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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 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 like to focus on three trends that define our third quarter results and will continue into the future; robust balance sheet growth, provision reflecting asset quality and consensus outlook and strong net interest income and PPNR that continue to build capital.
The combination of these variables generated record net income of $135.8 million and earnings per share of $1.36, each up more than 45% versus the prior quarter and exceeding our pre-pandemic performance in 2019.
The flexibility of Western Alliance's diversified business model was again demonstrated this quarter as our deep segment and product expertise enable us to actively adapt our business in response to the changing environment and continue to achieve industry-leading profitability and growth, while maintaining prudent credit risk management.
Total loans grew $985 million for the quarter to $26 billion and deposits increased $1.3 billion to $29 billion, reducing our loan to deposit ratio to 90.2%.
Our loan growth continues to be concentrated in low-loss asset classes such as warehousing lending, which accounted for over 100% of the loan growth and 56% of the deposit growth and $267 million in capital call lines where the risk-reward equation is heavily skewed in our favor.
The impact of this strategy will be seen near term in our reduced provisioning expense and longer term in lower net charge-offs.
We are encouraged by our expanding pipeline as clients have applied lessons learned from prior recessions to right-size cost structures and to begin to plan for future opportunities.
In the quarter, high average interest earning assets of $1.9 billion were offset by lower rates, substantial liquidity build and a one-time adjustment to PPP loan fee recognition to reflect modification and extension of the CARES Act forgiveness timeframe, which pushed our net interest margin downward to 3.71%, as net interest income declined $13.7 million from the second quarter to $285 million, but improved $18.3 million from a year ago period.
Excluding the impact of PPP loans, net interest income would have only fallen by $4 million, which was largely the impact of interest expense on our new subordinated debt issued in middle of the second quarter.
We believe approximately 21 basis points of this compression is transitory in nature and NIM is expected to rise as excess liquidities put to work through balance sheet growth, deposit seasonality and warehouse lending, driving balances lower and PPP loan forgiveness assumptions normalize.
Given these margin trends and balance sheet growth, we believe Q4's net interest income performance returns to Q2 levels and PPNR rises above Q3.
Provision for credit losses was $14.7 million in the third quarter considerably less than the $92 million in the second quarter, which was primarily attributable to stable to modest improvements in macroeconomic forecast assumptions, loan growth in low-risk asset classes and limited net charge-offs of $8.2 million or 13 basis points of average assets.
Dale, will go into more detail on the specific drivers of our provision but our total loan ACL to funded loans ratio now stands at 1.37% or $355 million and 1.46%, excluding PPP loans, which are guaranteed by the CARES Act.
If macroeconomic trends remain stable or begin to improve, future provision expense will likely mirror net charge-offs and reserve levels could decline.
Loan deferrals trended lower for the quarter as many of our clients have returned to paying as agreed following their deferral period.
As of Q3, $1.3 billion of loans are on deferral or 5% of the total portfolio, which represents a 55% decline from Q2.
We expect $1.1 billion of loan deferrals will expire next quarter, which will continue to drive down our outstanding modifications.
Our quarterly efficiency ratio improved to 39.7% compared to 43.2% from the year ago period, becoming more efficient during the economic uncertainty provides the incremental flexibility to maintain PPNR.
Finally, Western Alliance continues to generate significant excess capital, which grew tangible book value per share to $29.03, or 4.3% over the previous quarter and 13.4% year-over-year.
Supported by our robust PPNR generation, capital rose $121.6 million with a CET1 ratio of 10%, supporting 15.6% annualized loan growth.
Dale, will now take you through our financial performance.
Over the last three months Western Alliance generated record net income of $135.8 million or $1.36 per share, which was up 46% on a linked-quarter basis.
As Ken mentioned, net income benefited reduction in provision expense for credit losses to $14.7 million, primarily driven by stability and the economic outlook during the quarter in a release of specific reserves associated with the fully resolved credit.
