Western Alliance Bancorp (WAL) 2017 Q3 法說會逐字稿

Good day, everyone. Welcome to the earnings call for Western Alliance Bancorporation for the third quarter 2017. 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.westernalliancebancorp.com.

The call will be recorded and made available for replay after 2:00 p.m. Eastern Time, October 20, 2017, through Monday, November 20, 2017, at 9 a.m. Eastern time by dialing 1 (877) 344-7529 and entering passcode 10112871.

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 facts. 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 at 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.

Yes, thank you. Good morning, everybody, and welcome to our third quarter earnings call.

I'm going to review some high-level results and Dale will follow with some of the details. And then at the end of that, Dale and I, and Ken Vecchione, who's joined us, will be available to answer any questions you may have regarding the quarter.

But overall, as you can see with the numbers, we're pretty much on plan on all fronts. It was our 29th consecutive quarter of record operating earnings as our balance sheet growth continued while we were able to also maintain a good net interest margin and asset quality. We achieved record operating efficiency and again grew our tangible book value per share.

Net income for the quarter was $82.9 million, $0.79 a share. That's up 20% from the $0.66 of operating EPS in the third quarter of 2016, which was before $0.02 of acquisition charges back then. The net interest margin expanded by 4 basis points on a linked quarter basis to 4.65% and is up 10 basis points from 4.55% a year ago in the third quarter 2016.

For the quarter, revenue rose 4% unannualized while expenses climbed only 1%. This improved operating leverage drove our efficiency ratio down to 40% for the quarter.

Balance sheet growth was on plan with $532 million in loan growth during the third quarter and $1.5 billion in loan growth over the last 12 months. Deposit growth was $874 million for the quarter and has been $2.5 billion for the last 12 months. Nonperforming assets rose to 42 basis points of total assets, up from 32 basis at June 30 but are down from 53 basis points 1 year ago. Net charge-offs were a very modest $400,000 during the quarter as recoveries essentially masked our gross loan losses.

Our balance sheet growth was matched with rising capital. Our TCE ratio was 9.4% of assets. Tangible book value per share grew 18% during the past year, which essentially matched our return on tangible common equity.

Our net interest income climbed $8.9 million for the third quarter to $201.6 million driven by a $340 million increase in average loan growth during the quarter in realizing the full effect of the FOMC rate increase in June. Net interest income rose 17% compared to a year ago.

Operating noninterest income declined 6% during the quarter to $9.9 million as income from some of our equity investments and gains on the sale of SBA loans, which are cyclical, fell off. Operating expense rose 1% to $88.8 million from the second quarter and is up 8% from the third quarter a year ago, which is essentially half the rate of growth as our revenue has had.

We put $5 million in the loan loss provision during the quarter. This was driven by our loan growth. The income tax rate was just under 30% for the quarter or $34.9 million, and this all resulted in net income of $82.9 million and $0.79 EPS on what was a stable share count.

Strong deposit growth drove a total of $1 billion increase in the investment portfolio and loan book during the quarter, why the securities yields have been tracking to fairly flat term structure of the yield curve for the past 3 quarters. Loan yields climbed again primarily resulting from the 20 basis point average increase in the prime rate after the FOMC increased rates in June. The loan yield on new originations was slightly above the average loan yield for the period.

Reflecting the rising rate environment, the cost of interest-bearing deposits rose 7 basis points during the quarter, although our total cost of liability funding increased only 3 basis points to a total 38 basis points as it benefited from our strong noninterest-bearing deposit growth.

The earning asset yield rose 7 basis points during the quarter, driving the margin up 4 basis points to 4.65%. As the loan growth during the quarter was back-end weighted, average cash balances remained elevated at $845 million.

Total acquired loan accretion rose from $7.1 million in the second quarter to $7.5 million in the third and in total had a 17 basis point effect on the margin. The graph on the right shows that we expect fairly stable accretion from purchased accounting marks for the next year, albeit a step down from the level of the past several quarters. While actual accretion has usually been higher than what is projected due to loan prepayment activity, we expect this accretion trend to lower over time. Dale?

Yes. Strong revenue growth during the quarter coupled with our modestly rising expenses drove the efficiency ratio to a record low of 40% compared to 43% in the third quarter of last year. Our preprovision net revenue op return was 2.53%, which is also a new high as our return on assets held steady at 1.71% and has consistently been a top-decile performance compared to peers.

