Oct 20, 2017
Executives
Robert Sarver - Chairman and CEO Dale Gibbons - CFO Ken Vecchione - President
Analysts
Casey Haire - Jefferies Brad Milsaps - Sandler O’Neill Timur Braziler - Wells Fargo Michael Young - Suntrust Christopher McGratty - KBW Jon Arfstrom - RBC
Operator
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.westernalliancebancorporation.com.
The call will be recorded and made available for replay after 2 o’clock 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 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.
Robert Sarver
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 has 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 continue, 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 of 2016. For the quarter, revenue rose 4% on annualized 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. Non-performing assets rose to 42 basis points of total assets, up from 32 basis points at June 30th, but are down from 53 basis points one year ago.
Net charge-offs were very modest $400,000 during the quarter, as recoveries essentially masked our gross loan losses. Our balance sheet growth was masked 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, $201.6 million, driven by $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 non-interest 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 total of $1 billion increase in the investment portfolio and loan book during the quarter.
While the securities yields have been tracking the fairly flat term structure of the yield curve for the past three quarters, loan yields climbed again, primarily resulting from the 20 basis-point average increase in the primary 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 non-interest-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 backend 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 purchase 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?
Dale Gibbons
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 pre-provision net revenue return was 2.53%, which is also a new high as our return on assets held steady at 1.71 and it’s consistently been top docile performance compared to peers. Growth in core deposits provided liquidity to increase our investment and loan portfolio.
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 30th compared to 90% one year ago.
Loan growth of $532 million for the quarter was led by a $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 non-interest bearing deposits of $750 million comprised 86% of the $874 million increase in total. The continued success in deposit gathering for non-interest bearing deposits has increased that proportion of the portfolio to 45% compared to 39% one year ago and reduced the increase of 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 a 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 1st, bringing total nonperforming loans up $25 million to $55 million.
Upon receiving these results, we sold the loan with a loss of $1.4 million. As the conditions that resulted in this loss occurred prior to October 1st, 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 as the disposition of the downgraded loan was reflected in the third quarter results. The same is true for NPAs, which would have been 31 basis points of total assets including loan disposition instead [hp] of 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 a $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 a $136 million, which is $13 million from a year ago.
This reserve was 1.06% of non-acquired loans at September 30th, as acquired loans are booked at a discount to the unpaid principal balance and consequently have no reserve at acquisition. For acquired loans, on a 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 solid capital growth for the quarter essentially matched our strong balance sheet growth, leaving our capital ratios essentially flat from June 30, while edging higher during the past year. Tangible book value per the share rose $0.82 in the third quarter to $17.53 and is up 18% in the past year, matching 18% return on average tangible common equity that we’ve had for the past four quarters.
Robert Sarver
Looking forward in terms of finishing out the year, I don’t think you really see any surprises. We are essentially on plan to kind of the numbers and the guidance we have given you over the last three quarters.
As we have mentioned earlier, our loans year-to-date are up $1.3 billion organically and our deposits were up $2.4 billion. I would say that the positive growth is probably a little more frontend 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, at the end of the day, balance sheet growth is 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 the 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 looks much different than 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
Thank you. [Operator Instructions] And the first question today will come from Casey Haire of Jefferies.
Casey Haire
Thanks, guys. I wanted to start off on the excess liquidity.
It looks like you guys -- I mean, it was elevated, 850 or so on average. It 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?
Robert Sarver
Yes. So, the purchases that we did and then, toward the end of the quarter, 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 where our cash position was a little bit higher. Also, our loan growth was kind of backend 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. 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 will put some of that out.
Casey Haire
And just switching to expenses, I thought the message was that revenues were going to grow around 1.5 times 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?
Robert Sarver
Dale always, -- you can’t listen to Dale on the operating leverage or the margin. So, he -- we’re doing a little better than we thought we would, but I don’t know.
We’re doing fine…
Casey Haire
Okay.