Net interest income grew 1$8.3 million year-over-year to $284.7 million but declined $13.7 million during the quarter, primarily result of changes in prepayment assumptions on PPP loans that impacted fee accretion recognition.
The SBA's interim final rule published in August more than doubled the amount of time that people have to receive forgiveness on their loans and coupled with the systems delay in forgiving -- forgiveness request processing, we now expect that forgiveness processes to be elongated and the average time the loans will be outstanding is projected to double as well.
As a result, using the effective interest method, we reversed out $6.4 million of the fees recognized in Q2 and overall PPP fee recognition has been extended.
This is purely a change in timing, impacting NIM but with no change to cumulative fee revenue ultimately recognized from this program.
The $43 million, we are to receive will be simply be booked to income more slowly than our original expectations.
Net interest income was impacted in Q3, as a result of this timing change by $10.6 million.
Non-interest income fell $700,000 to $20.6 million from the prior quarter.
We benefited from a recovery of an additional $5 million mark-to-market loss on preferred stocks that we recognized in the first quarter.
Over the last two quarters, we recovered 80% of that $11 million original loss.
Finally, non-interest expense increased $9.3 million, as the deferral of loan origination cost fell, as PPP loan originations dropped, as well as an increase in incentive accruals as our third quarter pandemic -- as our third quarter performance exceeded our original third quarter budget, which was established before the pandemic.
Strong ongoing balance sheet momentum coupled with diligent expense management drove pre-provision net revenue to $181.3 million, up 13.5% year-over-year and consistent with our overall growth trend from the first quarter, as the second quarter benefited from one-time PPP recognition of BOLI restructuring in FAS 91 loan cost deferrals.
Turning now to net interest drivers.
Investment yields decreased 23 basis points from the prior quarter to 2.79% and fell 29 basis points from the prior year due to the lower rate environment.
Loan yields decreased 35 basis points following declines across most loan types, mainly driven by changing loan mix and in the reduction of PPP loan fees, resulted in lower PPP loan yield during the quarter.
Notably, for both investments and loans, spot rates as of September 30, are higher than the third quarter average yields.
Costs of interest bearing deposits was reduced by 9 basis points in Q3 to 31 basis points with an end of quarter spot rate of 0.27% [Phonetic], as we continue to lower posted deposit rates and push out higher cost exception price funds.
The spot rate for total deposits, which includes non-interest bearing deposits was 15 basis points.
When all of the company's funding sources are considered, total funding costs declined by 2 basis points with an end of quarter spot rate of 0.25%.
Unlike last quarter where spot rates indicated a likely margin compression in the third quarter, these rates appear to demonstrate that the margin will improve as both earning asset yields will rise and funding cost will fall in the fourth quarter.
Additionally, in October, we called $75 million of subordinated debt that has diminishing capital treatment with the current rate of 3.4%.
Despite the transition to a substantially lower rate environment during 2020, net interest income increased 6.9% year-over-year to $284.7 million.
As mentioned earlier, during Q3, our extraordinary build and liquidity and adjustments to PPP loan fee recognition compressed our net interest margin of 3.71%, as net interest income declined $13.7 million.
However, the majority of these reduction drivers are transitory.
PPP loans reduced our NIM during the quarter by 13 basis points.
This changes to prepayment assumptions, reduced SBA fees recognized resulting in PPP loan yield of 1.76%.
Excluding this timing difference, net interest income declined only $4 million quarter-over-quarter, primarily due to interest expense on the new subordinated debt that we issued last May, resulting in a net interest margin of 3.84%.
Referring to the bar chart on the lower left section of the page, of the $43 million in total PPP loan fees net origination costs that we received, only $3.3 million was recognized in the third quarter.
The recognized reversal of PPP was $6.1 million in Q3 and expect fee recognition to be approximately $6.9 million in the fourth quarter and taper off as prepayments and forgiveness are realized.
In reality, these assumptions are dependent on actual forgiveness from the SBA.
