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WESTERN ALLIANCE BANCORPORATION - 10-Q - Management's Discussions and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) This discussion is designed to provide insight into management's assessment of significant trends related to the Company's consolidated financial condition, results of operations, liquidity, capital resources and interest rate sensitivity. This Quarterly Report on Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2013 and the interim unaudited Consolidated Financial Statements and Notes to Unaudited Consolidated Financial Statements hereto and financial information appearing elsewhere in this report. Unless the context requires otherwise, the terms "Company," "we," and "our" refer to Western Alliance Bancorporation and its wholly-owned subsidiaries on a consolidated basis. Forward-Looking Information Certain statements contained in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2014 are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements be covered by the safe harbor provisions for forward-looking statements. All statements other than statements of historical fact are "forward-looking statements" for purposes of federal and state securities laws, including statements that are related to or are dependent on estimates or assumptions relating to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. The forward-looking statements contained in this Form 10-Q reflect our current views about future events and financial performance and involve certain risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from historical results and those expressed in any forward-looking statement, including those risks discussed under the heading "Risk Factors" in this Form 10-Q. Risks and uncertainties include those set forth in our filings with the SEC and the following factors that could cause actual results to differ materially from those presented: 1) financial market and economic conditions adversely effecting financial performance; 2) dependency on real estate and events that negatively impact real estate; 3) high concentration of commercial real estate, construction and development and commercial and industrial loans; 4) actual credit losses may exceed expected losses in the loan portfolio; 5) the geographic concentrations of our assets increase the risks related to local economic conditions; 6) sovereign credit rating downgrades; 7) exposure of financial instruments to certain market risks may cause volatility in earnings; 8) dependence on low-cost deposits; 9) ability to borrow from the FHLB or the FRB; 10) events that further impair goodwill; 11) a change in the our creditworthiness; 12) expansion strategies may not be successful; 13) risk associated with the recent consolidation of our bank subsidiaries; 14) our ability to compete in a highly competitive market; 15) our ability to recruit and retain qualified employees, especially seasoned relationship bankers and senior management; 16) the effects of terrorist attacks or threats of war; 17) perpetration of internet fraud; 18) information security breaches; 19) reliance on other companies' infrastructure; 20) risk management policies not fully effective; 21) risks associated with new lines of businesses; 22) risk of operating in a highly regulated industry and our ability to remain in compliance; 23) failure to comply with state and federal banking agency laws and regulations; 24) changes in interest rates and increased rate competition; 25) exposure to environmental liabilities related to the properties to which we acquire title; and 26) risks related to ownership and price of our common stock. For more information regarding risks that may cause our actual results to differ materially from any forward-looking statements, see "Risk Factors" in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013. Financial Overview and Highlights WAL is a bank holding company headquartered in Phoenix, Arizona, originally incorporated under the laws of the state of Nevada. On May 29, 2014, WAL was re-incorporated under the laws of the state of Delaware. WAL provides comprehensive business banking and related financial services through its wholly-owned subsidiary bank: WAB, doing business as ABA in Arizona, as FIB in Northern Nevada, as BON in Southern Nevada, as TPB in California, and as AAB throughout the U.S. In addition, the Company has two non-bank subsidiaries, WAEF, which offers equipment finance services nationwide, and LVSP, which holds and manages certain non-performing loans and OREO. On July 1, 2014, WAEF was contributed to WAB by WAL and is now a subsidiary of the Bank. Financial Result Highlights for the Second Quarter of 2014 