SVB Financial failed on March 10, 2023, and two days later, New York state regulators shut down Signature Bank. These events caused investors to fear that other regional banks would fail soon. As a result, Western Alliance Bancorporation's (WAL 7.93%) stock opened on Monday, March 13, down 74% from its Friday closing price. By the end of the day, the Phoenix-based bank had lost nearly two-thirds of its market value over the previous three trading sessions. 

In early April, Berkshire Hathaway Chief Executive Officer Warren Buffett appeared on CNBC, telling viewers, "We're not over bank failures," while reassuring depositors their money is safe thanks to the Federal Deposit Insurance Corporation (FDIC). Considering other banks have failed since Buffett made that statement, many investors have avoided investing in banks and are waiting for the next shoe to drop.

Western Alliance trades at just three times its trailing-12-month (TTM) earnings, well below its 10-year median valuation of 15.25 times TTM earnings. So should investors buy at this great valuation or heed Warren Buffett's warning about possible additional bank failures?

Let's discuss this.

What's behind the current banking crisis?

Western Alliance, like all commercial banks, primarily generates revenue from the difference in interest rates that it pays on its liabilities (the funds it borrows from other financial institutions or customer deposits) and the interest it receives from its assets (loans or investments in mortgage-backed securities or government bonds). So naturally, a bank sets it up so the interest it receives is more than the interest it pays out, resulting in profits -- a pretty slick system when it works.

The massive flaw in this setup is that a bank's loans and investments are often illiquid, meaning it will take a substantial loss if it tries to convert those assets quickly into cash. While at the same time, customers can demand their deposits back on short notice. Consequently, whenever customers try to withdraw more money than the total value of a bank's liquidated assets plus shareholder capital, you will witness an SVB Financial or Signature Bank event ending in insolvency.

To protect depositors against bank insolvency, the government created the FDIC to protect people's deposits of up to $250,000 per depositor. When customers know their deposits are insured, they are less likely to create a run on the bank demanding their money back.

One huge issue with SVB and Signature was that both had too many commercial customers with substantially more than $250,000 deposited. S&P Global Market Intelligence revealed in March that SVB and Signature Bank possessed an alarming amount of uninsured deposits. SVB took the lead among banks with $50 billion in assets, showcasing a staggering 93.8% of its total deposits as uninsured. Signature Bank followed closely behind, with the fourth-highest percentage.

The worst part is that many SVB depositors were well-known tech companies. Without the government stepping in and protecting depositors beyond the $250,000 limit, many young tech companies might have been in trouble, and possibly far more bank collapses would have occurred due to bank runs from scared depositors wanting their money back.

How is Western Alliance different?

SVB's heavy reliance on early stage tech and biotech depositors doomed the bank. As interest rates rose, venture capital and private equity funding dried up for SVB's tech customers, leading to fewer customers depositing money. Additionally, its customers needed the cash they had saved for a rainy day to continue their business operations. This situation led to cash withdrawals at a pace SVB ultimately could not satisfy.

In contrast, Western Alliance boasts a more diverse deposit base and a broader range of commercial banking customers. And its diversity likely saved the company from many of the headaches SVB encountered. Additionally, it rapidly protected itself when it saw signs of financial distress by raising its insured deposits and the cash it kept on hand to pay uninsured depositors.

A chart shows Western Alliance insured deposit exposure trend.

Image source: Western Alliance Bank.

When SVB and Signature failed, Western Alliance immediately borrowed $25 billion from the Federal Reserve Board. Consequently, although it had to weather an almost $7 billion loss of deposits due to customers' fears of losing their money, by March 20, its deposit base stabilized at $46.7 billion. Fortunately, as of April 14, the deposit base has increased by $2.9 billion since hitting rock bottom -- disaster averted, hooray!

After you do your due diligence by reading its earnings release for the first quarter and listening to its earnings call, management may convince you that the bank will survive and is well positioned. Yet the stock price has yet to recover fully from its March decline.

WAL Chart.

WAL data by YCharts.

What does the market know that you don't?

Be cautious about buying this stock

Some investors may consider investing in Western Alliance after its decent first-quarter earnings report that quelled investors' concerns about its deposit base. However, before you invest, you should consider one significant risk factor -- financial contagion.

A financial contagion is a chain reaction of collapsing financial institutions that spreads throughout the entire financial system. Additionally, financial contagion can occur quickly in the information age, where knowledge flows rapidly and bank transactions are processed much faster. So, although Western Alliance looks safe today, it is still susceptible to a financial contagion, which could happen more quickly than you could sell the stock in reaction to headlines.

On Monday, May 1, First Republic Bank collapsed, sparking fears of contagion and questions about which bank would be next, and Western Alliance is still high on short sellers' lists as the next bank to encounter problems. As a result, prudent investors should avoid this stock until the bank's fundamental metrics as well as the economy show further signs of improvement.