Additionally, average excess liquidity relative to loans increased $1.3 million in the quarter, the majority of which are held at the Federal Reserve Bank earning minimal returns, which impacted NIM by approximately 21 basis points in aggregate.
Given our healthy loan pipeline and ability to deploy these funds to higher yielding earning assets, we expect this margin drag to dissipate in the coming quarters.
Regarding efficiency, on a linked-quarter basis, our efficiency ratio increased to 39.7%, as we continue to invest in our business to support future growth opportunities.
As described earlier, the non-interest expense increase was largely related to a net increase in compensation costs, as we now have greater confidence in our ability to execute on our pre-pandemic budget and are no longer benefiting from deferred costs for PPP loan originations.
Excluding PPP, net loan fees and interest, the efficiency ratio for the quarter would have been 40.7%, which as we indicated last quarter should be moving closer to our historical levels in the low-40s.
Return on assets increased 44 basis points from the prior quarter to 1.66%, while provisions fell.
PPNR ROA decreased 47 basis points to 2.22%, as attractive decline in margin from the prior quarter.
This continued strong performance in capital generation provides us significant flexibility to fund ongoing balance sheet growth, capital management actions or meet our credit demands.
Our strong balance sheet momentum continued during the quarter as loans increased $985 million to $26 billion and deposit growth of $1.3 billion brought our deposit balance to $22.8 billion at quarter-end.
Inclusive of PPP, both loans and deposits grew approximately 29% year-over-year with our focus on loan loss segments and DDA.
The loan to deposit ratio decreased to 90.2% from 90.9% in Q2, as our strong liquidity position continues to provide us with balance sheet capacity to meet funding needs.
Our cash position remains elevated at $1.4 billion at quarter-end compared to $2.1 billion quarterly average, as deposit growth continues to outpace loan originations.
While this does impair margin near term, we believe it provides us inventory for selective credit growth this demand resumes.
Finally, tangible book value per share increased to $1.19 over the prior quarter to $29.03, an increase of $3.43, or 13.4% over the past 12 months.
The vast majority of the $985 million in loan growth was driven by increases in C&I loans of $892 million, supplemented by construction loan increases of $103 million.
Residential and consumer loans now comprise 9.3% of our portfolio, while construction loan concentration remains flat at 8.8% of total loans.
Within the C&I growth for the quarter and highlighting our focus on low-risk assets that Ken mentioned, capital call lines grew $267 million, mortgage warehouse loans grew over $1 billion and corporate finance loans decreased $141 million this quarter.
Residential loan originations were offset by higher prepayment activity leaving the balanced fairly flat.
We continue to believe our ability to profitably grow deposits as both a key differentiator and a core value driver to our firm's long-term value creation.
Notably, year-over-year deposit growth of $6.4 million is higher than the annual deposit growth in any previous calendar year.
Deposits grew $1.3 billion or 4.7% in the third quarter, driven by increases in non-interest bearing DDA of $777 million, which now comprise over 45% of our deposit base plus growth in savings in money market accounts of $752 million.
Market share gains and mortgage warehouse and robust activity in tech and innovation continue to be significant drivers of deposit growth.
As we initially described on our Q1 earnings call, while 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 in capacity to support their business interests.
We ask our clients to work with us hand-in-hand whereby our clients contribute liquidity, capital or equity as an inaugural component to modified prepayment plans.
Our approach collectively uses the resources of the borrower, government and the bank's balance sheet to develop solutions that extend beyond the six-month window provided for in the CARES Act.
By quarter-end, deferrals had declined by $1.6 billion or 55%, reducing total loan deferrals from 11.5% in Q2 to 5%.
Excluding the hotel franchise finance segment in which we executed a unique sector specific to hurdle strategy, the bank wide deferral rate is approximately 1.6%.
We have received minimal additional request for further deferrals and 98% of clients with expired deferrals are now current in payments.
We expect $1.1 billion of loan deferrals will expire in the current quarter, which will substantially drive down outstanding modifications.
