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Text: Joining me on the call today are Dale Gibbons and Tim Bruckner, our Chief Financial Officer and Chief Credit Officer.
I will first provide an overview of our quarterly results and how we are managing the business in this current economic environment, and then Dale will walk you through the Bank's financial performance.
I would like to focus on three trends that were present this quarter and will continue throughout the year: PPNR strength, credit provisioning expense and balance sheet growth.
Combined, these trends will support earnings and capital growth and dividend distribution throughout 2020 and 2021.
Starting with our second quarter results, Western Alliance generated net income of $93.3 million and earnings per share of $0.93, which was up 12% over the previous quarter.
Tangible book value per share of $27.84 was an increase of 4.2% over the previous quarter and 12.9% year-over-year.
Driving these results was record operating pre-provision net revenue of $194.7 million, up 27.7% year-over-year and 19.1% quarter-over-quarter, with strong operating PPNR ROA growth of 18 basis points to 2.56%, which benefited from a recognition of $13.9 million in Payment Protection Program net fees.
These results demonstrate that the long-term earnings power of Western Alliance's core business remained strong amid the current economic and market volatility and will support significant ongoing capital accumulation, provide financial flexibility to fund balance sheet growth and accommodate changes to the allowance for credit losses or revisions to the economic outlook.
In the quarter, we recorded provision for credit losses of $92 million versus $51.2 million in Q1, which was primarily attributable to changes in macroeconomic forecast assumptions and net charge-offs of $5.5 million.
Dale will go into more detail in a bit on the specific drivers of our provisions, but our total loan ACL to funded loan ratio now stands at 1.39% or $347 million.
Continuing our strong balance sheet momentum from 2019, loans increased $1.9 billion this quarter to $25 billion and deposits grew $2.7 billion to $27.5 billion.
Without the inclusion of PPP, loans grew a more modest $117 million and deposits demonstrated strong growth of approximately $1.6 billion.
The lower adjusted loan growth reflects muted demand, for which we held back our marketing activities and directed our focus to low-loss, high-quality loan segments, in addition to assisting our clients with their PPP applications.
We are encouraged by our pipeline and our opportunity to continue to grow in low-risk asset classes.
Throughout the crisis, we have continued to attract new high-quality relationships to our bank at pricing and terms that would not have been available to us in other circumstances.
Furthermore, this quarter's positive operating leverage supported our expanding PPNR, as our strong efficiency ratio improved sharply to 36.3% compared to prior year.
Becoming more efficient during this economic uncertainty provides the incremental flexibility to maintain PPNR.
Looking ahead, we will continue to invest in new product offerings and infrastructure to maintain operational efficiency, but Q2 levels are temporary and will eventually rise back to a sustainable level in the low-40s.
However, our branch-light business model and our National Business Lines strategy continue to give us a competitive advantage.
Finally, supported by our healthy PPNR generation, Western Alliance remains well capitalized with a CET1 ratio of 10.2%, which puts us in a position of strength, uniquely prepared to address what's ahead in this uncertain environment.
Now, let's take a moment to provide an update on Western Alliance's response to the COVID pandemic.
We continue to follow CDC protocol and state-by-state return to work guidance, as our organization returns to the office.
As I initially described on our Q1 earnings call, WAL's unique credit risk management strategy is focused on establishing individual borrower level strategies and direct customer dialog to develop long-term financial plans.
Our approach to payment deferral requests is to look for resourceful ways to partner with our clients, along with assessing their willingness and capacity to support their business interests.
We asked our clients to work hand in hand with us, whereby our clients contribute liquidity, capital or equity as an integral component to modify payment plans.
Our approach collectively uses the resources of the borrower [Phonetic], government and bank's balance sheet to develop solutions that extend beyond the six-month window provided for in the CARES Act.
Since April 1, WAL has funded $1.9 billion in PPP loans, which provided expedient liquidity to over 4,700 clients and benefited more than 150,000 employees.
At quarter end, $2.9 billion or 11.5% of loans had been modified with the bulk of these loans receiving principal and interest deferrals.
Excluding the Hotel Franchise Finance segment, in which we executed a unique sector deferral strategy, the Bankwide deferral rate is approximately 5%.
