Western Alliance Bancorp. in Phoenix believes it has what it takes to manage a portfolio that might give other bankers night sweats.
The $14 billion-asset company agreed Tuesday to buy a $1.4 billion portfolio of hotel loans from GE Capital even though credits to the hospitality sector are often among the first to have problems during an economic downturn. Western Alliance, however, is confident that its expertise makes the deal work even better than one involving a whole bank.
For now, analysts are willing to give the bank the benefit of the doubt. Investors also seemed supportive; Western Alliance's stock rose nearly 10% on Wednesday.
Western Alliance "has a lot of experience in this type of lending," said Brent Rabatin, an analyst at Piper Jaffray. "They espoused their strong feelings that the underwriting was thoroughly reviewed and they feel good about it."
That expertise starts with Western Alliance's chairman and chief executive, Robert Sarver, who has spent 30 years investing in hotel franchises through outside real estate interests, Brad Milsaps, an analyst at Sandler O'Neill, wrote in a note to clients. (Sarver's late father was a well-known hotel developer in Arizona.)
Sarver personally reviewed the portfolio, which largely consists of "mid-level hotel chains" such as Homewood Suites, Milsaps added.
Still, investors could be concerned because Western Alliance is getting into a national lending business in the later stages of a credit cycle, said Casey Haire, an analyst at Jefferies. Investors are already concerned because the fast-growing company suffered from credit problems a few years ago, he said.
"This opens you up to asset quality concerns if we hit a downturn," Haire said. Hotel lending "is a higher-loss product than some of their other lines, too."
Western Alliance approached the portfolio's review as though a recession was coming, though the company isn't predicting one, Chief Financial Officer Dale Gibbons said in an interview. The company, which has "considerable experience" with hotel loans, plans to keep hotel credits at around 10% of total loans, he added.
"Certainly, hotel loans generally have a higher volatility relative to other economic sectors," Gibbons said. "We evaluated this under different distressed environments. This will perform better than most hotel loans."
General Electric, which has been selling off assets as it winds down GE Capital, had been talking to Western Alliance since the fall, Milsaps said in his note. All the loans in the portfolio are currently performing, Western Alliance said.
Despite the credit risk, buying the loans from GE Capital was "better than a bank deal" for Western Alliance, Rabatin said. The all-cash acquisition, which allowed management to deploy excess capital, will also be accretive to earnings without diluting tangible book value.
Western Alliance is continuing to look at acquisitions, especially in Arizona, California and Nevada, Gibbons said. It has also made offers to banks in Colorado and the Pacific Northwest, he added. But sellers haven't adjusted their price expectations despite the decline in the stock market, he said.
Management could even have some interest in buying a bank in Texas next year if conditions worsen, Milsaps said in an interview.
Texas is "a great market and is one of the most business friendly states in the country," but it's probably too early to buy a bank there "given the uncertainty regarding the energy space but down the road it could be interesting," Gibbons said.
A low price-earnings multiple could hamstring Western Alliance from pursuing a stock acquisition, and its capital ratios will take a hit from the purchase of the hotel book, industry observers said. As a result, the company might be best served to sit on the sidelines until it rebuilds capital.
"M&A is really the wild card to the story," Haire said.
Western Alliance, like other banks, could still look to buy assets rather than whole institutions. Doing so would help the company avoid criticism other banks have received about lengthy earnback periods for tangible book value dilution tied to whole bank acquisition.
Asset purchases also receive better tax treatment than whole-bank purchases, Gibbons said.
"I think it's certainly possible that more banks buy assets," Milsaps said in the interview. "With rates where they are, every bank is looking to find as much yield as they can. People are trying to find ways to make money in a very low interest rate environment."