Western Alliance Bancorporation

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Western Alliance Bancorporation is a bank holding company with diversified banking services, with a focus on commercial banking, treasury management, real estate and homeowner services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Western Alliance Bancorporation (WAL), headquartered in Phoenix, Arizona, operates as a commercial bank focused on providing a range of financial services. The bank’s core operations revolve around commercial banking, treasury management, real estate lending, and homeowner services.

  • Revenue Distribution: WAL generates revenue primarily through net interest income (NII), which is the difference between interest earned on loans and interest paid on deposits, and non-interest income which is mainly generated through fees and other services. The bank operates through several different segments: Commercial Banking, Consumer Banking, Corporate and Other.
  • Industry Trends: The banking industry is currently facing increased uncertainty. Inflation, the Federal Reserve’s rate hikes, and a potential recession are all creating headwinds. Interest rates hikes put pressure on funding costs, while a slowing economy could affect the amount and quality of loan activity.
  • Competitive Landscape: The banking sector is quite competitive, with numerous players ranging from large national banks to small regional and community banks. These players compete on factors including interest rates, product offerings, customer service, and brand reputation. In the current environment, smaller banks like WAL are increasingly squeezed by the competition of bigger banks due to interest rate hikes and a potential recession, in turn hurting smaller banks’ funding and profitability. This is why they are often seen to become acquisition targets for bigger banks.
  • What makes the company different?: WAL sets itself apart through a number of factors. The bank operates through a “high-touch” model focused on relationship banking and specialized lending. This means that it focuses on catering to specific needs of its clients, often in industries it knows well. This approach may enable WAL to attract customers and offer specialized products and services. Furthermore, it concentrates on providing banking services across high-growth markets which could potentially result in growth as its presence in those areas increases. The company also has a digital payment platform and services through its digital subsidiary, and has made significant investments into its infrastructure in order to enhance its digital capabilities to improve the client experience.

Financial Analysis

Here’s an overview of WAL’s financials, incorporating data from the latest reports.

  • Overall Trend:

WAL is demonstrating a slowdown in revenue growth amid economic uncertainty.

  • Net Interest Income: In Q3 2022, the net interest income was $630 million (up 18.1% from Q2 2022). In Q3 2023, the net interest income was $596.5 million, a decrease of 5.3% as a comparison. The Net Interest income is declining which the management believes its due to an increased cost of funds and higher deposit rates, despite having strong loan growth. The company is projecting a higher cost of funding for 2024 in their guidance and are trying to offset this by increasing rates, but that strategy could cause further risks. In Q3 2023, net interest income as a percentage of average total assets has declined from 3.73% in Q2 2023 to 3.17%. This indicates how the net interest income is declining while assets are increasing.
  • Non-Interest Income: WAL has seen a slight decrease in non-interest income to $83.2 million in the most recent quarter compared to the prior one. Non-interest income, is highly cyclical and is largely comprised of investment banking revenue, net gains on sale of loans, and fees. This means that the company is more exposed to the effects of the economic cycle than a pure commercial bank.
  • Revenue: For the third quarter, the company’s total revenue was 831.6 million compared to 862 million in the second quarter of 2023. Revenue is down 3.5% over the quarter. This indicates slowing growth at the company.
  • Return on Invested Capital (ROIC): While the exact ROIC is not specified in the given documents, ROIC is a metric that measures the profitability of a company, is an important metric in the financial industry. The bank is aiming for a ROIC of 1.4 percent, it is not disclosed if it was the result they wanted to achieve in a year. In the past, however, WAL has managed to return relatively high rates on invested capital compared to the market, as its focus in specific industries allows it to enjoy profitability in niche areas, which gives an advantage compared to other average commercial banks.
  • Capital Structure: The bank’s capital structure includes a mix of debt and equity, with the equity ratio being 11%. Tier 1 capital ratio and leverage ratios for the company are well above regulatory minimums, indicating solid financial health.

  • Profitability and Efficiency: Despite a decrease in revenue, the bank still has robust performance, as it is able to produce earnings of $213 million in Q3 2023 compared to $213.5 million in Q2 2023. While the bank aims to control costs, a significant increase of the workforce in the company has driven higher salaries to the company, which has driven operating expenses to higher levels as well. The efficiency ratio for the company is 31.7% for the last 3 months.

