Western Alliance Bancorporation (WAL) Earnings Call Transcript & Summary

Yes. So the [indiscernible], to me, is an old story. It happened, one -- one, was a fraud, which was Cantor and the land for us is a breach of contract. So we think our positions there are very strong. We expect a favorable outcome and that will just transpire over the next year or so. It's a long process once it gets into litigation. As it relates to what we've learned, and I got to be careful, there's only so much I can talk about. I can say we've brought in outside people. We did this immediately to ensure that our credit process was fine, and it is, and it was. So where did the problems come, it came in the administration side, on how we administered titles and how we gave too much control to a large company to administer their asset quality, their cash flows. And that's where the mistakes were made, and we've changed that. As it relates to the canter fraud and looking at the double pledging of titles, we found no other instance in our book of business other than what we saw with Cantor.

So that's good. Great. You talked a little bit about growing the ACL. Western Alliance has always had a relatively low ACL due to the structure of the lending book, along with some of the specific guarantees on insurance coverage. In light of the credit moves and the balance sheet shift as you talked about, how should we think about the ACL normalizing longer term?

So in Q2, we added a couple of bps to the ACL. Our peer group came down about 3 bps. So if we keep that path going, it's -- we'll get to normalization a lot faster. Now first, we have to understand that our peer group, very different from us because they have a large consumer book of business and we don't carry those loans and so therefore, we don't have those losses. And so therefore, our ACL should be lower than our peer group. Having said that, it would be nicer to be closer to them, so there's one less story I need to tell back to the cost of capital, that gets into the beta, all right? So we continue to remix our book. We continue to see ACL kind of rising 2 bps per quarter, thereabouts. Our overall asset quality will be -- continue to improve. And so for me, I look at the ACL compared to the NPLs and make sure we have enough coverage. What I would say is that we do have a credit-linked node, a CLM, which removes up to 5% of residential losses from our balance sheet. By the way, we've never had a loss in our resi book. But if we were, the first 5% is eaten up by these CLNs. So that's the insurance policy. So when you take the monies that were -- that we still reserve for or the residential book and move them over to the rest of the book. Our ACL is closer to 1.01%. The peer group is about 1.2%. So we're not all that far apart. And we will, as I say, continue to work to close that gap. So I think we're making progress on that. I just wish we'd get a little more credit for the CLN. It's there, it's insurance. People have given us the money. So if we have a loss, we give them back less money. I don't know why that's not considered a very strong ACL.

Okay. Maybe shifting a little bit to the fees and expense side. Service charges and fees have grown steadily, not just from the legal disbursements, but from commercial banking services like treasury management. What do you attribute the success in this area, too? And what do you envision on mortgage fee revenues growing to and contributing to the revenue mix?

Yes. So our growth in fee income runs in concert with the change in our strategy with our balance sheet. So we used to be more balance sheet oriented, that's fine. As we pull back on the balance sheet, we're now becoming more revenue-centric to what the client is. To do that, we've invested in treasury management services and products, and we expect treasury management services income to grow at an accelerated pace such that it will continue to help fee income move along. The businesses of BES some stuff in private credit, corporate trust, digital asset group, those also begin -- they will, as they get bigger and bigger, grow fee income. So it's coming from there as well. Because with such a large spread business, and we don't have wealth management, we don't have credit cards, we don't have a bond trading desk. We don't have investment banking. We will move fee income year-over-year double digits in growth. But relative to our overall income, it's not going to move much. So it runs today absent mortgage, about 10%. And it will stay about 10% because it's going to be hard to outgrow the denominator of our net interest income.

On the expense side, ECR and non-ECR expenses have been 2 of the hardest things for investors to model. What are the biggest underlying drivers of each today? And where do you expect scale or efficiency, including AI to start providing more visible offsets?

Yes. So the ECR conversation also, I think, adds to the discount in our stock price. Sometimes you can actually see smoke coming out of people's ears when I have to explain it to them and what -- but I'll try to break it down and make things as simple as they were when I went to public school in Queens at PS 169, go tigers. And that is -- there are 3 businesses that contribute to the ECR. Warehouse lending, which is warehouse lending deposits mostly coming from MSR relationships, HOA and then [indiscernible] banking. We have about $30 billion of ECR-related expenses or balances, right? What I would do in terms of -- I had to model this, I would take that my denominator, I would take the numerator, which is what our deposit costs come up with a ratio. And then you got to have to do here a little work and make your best guess on where you think those deposits are moving, right? Certainly, the rate has to be coming down as we're transitioning off higher rate balances, all right? But mostly, the improvement quarter-to-quarter, and there will be another improvement in Q4. I said we'll be down about $10 million in Q3, will be down again in Q4, but Q4 is going to be just because of the seasonal drop that we always see. I would factor that in, and I would go back and kind of look at what that path has been for the last couple of years, quarter-by-quarter, and I think you can create a model that kind of draws you to where you need to go. And that's how I would think about the ECRs with a rate increase sitting in front of us, the warehouse lending business runs about a 90% beta, and the other 2 businesses run about 50-ish percent. And so I would keep that in mind as well. I hope I gave the answer to the test question.

Yes. You're approaching $100 billion, and you've already invested heavily in LFI readiness, how far along is that build out? And once you're fully subject to the requirements that come with crossing the threshold, what should be the ongoing run rate cost and the timing benefit of the Cat IV threshold [indiscernible]?

