA hovering around 150. Both measures are in the top decile performance compared to our peers.

Dale, do you want to continue with the balance sheet?

The $500 million increase in the investment book was partially offset by a $300 million decrease in cash, taking total cash and investments up $175 million at quarter end. Deposit growth was modestly in excess of loan growth, which took the loan deposit ratio down to 90%.

Total assets climbed 22% in the past year to $17 billion, while tangible book value per share rose nearly $3 or 25% in the past year to $14.84, which is one of the fastest capital growth rates in the industry. The $156 million in loan growth was driven by mortgage warehouse and corporate finance in the commercial and industrial category, while construction loans increased in Arizona and Nevada. We remain well within the 100% to 300% of capital regulatory guidelines for construction and investor commercial real estate loans at 68% and 252%, respectively.

Non-interest-bearing deposit growth of $350 million during the quarter exceeded the $242 million in total deposit growth, which improved the Company's interest rate risk profile and reduced its reliance on CDs. Growth leaders during the quarter were the HOA division, technology and innovation, and the Arizona and Nevada geographic markets.

Reviewing where our borrowers and depositors are located, over 70% are in our three-state primary market, reflecting that most of our national business lines clients are also in Arizona, California, or Nevada. Texas is our next largest state on the loan side with $421 million, $190 million of which is hotel finance.

On the funding side, Florida leads with $417 million as we bank 50 homeowners association management companies, with funds from over 1000 communities in the state. In total, we have loans in deposits in 48 states. Asset quality remains strong with NPAs to total assets and total grated assets to total assets lower than last quarter, and down roughly a quarter from a year ago. these amounts are net of the $30 million in discounts on these loans that were established when these loans were acquired.

Half of the gross loan charge-offs of $2.7 million during the quarter was offset by $1.5 million in recoveries, resulting in net losses of $1.2 million or 4 basis points of total loans annualized. The $2 million loan loss provision for the quarter covered these losses, as well as provided for loan growth.

The allowance for loan losses as a percentage of total loans was 94 basis points at quarter end as the reserve kicked higher to $123 million. Ignoring our recoveries and only considering gross loan losses for the past year which totaled $15 million, our reserve is large enough to handle eight years of losses at the current run rate. Eight years is more than double the duration or the average maturity of our loan book.

While this past year has been a fairly benign credit environment, this substantial level of reserves relative to losses may be important when the new currently expected credit loss accounting standard is to be implemented. In addition to the $123 million reserve, our loan portfolio is booked at a $56 million credit discount to the unpaid principal balance of our borrowers. As a number of these loans may well pay as agreed, this discount may also be used to cover credit charges. Together, it results in a reserve of 1.37% of total loans.

The tangible common equity ratio and the total capital ratio each ticked higher by 2/10 during the quarter, as capital grew at about double the rate of total assets. The decline in the leverage ratio results from it being the only ratio that is computed using average assets instead of ending assets.

As our average balance sheet grew 6% during the quarter compared to a 2% growth rate in total assets from June 30 to September 30, this ratio declined. While average assets for the quarter are now very close to ending assets, I expect the ratio will move in tandem with the others prospectively.

Okay, going on to our outlook, moving forward, seasonal sluggishness was apparent in our loan and deposit growth metrics for the third quarter; however, we expect these balances to increase consistent with our prior guideline of low double-digit annualized growth for the coming year. We also expect the recent trends of increased geographic and product diversification of our loan portfolios as well as higher core deposit funding will continue.

Western Alliance remains asset sensitive, and its investment portfolio yield was crimped by lower reinvestment returns and higher prepayments during the quarter, but pricing pressure for loans in CRE in particular has modestly abated. Deposit funding costs rose in the second and third quarters, as we are focused on accelerating growth to match our increased loan amounts, particularly from the GE funding.

We now see some important opportunity for trimming funding costs now liquidity needs have been met. As such, we anticipate our core margin to be fairly flat near term, absent a rate hike from the FOMC, which would come, which we would welcome. Less than half of the increase in compensation costs during the quarter should carry forward into 2017, as corporate bonus targets and other incentive plans reset for next fiscal year.

