Week In Review: A look inside what happened at Western Alliance

Last week was really the start of earnings season with the banks largely reporting. Western Alliance reported that the outflow of deposits has reversed and that cheered the Street. Western Alliance did make some securities sales and wrote down some investments. The stock rose by 28% over the past week.

On the earnings conference call, management was quite candid about what happened to the stock during the Silicon Valley Bank situation and deposit outflows. Western Alliance has a tech bank called Bridge Bank which is a competitor to Silicon Valley Bank. Fears over Bridge Bank was the main driver of Western Alliance’s deposit outflow. The big difference between Bridge Bank is that these tech deposit relationships were only part of Western Alliance’s business, while Silicon Valley Bank’s main business was that activity. Western Alliance CFO Dale Gibbons gave a window into what was going on in the markets.

In terms of kind of the stock situation -- so really, I think the question starts with how did we get caught up in this? And we think the original tie is because of Bridge and the relationship that we have is the prime competitor to Silicon Valley Bank. But for us, it was only 16% of our total versus for Silicon Valley Bank, it's basically their entire business.

So, -- but -- so what happened is that issue when they run started on SVB, I think they looked around who else is in the space, but that perception quickly metastasize into a short narrative.

And if you look at our options activity, we a lot of days, we wouldn't trade options at all. But on that Friday, March 10th, we traded about 1,000 times our normal volume. And the most common issue was somebody bought $30 put. Mind you, this is what our stock is trading at $50. So, they're $20 got the money, and they expired next week, the March 17th week. somebody that had an agenda, and then on Monday morning, before the market opens at 5:00 A.M. New York Times, there was a premarket session selling. And nobody treats premarket us, so it's pretty easy to move the stock price around and push it down, down, down. And so we've opened a $12 on Monday morning.

Well, that's what the print was. And so when depositors saw they say, oh my gosh, you're down 75% over the weekend, hence that triggered an $8 billion withdrawal on that Monday. Now, we traded down into the $7s and then on nearly quadruple and closed at $26 per share. That's not typical bank trading in terms of what goes on.

But I think the stock price recovery calmed down depositors and so we had a sharp drop about 85% in terms of withdrawals on Tuesday and then -- since it been basically flat. And after that entire week, we've been on this kind of uptrend again.

Western Alliance is expected to earn $8.22 this year, which puts the stock a 2023 P/E of under 5x. It also sports a 3.6% dividend yield and is trading a 13% discount to book value. Even after the run last week the stock is still looking cheap.

One item that made news this week was the Federal Housing Finance Agency (FHFA), which is the conservator of Fannie Mae and Freddie Mac playing with loan-level pricing grids to make lower credit score loans less expensive to the borrower and to make higher credit score loans more expensive. The change was announced a couple of months ago, and is being implemented shortly. It is a plan to subsidize lower-income / credit borrowers by lowering the fees they pay on a mortgage and increasing the fees that borrowers with good credit pay. In other words, low credit scores still get hit by Fannie and Freddie, however the size of the hit is smaller now. This doesn’t mean that you can get a better deal by destroying your credit. That said, will it make a difference in encouraging more lending to people with poor credit? My guess is that it won’t.

Most mortgage banks refuse to lend to the lowest credit scores, even if FHFA allows it. FHA loans can go as low as 580, but many lenders won’t go below 680. This is because the rules regarding the servicing of FHA loans are extraordinarily harsh. Under a foreclosure situation the mortgage lender will lose much more than the amount made on the loan in the first place. Mortgage servicers are the people that pay the borrower’s mortgage payment if the borrower doesn’t. The servicer will get a partial reimbursement for these fees, and will end up with a big loss on the loan. Plus, the government looks at loan performance and will revoke a lender’s right to securitize Ginnie Mae loans if delinquencies get too high.

Even if the lender doesn’t hold the mortgage as an investment, that doesn’t mean the lender has no credit risk. Lenders are always at risk of a buy-back request which means if Fannie and Freddie find something wrong with the loan, they can tell the lender to buy the loan back. Buybacks in the aftermath of the 2008 financial crisis caused many lenders to go bankrupt. They also explain why Jamie Dimon at JP Morgan refuses to do FHA loans any more. The government came after JP Morgan under the False Claims Act in the aftermath of the real estate bubble and imposed massive penalties. This was the government’s thank you for honoring the government’s request to buy Bear Stearns.

The punch line is that the government wants more low FICO lending, but the penalties of making these loans are so big when they go bad that this is pablum for the activist class and not much more. I can’t see it making that big of a difference in lending.

Homebuilder D.R. Horton reported its second quarter earnings. Revenues were largely flat, but earnings fell as gross margins collapsed. Still the company is seeing some encouraging signs in the spring selling season.

Spring selling season is off to an encouraging start with our net sales orders increasing 73% sequentially from the first quarter. Despite higher mortgage rates and inflationary pressures, demand improved during the quarter due to normal seasonal factors, coupled with our use of incentives and pricing adjustments to adapt to changing market conditions. Although higher interest rates and economic uncertainty may persist for some time, the supply of both new and existing homes at affordable price points remains limited and demographics supporting housing demand remain favorable.

The cancellation rate did increase from 16% to 18%, however. It looks like the use of incentives and pricing adjustments were a driver of the decline in gross margins. Builders would much rather throw in free upgrades or a subsidized mortgage instead of cutting prices.