Western Alliance Bancorporation: higher valuation warranted (NYSE: WAL)
Bank stocks have been battered from both sides in 2022. Not only have they had to deal with the market selling off (due to supply chain concerns, geopolitical tensions and rising rates), but they also experienced sectoral problems. for fear of Russian-led cyberattacks.
But the pain didn’t stop there. Bank stocks also felt the force of lower long-term rates as investors rushed to quality and into safer assets like gold and bonds.
Demand for bonds has pushed down longer-term rates, which is generally bad news for banks that borrow short and lend long. The chart above shows 10-year yields over the past year and the chart below shows the KBW, a banking index comprising major US national currency centers, regional banks and thrifts. When the above yields begin to decline in mid-February as over 100,000 Russian troops gathered at the Ukrainian border, the KBW index also begins to decline, losing 11% so far.
Overall, bank stocks (as measured by the KBW) are down 14% from their 2022 highs against the broader market correction of approx. 9%. However, with the fed funds rate on the rise and valuations pricing in nearly all the bad news available, now is a great time to start looking at the banks.
But which one? We look for undervalued bank stocks that will perform especially well in a rising rate environment, research that led us to Western Alliance Bancorporation (NYSE:WAL).
Western Alliance Bancorporation was founded in 1994 and currently operates in two segments, commercial and consumer. WAL has been beaten more than the general sector, losing more than a quarter of its value since hitting highs in January 2022, which is more than double the decline of KBW.
The title is now showing signs that the hard times are over. WAL bounced around the support at $89 last week and currently sits at $92. The MACD and CCI both indicate that the stock is oversold and may be on the verge of a comeback.
From a technical standpoint, the stock looks ripe for selection, but we also like WAL for fundamental reasons and expect it to outperform expectations this year due to cautious guidance and a interest rate sensitivity management.
Net interest income
WAL expects the addition of AmeriHome to help by accelerating “diversification of loans, deposits, EPOs and product channels.” AmeriHome issues home loans and buys closed mortgages across the United States. The market may well be undervaluing the addition of AmeriHome to WAL’s 2022 and 2023 top line.
For example, the company has moved toward a deposit growth floor of $2 billion; however, on the first quarter conference call, he also opined that he expects the actual figure to be more than double, with most of the above forecast coming from AmeriHome. Similarly, we expect management to have played down the potential loan growth we will see over the next two years.
Management seemed keen to make investors aware that its 2022 guidance is conservative, and for good reason:
The table above shows that management generally likes to be conservative. The average deviation from the guidance is +14.8%.
In truth, we probably won’t be able to meaningfully assess the sub guidance until later in the year when AmeriHome ramps up, but management also expects a big Q3 and Q4 due to the “seasonality and cyclical nature” of their business.
Sensitivity to interest rates
Another interesting point for the company is that WAL has positioned itself to benefit from the high rate environment via significant increases in net interest income. They did this via a) interest rate floors on their available rate commercial loans, and b) increasing fixed rate residential mortgages.
Management has done an excellent job of increasing the proportion of floating rate loans in anticipation of rate increases. 94% (2020: 82%) of WAL’s floating rate loans are at their floors and management expects a 25 basis point rise in rates to lift 25% of these loans from their floors to 75% of loans in a 100 bp rise in pricing environment. In its ramp-up scenario, it forecasts a $62m increase in net interest income (reaching $73m in a shock rate hike +100bps scenario).
The main risk to our valuation is that the company does not achieve its growth targets, which we consider to be relatively distant.
One of its biggest markets is in Nevada, which is heavily tourism-based, so a weak consumer and COVID resurgence could mean the stock lacks direction.
Employment has increased in Nevada since the pandemic, but investors would be wise to keep an eye out for negative job growth.
WAL is valued by reference to their peer group and their own historical averages.
The top of our valuation range assumes that WAL’s valuation multiple can catch up to the peer average, while the bottom of our range assumes that WAL’s valuation remains anchored at its historical average. The base case on which we anchor our expectations, and which we consider to be the most probable scenario, takes the average of these two scenarios.
With a full year EPS estimate (approximately 2.5% above the street target) of $9.99, we can expect a price underperformance.
Our baseline expectation is for WAL to reach $140 by YE 2022 for a 55.5% return. We first expect the bank to return to its volume-weighted average price between $103 and $107 before moving to $140.