We have three main plans that are aligned with our performance. Our annual bonus plan, which is paid out in cash, and all employees in the Company participate. Our new business incentive plan, which is paid out in cash and all employees participate, and performance shares to Management. In total, these plans amount to about 25% of total compensation costs for the Company.

Together, we'll slow our expense growth rate to notably lower than that of revenue and taking our efficiency rate lower moving forward. For the fourth quarter of this year, I expect our expenses will be flat to down slightly. One-time contract termination, other consolidation costs will result in a merger charge for the fourth quarter that should be similar in magnitude to the past two quarters, these expenses should cease by year end.

The income tax rate climbed to the highest level in over five years during the quarter as fully taxable income rose, due to increased revenue from the hotel finance financial loan portfolio. We have now instituted tax strategies that will lower the rate to again below 30%, through at least 2017.

We don't see any significant changes to credit metrics on the horizon, but our tail of credit recoveries will start to wane in 2017. At this point, I'd like to open it up to your questions.

(Operator Instructions)

Or first question will come from Timur Braziler of Wells Fargo.

Hi, good morning. I guess my first question is in relation to the securities purchases during the quarter. Parking of the excess liquidity on securities, is that at all a sign of an increasingly challenging lending environment? And maybe more broadly speaking, what are you generally seeing as far as the lending environment in terms of increased regulatory scrutiny over CRE lending, potentially pressuring some banks that have historically been CRE lenders to now compete in the C&I space?

Yes, I think on the CRE side that's actually been a little bit of a plus for us, as some of the banks have been in that space probably used all of their bucket for CRE lending, so we're seeing our ability on the CRE side to get a little better.

But in general, pricing competition and structure competition is getting tough and I want to run this Company to be smart not just to try to drive to a certain goal of loan growth during the quarter, so we're going to be aggressive at soliciting new business but we're going to take what the market gives us from a quality standpoint and a rate standpoint and be selective, because I think over time there's a lot of other opportunities to grow our loan book through portfolio and bank acquisitions, and I definitely don't want to just see ourselves following the herd on the lending side. So we're not really inclined to manage quarter to quarter in terms of loan growth if that loan growth isn't there that will provide us the proper risk adjustment returns.

Timur, another thing to note regarding the securities portfolio is, so we have we kind of overshot what we were trying to do on the deposit side. We paid up a little bit for that, and you can see that in our funding costs. As a result, rather than have these excess funds basically sit at the Federal Reserve earning 50 basis points, we've gone out into securities a little bit.

Now, if the market situation allows us for our loan growth to be strong, we can run that down fairly easily as the duration of the portfolio is just over three years, so it gives us a little more interim income in the meantime as we work on our funding cost, which we think we can drive a little bit lower as well as loan opportunity.

That's good color, I appreciate that, thank you. What was the yield on the securities purchased in the third quarter, if you have that?

Just over 2%.

And then switching over to the core systems conversion, is that still on pace for the fourth quarter, and looking out into 2017 should we still be expecting a normalized mid single-digit increase in expenses once all the efficiencies of the conversion are flushed out?

Yes, so we actually did our conversion last weekend, and so we're going through that now. It went well. It didn't go perfectly, but we think we're really on track and finishing up a few items that are still standing with that.

Now, in terms of the expense savings, I don't think you're really going to see that until the first quarter as we do have a tail from the conversion we just undertook. In addition, we converted from the GE system to our new platform at the end of September, so there will be some savings.

I am looking for, as you indicated, some mid single-digit expense rate, which should be a fraction of what our revenue growth should be. We expect that we can continue to drive operating leverage better and have the efficiency ratio come in lower.

Thank you for taking my questions.

The next question will come from Brad Milsaps of Sandler O'Neill.

Hi, good morning, guys.

Hi.

