Good morning, everybody. Thank you for joining us on day three of our financial services conference. This morning, we're excited to have Western Alliance joining us, and Ken Vecchione, the Chairman, President, and CEO. Ken, thanks for being here. Appreciate you making the trip out.
My pleasure. Thank you for inviting me.
Well, I think there's a lot to discuss, clearly, with Western Alliance. Maybe we just kick it off with, at Investor Day in May, you laid out medium-term targets, and later in the second quarter, you began acting on them. Reframing the story from maximizing balance sheet growth towards optimizing profitability and returning capital. Walk us through what changed and how you think about growth versus value creation and what you want us to understand about the kind of company that Western Alliance is becoming over the next two to three years.
Yeah. There's a lot to unpack in that simple question. Let me start with why did we pivot? We are generally a strong organic growth company. What we found was that we weren't being paid for our excess growth, and it wasn't being reflected in the share price. In addition, the excess growth was being considered as risky growth, which also weighed on our share price. We saw our share price where it is, and we said, look, the best thing we can do is buy back our shares." We started to do that. So we took that excess capital and we purchased our shares with it, and we continue to do it. What we think the market doesn't fully understand yet is the improvements we made in asset quality, how the business is positioned, the success we're having with our deposit optimization strategy.
I assume all these things you're going to ask, and that we're taking advantage of that by buying back our shares. We had expected to buy back $150 million in the second half of the year. That's correct. We're buying a little bit more in Q3 than in Q4. As I said, the company's on sale, and we're taking advantage. As it relates to the Investor Day targets, certainly around share repurchase, we only had $200 million- $300 million in there over a three-year horizon. Here we are buying back $150 million now, and we'll probably continue with that process into 2027. We'll accelerate that on our way towards hitting our Investor Day goals of return on average assets of 120- 130, and return on equity of between 16% and 17%.
Great. As you said, the focus has really shifted. Now it's really on deposit optimization on the right side of the balance sheet. As you move deeper into that, how do you decide which relationships are no longer earning an adequate return? Where is there still room to reprice or reposition funding without disrupting the broader relationship, I guess, given how many of these clients touch multiple products?
Right. Deposit optimization was clearly laid out as one of our key strategic initiatives at our Investor Day. There's a three-pronged strategy to the deposit initiatives. Number one, those clients that were carrying excess liquidity, we helped transition that to other banks. Second, for select clients, we changed the pricing grid and capped what we pay for deposits. Third, and most importantly for our long-term growth, we are accelerating and putting more time and attention against our deposit-only channels, such as Business Escrow Services, Corporate Trust, Juris Banking, our Digital Assets Group, and HOA is a couple of them. Now, what does all this mean in the progress we've made? In Q2, we transitioned $1.4 billion of deposits outside of the bank. In Q3, we've already transitioned $2.5 billion. So now we're a total of $4 billion. We set as our goal $3 billion for the year.
We actually accelerated deposits that were going to transition in Q4 into Q3. We're now ahead of our full-year goal at $4 billion versus $3 billion. The net benefit of all this is several things you'll see. One, our deposit fees, which located in our operating expense line, will be down near slightly over double digits in the millions. You'll see a significant improvement in deposit fees. That will lead to a higher adjusted net interest margin by several basis points. Then our headline NIM will just be down maybe about a basis point because of the deposit remix from the deposit optimization strategy. We're very pleased that one of the key items that we wanted to take care of coming out of Investor Day, we have done so, and we've done it at an accelerated pace.
For the rest of the year, we are not going to look to move any more deposits out of the bank. We are going to review it again, and we will give additional guidance either on our Q3 call or as we enter into the new year.
That $3 billion is now $4 billion, but you are still seeing growth in the other areas.
Oh, yeah. Let me just say, the thing is, not only did we get $2.5 billion out of this quarter, we expect to still be positive deposit growth. That is kind of a Herculean trick to be able to move that much out and be able to also grow.
Where are you seeing the most benefit or the most success on the deposit growth side on the areas that you are focusing?