  • Recent Concerns: WAL experienced a major shock in its stock price during Q1 of 2023 when the banking crisis was unfolding due to the collapse of Silicon Valley Bank, due to deposit volatility and concerns over the bank’s assets and liquidity. While these fears are somewhat unfounded now, as there is no bank run in the company currently, this shows how much market sentiment can change very fast. It must be noted that these concerns came from outside, and that the company itself has not been facing significant fundamental concerns other than those tied to macroeconomic trends.
  • Management’s Stance: Management is constantly monitoring the developments in the markets and its own performance, and has reiterated their long term goals that focus on profitability. They are focusing on revenue generation, with a focus on specialized banking strategies. They are also keeping an eye on the changes in the economy and are prepared to change their strategy if and when required.

Moat Assessment

An economic moat represents a company’s sustainable competitive advantage that protects its profits from competitors.

  • Moat Strength: Based on the information provided, WAL appears to have a Narrow Moat (2/5). The company’s strengths lie in its focused lending approach, its established network within specialized industries, and its high-touch relationship banking with clients, which can produce long term relationships and loyalty. However, its current cost structure, high exposure to interest rate changes, and the competition of other banks does not allow for a stronger position, and thus a wider moat. Although the company benefits from network effects in specific industries that it is heavily involved in, its focus on niche sectors, as opposed to mass-market, does not have the same moat characteristics as other companies with similar network effects, meaning that its competitive advantage is more restricted to niche sectors, and would not be as applicable for other areas.
  • Risks to the Moat:
  • Interest Rate Risk: The bank’s revenues and financial structure can be easily affected by changes in interest rate, as its loan rates are usually tied to prevailing interest rates, so that an increase would be beneficial to the company, however, deposits rates usually increase with it, negatively impacting the profits for the company.
  • Industry and Competition: Since WAL is a bank, it faces the constant risk of new competitors entering the financial sector, as well as the competition from existing banks. Increased consolidation in the banking industry means bigger competitors, which could squeeze smaller banks like WAL. Also, Fintech companies are a growing threat, with innovative solutions that might compete with services provided by WAL in the long term, requiring management to adjust accordingly.
  • Economic Downturn: Being a bank, WAL is highly susceptible to recessions and economic contractions, which could hurt its business due to lower loan growth and increasing credit losses. Downturns are usually bad for most banks, leading to a decrease in revenues, and a worsening in the quality of the loan portfolio, requiring the bank to increase its allowance for loan losses, and in turn, decreasing profitability.
  • Business Resilience: While WAL has strengths that help with its sustainability, in practice the bank’s operations are somewhat cyclical. This is due to the nature of the financial industry which has a greater exposure to economic downturns. In this vein, the company’s profitability is tied to the rate of return on its loans, while the cost of funding can sometimes quickly rise due to interest rate hikes from the Federal Reserve. All of these things make the company less resilient than other businesses that have less sensitivity to macroeconomic trends. However, its focus on niche industries helps the company to retain solid customer relationships and limit losses when external factors make revenues harder to obtain.

Understandability

This rating reflects how easy it is for an average person to understand the business model.

  • Understandability: I’d give WAL a rating of 3/5. While the core business of banking is relatively straightforward (taking deposits and providing loans), the specific nature of its target markets, its use of specialized strategies, and the various regulations around finance may be more difficult for investors to fully understand. Also, some accounting practices in banks can be somewhat complex. While the company tries to be transparent, the many moving pieces of the business could cause misunderstanding for non-banking experts. This means the company should be approached with reasonable caution, and may be hard for all investors to fully understand.

Balance Sheet Health

This rating reflects the stability of the company’s assets and liabilities.

  • Balance Sheet Health: WAL’s balance sheet health is rated 3 / 5. On the positive side, the company has a strong base of assets and a high ratio of Tier 1 capital (at 12.6%), indicating solid financial health. However, it has seen an increase in net charge-offs from 0.09% in Q2 2023 to 0.27% in Q3 2023, along with a large decrease of 17% in loans to finance companies. These facts indicate the company’s vulnerability to the economic downturn. It is worth to note that while WAL was able to keep its debt level steady, the company had to face a rapid increase in deposits in Q1 of 2023 due to the influx of capital, however this increase has slowly diminished in the last 2 quarters as deposits leave the company, while loans still grow. This could also potentially create concerns over the company’s liquidity. Further, the company has several intangible assets which further obscure its true value, making its assets a bit more difficult to value.