Robert, I was going to see could you comment on -- I know Dale mentioned only five new FTEs in the quarter, but I know there can be a lot of movement in any major new hires or lending teams you are able to bring on in the third quarter, and curious what your outlook might be there.

We've got a few different business lines. Our life science line, our fund management line, we're getting ready to open up the new office in a growing area in Phoenix called Gilbert, so we brought in, looks like about eight new officers to gross number, obviously there's some turn, so that number of five was the net increase, but we brought in about eight new officers and they are pretty well spread out.

Boston, San Jose, Menlo Park, getting ready for a new office in Arizona, so we're continuing to get some good people. It slows down a little bit, like at the end of the year, because people are tied into bonuses elsewhere, and then in the first quarter I think that will pick up a little more.

Great, that's helpful, and I appreciate all the color on kind of the growth dynamics related to loan growth during the quarter. But can you talk a little bit about the credit quality that you're seeing out there, any pockets that you guys are avoiding or think you're getting a little bit over extended at this point?

Well, I think we continue to just evolve. Five, six years ago we were a lot more aggressive at looking at credits, given where the market is, and now as the markets recovered, and especially on the real estate side a lot of prices have gotten frothy, our underwriting criteria has changed.

So, where we may have done an 80% loan to cost, today it may be 55% or 60%. So I would say we're a little more cautious all the way around compared to the market, but that makes us more consistent compared to where we have been. And as you heard me talk before, we'll tend to be more aggressive in a down market and a little more conservative than peers in a bull market.

I think there's going to be plenty of opportunities next year. You can see by listening to some of these earning calls around the country, there's little land mines out there and potholes that people are stepping into and I think that will bode well for opportunities. So I'm less concerned about a quarter-to-quarter number than I am as a year-over-year number in our ability to be smart.

Just one final followup. With what you're seeing going out to, you mentioned potholes, etc. How does that play into your M & A strategy, as you think about--

It helps, it helps, because it creates more opportunities.

Would you guys, you've always talked about being sort of West of the Rockies maybe with the addition of Texas. Would you expand that at this point or is that still kind of where you'd want to be?

I think we're starting to look at some other markets, we're studying them, getting to know them a little better. As Dale mentioned, we've got credit in 48 states, so I think there's opportunities in other markets for us, but we're aware that the bulk of the value in our franchise is the fact that in a half a dozen key markets in the western US, we now, looking at these June 30 deposit numbers, have the number one market share of any of the non-SIFI banks in every one of those markets.

As a matter of fact, in Phoenix we have climbed to number four in the whole market. So, that's where a lot of our value is, but having said that, I think there's other opportunities and some fill-ins and also a few new markets, we're doing some other business, some national business line business that we're open to looking at going forward. So we are studying a few different markets, but I think there's going to be plenty of opportunity next year.

Industry continues to evolve and there's a fair amount of uncertainty out there in terms of where certain institutions are going, and so I think there will be opportunities. So I'd rather be more patient in some areas rather than just trying to push loan growth an extra $300 million or $400 million a quarter to hit certain numbers, I'm not going to do that.

Thanks, guys, appreciate it.

Next we have a question from Brett Rabatin of Piper Jaffray.

Hi, guys, good morning.

Good morning.

Wanted to first just point of clarification on the guidance for expenses in the fourth quarter, flat to slightly down. I assume that excludes the monitoring merger-related charges?

It does.

Well, but they are going to be about the same as they were --

Yes, so, probably holds anyway. Either way.

Okay. And then any commentary on the SBA warrant line and then fee income in general, can you continue to drive some leverage in that and any plans on some of those businesses?

I think some of our opportunity there, we're seeing some opportunity in growth in our business cards and getting the cards out, and fee income from cards. Our SBA income has been a little sluggish, but our warrant income has picked up a little bit.

And also on the international side from a fee standpoint, we're seeing some growth there. And then our service charges income in revenue are on our commercial accounts with our new kind of computer systems and some of the enhancement in some of those products, we've got some opportunity there. So the fee income growth is a key component of our business plan for 2017.