A couple of things. For this quarter, you will see it, one, in Technology and Innovation. That specialty finance line. There is a lot of venture capital financing, and deposits are growing above trend for Q3. BES, which is Business Escrow Services, which caters to private M&A transactions. They are very busy, and they too will be above-trend growth for Q3. Corporate Trust, which has a long or deep pipeline will continue to grow as it has a couple hundred million dollars per quarter, but they have got a deep pipeline. Those three business lines, which I just mentioned, have also lower cost of funds related to them, and over time, that will help change the mix of our deposit composition, but also lower our deposit costs.
Yeah, I think the deposit optimization gets a lot of the attention, but you also have fixed-rate asset repricing and securities being reinvested at higher yields. Independent of what the Fed does, how much of the next leg of margin improvement is driven by the asset side versus the funding side? I guess what gives you that confidence in that 360-370 medium-term margin target?
Right. The 360-370, to be clear, is going to happen over three years. That is number one. Number two, yes, the deposit mix is helping and the growth of the deposit-only businesses should help change the overall cost of funds and lower that. Then also, as we described on Investor Day, we have a number of specialty finance businesses that are part of our S-curve strategy, and those businesses continue to build out and grow. Some of them are in lines of business that bring in above-trend spread. We expect to continue that as well. Those things taken all together will drive NIM and then also adjusted net interest margin up over the next three years.
Yeah. Looking at the loan growth side, you have deliberately scaled back some loan growth to lean into the buybacks, as you mentioned earlier, but you still screen as a top-quartile grower in the group. How should investors think about the pace of balance sheet growth from here as you keep reassessing lower return loan and deposit relationships? What would pull you back towards that higher growth?
Yeah. I will break my answer into two pieces, tactical and strategic. Tactically, I would expect that our total assets for Q3 will be below that of Q2 because of the acceleration of the transitioning of deposits. Think about $98 billion coming down from almost $99 billion for Q3. I would not expect us to cross over into LFI territory until the end of the first quarter. As we look for going forward on balance sheet growth, right now our stock is well below its intrinsic value. I think there are two things that are embedded in the stock that we are taking advantage of in terms of buying back the stock. The first, which is very obvious, is the mortgage industry and what is happening to the 10-year yield and to mortgage rates, which we can talk about in a few minutes.
The second is the progress that we have made in asset quality that the market has not yet digested. I assume we will talk about that. But those things allow us to continue to buy back the stock. Now, relative to the market, to the growth, as long as our stock is on sale, we are going to keep buying. But we are one of the few companies that can actually buy back its stock and grow at the upper end of the peer. Our peers for us are between $50 billion and $300 billion. Again, we were not getting paid for the much higher growth rate. That is our way of saying that when you kind of raise up to a higher level, what are we trying to do as a bank?
One, we are trying to lower our cost of equity, and we are trying to lower our cost of equity through having a lower beta. We will get a lower beta by having a more durable and sustainable earnings, which I think we have basically today. Two, reducing asset quality. Three, getting rid of any stories that get connected to us. Four, looking like everyone else. Apparently being outside the box. If this is the box of growth and you are here, being over here, you are not getting rewarded for. So we are coming inside of the box, if you will, and we believe all those things taken together over time will lower our cost of capital. As we are doing that, as you mentioned about Investor Day, we are also doing a number of things to raise our return.
What we are trying to do is bring down the cost, increase the returns, make that gap wider and wider. That has yet to be captured in our share price. Until it does, we are going to go out and buy back our shares while still doing all the things we normally do, which is to grow organically.
Yeah. As you look into 2027, you talked about some of the specialty deposit verticals, HOA, Business Escrow Services, Corporate Trust, Juris Banking Group, Digital Assets Group, and they've been compounding far faster than the rest of the bank. Which do you see carrying the most weight going into next year? Are there newer verticals investors aren't paying enough attention to yet?
We're not launching any new deposit verticals. We think the ones that we have are still in their early stages, and we are paying attention to those and continuing to put more technology behind them so that they can grow at a faster pace. The nice thing about the combination of these businesses, let me just take you through them. HOA is a very stable business. We'll grow a billion dollar every year just in deposits on that business. It grows below what our effective cost of funds rate is. That's good. What we do there, we use technology to drive deposit growth. Technology that we have APIs that connect to the management company that then connect right to the HOA association. It's a lot of connectivity.