Consistent with this trend, as of yesterday deferrals are down $420 million in October, bringing the current total to $880 million.
Regarding asset quality, our non-performing assets and OREO to loan ratio remained flat at 47 basis points to total assets, while total classified assets increased to $28 million or 4 basis points to 98 basis points to total assets.
Classified accruing loans rose by $21 million, explainable by a few loans 90 days past due as of September 30.
All of these loans are now current.
Special Mention loans increased $81 million during the quarter to 1.83% of funded loans, which is a result of our credit mitigation strategy to early identify, elevate and apply heightened monitoring to loans and segments impacted by the current COVID environment.
Over 60% of the increase in Special Mention loans are from previously identified segments uniquely impacted by the pandemic, such as the hotel portfolio and a component of our corporate finance division credits determined to have some level of repayment dependency on travel, leisure or entertainment.
As we have discussed in the past, Special Mention loans are not predictive of future migration to classified or loss, since over the past five years, less than 1% has moved through charge-offs.
If borrowers do not have through cycle liquidity and cash and capital plans, we downgrade to substandard immediately to remediate.
Our total allowance for credit losses rose a modest $7 million from the prior quarter due to improvement in macroeconomic forecasts and loan growth in portfolio segments with lower expected loss rates.
Additionally, we covered $8.2 million of net charge-offs.
The ending allowance related to loan losses was $355 million.
For CECL, we are using a consensus economic forecast outlook of blue chip -- blue chip forecasters as it tracks management's view of the recession and recovery.
The economic forecast improved during the quarter, which would have implied a reserve release.
However, given the still unknown time horizon of COVID impacts, political uncertainty and the unknown status of further stimulus, we adjusted our scenario weightings to a less optimistic outlook.
In all, total loan allowance for credit losses to funded loans declined a modest 2 basis points to 1.37% or 1.46%, when excluding PPP loans.
On a more granular level, our loan loss segments account for approximately one-third of our portfolio and includes mortgage warehouse, residential and HOA lending, capital call lines and resort lending.
When we exclude these segments, the ACL to funded loans on the remainder of the portfolio is 2%.
Provision expense decreased to $14.7 million for Q3, driven by loan growth in lower loss segments and improved macroeconomic factors, while fully covering charge-offs.
Net credit losses of $8.2 million or 13 basis points of average loans were recognized during the quarter compared to $5.5 million in Q2.
Relative to other banking companies our lower consumer exposure continues to result in much lower total loan losses.
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 Equity Tier 1 ratio of 10, a decrease of 20 basis points during the quarter due to our strong loan growth.
Excluding PPP loans, TCE to tangible assets is 9.3%, a modest decline of 10 basis points from the first quarter.
Inclusive of our quarterly cash dividend payments of $0.25 per share, our tangible book value per share rose $1.19 in the quarter to $29.03, up 13.4% in the past year.
We continue to grow our tangible book value per share rapidly as it has increased three times that of the peers over the last 5.5 years.
I would now like to briefly update you on our credit risk mitigation efforts and the current status of a few exposures to industries generally considered to be the most impacted by COVID- 19 pandemic.
Throughout the quarter, Tim Bruckner and the credit administration team led ongoing focus portfolio reviews by risk segments to monitor credit exposures and performance against cash budgets, operating plans through the liquidity trough.
We are not waiting for deferrals to run out to make great changes or effect remediation strategies.
If borrowers are non-performing against defined operating plans or determined to not have a sufficient through cycle liquidity, we downgrade them now to substandard and enact remediation strategies to ensure the best outcomes.
We do not hold loans in SM, the Special Mention for a time to eventually downgrade.
And as a result, Special Mention graded loans slowly migrate to classified or substandard.
These facts and daily conversations with our people and our clients help me feel confident that our credit mitigation strategy and early approach to proactively manage 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.
In our $500 million gaming book focused on all strip, middle market gaming-linked companies, total deferrals were reduced from 37% of the portfolio to only 4% and as of today, it's zero, as our clients are now open for business and are performing at or above their reopening plans.