The vast majority of our borrowers elect to utilize their own resources or PPP funds to bridge their business through the COVID crisis.
I will provide an update on the portfolios most impacted by COVID later on, but I did want to highlight, in our Hotel Franchise Finance portfolio, our sophisticated hotel sponsors continue to see value in and support their properties with 92% of deferrals achieved by posting additional liquidity as a component of future payment deferrals.
Our differentiated deferral strategy provides our customers the runway to resolve their liquidity issues and allow the appropriate time to recover.
Unlike the cookie-cutter big bank approach, we established the expectation that the burden of responsibility of solving the long-term cash flow problems remains with our client base.
In our Gaming book, all borrowers continued to make interest payments as 90-day principle-only deferrals were approved for 37% of the portfolio.
Today, 95% of our clients are open for business and are experiencing a strong rebound of demand.
These facts and the daily conversations with our people and clients help me feel confident that our credit mitigation strategy and early approach to proactively managing our risk segments is bearing fruit and puts Western Alliance in a strong position to come out on the other side of the pandemic in better shape than our peers.
Dale will now take you through our financial performance.
Over the last three months, Western Alliance generated net income of $93.3 million or $0.93 per share.
As mentioned, net income was impacted by elevated provision expense for credit losses, driven by the adoption of CECL in Q1 and changes in the economic outlook during the quarter.
Net interest income increased $29.4 million, primarily as a result of loan growth and lower rates on liabilities, as interest expense was cut in half.
Operating non-interest income fell $5.2 million to $11.1 million from the prior quarter as lower levels of financial activity generated lower -- fewer fees.
We also benefited from several non-operating items during the period, including a recovery of approximately 40% or $4.4 million of the mark-to-market loss on preferred stock holdings we recognized in Q1.
Additionally, bank owned life insurance was restructured, resulting in an increase of $5.6 million as we surrendered and reinvested lower-yielding policies.
In addition to this gain, this should moderately increase BOLI revenue prospectively.
Finally, non-interest expense declined $5.7 million, primarily from an increase in deferred compensation expense of $3.3 million related to PPP loan originations, plus a 52% decrease in deposit costs and a 64% decline in business development and travel expenses.
Strong ongoing balance sheet momentum, coupled with diligent expense management, drove operating pre-provision net revenue of $194.7 million, which was up 27.7% year-over-year.
We believe this is the most relevant metric to evaluate the ongoing earnings power of the Bank.
Our strong PPNR covered an 80% increase in provision costs from Q1 to $92 million, while driving earnings per share up 12% to $0.93 on a linked quarter basis.
Turning now to our interest drivers, investment yields increased 4 basis points from the prior quarter to 3.02%.
However, the overall quarterly portfolio yield decreased by 32 basis points from the prior year due to the lower rate environment.
Loan yields decreased 45 basis points, following declines across most loan types, mainly driven by the 83 basis point reduction in one-month LIBOR during the quarter.
Yield reductions were partly offset by an average yield on our PPP loans of 5.02%.
Prospectively, we expect loan yields to trend toward the end-of-quarter spot rate shown of 4.66%.
Interest-bearing deposit costs fell by 50 basis points in Q2 to 40 basis points, as this quarter received the full benefit of our proactive steps taken to reduce deposit rates immediately after the FOMC cut rates twice in March.
The spot rate of total deposits at quarter end was 20 basis points.
Total funding costs declined by 34 basis points when all of the Company's funding sources are considered, including non-interest-bearing deposits and borrowings.
The spot rate on total funding costs of 31 basis points is higher than the quarterly average due to the issuance of subordinated debt mid-quarter at 5.25%.
We expect funding costs to have stabilized at these levels as no further Fed actions are anticipated.
Demonstrating the flexibility of our business model, despite a transition to a substantially lower rate environment during the quarter, net interest income rose 10.9% or $29 million during Q1 [Phonetic] to $298.4 million, up 17% year-over-year.
Our origination of PPP loans, coupled with strong balance sheet growth and immediate steps taken to reduce the cost of interest bearing deposits, counteracted the decline in prime and LIBOR.