Growth in core deposits provided the liquidity to increase our investment and loan portfolios. Total assets were just under $20 billion at quarter-end while shareholders equity rose $87 million during the period. Consistently strong deposit growth drove the loan to deposit ratio down to 86% at September 30 compared to 90% 1 year ago.

Loan growth of $532 million for the quarter was led by $207 million in mortgage warehouse to $1.7 billion. Regionally, loans grew $88 million in Northern California, $41 million in Arizona, $35 million in Southern Cal while declining $44 million in Nevada.

Growth in noninterest-bearing deposits of $750 million comprised 86% of the $874 million increase in total. The continued success in deposit gathering for noninterest-bearing deposits has increased that proportion of the portfolio to 45% compared to 39% 1 year ago and reduced the increase in liability funding cost to 3 basis points from the second quarter.

Among the business segments, Arizona led deposit growth of $420 million followed by $261 million in Southern California and $187 million in technology and innovation. As the headquarters of the company are in Phoenix, Arizona's deposit growth benefits from activity in other markets.

Total adversely graded assets increased $38 million during the quarter to $406 million, largely reflecting the more conservative assessment of special mention investor-dependent technology loans that we discussed on our last call. Included in this total is a $23 million shared national credit that was downgraded to nonperforming in the shared national credit exam results released on October 1, bringing total nonperforming loans up $25 million to $55 million.

Upon receiving these results, we sold the loan at a loss of $1.4 million. As the conditions that resulted in this loss occurred prior to October 1, this loss was reflected in the $400,000 of net charge-offs for the third quarter. On a ratio basis, adversely graded assets and NPAs were up slightly to 2.1% but are down a bit with the disposition of the downgraded loan was reflected in the third quarter results. The same is true for NPAs, which would've been 31 basis points of total assets, including the loan dispositions instead of the 42 basis points shown here.

Gross credit losses of $3.2 million during the quarter were substantially offset by $2.8 million of recoveries of prior charge-offs, resulting in net loan losses of $400,000, just 1 basis point of total loans. Net loan losses are only $500,000 year-to-date. Provision expense rose $2 million to $5 million for the third quarter as the rate of loan growth increased. The allowance for loan and lease losses rose to $136 million, which is up $13 million from a year ago. This reserve was 1.06% of nonacquired loans at September 30 as acquired loans are booked at a discount to the unpaid principal balance and consequently have no reserve at acquisition.

For acquired loans on the lower right, credit discounts totaled $32.7 million at quarter-end, which was just over 2% of the $1.6 billion purchased loan portfolio.

Our strong capital growth for the quarter essentially matched our strong balance sheet growth, leading our capital ratios essentially flat at June 30 while edging higher during the past year. Tangible book value per share rose $0.82 in the third quarter to $17.53 and is up 18% in the past year, matching the 18% return on average tangible common equity that we've had for the past 4 quarters.

Looking forward, in terms of finishing out the year, I don't think you'll really see any surprises. We are essentially on plan to kind of the numbers and the guidance we've given you over the last 3 quarters. As we mentioned earlier, our loans year-to-date are up $1.3 billion organically, and our deposits are up $2.4 billion. I would say the deposit growth is probably a little more front end-loaded, and so the fourth quarter will be a slower deposit growth quarter for us. On the other hand, the fourth quarter on the loan side should be pretty robust. So the end of the day, balance sheet growth's going to come in right about where we guided at the beginning of the year.

In terms of operating leverage, as we continue to talk, we're still growing our revenue at about double our expense growth, so that's all good. Maybe we'll get a little bump if the rates go up a quarter in December, which will help us a little bit. And asset quality, nothing really on the horizon as I look at it today that puts much difference in where we're at. So we should finish up pretty strong for the year and just kind of essentially on plan, so that's good.

At this point, I think we can open it up for some questions and try to give you any more color on anything you want to ask in particular.

(Operator Instructions) The first question today will come from Casey Haire of Jefferies.

Wanted to start off on the excess liquidity. Looks like you guys -- I mean, it was elevated to $850 million-or-so on average. Looks like you did pick up the securities book at the end of the quarter. I was wondering what the yield was on that incremental outlay. And then how quickly you plan on rightsizing that excess liquidity and to what degree?

Yes. So the purchases that we did, and they were towards the end of the quarter. We -- frankly, we didn't think it was the best environment to be extending out in securities. We kind of disagreed with how rates got, and so far that seems to have been correct. So that's why our cash position was a little bit higher. Also, our loan growth was kind of back end-loaded as well, but we did buy securities in September. They were yielding in the mid- to high 2s. And we have $850 million on average in cash, like you mentioned. I do expect that to come down significantly in the fourth quarter. I think we're going to have decent loan growth. Deposit growth could be a little bit softer than what we've shown. And that, coupled with additional securities purchases at these rate environment, that's about 25 bps higher. I expect we'll put some of that out.

