Investing in a bank can be daunting, especially after multiple bank failures this year. However, Western Alliance Bank (WAL 0.09%) stands out as a safe and reliable option for investors. With its strong financial position and commitment to responsible banking practices, Western Alliance is well-positioned to weather potential economic downturns. Here's why.
Not all banks are the same
There's a lot investors can learn from the survival of Western Alliance compared to the failure of Silicon Valley Bank and Signature Bank. For starters, it had a more diversified loan portfolio, which helped to reduce its risk exposure.
In contrast, Silicon Valley Bank had heavy loan exposure to venture capital (VC) and start-ups, and Signature Bank had concentrated its loans heavily in commercial real estate (CRE). These areas came under pressure due to rising interest rates, a decline in the value of CRE, and the collapse of the VC market, an unfortunate situation that led to both banks holding more loans that were not likely to be repaid and starved for cash to cover their potential losses. These two banks' aggressive lending practices ultimately led to their downfall.
What's more, the quality of the management team is important when choosing a bank to invest in. While many criticized the management teams of Silicon Valley Bank and Signature Bank for their poor response to the 2023 banking crisis, the management team of Western Alliance Bank remains well-respected with a positive and proven track record.
Executing safe and sound growth
By the end of 2022, the Western Alliance management team had already recognized that 2023 would be challenging for banks and were adjusting. One of their most important steps was to increase the bank's capitalization.
Capital is a reflection of how much a bank's assets exceed it liabilities. It serves as a financial cushion to help absorb losses and it also provides the wherewithal for growth.
CET1, or Common Equity Tier 1, is a measure of a bank's core capital, and it consists of common stock, retained earnings, and certain other instruments. The higher the CET1 ratio, the stronger the bank's capital position and ability to withstand potential losses. Today, Western Alliance carries a CET1 of 10.1% -- above regulatory requirements -- compared to 8.7% at the end of the third quarter of 2022.
After the collapse of several regional banks in March, management took additional measures to ensure the safety of its operations. One of the most significant actions was lowering its loan-to-deposit ratio (LDR) -- a measure of its financial health -- from 98% at the end of the first quarter of 2023 to 94% at the end of the second quarter. Its ultimate goal is to reach an LDR of about 85%, typical for most banks. The LDR shows how much of its deposits the bank has lent out, and a high ratio can indicate that a bank is taking on too much risk and may not have enough cash to cover defaults.
Another smart move it made was decreasing use of Federal Home Loan Bank (FHLB) funding for loans. The FHLB provides member financial institutions with wholesale financing. During times of financial stress wholesale funding tends to be volatile, and reducing funding from the FHLB can help decrease the bank's risk of being caught up in a contagion event or a liquidity crisis.
In Q2, management decreased the money from FHLB from $6.1 billion to $4.9 billion. Ultimately, it aims to reduce the FHLB borrowings to $4 billion.
Western Alliance has also made a big push to increase its deposits, especially the insured ones. In Q2 of 2023, it managed to grow deposits by an impressive $3.5 billion, with 81% insured and collateralized. This move has helped significantly reduce the bank's funding risks and enhance its ability to meet its financial obligations, as insured deposits are much more reliable in times of stress or uncertainty than wholesale funding. By having a high percentage of insured deposits, the bank can be more confident in meeting its obligations and supporting its lending activities.
One long-term reason to be cautious
As we move toward a more tech-savvy world, traditional banks face stiff competition from financial technology companies, or fintechs. These companies are revolutionizing the financial industry by providing services such as lending, payments, and investment management at lower prices. What makes fintechs so popular is their use of technology to automate processes, making financial interactions more user-friendly. Moreover, with lower overhead costs compared to traditional banks, fintechs have become strong competitors. If it fails to adjust to this evolving market, Western Alliance may lose market share to fintechs, hurting its profitability and stock value. The stock has declined about 16% this year, largely on concerns spawned by the regional banking crisis earlier this year.
Management has taken steps to invest in technology to compete with the fintechs, including investing in innovative blockchain solutions for customers. Its strong financial foundation, large customer base, and focus on innovation give it a solid chance to keep pace.
Western Alliance is a worthy investment consideration if you are searching for a banking institution that can remain stabile and grow during uncertain economic times.