PPP lending supported our net interest margin during Q2 as SBA fees were recognized, resulting in a loan yield of 5.02% in this sector.
We estimate most of PPP loans will be forgiven within eight months from origination.
Of the $43 million in triple PPP loan fees we received from the SBA net of origination costs, one-third or $13.9 million was recognized in the second quarter.
Net interest margin contracted 3 basis points to 4.19% during the quarter, as our earning asset yield fell 34 basis points, but was offset by an equal improvement in funding costs.
Our outsized deposit growth and mounting cash reserves will continue to place downward pressure on the NIM until the excess liquidity can be deployed, which we expect will take two to three quarters.
With regards with our asset sensitivity, our rate risk profile has declined notably over the last year, and we are now asymmetrically positioned to benefit from any future rate increases as 70% of our loan portfolio is behaving as a fixed rate since floors on variable-rate loans have largely been triggered.
Our estimated net change of net interest income in a 100 basis point parallel shock higher is 4.2% over the next year, and we now project zero net interest income at risk if rates move lower.
Turning now to operating efficiency, on a linked quarter basis, our efficiency ratio improved 550 basis points to 36.3%, which continues to demonstrate our industry-leading operating leverage.
As mentioned earlier, the non-interest expense improvement is related to an increase in deferred compensation expense of $3.3 million unrelated PPP loan originations, plus a 52% reduction in deposit costs and a 64% decrease in development and travel costs.
Normalizing for PPP net loan fees and interest, the efficiency ratio for Q2 would have been 38.4%.
Additionally, our branch-light model has given us the flexibility to identify two locations that we are transitioning from full service offices to loan production facilities.
Our core underlying earning power remained strong as pre-provision net revenue ROA increased 18 basis points from the prior quarter to 2.56% and return on assets was flat at 1.22%.
While we expect the 2.56% is a high watermark as elevated liquidity will hold down the margin, we believe we will continue to maintain industry-leading performance.
This provides a significant flexibility to fund ongoing balance sheet growth, capital management actions or any credit demand.
Our balance sheet momentum continued during the quarter as loans increased $1.9 billion to $25 billion, and deposit growth of $2.7 billion brought our deposit balances to $27.5 billion at quarter end.
The loan to deposit ratio fell to 90.9% from 93.3% in Q1, as our strong liquidity position continues to provide us with balance sheet capacity to meet all funding needs.
Our cash position increased to $1.5 billion as deposit growth continues to outpace credit expansion.
While this impairs the margin near term, we believe it provides us with inventory for good credit growth as demand resumes.
Of note, during the quarter, we issued $225 million of bank level subordinated debt to ensure ample capacity to support our growth trajectory by bolstering our total capital ratio.
Finally, tangible book value per share increased $1.11 over the prior quarter to $27.84, an increase of $3.19 or 13% over the prior year.
The vast majority of the $1.9 billion in loan growth was driven by increases in C&I loans of $1.6 billion, residential loans of $154 million and construction loans of $138 million.
Residential and consumer loans now comprise 9.8% of our loan portfolio, while our construction loan concentration continues to trend downward and is now at 8.8% of total loans.
Excluding PPP loans, loan growth was $117 million, which was affected by line paydowns from draws during Q1 and offset by growth in residential and construction.
Highlighting our continued focus on growth in low-risk assets, tech and innovation loans were flat in total, while within the category, capital call and subscription lines grew $35 million, mortgage warehouse loans grew $325 million and residential mortgages grew $165 million.
Corporate finance loans decreased $233 million compared to the increase we saw in Q1 as borrowers repaid their line draws, reducing utilization rates down from 38% to 17%.
And all loan growth was fully funded by deposit growth.
We continue to believe our ability to profitably grow deposits is both a key differentiator and a core value driver to our firm's long-term value creation.
Notably, year-to-date deposit growth of $6.1 billion is higher than the annual deposit growth of the Company in any previous calendar year.
Deposits grew $2.7 billion or 10.9% in the second quarter, driven by increases in non-interest-bearing DDAs of $2.3 billion, which now comprise over 44% of our deposit base.
PPP loan related deposits grew $1.1 billion, and savings and money market accounts were up $845 million.