We look for that to climb faster than our net interest income growth.

Okay, great, thanks for the color.

The next question will be from Casey Haire of Jefferies.

Good morning, guys.

Good morning.

Dale, question for you on the NIM guide. The short-term investment bucket was actually up on an average basis quarter to quarter. Historically, that's been around 2% of average earning assets. Does the NIM guide presume that stays elevated, or are you going to run that down some to keep the NIM stable?

It might stay a little bit elevated. I don't know.

I do think that we're likely to see a Fed Reserve increase in rates in December. I don't make a lot of calls on that, but it seems like there's momentum that might happen. So, we are running a little higher in cash, really, with the debate -- do we tie up with 2% investment alternatives, or do we wait a little bit for a better day and take a little bit in the tin in terms of on the NIM?

And so, that's been the dilemma that we had, along with a lot of other institutions, but I can see us running a little bit heavier on liquidity than we'd otherwise need to be, based upon what might happen with FOMC as well as maybe there's opportunities in M&A that are going to come up based on the comments Robert made earlier.

Okay, makes sense. Then switching to Northern California, the warrant income was a nice uptick this quarter, but the loan balances, if I'm remembering correctly, were actually down, was that just capital call lines paying down? Just a little color on what's going on in Northern California.

Yes, I think you've seen a little bit of bumpiness in terms of some of the technology markets, and to a degree that's kind of vibrated through our portfolio a little bit, and a little bit of it I think is seasonal. I think the prospects for Northern California are going to be to have loan balances go up a little bit, but we're pretty cautious there, especially on the real estate side, so it's not a market we think makes sense to be out trying to pick up every deal on the street right now.

Got you. Rob, just one more, the M&A prospects, can you just give a little color there, are those active conversations? Are they more on the bank side or portfolio lift out similar to the GE?

Well, we look at both. I mean, we feel we've got the GE deal digested and we're in pretty good shape. We're focused on this quarter with our system integration and getting all of that done, and then I think starting next year, we want to be looking at what we can get done on the M&A front, and I would say over the last 90 days there's a pickup in opportunities and discussions, significant pickup.

Okay, great, thank you.

The next question comes from John Moran of Macquarie.

Hi, guys, thanks. Just, Dale, I was wondering if you could put a finer point maybe on the taxes, I know that you guys said it's going to drop down below 30, but unless you put on a ton of tax credit deals, it's probably not going back to 25, so wondering if you could just give a little bit of help there?

You bet. I think we're going to be in the high 20s, I don't know if that's 28, 29, but there's a variety of things we're pursuing, we're doing a little bit more in the municipal side, probably a little bit more on the low income housing tax credit side as well, some other initiatives that are underway, that we think are going to be successful.

And maybe more importantly is, I don't think you're going to be able to see it. It's not like we're going to be buying municipal investments that have a lower yield, you're going to see the net interest income come down while tax rates come down as well. I don't think you're going to be able to see a change in revenue related to an improvement in the tax liability.

Got it. And then the other one I had, just following up on the Bay Area there. So, it sounds like really just some bumpiness in demand drivers, but nothing that you guys are seeing in terms of credit or the acquired book that's kind of catching you by surprise or anything like that.

No.

Okay, great. And then the last one I had is just a bigger picture question.

In my understanding, what's going on with Wells is primarily in the community bank, but they are a large competitor in basically all your markets at number one and number two, basically everywhere. Are you seeing any opportunity shake out from sort of clients being a little bit frustrated there or lenders maybe being frustrated?

Yes, I don't have any comment on that.

Okay, fair enough.

I don't think it's appropriate for me to comment on that one.

Got you. Thanks.

This concludes our question-and-answer session. I'd like to turn the conference back over to Robert Sarver for any closing remarks.

Well, again, just another consistent quarter for us. We're growing our tangible book per share, generating good returns and asset quality looks pretty solid, and looking forward to what opportunities present themselves for us over the next 12 months, and continue stamping out some good returns. So, appreciate you calling in and thanks for your interest in the Company.

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