When the $43 billion asset Western Alliance Bancorporation (WAL 3.05%) announced that it would purchase the mortgage company AmeriHome Mortgage, some investors might have been surprised, given Western Alliance's dominance in the commercial and industrial (C&I) lending space. After all, if it's not broke, why fix it? And in this case, if it's an industry leader, why fix it?

But since the deal got announced in February, it is already looking like Western Alliance made the right decision. Here's why.

Generating significant loan growth

Despite the economy beginning to show signs of recovery, loan growth at most banks remained stagnant in the first quarter of the year, with many banks reporting a decline in total loan volume and net interest income from the preceding quarter. Furthermore, even with many economists expecting the U.S. government to generate robust gross domestic product (GDP) growth this year, some banks have seemed a little less optimistic about loan growth. Many say they expect loan growth to pick up in the back half of the year, although many aren't presenting precise numbers to go with their predictions, making it look more like optimism than anything else.

But Western Alliance is guiding very specific and significant loan growth of $1 billion to $1.5 billion per quarter. That would mean between 3.5% and 5.2% next quarter based on Western Alliance's total loan volume of $28.7 billion at the end of the first quarter of this year. It also means as much as 10.5% and 15.7% of loan growth between the first quarter and the end of this year.

Outline of two people shaking hands.

Image source: Getty Images.

Now, to be clear, Western Alliance's management team said the $1 billion to $1.5 billion of new loan growth per quarter is actually not dependent on AmeriHome -- the bank was expecting to do that anyway. Within its C&I portfolio, Western Alliance does mortgage warehouse lending -- that is, lending to mortgage originators -- and also purchases mortgages that will benefit loan growth. But once AmeriHome gets up and running, Western Alliance will use the new channel to purchase non-qualified and jumbo mortgages that it will retain on its balance sheet. Non-qualified mortgages are considered fairly low-risk because they pretty much comply with guidelines set by Fannie Mae and Freddie Mac, although they are not guaranteed by the government. Jumbo loans are for more expensive homes and generally carry higher interest rates because of the bigger loan amounts. AmeriHome will also be more profitable as part of the bank because Western Alliance can fund its operations through cheap deposits instead of higher-cost borrowings.

In the words of Western Alliance's CFO, Dale Gibbons, loans from AmeriHome will be "accretive to net interest income" and give the bank "more confidence to be able to execute a better price point for the residential real estate we pick up." He added AmeriHome will be expanding its product line, which will give Western Alliance "even more volume." If the bank executes really well, Gibbons said, AmeriHome could help Western Alliance exceed guidance on loan growth.

Driving earnings 

The addition of AmeriHome and loan growth from the business is going to drive earnings significantly at Western Alliance. For one, it will help get the bank's loan-to-deposit (LTD) ratio back up to its normal level. Following the first quarter, Western Alliance's LTD ratio had fallen to 75%, meaning the bank had roughly 75% of its deposits deployed into loans. The bank historically operates with an LTD over 90%. AmeriHome will help boost the LTD ratio back to a more normal level, which is impressive considering all of the deposits the bank has been bringing in and expects to keep bringing in.

When it acquired the company, Western Alliance said it expected the addition to be 30% accretive to its earnings by 2022, meaning its earnings with AmeriHome will be 30% larger than they would have been on a stand-alone basis. The bank also said at the time that AmeriHome should grow the bank's return on average tangible common equity (ROATCE) by 5%, a big number considering Western Alliance already generates a high ROATCE.

On the bank's recent earnings call, Western Alliance CEO Kenneth Vecchione said he thinks the bank can exit the year with a $9 earnings per share (EPS) run rate. In 2020, the bank's best year of earnings in the past five, it generated $5.06 EPS,so that's a massive increase.

Proving to be a good use of capital

Most banks have an excess of capital that they are struggling to put to use right now. Capital can be used to repurchase shares, support loan growth, or make opportunistic acquisitions. The purchase of AmeriHome is an acquisition that will help grow annual EPS almost 80% from 2020 if the bank achieves the $9 EPS run rate. AmeriHome gives Western Alliance loan growth that it may not otherwise have been able to find on its own. With the outlook for loan growth more uncertain, the acquisition of AmeriHome is looking better and better.