Okay, great. And just switching to expenses, I thought the message was that revenues were going to grow around 1.5x expenses, and obviously, we're tracking to that 2x level in this quarter here. Is that now the standard, having digested some of the infrastructure spend earlier in the year?

Dale always -- you can't listen to Dale on the operating leverage or the margin. So just -- we're doing a little better than we thought we would, but I don't know. We're doing fine. We can't plug in your (inaudible) for you. You got to kind of have to do your own model.

All right, very good. Just lastly, the M&A front, activity levels aren't -- is it still an active pipeline and you guys just being disciplined? Just some updated thoughts there.

Yes. We've looked at some deals. We've looked at some nonbank lending platforms, which actually have been a little more interesting to us. But we're -- when you look at the pace of growth of our earnings and you look at some of the price expectations in some of the markets that we have some interest in, we haven't been able to make anything work. And so we're going to be select and opportunistic, and we're not going to really deviate from that because when you're growing your earnings 20% a year, we got to find something that's to grow more than 20% once we fold it in. So that activity hasn't led to anything in the last 12 months.

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

Hey Robert, just want to see if you can maybe give a little more color on the deposit growth, which has been tremendous this quarter and over the last year. What do you think your opportunity set is there? Obviously you've developed some great niches amongst some different industries. I know you mentioned it might slow the fourth quarter, but how big can this get? In your mind, what's kind of the runway there in continuing to grow the DDA balances longer term?

I'm going to turn that over to Ken. He's been on the road a lot in the last month and meeting with our different regional heads and different National Business Line groups. So go ahead, Ken.

So as we said, deposit growth will trail loan growth going into Q4. I mean, I think we had an exceptional deposit growth quarter, $874 million versus the loans growing $532 million. And one of the things that is ingrained in our folks, whether it be BDOs, relationship managers and lenders, they're always constantly working to develop a deeper relationship with our clients, and that deeper relationship drives deposits. It also drives better credit performance because we understand those businesses better. So where the deposit growth comes from specifically region by region or product line by product line, not as important as the fact that the culture here is to drive forward, always looking for deposit growth. Having said that, this quarter, the banks, all the regions generated about $121 million of incremental deposit growth, and some of the other business lines generated the remainder piece. So we always look for opportunities, and those opportunities are also tied to the loan growth as well.

Okay. And then maybe just on the loan growth. Dale, I think you mentioned that warehouse is up a couple hundred million, but it sounds like you got offset maybe in other categories to maybe offset a seasonal decline of that business. Just curious, kind of what areas you see growing the fastest. I think it's interesting that you guys really haven't grown CRE at all this year. Just would -- any updated thoughts around that business? Is it still -- pricing is still tough in terms, et cetera? Just kind of any color on kind of the big drivers of the loan growth as you get into the back half of the -- the last quarter of the year.

Yes, I think on the CRE front, we are seeing -- it's fairly competitive. And on the commercial front, it's an area we're probably a little more selective in terms of our underwriting standards now as valuations have gotten pretty frothy in that area. So we've been a little more focused on the residential construction side, lots of houses, which we think are a little bit in the earlier stage of recovery, and we have better visibility there in terms of values and demand. And on the C&I side, we're fortunate in that we've got a lot of different divisions, a lot of different business niches and we're pretty well diversified. We're picking up a lot of new relationships. I'd say the disappointing side is, and one of the reasons maybe our deposits are growing quite a bit faster is that the actual demand or the actual incentive and mindset of businesses to borrow a lot of money right now is pretty muted. So average uses on lines of credit, growth drivers for businesses where they really want to borrow money to build a new plant, new facility is fairly low. So we're having a lot of customers that hopefully will start borrowing a little more money. But right now, their appetite for debt is still pretty muted.

Regarding mortgage warehouse, as you know, we're -- we skew toward purchase money instead of refi. Obviously, the refi business isn't going to be doing so well with rates higher. But for us, we don't think we're going to have as steep a decline as some of the other players in this space have indicated for the fourth quarter. But it will be down.

And our next question will come from Timur Braziler of Wells Fargo.

Maybe just one follow-up on the warehouse business. What percentage of that growth came from new clients versus increased utilization at existing clients?