The $1.3 billion investor dependent portion of our Technology and Innovation segment has continued to benefit from significant sponsor support for technology firms best positioned to succeed in this COVID environment and an active fund raising environment as well.
Since March 2020, 65 of our clients have raised over $1.7 billion in capital, resulting in 87% of borrowers with greater than six months remaining liquidity, up from 77% in Q1.
Our CRE retail book of $674 million focus on local personal services based retail centers with no destination mall exposure, continues to modestly exceed national trends that shows rent collections rising from 50% in May to 80% in August.
Similarly, the portfolio's deferrals have fallen from $176 million to $31 million.
Lastly, our $2.1 billion Hotel Franchise Finance business focused on select service hotels with greater financial flexibility and LTVs at origination of approximately 60% continues to trend toward stabilization.
Occupancy rates are tracking national averages, currently around 50%, which have tripled from April lows.
At approximately 55% occupancy, select service hotels are estimated to cover amortizing debt service, so a typical hotel is operating at break even.
Furthermore, we have seen deferrals declined from 83% of the portfolio to 44% of the portfolio and currently, we do not anticipate granting any additional deferrals in the hotel portfolio.
We are proactively engaging with hotel sponsors to validate ongoing support and hotel performance against operating plants.
As mentioned earlier, we are not waiting for deferrals to end before migrating to ensure remediation options.
With strong sponsor support the worst a great hotel typically receives is SM or Special Mention.
Let me just finish up with our management outlook.
We believe that our third quarter performance is the baseline for future balance sheet and earnings growth.
With this record quarter, we beat our quarterly budget that was established pre-pandemic.
Our pipelines are strong and we expect loan growth to return to previously anticipated levels of $600 million to $800 million for the next several quarters in low risk asset classes.
However, there will be some offsets as PPP loans pay-off or are forgiven.
Depending on the timing of the realized PPP forgiveness, organic loan growth should be -- should more than offset PPP run-off.
In Q4, we expect to see the seasonal declines associated with our mortgage warehouse clients.
Therefore, deposit growth will be at the lower end of the target range, reducing our excess liquidity.
To supplement our residential lending initiative, we acquired Galton Funding, a residential mortgage platform that specializes in the acquisition of prime non-agency residential home loans.
The acquisition is a low risk, low cost entry point to build a meaningful residential mortgage business line at an accelerated timeframe with over 100 additional mortgage originator relationships.
We anticipate that the Galton team will be fully integrated by the end of October and be contributing to loan growth by the end of the year.
As Dale mentioned, our current spot rates indicate that the net interest margin pressure experienced this quarter will subside and net interest margin will trend upwards toward 3.9% in Q4.
We expect net interest income to rise in Q4, aided by both an increased NIM and higher end of quarter loan balances compared to the quarterly average.
Additionally, it is expected that PPP fee income will pick up next quarter as forgiveness is granted.
This will however, abate during 2021 PPNR is expected to increase as net interest income growth will more than offset any increase in non-interest expense.
Looking ahead, we will continue to invest in new product offerings and infrastructure to maintain operational efficiency but Q2 and Q3 efficiency ratios are temporary and will eventually return to sustainable level in the low-40s.
Our long-term asset quality and loan loss reserves are informed by economic consensus forecast, which is consistent going forward, could imply reserve releases in the coming quarters.
We believe that the provisions in excess of charge-offs year-to-date are more than sufficient to cover charge-offs through the cycle as we do not see any indicators that imply material losses are on the horizon.
Finally, Western Alliance is one of the most prolific capital generators in the industry.
Our strong capital base and access to ample liquidity will allow us to take advantage of any market dislocations to maintain leading risk adjusted returns to address any future credit demands, all while maintaining flexibility to improve shareholder returns.
Operator, if you want to open up the line.

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compname posts q3 earnings per share $1.36.
q3 earnings per share $1.36.

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