This week in the premium service of The Institutional Risk Analyst, we take a look at the merger of Western Alliance Bancorporation (NYSE:WAL) with AmeriHomeMortgage (AH). This public report is an example of the content available to subscribers to The IRA premium service.
WAL is the $33 billion asset parent of Western Alliance Bank, a state-chartered depository based in Phoenix, AZ. AH is controlled by insurance companies owned by Athene Holding Ltd. (NYSE: ATH), and funds managed by Apollo Global Management, Inc (NYSE:APO).
WAL closed at $88 on Friday, an equity market valuation of 2.6x book value and a 17x trailing price to earnings. WAL closed below 50bp in credit default swaps on Friday, roughly in line with the large money centers such as Citigroup (NYSE:C) and Bank of America (NYSE:BAC), with a beta of just 1.6x the average market volatility.
No surprise then that both Moody’s and Kroll Bond Rating Agency reaffirmed the long- and short-term ratings for WAL immediately after the transaction was announced. Indeed, KBRA put AH on watch for a rating upgrade to reflect the superior credit of the bank holding company. KBRA noted last week:
“AmeriHome’s Issuer rating was most recently affirmed on October 26, 2020 in an action that was supported by the company’s consistent multiyear operating performance, and reasonable pro forma leverage, following a partially debt financed special dividend to its owners – insurance companies owned by Athene Holding Ltd… and funds managed by Apollo Global Management – as well as the company’s bolstered liquidity. AmeriHome’s credit profile has benefitted from a highly qualified management team, the majority of which gained some of their most valuable experience during and following the Global Financial Crisis (GFC).”
The “capital light” nature of the AH business model and the focus on acquiring loans from a network of trusted partners results in superior equity returns, lower risk and an investment grade credit profile from the major agencies. We believe that combining the hyper-efficient AH loan acquisition and servicing platform with a solid regional lender such as WAL promises to make 1+1 > 2.
Last week WAL described the transaction in a press release:
“AmeriHome brings a B2B approach to the mortgage ecosystem through its relationships with over 700 independent correspondent mortgage originator clients, including independent mortgage bankers, community and regional banks, and credit unions of all sizes. Based in Thousand Oaks, CA, AmeriHome is the nation’s third largest correspondent mortgage acquirer, purchasing approximately $65 billion in conventional conforming and government insured originations during 2020 from its network of independent mortgage originators and managing a $99 billion mortgage servicing portfolio, as of December 31, 2020.”
The proposed transaction, which is currently expected to close during 2Q 2021, is priced around 1x book and envisions AH retaining a corporate structure as a subsidiary of Western Alliance Bank. This structure as an operating sub of the bank will provide AH with shelter from much of state-law regulation and licensing requirements due to the fact of FDIC insurance and federal regulation as per the SAFE Act.
AH is one of the top correspondent lenders in the US and a major player in the conventional loan market. AH has a low-cost operating model compared to its peers among independent mortgage banks due to its relatively new internal systems and controls, as well as an outsourced model for loan servicing. The table below shows loan origination and unpaid principal balance (UPB) through Q3 2020 from the AH S-1 filed with the SEC.
At the end of Q3 2020, AH had assets of $6.9 billion, corporate debt (excluding $2.4 billion in secure warehouse lines) of $360 million, and mortgage servicing rights (MSRs) totaling $830 million. Notice that the MSR equals ~ 0.86% of the total unpaid principal balance (UPB) of the loans serviced. In the nine-months ended September 30, 2020, AH reported net revenue of $709 million, up over 100% year-over-year. With interest rates rising and mortgage volumes starting to slow, it is reasonable to expect industry volumes to slow.
WAL is an outstanding performer and one of the stronger regional banks in Peer Group 1, which includes the top US banks over $10 billion in assets. The bank’s net income as a percentage of average assets was 1.38% at the end of Q3 2020, placing WAL in the top 10% of large US banks. Net losses on loans and leases were 0.06% vs 0.28% of total loans for Peer Group 1. The gross spread on WAL’s total loans and leases was 4.82% in Q3 2020 vs 4.35% for Peer Group 1, putting WAL in the top third of large banks in terms of loan pricing.
By putting AH within the bank’s operational and regulatory envelope, WAL can achieve big synergies and cost savings, even while operating the mortgage acquisition and servicing business as a separate division within the depository.
AH CEO Jim Furash and his veteran team came through the crisis and have proven their business model over the past decade, making a compelling case for the transaction with regulators. AH built their platform with the support of ATH and APO, which gives them a big leg up vs the competition in terms of both financial and risk management, and operating efficiency.
WAL too is very well-managed, with an efficiency ratio calculated by the FFIEC of 40% in Q3 2020 vs 62% for Peer Group 1. That puts WAL in the top decile of all large banks in the US, where this indicator has been for the past five years. In Q3 2020, the bank’s earning assets as a percentage of average assets was 95.7% vs 92% for Peer Group 1, again putting WAL in the top decile of its peers in terms of keeping maximum sail aloft.
We have long advocated the idea of an independent mortgage bank (IMB) combining with a strong regional lender because of the economics of retaining escrow balances within the bank and thereby growing a business that supports both mortgage lending and servicing, while greatly enhancing the liquidity and income of the depository.
WAL’s bank subsidiary has almost $30 billion in core deposits and only $1.5 billion in non-core funding, creating the potential for big growth ahead as the bank expands lending and other services to the AH ecosystem funded with the escrow deposits of the servicing book. We view the combination of AH and WAL as a showcase transaction for the mortgage bank concept we outlined previously in The Institutional Risk Analyst and on SSRN. We hope that other IMB’s take the hint.
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