Yes. So we're just about done with the LFI readiness program. We won't have to start filing the appropriate reports if we cross over by the end of Q1, assuming there's no tailoring changes, we don't start filing reports until -- so most of them are filed in '28, not in '27. So we even still have time. But we put in about $25 million a year, $25 million to $30 million. That's going to be the run rate going forward to support the LFI. Whether tailoring happens or not, we're just assuming that it is, a lot of the infrastructure that we put in around capital stress testing around liquidity management and stress testing, very valuable. We're keeping that. So that's going to just be with us regardless if we move the LFI levels are moved. But we're ready. And we'll just wait to hear. Hopefully, I understand there are going to be some speeches coming up soon, and one of them may very well be on LFI, I hope, and maybe we'll get a little more insight. We're going to be the first bank that crosses over organically, which is kind of interesting. And what I've said to the FRB is that you should use us as the model. I mean we started planning for LFI back in 2021, 2022, we started putting it into our cost base very slowly, and then we accelerated a little bit more recently. So we've been working on this for a while.

Okay. You talked about the buybacks earlier. You've increasingly emphasized buybacks relative to incremental growth. And you've pointed to potential Basel III capital relief. What would make you shift capital back towards growth and what could lead you to lean further into repurchases, including, I guess, how you deploy the about 80 basis points of potential CET1 benefit?

Yes. Well, everyone likes a deal, and we're not paying full retail for our stock price today. So we're going to continue to buy. And we had our Board meeting last week, showed these models to the Board and where we think intrinsic value is. And what we need to do to kind of grow the stock price. And as we get closer to that intrinsic value, will probably slow down. But right now, I think there's a real sizable gap to where we think the company should be valued and we're going to be continuing to buy. One thing I'll keep noting is that we're continuing to grow. So that's very important. That organic growth is very important for long-term growth. I went back and I looked at some of the big money center banks over the last 15 years. And what made them scale up and how are they successful? And a number of the large banks actually for an extended period of time, never saw their stock price move. It was kind of interesting. And you go to the top 2 or 3 -- one over the last 15 years has seen total shareholder return of about 1,100%. A couple of others have been in the 500 to 600 range. We over that same period of time grew 1,700%. Now we're not -- we don't have a couple of trillion dollars in assets, and I appreciate that we're a different model. But our model has worked over time. And right now, one of the things we're trying to shift with our model is getting a higher PE will allow us to be more opportunistic in buying other banks. And when you look at these other money center banks, the way they got their growth or accelerated growth was having a foundational balance sheet, which is what we're trying to do. So we've got very strong CET1 now. We've got very strong liquidity. We're improving on the allowance for loan loss reserve, which is, I think, the last component. And so we'll have a very strong foundational balance sheet. And if we have a higher PE multiple, we'll be in the right position [Audio Gap] [Audio Gap]

Great. You talked a little bit about tech, but you've moved beyond broad AI experimentation into specific use cases, incited some productivity gains at Investor Day, which applications are closest to a measurable P&L benefit and how are you using AI to support the deposit optimization and relationship profitability effort without weakening the client experience?

Yes. We spent some time on this at our Board meeting. And I laid out 15 strong use cases for AI. We're going to focus on the Top 5 first so that we can embed the cost into our models for 2027. And as soon as we see a return or a lack of return in these areas, we'll make our decisions and roll on to the next thing. But where we're seeing initial early gains, let's go to Corporate Trust and their pipeline, we are consolidating the period it takes to onboard, which is incredibly important for us. So that's been positive. We've used AI in the mortgage business in terms of our pricing models. That's been a positive for us. So we have some very specific uses -- use cases that have worked out. We're continuing -- actually, the first thing we needed to do and what took us a little bit on a side road was when lithos came out, we had to use our AI team to prevent AI from hurting us. And so that was our first goal, which is, hey, let's make sure the core of the business stays intact and everything else will catch up. Now we think we've done that, and now we can start putting the time and resources against AI projects that will help us. But I haven't embedded any of that into our models yet. We're going to wait and see a definitive ROI on these businesses. Around the edges, we know they're definitely going to help. I just want to understand what the real return is for each business. But we're very positive about them. We do think it will contribute.

Great. In last few mins, seeing if any in the audience has any questions? So from now and if the market is rerated the stock towards what you think is the intrinsic value, what do you think will have driven it? And I guess what's the one thing you think investors most underappreciate about Western Alliance today?

That's a therapy question. So I'm going to sit down and get a couch for that one. Okay. What don't they appreciate about the bank is our long track record for providing value. Our ability to find specialty finance businesses, craft them, take our time to understand them, roll them out. That's part of the S-curve strategy and then see the growth that follows. For a small bank, we run a very complicated operations. And so the management team, I think, is very gifted. And I don't think people appreciate that as well. What will be different here a year from now is I hope everything I talked about on the tactics, which is deposit optimization share repurchase and the asset quality improving, leading to a lower beta and a lower cost of capital, that would be one of my goals. If that happens, I think the price of the stock is going to move up, and I think you'll see a higher PE multiple. And that's what I hope -- that's what I hope will happen next year at this time.

Great. Well, thank you very much. It was great to have a chance to talk to you.

Thank you very much. I appreciate it. Thank you.

Thank you.