That connective tissue is very hard to separate, and we grow that business, as I said, about a billion dollars a year. Mostly in Q1, a little bit in Q2, flat in Q3, a little bit more in Q4, but most of it comes in Q1. Then we have some of the other lines of business. The Business Escrow Services is M&A. Right now, the M&A environment is still strong. As I said, this quarter, you're going to see us do rather well. But there will be times when the M&A environment pulls back and you'll see deposit growth in that business pull back. Offsetting that is Corporate Trust. We just continue to gobble up market share. We have a long and deep pipeline of clients looking to come on, and that will increase our deposits. But that is going to be one of these steady deposits.
They're like the Pete Rose of our company, which is, they'll get up to bat, they'll always get a single, but more likely they'll get a double every time. That double is $200 million plus a quarter in deposits. Then you continue to drop down and you say, well, what can really give you some outsized growth? Our Digital Assets Group, which is the business that provides bank rails for our digital asset customers that trade currencies on other platforms to move their cash 24/7. We went live with that last quarter. Transaction volume so far, knock on wood, is very good. Deposit growth will follow from there. That will grow over time, and we believe it will grow at an outsized pace. What will determine that growth, besides our service levels, will be the price of the currencies and what's happening in the overall economy.
Those businesses together with also Juris Banking. Juris Banking is another interesting line of business. Deposit growth is somewhat contingent upon court cases, settlements, and then distributions. But when that money comes with us, it becomes sticky. There is some up and down as when that happens. This quarter will be more or less in line, flat to slightly down, I think, in deposit growth. But in the previous set of quarters, they have been growing very steadily. The thing that most people don't talk about with Juris and Digital Assets Group and BES and Corporate Trust, people forget about the fee income that comes with this. This will help us with fee income over time. Those are the deposit verticals that we are excited about and we think will add value to the company.
Great. Credit, you touched on that a little earlier, and you are right. We have a couple questions on credit. You have expected several larger NPL resolutions to improve reported metrics in the second half. Setting those identified credits aside, what are you seeing in the new inflows and outflows of criticized and non-performing balances? Where across your national footprint are customers still investing in borrowing versus showing more caution?
We mentioned six credits. Two were resolved in Q2. Two have been resolved in Q3, so we are four down, two to go. The other two are on a glide path to be resolved in Q4. We expect our NPLs to come down about 10% this quarter in Q3. They are going to move from $567 million to about $500 million. That is very positive. We expect our charge-off rate and dollars to be under that of Q2. Again, that is positive. That asset quality story, as we laid out, is unfolding and tracking against our expectations and forecasts. The other part of the asset quality story, which is going to be helpful, is that our allowance for loan loss reserves continue to build as we remix our balance sheet.
We expect our allowance for loan loss reserves to grow a couple of basis points per quarter. So you have the allowance growing. Certainly in dollars, our ACL to where our NPLs will be at the end of Q3 will be well over 100%, whereas in the previous quarter, they are at 95%. That asset quality story is taking hold, and we are excited by it. In terms of the question was where is the rest of the growth coming, or?
Where are you seeing customer sentiment, or I guess, across the national footprint where are customers still investing in borrowing versus showing more caution?
Technology and Innovation, active. National Builder Finance, active. Segments of our regional banking book are active. Still Warehouse Lending and MSR lending. I am assuming the Fed is going to move today. Probably won't be as active going forward, but has been active up to today. I think that is probably it in terms of the big areas.
Okay. Following Cantor and the other fraud-related credits, what has changed in how you evaluate collateral controls, counterparties in single-source repayment structures? I guess how are those lessons being applied across the broader portfolio, including areas like Lender Finance and innovation banking?