Robert Sarver
You got to kind of do your own model.
Casey Haire
All right, very good. Just lastly, the M&A front, activity levels just -- is it still an active pipeline and you guys just being disciplined, just some updated thoughts there?
Robert Sarver
Yes. We’ve looked at some deals, we’ve looked at some non-bank lending platforms, which actually have been 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 going to grow more than 20% once we’ve folded in.
So, that activity hasn’t led to anything in the last 12 months.
Operator
The next question comes from Brad Milsaps with Sandler O’Neill.
Brad Milsaps
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 in the fourth quarter, but how big can this get in your mind, what’s kind of the runway there and continuing to grow the DDA balances longer term?
Robert Sarver
I’m going to turn that over to Ken. He has been on the road a lot in the last month and meeting with our different regional heads and different National Business Lines groups.
So, go ahead, Ken.
Ken Vecchione
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 would 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.
Brad Milsaps
Okay. 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 the seasonal decline of that business. Just curious kind of what areas you see growing the fastest.
I think it’s interesting you guys really haven’t grown CRE at all this year, just 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 year - the last quarter of the year?
Dale Gibbons
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 little more selective in terms of our underwriting standards now as valuations have gotten pretty frothy in that area. So, we’ve been little more focused on the residential construction side, lots and houses which we think are 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 and 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 reasons maybe our deposits are growing quite a bit faster is that 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 the new plant, new facilities is fairly low. So, we’re adding a lot of customers that hopefully will start borrowing a little more money.
But right now, their appetite for debt is still pretty muted.
Robert Sarver
Regarding mortgage warehouse, as you know, 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 some of the other players in this space have indicated for the fourth quarter, but it will be down.
Operator
And our next question will come from Timur Braziler of Wells Fargo.
Timur Braziler
Maybe just one follow-up on the warehouse business. What percentage of the growth came from new clients versus increased utilization at existing clients?
Robert Sarver
Mostly new clients.
Timur Braziler
And how does that new client pipeline look, heading into fourth quarter and 2018?
Ken Vecchione
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 are 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.
Robert Sarver
We’ve also developed a niche in 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 in their lending money at more maybe the 80%, 85% advance rate. We’re putting in warehouse lines for those clients, where we’re essentially lending 56% to 60% of what their 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. We’ve developed nice little niche there.
Timur Braziler
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?
Robert Sarver
It’s pretty broad based.
Timur Braziler
And then, I guess, just one last one for me if I could. As you’re looking into 2018, maybe I 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?
Robert Sarver
I don’t think a lot. I mean, we’ll continue to recap 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 in Gilbert, which is a little bit growing area. And over the last 12 months with Bridge, we’ve opened up a 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 are at now.
So, I think it looks pretty predictable going into next year.
Timur Braziler
And then just one modeling question. What was the charitable contribution made this quarter?
Robert Sarver
We just spent a lot more money. We have got -- it was a tax credit deal in Arizona where if you give some money to nonprofit kind of schools to help low income kids its scholarships, you get a tax credit dollar for dollar.
It’s a program state of Arizona has. So, the credit is more fully 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 costs us anything, but we will get a tax credit over the remainder of this year that will kind of reduce our income taxes but the actual money is donated in certain months and so it pops up a little bit.
Dale Gibbons
The tax recovery comes in a different period generally than when the charge is taken on the donation.
Operator
And next we have a question from Michael Young of Suntrust.
Michael Young
Rob, I just wanted to ask a big picture question if we are back on the kind of 2x expense or 2x revenue growth to expense growth rate. I mean, does that sort of pretend that the efficiency ratio is going to continue to decline at 200 basis points to 300 basis points a year like it has for the last several years.
Robert Sarver
I don’t know, probably not, but maybe. I don’t know.
We are going to continue to grow revenue faster than our expense; that’s our culture, we have been doing that a long time. Whether you could go with those numbers, that’s probably a little aggressive to model.
