A Strategy For Sustained Growth In The Banking Sector

Key Takeaways

• Strategic emphasis on high-quality C&I loans shows a commitment to enhanced earnings with lower risk, implying better net margins.
  
• Expected net interest income growth, alongside reduced interest expenses due to forecasted rate cuts, indicates improved future margins and earnings.
  
• Risks from higher interest rates, dependence on mortgage warehouse deposits, and intense mortgage competition could impact loan performance, liquidity, and profitability.

Catalysts

Operates as the bank holding company for Western Alliance Bank that provides various banking products and related services primarily in Arizona, California, and Nevada.

• Deposits growth exceeding guidance and the significant core deposit growth of $4 billion signals sustained liquidity strength, boosting the ability to fund loan growth, likely positively impacting revenue growth and net interest income.
  
• Notable loan growth, especially in the Held for Investment (HFI) portfolio, growing $1.7 billion or 14% on an annualized basis, aimed at exceeding peer growth, suggests potential revenue growth through increased interest income.
  
• Enhanced liquidity profile and capital base, with CET1 capital remaining at 11% despite aggressive balance sheet growth, indicates operational resilience and potential for future growth, positively affecting earnings stability and capacity for further lending.
  
• Strategic focus on no to low loss Commercial & Industrial (C&I) loans due to deep segment and product expertise, indicates a higher quality of earnings with reduced risk, likely enhancing net margins.
  
• Anticipated net interest income growth of 9% to 14% from the Q4 2023 annualized rate, combined with expectations of lowering interest expenses as rate cuts approach, suggests improved net interest margins and earnings growth into the future.

Assumptions

• Analysts are assuming Western Alliance Bancorporation's revenue will grow by 12.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 25.6% today to 34.1% in 3 years time.
• Analysts expect earnings to reach $1.4 billion (and earnings per share of $11.04) by about October 2027, up from $722.7 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $960 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 11.1x on those 2027 earnings, down from 13.7x today. This future PE is lower than the current PE for the US Banks industry at 11.9x.
• Analysts expect the number of shares outstanding to grow by 4.24% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.99%, as per the Simply Wall St company report.

Risks

• Risks associated with higher interest rates impacting debt service costs for CRE, potentially affecting loan performance metrics such as DSCR and LTV ratios, which could influence net interest income and overall asset quality.
  
• Dependence on mortgage warehouse deposits for growth may increase exposure to seasonal fluctuations and interest rate changes, affecting the bank's liquidity profile and net interest margin.
  
• Intense competition in the mortgage business, exacerbated by rate cuts, could influence the bank's market share and profitability in this segment, impacting noninterest income from mortgage banking.
  
• Elevated provisioning for loan losses in an expanding loan portfolio, especially if loan growth exceeds expectations, could pressure earnings due to the CECL accounting model requiring upfront recognition of expected credit losses.
  
• Market assumptions on the trajectory and impact of Federal Reserve rate cuts may not align with actual outcomes, influencing the bank's ability to manage interest expense on ECR deposits and affect net interest income.

Valuation

• The analysts have a consensus price target of $100.13 for Western Alliance Bancorporation based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $110.0, and the most bearish reporting a price target of just $87.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $4.0 billion, earnings will come to $1.4 billion, and it would be trading on a PE ratio of 11.1x, assuming you use a discount rate of 7.0%.
• Given the current share price of $90.88, the analyst's price target of $100.13 is 9.2% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.