HOAs contributed to total deposit growth by adding $136 million, and Tech & Innovation increased $262 million as capital raising activity during the quarter was active.
Excluding PPP-related deposits, growth would have been $1.6 billion or 6.5%.
Regarding asset quality, special mention loans increased $292 million and non-performing loans rose $53 million during the quarter.
One-half of the increase in SM loans are from the hotel portfolio.
Generally consistent with our previously discussed Tech & Innovation rating guidelines, these loans were downgraded as we do not have clear line of sight to more than six months of remaining operating liquidity.
These borrowers are current, however, as they made loan prepayments that were -- we required for us to consent to a deferral modification.
Our other borrowers in this segment are also paying as agreed or provide cash -- or provided cash payments when the -- that when coupled with the payment deferral, have no additional debt service requirement until sometime in 2021.
Second, we've aggregated an event planning and leisure sub-segment, in which the business models are essentially dependent on social distancing relief, and in some cases, the resumption of group events.
Of the $150 million total exposure to this sector, $60 million has been moved to special mention and $40 million to non-performing.
While the portion to FM has over a year of current liquidity, it was downgraded as the revenue models have been sharply impaired.
The loan moved to non-performing has had -- now has limited remaining liquidity.
The remainder of the migration to special mention is fairly granular from our client spreads throughout our metropolitan markets where liquidity has been tightened.
These loans are generally collateralized by an array of assets that include real property.
Frequently, a loan may be downgraded to SM because of liquidity concerns, even though collateral average may be considerable.
For this reason, migration to special mention has a low correlation to ultimate credit losses as over the past five years, less than 1% has moved through to charge-off.
Our allowance for credit losses rose $86 million during the quarter as the change in mix of the balance sheet released $4.2 million of reserves and changes to the outlook accounted for $96.2 million, including covering $5.5 million of net charge-offs.
Revisions to the CECL macroeconomic outlook assumptions, which have declined since March 31 but have generally stabilized since April, accounted for the entire net reserve build.
The earning [Phonetic] allowance related to loan losses was $347 million excluding held-to-maturity securities, or 1.39% of funded loans, an increase of 25 basis points.
The current reserve build reflects our best estimate of the future economic environment as of quarter end, including the impact of government stimulus programs and credit migration actions.
We have migrated to a consensus economic outlook of Blue Chip Economic Forecasts as it tracks largely management's view of a recession and recovery.
Net credit losses of $5.5 million were recognized during the quarter, which were mainly attributable to small business and C&I borrowers.
In all, total loan ACL to funded loans increased 25 basis points to 1.39% in Q2 as provision expense for loan losses of $87.3 million significantly outpaced net loan charge-offs.
Relative to most other banking companies, our lower consumer exposure continues to result in lower total loan losses.
I would now like to briefly update you on the current status of a few exposures to the industries generally considered to be the most impacted by the COVID-19 pandemic.
During the last two weeks of the quarter, Tim Bruckner, the credit administration team and I conducted the most extensive quarterly portfolio review process in the Bank's history.
The review covered 95% of WAL's outstanding loan balances, excluding purchased residential mortgages.
Our $2 billion Hotel Franchise Finance business, focused on select service hotels, represents approximately 8.2% of the loan portfolio.
The financial flexibility of these borrowers is maximized by working with financially strong institutional operating partners with deep industry experience, expertise and conservative underwriting structures focused on loan to cost.
Occupancy rates are tracking national averages, currently around 46%, which have tripled compared to the lows in April of around 15% and are now only a few percentage points short of fully covering estimated operating expenses.
At approximately 55% occupancy, select service hotels are also estimated to cover amortizing debt service.
As a testament to the operating models of the select service hotels, revenue per available room has fallen 55%, but they have been able to shrink their cost structure by over 40%.
And as a result, the typical hotel is operating at breakeven.
Nearly 85% of our hotel portfolios either pay as originally agreed or on proactive payment deferral plans that bridge into 2021.
We feel positive about the trajectory of the portfolio and that our proactive deferral strategy will produce relatively stronger credit performance, given the active support of our sponsors have demonstrated through the material upfront payments made to receive deferral plans.