Mostly new clients.

Got it. And how does that new client pipeline look heading into fourth quarter and 2018?

Yes, so this is Ken. I just came off the road and spent a lot of time with a lot of warehouse lenders, and they're very optimistic about what they see coming towards them. And we're optimistic also that we're signing up new clients as well. So I'm probably more constructive on volume and growth for that product for the company.

We've also developed a nice niche and product line where mortgage companies and lenders that are making loans on the commercial side at a little higher advance rate than we would, they've put funds together, and they're lending money at more maybe that 80%, 85% advance rate. We're putting in warehouse lines for those clients where we're essentially lending 50% to 60% of what they're lending. And so it's another way for us to penetrate the market but yet with a much lower risk profile than what some of these folks are doing because we've got that 50% cushion between what the lender we're lending money to is putting in versus what we're supporting. So we've built a nice little niche there.

Okay, that's great color. And then just maybe looking at the other -- the growth in the other National Business Lines, excluding warehouse, still fairly strong. Any particular category driving that incremental growth? Or is that pretty broad based?

Pretty broad based.

Okay. And then I guess, just one last one from me, if I could. As you're looking into 2018, maybe ask the expense question a little different. Any incremental projects that are going to be coming on during 2018 that might pressure that revenue to expense ratio? Or are we fairly baked in as far as what you can see today for what's coming down the pipe for infrastructure build?

No, I don't think a lot. I mean, we'll continue to reach out and try to add and recruit new teams to the company. But like in terms of just offices, we just opened an office, another one in Phoenix out in Gilbert, just a real good growing area. And over the last 12 months with Bridge, we've opened up a few locations to penetrate some good different markets down in Raleigh and over in Atlanta. We don't really have a new office on the pipeline right now to open, and we don't have any major significant technology spend-type or risk management spend-type projects in place that would lead us to levels of significant increase over where we're at right now. So I think it looks pretty predictable going into next year.

Okay. And then, just one modeling question. What was the charitable contribution made this quarter?

We just spent a lot more money. We've got -- there's a tax credit deal in Arizona where, if you give some money to kind of nonprofit schools to help low-income kids get scholarships, you get a tax credit, dollar-for-dollar. It's a program the state of Arizona has, so -- the credits weren't formally utilized, so they called back, and we gave some more money. It helps the kids. At the end of the day, it doesn't really cost us anything because we'll get a tax credit over the remainder of this year that'll kind of reduce our income taxes. But the actual money is donated in a certain month, and so it pops up a little bit.

The tax recovery comes in a different period generally than when the charge is taken, the donation.

And next, we have a question from Michael Young of SunTrust.

Robert, just wanted to ask a big-picture question if we're back on the kind of 2x expense or 2x revenue growth to expense growth rate. I mean, does that sort of portend that the efficiency ratio's going to continue to climb at 200 to 300 basis points a year like it has for the last several years?

I don't know. Probably not, but maybe. I don't know. It's -- I mean, we're going to continue to grow our revenue faster than our expenses. That's our culture. We've been doing that a long time. Whether you could go at those numbers, that's probably a little aggressive of the model, so -- if you just keep it at 40%, we make a lot of money. You'll be okay. We may do a little better, but...

Getting greedy. I got you.

Yes...

And then, maybe just a little more ticky-tack, Dale, just on the professional fees, you called that out, the divesting of 4 director restricted stock. I mean, is this kind of a good run rate going forward? Or is that going to pop back up?

It'll pop back up in the first quarter, so it's heavy in Q1 and Q2, much lighter in Q3 and Q4.

And next, we have a question from Chris McGratty of KBW.

If you look at -- Dale, if you look at year-to-date headcounts of about 11%, I'm interested in kind of color how much of that is kind of revenue-producing people that you've talked about versus kind of back-office build as you become a bigger company?

Yes, I mean, so the actual revenue producers in that were 7 FTE, but a lot of the other individuals involved do support the revenue production. So -- but as we talked about in the first quarter, I mean, we made hires in terms of infrastructure to prepare us to grow to a bank, say, twice our size today. And so that's been a factor in 2017 hiring. But we continue to focus on themes, as Robert mentioned, and the -- and about half of those remaining people are support people for those teams.

Okay, that's great. And maybe Dale, if I can ask a kind of a margin question. Excluding the accretion, it kind of looks like your core was up a few basis points, obviously, with June helping by the Fed, but also the cash hurting you a bit. As you kind of stand today, given the dynamics of the balance sheet, it's kind of a few basis points a quarter ex rates moving again about a fair assumption. I think in the past, you've talked about each 25 is about 5 to the NIM?

