The past year has been awful for the mortgage space. Mortgage real estate investment trusts (REITs) were battered by rising rates and mortgage-backed security underperformance. Mortgage originators were hammered by collapsing volumes. How did one of the mortgage-banking industry's biggest bankers fare?
Western Alliance (WAL 0.45%), which has heavy exposure to the mortgage space, recently released earnings. Let's take a look at how this banker is doing in the current mortgage environment and whether the stock has been affected.
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Western Alliance has a large mortgage component
One of Western Alliance's biggest mortgage-related businesses is warehouse banking. Most independent mortgage banks have a limited supply of cash on hand at any particular time. When they give a consumer a mortgage, the money that actually changes hands at the closing table generally doesn't come from the mortgage company. It comes from a warehouse bank, which advances the funds to complete the sale.
Once the mortgage originator sells the loan to another bank or Fannie Mae or Freddie Mac, the proceeds from the sale pay off the loan to the warehouse bank. This is generally not that risky of a business, but when the mortgage industry stalls out, the amount of interest that Western Alliance earns from this business line falls.
Some mortgage loans, particularly those that are not guaranteed by the U.S. government, can be subject to liquidity squeezes where the value of the non-guaranteed loan falls to the point where its sale won't cover the bank's advances. We saw this happen to a number of mortgage bankers like Sprout and First Guaranty. Both declared bankruptcy.
Western Alliance also has a lending presence, particularly with mortgage lender Amerihome. Amerihome is a correspondent lender, which means it purchases funded loans from smaller originators and then securitizes them or sells them to Fannie Mae and Freddie Mac. Mortgage banking volume fell 29% compared to the third quarter of 2022 and 55% from a year earlier to $8.3 billion. There wasn't a mortgage originator which escaped the pronounced decline in volumes. Gain-on-sale margins (basically, the profit Western Alliance earns from flipping a mortgage) increased to 0.19%, which is still pretty low and reflects the low-margin business that is correspondent lending.
Credit quality remains high
While many banks were taking large provisions for credit losses, Western Alliance took only a $3.1 million provision in Q4 compared to $28.5 million in Q3 2022 and $13.2 million a year ago. Net charge-offs were $1.8 million compared to a recovery of $1.9 million in Q3 and $1.4 million from a year ago. So far, it doesn't appear that counterparty risk is an issue. Net-interest margin (which is the difference between what the bank earns on its assets and its cost of borrowing) increased by 20 basis points quarter over quarter to 3.98%. Book value per share also rose 8% quarter over quarter to $40.25, which is a pretty strong growth rate.
Western Alliance is trading at a discount to some of its competitors that are big in the mortgage banking space, such as New York Community Bank (NYCB -0.67%), which just bought Flagstar, and Texas Capital Bancshares (TCBI 0.11%), a big warehouse lender.
WAL PE Ratio data by YCharts.
Negative sentiment for the mortgage space probably affected share performance last year. However, things are about as bad as they can get in the mortgage business, so everything is pretty much priced in. Western Alliance is expected to earn $10.42 per share in 2023, which represents a 7.4% growth rate in earnings per share. Western Alliance is trading at 6.9 times expected 2023 earnings per share. When the price-to-earnings (P/E) ratio is below the earnings growth rate, it is usually considered a buy signal.
