Western Alliance makes a major bet on mortgage banking services
The COVID-19 pandemic has created a mortgage banking boom, which in turn creates new opportunities for many banks.
At the start of the pandemic, the Federal Reserve cut interest rates to 0%. This reduction triggered a wave of refinancing that turned into a record year for mortgage originators. One of the banks taking advantage of the new conditions is Western Alliance (NYSE: WAL). Formerly known primarily as a niche lender to mortgage banks, Western Alliance has recently made major acquisitions which represent a significant bet on the sector. Will they pay?
Western Alliance has historically focused its loan portfolio on commercial and industrial (C&I) loans. Last year, C&I loans represented nearly 53% of Western Alliance loans held for investment. Commercial real estate represented about 29% and residential mortgages represented 9% of its loan portfolio.
In recent months, Western Alliance has purchased two mortgage originators: Galton Funding and Amerihome. Amerihome focuses on more traditional mortgage products, mainly loans guaranteed by Fannie Mae and Freddie mac. Galton focuses more on non-traditional mortgages that are unsecured by the US government. Between Galton, Amerihome and Western Alliance’s own retail operations, the company is now one of the leading creators in the United States.
Recent changes by the Federal Housing Finance Agency (FHFA) have opened up the possibility of a new subset of loans that generally meet Fannie Mae and Freddie Mac guidelines (hence low risk) but are not not guaranteed by the government. Many of these loans are for second homes and investor properties. These loans are generally referred to as “non-QM” (unqualified mortgages), and they have attractive risk-return characteristics. Western Alliance is targeting this market, and CFO Dale Gibbons discussed this during the earnings call:
What we’re also going to get from AmeriHome is that we’re going to be able to have some sort of rapid rollout in mortgages that we would like to put on our balance sheet. And we prefer to have something with low LTV but higher yield, which pushes you towards some kind of non-QM solution, which is going to roll out that product as well.
In addition to mortgage banking services, Western Alliance offers warehouse financing, a lucrative niche product that serves mortgage bankers. Warehouse loans are essentially bridging loans that allow a mortgage banker to finance a loan and then sell it. Once he receives the loan proceeds, he repays the warehouse bank. These loans are generally short term (two to three weeks), they generate a fee up front, and they charge an interest rate of 3% to 4%. Since the loans are secured by salable mortgages, the risk of credit losses is low. CEO Kenneth Vecchione sees warehouse lending as a “strategic weapon” for the bank, as he put it in the recent call for results.
Western Alliance is growing faster than its peers
While mortgage banking and ancillary services to the industry will be a greater part of Western Alliance’s future, the bank continues to grow at a rapid pace. In the first quarter of 2021, total assets increased 49% year-over-year to $ 43.3 billion. Revenue rose 29% and earnings per share (EPS) more than doubled year over year to $ 1.90 per share. Note that year-over-year profit growth is somewhat overstated, due to the current large Expected Credit Losses (CECL) taken in early 2020, as well as large provisions for COVID-related credit losses. -19.
The Western Alliance title was on a tear, outperforming the ETF SPDR S&P Bank significantly over the past year. Its stock has more than tripled since the poor start of COVID-19.
WAL data by YCharts
Western Alliance increased its tangible book value (TBV) per share by 25% year-over-year, and its five-year growth rate of TBV was three times that of its peers. The bank is trading at 14 times the EPS expected for 2021, which is more or less in line with peers like American Bank. The dividend yield is rather modest compared to the big banks, but it uses its capital to finance growth.
Going forward, Western Alliance’s increased focus on mortgage banking services should provide additional growth opportunities. If it securitizes and sells its mortgage production, it generates fee income. At the same time, Western Alliance is expected to be one of the first players in the emerging market for unsecured government mortgages.
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