Yeah. The Cantor and Lam to me is an old story. It happened. One was a fraud, which was Cantor. And the Lam for us is a breach of contract. So we think our positions there are very strong. We expect a favorable outcome, and that will just transpire over the next year or so. It is a long process once it gets into litigation. As it relates to what we have learned, and I got to be careful, there is only so much I can talk about. I can say we have brought in outside people. We did this immediately to ensure that our credit process was fine. And it is, and it was. So where did the problems come?
It came in the administration side on how we administered titles and how we gave too much control to a large company to administer their asset quality, their cash flows. That's where the mistakes were made. We have changed that. As it relates to the Cantor fraud and looking at the double pledging of titles, we found no other instance in our book of business other than what we saw with Cantor. So that's good.
Great. You talked a little bit about growing the ACL. Western Alliance has always had a relatively low ACL due to the structure of the lending book, along with some of the specific guarantees and insurance coverage. In light of the credit moves and the balance sheet shift as you talked about, how should we think about the ACL normalizing longer term?
Yeah. So in Q2, we added a couple basis points to the ACL. Our peer group came down about three basis points. If we keep that path going, we will get to normalization a lot faster. Now, first, we have to understand that our peer group is very different from us because they have a large consumer book of business. We do not carry those loans, and so therefore we do not have those losses. So therefore, our ACL should be lower than our peer group. Having said that, it would be nicer to be closer to them so there is one less story I need to tell back to the cost of capital that gets into the beta. All right? We continue to remix our book. We continue to see ACL kind of rising two basis points per quarter, thereabouts. Our overall asset quality will continue to improve.
So for me, I look at the ACL compared to the NPLs and make sure we have enough coverage. What I would say is that we do have a credit-linked note, a CLN, which removes up to 5% of residential losses from our balance sheet. By the way, we have never had a loss in our resi book. But if we were, the first 5% is eaten up by these CLNs. So that is the insurance policy. So when you take the monies that we still reserve for the residential book and move them over to the rest of the book, our ACL is closer to 1.01%. The peer group is about 1.2%. So we are not all that far apart, and we will, as I say, continue to work to close that gap. So I think we are making progress on that.
I just wish we'd get a little more credit for the CLN. It's there. It's insurance. People have given us the money. So if we have a loss, we give them back less money. I don't know why that's not considered a very strong ACL.
Yeah. Okay. Maybe shifting a little bit to the fees and expense side. Service charges and fees have grown steadily, not just from legal disbursements, but from commercial banking services like Treasury Management. What do you attribute the success in this area to, and what do you envision non-mortgage fee revenues growing to and contributing to the revenue mix?
Yeah. Our growth in fee income runs in concert with the change in our strategy with our balance sheet. We used to be more balance sheet oriented. That's fine. As we pull back on the balance sheet, we're now becoming more revenue centric to what the client is. To do that, we've invested in Treasury Management Services and products, and we expect the TMS, Treasury Management Services income to grow at an accelerated pace such that it will continue to help fee income move along. The businesses of BES, some stuff in private credit, Corporate Trust, Digital Assets Group, those also begin. They will as they get bigger and bigger, grow fee income. So it's coming from there as well.
Because we're such a large spread business and we don't have wealth management, we don't have credit cards, we don't have a bond trading desk, we don't have investment banking. We will move fee income year-over-year double digits in growth. But relative to our overall income, it's not going to move much. So it runs today absent mortgage about 10%. And it'll stay about 10% because it's going to be hard to outgrow the denominator of our net interest income.
Yep.
Yeah.
On the expense side, ECR and non-ECR expenses have been two of the hardest things for investors to model. What are the biggest underlying drivers of each today, and where do you expect scale or efficiency, including AI, to start providing more visible offsets?
Yeah. The ECR conversation also I think adds to the discount in our stock price.
Yep.
Sometimes you can actually see smoke coming out of people's ears when I have to explain it to them. But I try to break it down and make things as simple as they were when I went to public school in Queens at PS 169. Go Tigers. That is there are three businesses that contribute to the ECRs. Warehouse Lending, which is Warehouse Lending deposits mostly coming from MSR relationships, HOA, and then Juris Banking. We have about $30 billion of ECR-related expenses or balances. What I would do in terms of if I had to model this, I would take that my denominator, I would take the numerator, which is what are deposit costs. Come up with the ratio, and then you're going to have to do here a little work and make your best guess on where you think those deposits are moving.
