Update: Western Alliance Bancorp

August 9, 2023 | Premium Service | Moody’s (MCO) downgraded the credit rating of a number of banks this week and put more on watch for a future downgrade. These were institution-specific downgrades that were more attributable to the bank failures in Q1 2023 than to the downgrade of the US by Fitch Ratings earlier this month.

A couple of readers asked about the impact of the US ratings downgrade on the largest globally systemically important banks (GSIB). Here's what you need to know:

• First, in the world of credit we always use the lowest rating. Now that S&P and Fitch are at AA+ for US risk, the whole credit market must go there in terms of using the lowest rating for asset allocation purposes. We could ignore S&P for a decade. Not now.

• Second, GSIBs tend to have 1-2 ratings notches of "uplift" in the rating on the assumption of sovereign support. In the US, one notch. Japan, two notches for GSIBs. Most of the agencies have explicit sovereign support in their published criteria.

When the sovereign goes down, everything else in the world of credit ratings that depends upon it goes down, GSIBs, GSEs, agencies, etc. The sovereign credit of the US is now AA+. The rating on Ginnie Mae MBS is now AA+. And the sovereign rating may go lower before we are done. Large banks will definitely move lower as Moody and other agencies adjust their view of the industry’s prospects.

The Basel capital proposal, in this regards, is pretty much a guarantee of downgrades for the largest US banks, first because it hurts profitability. The increase in risk weights for high-LTV loans will basically push commercial banks out of lending to low-income households.

The Mortgage Bankers Association (MBA) has voiced strong opposition to the Basel capital rule changes, pointing out seven key areas that could affect major banks and regional banks, lenders, servicers, and borrowers within the housing finance ecosystem.

Western Alliance Bancorp

In February of 2021, when The Institutional Risk Analyst wrote about the combination of Western Alliance Bancorp (WAL) and Apollo Global Management (APO) offspring AmeriHome, we described the marriage of a great wholesale bank with one of the leading aggregators of conventional loans.

Built by APO on a greenfield platform, AmeriHome remains one of the dominant bidders for conventionals – sometimes maybe too dominant — but within a bank that has changed dramatically in the past two years. As we noted in our last comment, the fact of APO being a seller of AmeriHome in 2021 may have been the point, with industry total new issue volumes below $2 trillion with 90% purchases mortgages.

With industry losses on every loan closed well north of 200 bp, you might ask yourself why WAL would still be buying conventional loans. Several issuers tell The IRA that AmeriHome has been bidding more than half a point above other aggregators for conventional loans. The answer in simple terms is coupons above 7% and rising. Even before acquiring AmeriHome, WAL excelled at achieving levels of interest earnings well-above its peers.

In Q1 2023, WAL had increased its gross yield on loans and leases to over 6.2% The bank’s yield on earning assets is a full point higher than the average for Peer Group 1. As the chart below suggests, the $70 billion asset WAL is outpacing most of the regional leaders in Peer Group 1 in terms of gross yields.

Source: FFIEC

Like most banks, WAL has seen an uptick in delinquent loans, but the bank’s credit performance remains stellar vs its peers. WAL’s expenses have risen as its insured deposits have grown, but the bank now has the highest ratio of insured and collateralized deposits and tangible capital in Peer Group 1. The chart below comes from the WAL Q2 2023 earnings presentation.

In most ways, WAL outperforms its asset peers and the larger players in Peer Group 1 by a considerable margin. So why is the stock just 1x book value, this after running up 40% in the past month? Short answer is that many people recognize the superior operating performance of WAL and want to benefit from management’s aggressive restructuring of the loan portfolio and funding base. WAL, for example, is expecting to expand net interest margin in 2H 2023 after several quarters of house cleaning.

It is interesting to note that WAL has managed to retain 1/3 of total deposits in non-interest bearing balances. The cost of funding has risen in line with Peer Group 1, but the $80 billion asset bank's funding seems quite solid. But perhaps the larger reason to look at WAL is management's consistent track record of delivering value to shareholders in terms of tangible equity. The chart below comes from the Q2 2023 WAL earnings presentation.

The bottom line on WAL for us is that the bank has stabilized from the problems seen in the first quarter of 2023. It is good to see the stock trading above book value again, especially since WAL was the best performing large bank in the US in 2021.

We prefer holding New York Community Bank (NYCB) to WAL at the present time because of NYCB's strong funding, but as and when an interest rate cut comes into view, WAL will likely benefit. Given the growing distress at many non-bank mortgage firms, we suspect that WAL and other depositories will be long-term survivors in the mortgage lending channel.

Source: Google

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