Yes, so if we get a Fed increase in December, that's only going to count for 1/6, so that wouldn't be much of an effect, at least in the fourth quarter, of what we might see. But things we have going positive -- positively is that we had ending loans that were $500 million more than average loans. That should give us a bit of a lift. And then we have an excess cash position as we discussed earlier, that if we, as we deploy that, that should give us a lift. I do think that we have a bit of a risk though, with what we've been recognizing in purchase credit-impaired loans, whereby that number at 7.5, I think, is likely to fall. Don't really have insight on that because we don't know what necessarily our clients are going to be doing. But that could mitigate the other relatively modest increase with other rise experience.

Okay, great. And maybe, if I could, the tax rate going forward, given the comments about the contribution, fourth quarter into '18, how should we think about that?

Yes, I think the tax rate we're at right now, we're on a -- we're -- year-to-date basis is likely what we're going to continue to see. I'm not looking for a significant increase nor a significant recovery, absent something being done in Washington. We will, however, in the first quarter have a lower tax rate because our stock price is up, and that rule change that went into effect in 2016 of accounting for taxes for compensation on restricted share awards.

And next, we have a question from Jon Arfstrom of RBC.

Follow-up on Brad Milsaps' question earlier on the noninterest-bearing growth. Ken, maybe a question for you. That number, noninterest-bearing as a percentage of total deposits keeps creeping up. And curious if there's anything structurally that holds that back in terms of going even higher. Or does it just feel like there's a lot of room to continue to grow that percentage?

Maybe a little bit.

When we acquired Bridge Bank, their DDA as a percentage of total deposits was about 68%, and so there are certain segments of our portfolio that have a little more opportunity. But that said, at a higher rate environment, the incentive that clients have to do something in an interest-bearing capacity obviously rises, so...

Yes, what -- we get a lot of core deposits from some of these National Business Lines because our competition is primarily larger companies, and they have a focus on some of these sectors, too, but their focus is really on the credit side. And so our folks thought that we're selling the credit and the deposit side together and we're wrapping it together. In many cases, we're leading with the deposit side. That's how we get in the bank with some of our cash management systems and our deposits and all that. And so, customers really appreciate the fact that they got a central point of contact with us for everything. And oftentimes, like some of our larger bank competitors are real effective on that credit side in some of these specialty areas. They're not real focused on the deposit side of those areas. And so we're able to pull significant, strong relationships on the deposit front from our National Business Lines.

Good, that makes sense. Yes, it's just -- it's very -- that percentage continue to creep up, and obviously, there are a lot of other banks that are struggling with deposit costs, and it just seems like that's -- it's notable for you.

Yes, the deposit piece has always been really kind of a hallmark of our franchise. And it's, as I think ken mentioned earlier, it's really part of our culture, so...

Okay. And then Robert, you touched on credit, and it seems like it's very isolated in terms of the credit issue for the quarter. But anything out there that's bothering you? Anything you're watching a little more closely?

We're watching everything closely. I think that's really the key right now. I mean, it's everything. Very vigilant on everything and trying to prevent surprises, trying to get out ahead of clients, trying to be proactive and realize that things are good right now, but they're not good forever. And we want to make sure we're vigilant, so we're all over everything.

One maybe quick story on that. I was out at a couple offices and one of the younger folks said to me, well, what credit loss amount is acceptable? What's it -- what credit loss ratio is acceptable? And I tried to explain to him that 0 is the number we shoot for, and that's what's acceptable. But more importantly, we don't want credits that start out as pass, move down to special mention, find a way to substandard, we've got to work like heck to move them back up to pass. And even though we get these cash good loans, we don't want to go through that exercise. So it's not only not losing money, it is also thinking about making the right credit that doesn't require all that incremental work to keep it as a pass loan. And that's the mental set. It's sort of like Vince Lombardi once said, you strive for perfection and you end up with excellence. So we'll have our losses, but that's the mental set that we're trying to communicate to the field and all the lenders.

And this concludes our question-and-answer session. I would like to turn the conference back over to Robert Sarver for any closing remarks.

Yes, thanks. No, I just think another consistent quarter, and we're just keeping it rolling, kind of like that old theme song from Rawhide. Rolling, rolling, rolling. Keep them doggies rolling, Rawhide. That's a wrap. Thanks, guys.

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