Certainly the rate has to be coming down as we're transitioning off higher rate balances. But mostly the improvement quarter- to- quarter, and there'll be another improvement in Q4, I said we'll be down about $10 million in Q3. We'll be down again in Q4, but Q4 is going to be just because of the seasonal drop that we always see. I would factor that in, and I would go back and kind of look at what that path has been for the last couple years, quarter- by- quarter, and I think you can create a model that kind of draws you to where you need to go. That's how I would think about the ECRs. With a rate increase sitting in front of us, the Warehouse Lending business runs about a 90% beta, and the other two businesses run about 50-ish percent.
I would keep that in mind as well.
Great. Thank you.
I hope that gave the answer to the test question.
Yes, I think so. You are approaching $100 billion, and you have already invested heavily in LFI readiness. How far along is that build-out? Once you are fully subject to the requirements that come with crossing the threshold, what should be the ongoing run rate cost and the timing benefit if the Category IV threshold moves up?
Yeah. We are just about done with the LFI readiness program. We will not have to start filing the appropriate reports if we cross over by the end of Q1, assuming there are no tailoring changes. We do not start filing reports until most of them are filed in 2028, not in 2027. We even still have time. We put in about $25 million a year, $25 million- $30 million. That is going to be the run rate going forward to support the LFI. Whether tailoring happens or not, we are just assuming that it is. A lot of the infrastructure that we put in around capital stress testing, around liquidity management and stress testing, is very valuable. We are keeping that. That is going to just be with us regardless if the LFI levels are moved. We are ready. We will just wait to hear.
Hopefully, I understand there are going to be some speeches coming up soon, and one of them may very well be on LFI, I hope, and maybe we will get a little more insight. We are going to be the first bank that crosses over organically. That is kind of interesting. What I have said to the FRB is that you should use us as the model. We started planning for LFI back in 2021, 2022. We started putting it into our core space very slowly, and then we accelerated a little bit more recently. We have been working on this for a while.
Okay. You talked about the buybacks earlier. You have increasingly emphasized buybacks relative to incremental growth, and you have pointed to potential Basel III capital relief. What would make you shift capital back toward growth, and what could lead you to lean further into repurchases, including, I guess, how you deploy the about 80 basis points of potential CET1 benefit?
Yeah. Everyone likes a deal, and we are not paying full retail for our stock price today. We are going to continue to buy. We had our board meeting last week. I showed these models to the board and where we think intrinsic value is and what we need to do to kind of grow the stock price. Then as we get closer to that intrinsic value, we will probably slow down. Right now, I think there is a real sizable gap to where we think the company should be valued, and we are going to be continuing to buy. One thing I will keep noting is that we are continuing to grow. That is very important. That organic growth is very important for long-term growth.
I went back, I looked at some of the big money center banks over the last 15 years and what made them scale up and how were they successful. A number of the large banks, actually for an extended period of time, never saw their stock price move. It was kind of interesting. You go to the top two or three. One over the last 15 years has seen total shareholder return of about 1,100%. A couple others have been in the 500-600 range. We, over that same period of time, grew 1,700%. Now, we don't have a couple trillion dollars in assets, I appreciate that we're a different model. Our model has worked over time.
Right now, one of the things we're trying to shift with our model is getting a higher PE will allow us to be more opportunistic in buying other banks. When you look at these other money center banks, the way they got their growth or accelerated growth was having a foundational balance sheet, which is what we're trying to do. We've got very strong CET1 now. We've got very strong liquidity. We're improving on the allowance for loan loss reserve, which is, I think, the last component. We'll have a very strong foundational balance sheet. If we have a higher PE multiple, we'll be in the right position, hopefully at the right time, to buy a bank if there's one that falls into trouble or if there's one that falls into our lap that meets our criteria.
