Western Alliance Bancorporation Stock: Strong Growth on Cards (NYSE:WAL)

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courtney

Earnings of Western Alliance Bancorporation (NYSE:WAL) will most likely continue to rise in the coming quarters due to the remarkable loan growth. In addition, a slight expansion in margins will support revenues. On the other hand, higher provisioning will limit earnings growth. Overall I expect Western Alliance Bancorporation will report earnings of $10.0 per share for 2022, up 15% year-over-year. Compared to my last company report, I haven’t changed my revenue estimate much. For 2023, I expect earnings to grow another 17% to $11.7 per share. The year-end target price suggests a strong upside from the current market price. Therefore, I maintain a buy rating on Western Alliance Bancorporation.

Loan growth expected to slow after phenomenal second quarter

Western Alliance Bancorporation reported outstanding loan growth of 18.2% in the second quarter of 2022, or 72.8% annualized. Most impressively, this growth was mostly organic, with only a small portion attributable to accounting metrics. Western Alliance transferred $1.9 billion (4% of loans) from loans held for sale to loans held for investment. Within organic loan growth, the commercial and industrial segment, C&I, was the primary driver of loan growth.

Loan growth in the second quarter obviously cannot be sustained because it is an anomaly. Additionally, interest rates are expected to peak later this year before falling next year. Such an interest rate outlook will encourage borrowers to postpone some of their less urgent borrowing plans until next year.

On the other hand, strong labor markets will support loan growth. Western Alliance is a national lender; therefore, the national unemployment rate is an appropriate indicator of corporate credit demand. The labor market is close to full employment and at historically low levels, as shown below.

US unemployment rate
US unemployment rate data from YCharts

Management said on the conference call that it expects loans and deposits to grow by more than $2 billion per quarter. Part of management’s confidence is attributable to strong lending pipelines.

Based on the factors listed above and management guidance, I expect the loan portfolio to grow 36% in 2022. In my last report on Western Alliance, I estimated loan growth at 21% for this year. I have revised my estimate of loan growth for the year upwards, primarily due to the phenomenal performance of the portfolio in the second quarter of 2022. For 2023, I expect loan growth returns to a more normal level. Meanwhile, I expect other balance sheet items to grow mostly in line with lending. The following table shows my balance sheet estimates.

EX18 FY19 FY20 FY21 FY22E FY23E
Financial situation
Net loans 17,558 20,934 26,774 38,823 52,870 61,850
Net loan growth 17.4% 19.2% 27.9% 45.0% 36.2% 17.0%
Other productive assets 4,087 4,307 8,009 13,526 13,524 13,935
Deposits 19,177 22,796 31,931 47,612 57,816 66,345
Loans and sub-debts 874 410 554 2,414 6,004 6,248
Common equity 2,614 3,017 3,414 4,668 5,169 6,275
Book value per share ($) 24.8 29.3 34.0 44.7 48.0 58.3
Tangible BVPS ($) 22.0 26.4 31.0 38.6 41.5 51.8

Source: SEC filings, earnings releases, author’s estimates

(In millions of dollars, unless otherwise indicated)

Margin moderately rate sensitive thanks to sticky deposit costs

The share of non-interest bearing deposits in total deposits declined in the second quarter. Nevertheless, non-interest bearing deposits still make up a significant portion of the deposit portfolio. According to the details given in the 10-Q file, non-interest bearing deposits represented 44.2% of total deposits at the end of June 2022, compared to 45.1% at the end of March 2022 and 44.8% at the end of December. 2021. These deposits will make the average cost of deposits stable on the upside in a rising rate environment.

The strong anticipated loan growth discussed above will likely further support the margin. The results of management’s interest rate sensitivity analysis presented in the earnings presentation showed that a 100 basis point increase in interest rates could increase net interest income by 5.3 % over twelve months.

Western Alliance Bancorporation Interest Rate Sensitivity

Presentation of Western Alliance Bancorporation 2Q 2022

Given these factors, I expect the margin to increase by 18 basis points in the second half of 2022 before stabilizing next year.

Drive Provisioning Loan Additions

Western Alliance reported an unusually high net provision charge for the second quarter of 2022, primarily due to extraordinary loan additions during that quarter. Additions to the portfolio will most likely continue to be the main source of funding in the coming quarters. In addition, rising interest rates and the resulting increase in borrowing costs for floating rate loans will deteriorate the quality of portfolio assets. In addition, the possibility of a recession will require additional funding.