If you just keep it at 40%, we make a lot of money; you will be okay. We may do little better, but you know...
Michael Young
Getting greedy, I got you. And then, maybe just a little more, Dale, just on the professional fees.
You called that out due to the vesting of board director restricted stock. I mean, is this kind of a good run rate going forward or is that going to pop back up?
Dale Gibbons
It will pop back up in the first quarter. So, it’s heavy in Q1 and Q2, much lighter in Q3 and Q4.
Operator
And next we have a question from Christopher McGratty of KBW.
Christopher McGratty
If you look at year-to-date headcounts, up about 11%, I’m interested in kind of color, how much of that is kind of revenue producing people that you talked about versus kind of back office deal as we come up as a bigger company?
Dale Gibbons
So, the actual revenue producers in that were 7 FTEs but a lot of the other individuals involved do support the revenue production. 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 teams, as Robert mentioned and -- about half of those remaining people are support people for those teams.
Christopher McGratty
And maybe, Dale, if I can ask a kind of margin question. Excluding the accretion, it looks like your core was up a few basis points, obviously with June, helping by the fed but also the cash in a bit.
As you kind of stand today, given the dynamics of the balance sheet, it’s kind of few basis points a quarter, ex-rates moving again, about a fair assumption. I think in the past you talked about each 25, is about [indiscernible]
Dale Gibbons
Yes. So, if we get that increase in December, that’s only going to count for one sixth, so that wouldn’t be much of 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 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. I 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 [ph] experience.
Christopher McGratty
And maybe if I could, the tax rate going forward, given the comments about the contribution, fourth quarter into 2018, how should we think about that?
Dale Gibbons
Yes. I think the tax rate we’re at right now on year-to-date basis is likely what we’re going to continue to see.
I’m not looking for a significant increase, nor 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 accounting for taxes or compensation on restricted share awards.
Operator
And next, we have a question from Jon Arfstrom of RBC.
Jon Arfstrom
Follow-up on Brad Milsaps question earlier on the non-interest bearing growth. Ken, maybe a question for you.
That number, non-interest bearing as a percentage of total deposits keeps creeping up. And curious if there is 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?
Ken Vecchione
Maybe a little bit.
Robert Sarver
When we acquired Bridge Bank, their DDA as a percentage of total deposits was about 68%. And so, there’re certain segments of our portfolio that have a little more opportunity.
But that said, at a higher rate environment, the incentives that clients have to do something in an interest bearing capacity obviously rises, so.
Ken Vecchione
We did a lot of core deposits in 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 got there were some on 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 report contact with us for everything. And often times, some of our larger bank competitors are real active on the credit side in some of the 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.
Jon Arfstrom
Okay. That makes sense.
It’s just very -- that percentage continues 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.
Robert Sarver
Yes. The deposit piece has always been really kind of a hallmark of our franchise, and I think as Ken mentioned earlier, it’s really part of our culture, so.
Jon Arfstrom
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 else there that’s bothering you, anything you’re watching little more closely?
Robert Sarver
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 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.
Ken Vecchione
One maybe quick story on that. I was out couple offices and one of the younger folks said to me, well, what credit loss amount is acceptable, what is -- or what credit loss ratio is acceptable?
And I tried to explain them that zero is the number we shoot for. And that’s what’s acceptable.
But more importantly, we don’t want credits that start out at pass, move down the special mention, find a way to substandard. We’ve got to work like have to move and 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 -- 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 pass loan.
And that’s the mental set. It’s sort of like [indiscernible], 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 fields and all the vendors.
Operator
And this concludes our question-and-answer session. I would like to turn the conference back over to Robert Sarver for any closing remarks.
Robert Sarver
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, rollin’, rollin’, rollin’, keep them doggies rollin’, Rawhide.
That’s a wrap. Thanks, guys.
Operator
The conference has now concluded. Thank you for attending today’s presentation.
You may now disconnect.