That's sort of what we're thinking about in terms of the share pricing and also how to use capital versus growth. If we get closer, listen, if we're trading at two times book, which we're not, but if we were, I'd just put the money back into organic growth. We've got an organic growth machine with all these S-curves and with all these. We still have a number of new businesses we talked about on Investor Day that are in their infancy in terms of their growth. We're just moderating them because we don't want to grow more than $5 billion in total loan growth this year.
You've built this franchise almost entirely organically through new specialty verticals rather than M&A. As consolidation picks up across the space, does that create more opportunity for you to add customers and talent, or does that make the organic expansion to certain markets harder?
I think it gives us an opportunity. When you just look at commercial banks, we're the 16th largest commercial bank in the country, right? Only in banking can you be $100 billion and not be big enough. All right? Even the guys that are $500 billion and $600 billion complain that they're not a trillion, and so forth and so on. But we're one of the larger banks that no one really has ever heard about, right? Now, as our profile has increased, we have people coming to our company that want to bring their expertise. The reason why they want to bring their expertise is, one, access to me and the senior management team, the ability to prioritize their technology development, which is very important. That was Corporate Trust's whole pitch when they came to us.
How do I know that I'm going to get the time and attention? They came from a very large money center bank, and I said, well, if you grow $1 billion- $2 billion over the next two years at this money center bank, it's not going to be noticed. Here, it's going to be noticed. I'll make sure you get all the tech support. We're bringing that in. That's really an advantage to us. If things slow and we have opportunities, possibly through M&A, and it's hard really to talk about that without smiling, since we don't have the P/E multiple. But we do track a number of businesses that we like, and if they become available, and if the right circumstances line up, that will allow us to move into different territories and allow us to continue to grow that way.
Great. You talked a little bit about tech, but you've moved beyond broad AI experimentation into specific use cases and cited some productivity gains at Investor Day. Which applications are closest to a measurable P&L benefit, and how are you using AI to support the deposit optimization and relationship profitability effort without weakening the client experience?
Yeah. We spent some time on this at our board meeting. I laid out 15 strong use cases for AI. We're going to focus on the top five first so that we can embed the cost into our models for 2027. As soon as we see a return or a lack of return in these areas, we'll make our decisions and roll on to the next thing. But where we're seeing initial early gains, let's go to Corporate Trust and their pipeline. We are consolidating the period it takes to onboard, which is incredibly important for us. That's been positive. We've used AI in the mortgage business in terms of our pricing models. That's been a positive for us. We have some very specific use cases that have worked out.
Actually, first thing we needed to do, and what took us a little bit on a side road, was when Mythos came out, we had to use our AI team to prevent AI from hurting us. That was our first goal, which is, hey, let's make sure the core of the business stays intact and everything else will catch up. Now, we think we've done that, and now we can start putting the time and resources against AI projects that will help us. But I haven't embedded any of that into our models yet. We're going to wait and see a definitive ROI on these businesses. Around the edges, we know they're definitely going to help. I just want to understand what the real return is for each business. But we're very positive about them. We do think it will contribute.
Great. In the last few minutes, seeing if anybody in the audience has any questions. No, I guess, Ken, when we're sitting here a year from now, and if the market has rerated the stock toward what you think is the intrinsic value, what do you think will have driven it? I guess, what's the one thing you think investors most underappreciate about Western Alliance today?
Oh, that's a therapy question. So I'm going to sit down and get a couch for that one. Okay, what don't they appreciate about the bank? Is our long track record for providing value. Our ability to find specialty finance businesses, craft them, take our time to understand them, roll them out. That's part of the S-curve strategy, and then see the growth that follows. For a small bank, we run a very complicated operations, and so the management team, I think, is very gifted, and I don't think people appreciate that as well. What will be different here a year from now is, I hope everything I talked about on the tactics. Which is deposit optimization, share repurchase, and the asset quality improving, leading to a lower beta and a lower cost of capital. That would be one of my goals.
If that happens, I think the price of the stock is going to move up, and I think you'll see a higher P/E multiple. That's what I hope will happen next year at this time.
Great. Well, thank you very much. It was great to have a chance to chat with you.
Thank you very much. I appreciate it.
Yeah. Thank you very much.
Okay. Be well. Thank you.