On the positive side, approximately 27% of the loan portfolio is protected by credit protection, including government guarantees, as mentioned in the presentation of the results. Overall, I expect the net provision charge to be around 0.24% of total loans (annualized) in the second half of 2022 and 0.13% of total loans in 2023. In comparison, the net provision charge averaged 0.11% of total loans. from 2017 to 2019.

In my last report on Western Alliance Bancorporation, I estimated a net provision charge of $30 million for 2022. By comparison, I now expect a net provision charge of $97 million. I have revised my provisioning estimate upwards due to stronger than expected loan growth. In addition, a larger than expected deterioration in the economic outlook has pushed my estimate up.

Earnings to increase by 15%

Remarkable loan growth and modest spread expansion will play a central role in driving earnings growth this year and next. On the other hand, higher provisioning charges will likely dampen earnings growth. Overall, I expect Western Alliance to report earnings of $10.0 per share for 2022, up 15% year over year. For 2023, I expect the company to report earnings of $11.74 per share, up 17% year-over-year. The following table shows my income statement estimates.

EX18 FY19 FY20 FY21 FY22E FY23E
income statement
Net interest income 916 1,040 1,167 1,549 2,173 2,567
Allowance for loan losses 23 19 124 (21) 97 80
Non-interest income 43 65 71 404 391 385
Non-interest charges 426 483 492 851 1,109 1,275
Net income – Common Sh. 436 499 507 896 1,077 1,265
BPA – Diluted ($) 4.14 4.84 5.04 8.67 10.00 11.74

Source: SEC filings, earnings releases, author’s estimates

(In millions of dollars, unless otherwise indicated)

In my last Western Alliance report, I estimated earnings per share at $9.92 for 2022. I haven’t changed my earnings estimate much, as the upward revision to the earnings growth estimate loans reverses the upward revisions to operating and provisioning expenses.

Actual earnings may differ materially from estimates due to the risks and uncertainties associated with inflation and, therefore, the timing and magnitude of interest rate increases. Also, a deeper or longer than expected recession may increase the expected loan loss provisioning beyond my estimates.

Maintaining a Buy rating due to a high rise

Given the earnings outlook, I expect Western Alliance to increase its dividend per share from $0.02 to $0.38 in the third quarter of 2023. Earnings and dividend estimates suggest a payout ratio of 13% for 2023, which is in line with that of 2020. -2021 average of 15%. The dividend expectation for 2023 implies a dividend yield of 1.9%.

I use historical price/book tangible (“P/TB”) and price/earnings (“P/E”) multiples to value Western Alliance. The stock has traded at an average P/TB ratio of 2.05 in the past, as shown below.

EX18 FY19 FY20 FY21 Medium
T. Book value per share ($) 22.0 26.4 31.0 38.6
Average market price ($) 56.1 46.2 41.7 98.1
Historical P/TB 2.55x 1.75x 1.34x 2.54x 2.05x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple by the expected tangible book value per share of $41.5 yields a target price of $85.1 for the end of 2022. This price target implies an upside of 10.2% compared to the closing price on August 5. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB 1.85x 1.95x 2.05x 2.15x 2.25x
TBVPS – Dec 2022 ($) 41.5 41.5 41.5 41.5 41.5
Target price ($) 76.8 80.9 85.1 89.2 93.4
Market price ($) 77.2 77.2 77.2 77.2 77.2
Up/(down) (0.5)% 4.9% 10.2% 15.6% 21.0%
Source: Author’s estimates

The stock has traded at an average P/E ratio of around 10.7x in the past, as shown below.

EX18 FY19 FY20 FY21 Medium
Earnings per share ($) 4.14 4.84 5.04 8.67
Average market price ($) 56.1 46.2 41.7 98.1
Historical PER 13.6x 9.6x 8.3x 11.3x 10.7x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple with the expected earnings per share of $10.0 yields a target price of $106.7 for the end of 2022. This price target implies a 38% upside from the stock price. August 5 closing date. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E 8.7x 9.7x 10.7x 11.7x 12.7x
EPS 2022 ($) 10.00 10.00 10.00 10.00 10.00
Target price ($) 86.7 96.7 106.7 116.7 126.7
Market price ($) 77.2 77.2 77.2 77.2 77.2
Up/(down) 12.3% 25.3% 38.2% 51.2% 64.1%
Source: Author’s estimates

An equal weighting of the target prices from the two valuation methods gives a target price of $95.9, which implies an increase of 24% compared to the current market price. Adding the forward dividend yield gives an expected total return of 26%. Therefore, I maintain a buy rating on Western Alliance Bancorporation.

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