To augment the strategy, we nearly doubled the reserve of the portfolio this quarter and increased the ACL to loans ratio by 93 basis points to 1.95%.
The investor dependent portion of our Technology & Innovation segment is primarily focused on lending to established growth companies with successful products and strong investor support, which provides greater operating and financial flexibility in this environment.
Overall, a significant sponsor support and an active fund raising environment continue for these growth firms.
81% of loans have greater than six months' remaining month liquidity, up from 77% in Q1.
Additionally, we have had over 50 clients successfully raise over $1.4 billion in new capital since March 1.
Our $509 million Gaming book is focused on off-strip, middle market gaming-linked companies whose revenue is driven by local demand factors.
37% of the portfolio is on 90-day principle-only payment deferral as they continue to cover interest payments.
Additionally, these clients benefited from $28.4 million of PPP loans.
Inclusive of our recent closure mandates in Nevada to limit certain business activities, businesses representing 95% of the portfolio are open for operations.
Upon reopening, all casinos borrowers are performing at or above their COVID operating plan, and no loans were downgraded to criticized or classified at quarter end.
Lastly, our commercial real estate portfolio continues to perform as 99% of our industrial leases are current.
90% of our office rents are paid on par with the national average.
The sub-segment of CRE that's showing signs of stress for the industry is retail.
WAL's CRE retail exposure of $676 million is focused on local personnel service-based retail strip centers with limited merchandise retail exposure.
Similar to HFF, we are utilizing deferrals to support a path to recovery for these borrowers, while requiring demonstrated sponsor support with high level of additional payment reserves.
Of note, 67% of WAL's [Phonetic] investor CRE retail tenants paid May's rent payments compared to 50% nationally.
We continue to generate significant capital and maintain strong regulatory capital ratios with tangible common equity to total assets of 8.9% and a common tier 1 ratio of 10.2%, an increase of 20 basis points during the quarter.
Excluding PPP loans, TCE to tangible assets is flat from Q1 at 9.4%.
Inclusive of our quarterly cash dividend payment of 25% per share, our tangible book value per share rose $1.11 in the quarter to $27.84, an increase of 12.9% in the past year.
We continue to grow our tangible book value per share at a rate significantly faster than our peers as it has increased three times that of our peers over the last 5.5 years.
In conclusion, we expect loan growth to be fairly flat in Q3 as PPP pay-offs and forgivenesses are largely offset by the organic growth in low risk asset classes.
Depending on the timing of the realized PPP forgiveness, organic loan growth should offset PPP run-off, resulting in net loan growth being relatively stable.
We anticipate another strong quarter of deposit growth in Q3, primarily by executing on our deposit initiatives and achieving our market share gains in mortgage warehouse.
The anticipated deposit growth and resulting liquidity will primarily be deployed into residential mortgage assets to improve returns on cash over the next several quarters.
However, as PPP loans roll off and liquidity continues to rise, pressure on NIM will also continue until it can be fully deployed into productive assets.
While we are pleased with our deposit growth, the pace is exceeding loan growth.
And as Dale mentioned, it will take several quarters to redeploy this liquidity into low risk loans or assets providing yields greater than the Fed's current offering.
Operating PPNR is expected to decline modestly as PPP income begins to abate, loan balances growth -- grow begin -- growth begins to reignite and the deployment of excess liquidity continues and deferred loan origination costs return to normal levels.
Our long-term asset quality and loan loss reserves are informed by the economic consensus forecast, which is [Phonetic] consistent going forward, should preclude material increases in reserve levels from this point.
The pace, timing and size of future net charge-offs are uncertain to us as we have not seen a material increase in delinquencies or substandard [Phonetic] migration.
Finally, our strong capital base and access to ample liquidity will allow us to both take advantage of any market dislocations to grow in low-risk areas and to address any credit demands in the future.

user
compname reports q2 earnings per share $0.93.
q2 earnings per share $0.93.
company does not anticipate any need for additional liquidity.
net interest income was $298.4 million in q2 2020, an increase of $29.4 million from $269.0 million in q1 2020.
co's net interest margin in q2 2020 was 4.19%, a decrease from 4.22% in q1 2020.

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