Net income available to common stockholders for the Company of $35.2 million, or $0.40 per diluted share, for the second quarter of 2014, compared to $33.7 million, or $0.39 per diluted share, for the second quarter of 2013. For the six months ended June 30, 2014, net income available to common stockholders was $65.9 million, or $0.76 per diluted share, compared to $54.3 million, or $0.63 per diluted share, for the six months ended June 30, 2013. The significant factors impacting earnings of the Company during the second quarter of 2014 were: 57-------------------------------------------------------------------------------- Table of Contents • Pre-tax, pre-provision operating earnings (see Non-GAAP Financial Measures beginning on page 60) for the second quarter of 2014 increased $7.3 million to $47.4 million, compared to $40.1 million for the second quarter of 2013. For the comparable six month periods, pre-tax, pre-provision operating earnings increased $16.6 million to $91.8 million, compared to $75.2 million for the six months ended June 30, 2013. • The Company experienced loan growth of $743.2 million to $7.54 billion at June 30, 2014 from $6.80 billion at December 31, 2013. • Other assets acquired through foreclosure declined by $7.4 million to $59.3 million at June 30, 2014 from $66.7 million at December 31, 2013. • The Company increased deposits by $631.3 million to $8.47 billion at June 30, 2014 from $7.84 billion at December 31, 2013. • Provision for credit losses for the second quarter of 2014 decreased by $3.0 million to $0.5 million, compared to $3.5 million for the second quarter of 2013, as net charge-offs also declined by $4.2 million to net recoveries of $1.5 million in the second quarter of 2014, compared to net charge-offs of $2.7 million for the second quarter of 2013. For the comparable six month periods, provision for credit losses decreased by $4.9 million to $4.0 million, compared to $8.9 million for the six months ended June 30, 2013 as net charge-offs declined by $9.9 million to net recoveries of $1.9 million, compared to net charge-offs of $8.0 million for the six months ended June 30, 2013. • Net interest margin increased to 4.39%, compared to 4.36% for the second quarter of 2013. For the comparable six month periods, net interest margin increased to 4.40%, compared to 4.36% for the six months ended June 30, 2013. • Key asset quality ratios improved at June 30, 2014 compared to December 31, 2013. Nonaccrual loans and repossessed assets to total assets improved to 1.23% from 1.53% at December 31, 2013 and nonaccrual loans to gross loans improved to 0.85% at the end of the second quarter of 2014 compared to 1.11% at December 31, 2013. • Tangible book value per share, net of tax, at June 30, 2014 increased by $1.12 to $9.02, compared to $7.90 at December 31, 2013. The impact to the Company from these items and others, of both a positive and negative nature, are discussed in more detail below as they pertain to the Company's overall comparative performance for the three and six months ended June 30, 2014. Results of Operations and Financial Condition A summary of our results of operations, financial condition and select metrics are included in the following tables: Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 (in thousands, except per share amounts) Net income available to common stockholders $ 35,186 $ 33,719 $ 65,918 $ 54,252 Earnings per share applicable to common stockholders--basic 0.41 0.39 0.76 0.63 Earnings per share applicable to common stockholders--diluted 0.40 0.39 0.76 0.63 Net interest margin 4.39 % 4.36 % 4.40 % 4.36 % Return on average assets 1.46 1.62 1.39 1.35 Return on average tangible common equity 17.41 21.41 16.77 17.66 June 30, 2014 December 31, 2013 (in thousands) Total assets $ 10,023,587 $ 9,307,342 Loans, net of deferred loan fees and costs 7,544,567 6,801,415 Total deposits 8,469,505 7,838,205 58-------------------------------------------------------------------------------- Table of Contents As a bank holding company, management focuses on key ratios in evaluating the Company's financial condition and results of operations. Asset Quality For all banks and bank holding companies, asset quality plays a significant role in the overall financial condition of the institution and results of operations. The Company measures asset quality in terms of nonaccrual loans as a percentage of gross loans and net charge-offs as a percentage of average loans. Net charge-offs are calculated as the difference between charged-off loans and recovery payments received on previously charged-off loans. The following table summarizes asset quality metrics: June 30, 2014 December 31, 2013 (in thousands) Non-accrual loans $ 64,345 $ 75,680 Non-performing assets 216,341 233,509 Non-accrual loans to gross loans 0.85 % 1.11 % Net (recoveries) charge-offs to average loans - annualized (0.09 ) 0.13 Asset and Deposit Growth The Company's assets and liabilities are comprised primarily of loans and deposits; therefore, the ability to originate new loans and attract new deposits is fundamental to the Company's growth. Total assets increased to $10.02 billion at June 30, 2014 from $9.31 billion at December 31, 2013. Total loans, net of deferred loan fees and costs, increased by $743.2 million, or 10.9%, to $7.54 billion as of June 30, 2014, compared to $6.80 billion as of December 31, 2013. Total deposits increased $631.3 million, or 8.1%, to $8.47 billion as of June 30, 2014 from $7.84 billion as of December 31, 2013. RESULTS OF OPERATIONS The following table sets forth a summary financial overview for the comparable periods: Three Months Ended June 30, Increase Six Months Ended June 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in thousands, except per share amounts) Consolidated Income Statement Data: Interest income $ 101,973 $ 89,285 $ 12,688 $ 200,674 $ 172,393 $ 28,281 Interest expense 8,075 7,133 942 15,999 14,038 1,961 Net interest income 93,898 82,152 11,746 184,675 158,355 26,320 Provision for credit losses 507 3,481 (2,974 ) 4,007 8,920 (4,913 ) Net interest income after provision for credit losses 93,391 78,671 14,720 180,668 149,435 31,233 Non-interest income 5,773 11,762 (5,989 ) 10,608 16,561 (5,953 ) Non-interest expense 52,416 48,531 3,885 102,165 95,460 6,705 Income from continuing operations before provision for income taxes 46,748 41,902 4,846 89,111 70,536 18,575 Income tax expense 10,706 7,661 3,045 21,330 15,448 5,882 Income from continuing operations 36,042 34,241 1,801 67,781 55,088 12,693 Loss from discontinued operations, net of tax (504 ) (169 ) (335 ) (1,158 ) (131 ) (1,027 ) Net income $ 35,538 $ 34,072 $ 1,466 $ 66,623 $ 54,957 $ 11,666 Net income available to common stockholders $ 35,186 $ 33,719 $ 1,467 $ 65,918 $ 54,252 $ 11,666 Earnings per share applicable to common stockholders--basic $ 0.41 $ 0.39 $ 0.02 $ 0.76 $ 0.63 $ 0.13 Earnings per share applicable to common stockholders--diluted $ 0.40 $ 0.39 $ 0.01 $ 0.76 $ 0.63 $ 0.13 59-------------------------------------------------------------------------------- Table of Contents Non-GAAP Financial Measures The following discussion and analysis contains financial information determined by methods other than those prescribed by GAAP. The Company's management uses these non-GAAP financial measures in their analysis of the Company's performance. These measurements typically adjust GAAP performance measures to exclude the effects of unrealized gains (losses) on assets/liabilities measured at fair value as well as other items to adjust income available to common shareholders for certain significant activities or transactions that, in management's opinion, do not reflect recurring period-to-period comparisons of the Company's performance. Since the presentation of these non-GAAP performance measures and their impact differ between companies, management believes presentation of these non-GAAP financial measures provide useful supplemental information that is essential to a complete understanding of the operating results of the Company's core businesses. These non-GAAP disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Pre-Tax, Pre-Provision Operating Earnings Pre-tax, pre-provision operating earnings adjusts the level of earnings to exclude the impact of income taxes, provision for credit losses and non-recurring or other items not considered part of the Company's core operations. Management believes that eliminating the effects of these items makes it easier to analyze underlying performance trends and enables investors to assess the Company's earnings power and ability to generate capital to cover credit losses. The following table shows the components of pre-tax, pre-provision operating earnings for the three and six months ended June 30, 2014 and 2013: Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 (in thousands) Total non-interest income $ 5,773 $ 11,762 $ 10,608 $ 16,561 Less: Unrealized gains (losses) on assets/liabilities measured at fair value, net 235 (3,290 ) (1,041 ) (3,761 ) Bargain purchase gain from acquisition - 10,044 - 10,044 (Loss) gain on sales of investment securities, net (163 ) (5 ) 203 143 Legal settlements - - - 38 Total operating non-interest income 5,701 5,013 11,446 10,097 Add: net interest income 93,898 82,152 184,675 158,355 Net operating revenue $ 99,599 $ 87,165 $ 196,121 $ 168,452 Total non-interest expense $ 52,416 $ 48,531 $ 102,165 $ 95,460 Less: Net loss (gain) on sales and valuations of repossessed and other assets 184 (1,124 ) (2,363 ) (605 ) Merger / restructure expense 26 2,620 183 2,815 Total operating non-interest expense $ 52,206 $ 47,035 $ 104,345 $ 93,250 Pre-tax, pre-provision operating earnings $ 47,393 $ 40,130 $ 91,776 $ 75,202 60-------------------------------------------------------------------------------- Table of Contents Tangible Common Equity The following table presents financial measures related to tangible common equity. Tangible common equity represents total stockholders' equity less identifiable intangible assets, goodwill and preferred stock. Management believes that tangible common equity financial measures are useful in evaluating the Company's capital strength, financial condition, and ability to manage potential losses. In addition, management believes that these measures improve comparability to other institutions that have not engaged in acquisitions that resulted in recorded goodwill and other intangibles. June 30, 2014 December 31, 2013 (dollars and shares in thousands) Total stockholders' equity $ 957,664 $ 855,498 Less: Goodwill and intangible assets, net 26,475 27,374 Total tangible stockholders' equity 931,189 828,124 Less: Preferred stock 141,000 141,000 Total tangible common equity 790,189 687,124 Add: Deferred tax - attributed to intangible assets 1,138 1,452 Total tangible common equity, net of tax $ 791,327 $ 688,576 Total assets $ 10,023,587 $ 9,307,342 Less: Goodwill and intangible assets, net 26,475 27,374 Tangible assets 9,997,112 9,279,968 Add: Deferred tax - attributed to intangible assets 1,138 1,452 Total tangible assets, net of tax $ 9,998,250 $ 9,281,420 Tangible equity ratio 9.3 % 8.9 % Tangible common equity ratio 7.9 7.4 Return on tangible common equity 18.0 18.3 Common shares outstanding 87,774 87,186 Tangible book value per share, net of tax $ 9.02 $ 7.90 Efficiency Ratio The following table shows the components used in the calculation of the efficiency ratio, which management uses as a metric for assessing cost efficiency: Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 (dollars in thousands) Total operating non-interest expense $ 52,206 $ 47,035 $ 104,345 $ 93,250 Divided by: Total net interest income $ 93,898 $ 82,152 $ 184,675 $ 158,355 Add: Tax equivalent interest adjustment 6,029 2,929 11,734 6,311 Operating non-interest income 5,701 5,013 11,446 10,097 Net operating revenue - tax equivalent basis $ 105,628 $ 90,094 $ 207,855 $ 174,763 Efficiency ratio - tax equivalent basis 49.4 % 52.2 % 50.2 % 53.4 % 61-------------------------------------------------------------------------------- Table of Contents Tier 1 Common Equity The following tables present certain financial measures related to Tier 1 common equity, which is a component of Tier 1 risk-based capital. The FRB and other banking regulators have used Tier 1 common equity as a basis for assessing a bank's capital adequacy; therefore, management believes it is useful to assess financial condition and capital adequacy using this same basis. In addition, management believes that the classified assets to Tier 1 capital plus allowance measure is a critical regulatory metric for assessing asset quality. June 30, 2014 December 31, 2013 (dollars and shares in thousands) Stockholders' equity $ 957,664 $ 855,498 Less: Accumulated other comprehensive income (loss) 8,472 (21,546 ) Non-qualifying goodwill and intangibles 25,204 25,991 Disallowed unrealized losses on equity securities - 8,059 Add: Qualifying trust preferred securities 49,039 48,485 Tier 1 capital (regulatory) 973,027 891,479 Less: Qualifying trust preferred securities 49,039 48,485 Preferred stock 141,000 141,000 Tier 1 common equity $ 782,988 $ 701,994 Divided by: Risk-weighted assets (regulatory) $ 8,673,807 $ 8,016,500 Tier 1 common equity ratio 9.0 % 8.8 % June 30, 2014 December 31, 2013 (dollars in thousands) Classified assets $ 263,910 $ 270,375 Divide: Tier 1 capital (regulatory) 973,027 891,479 Plus: Allowance for credit losses 105,937 100,050 Total Tier 1 capital plus allowance for credit losses $ 1,078,964 $ 991,529 Classified assets to Tier 1 capital plus allowance 24.5 % 27.3 % 62-------------------------------------------------------------------------------- Table of Contents Net Interest Margin The net interest margin is reported on a TEB. A tax equivalent adjustment is added to reflect interest earned on certain municipal securities and loans that are exempt from Federal income tax. The following tables set forth the average balances and interest income on a fully tax equivalent basis and interest expense for the periods indicated: Three Months Ended June 30, 2014 2013 Average Yield Average Average Balance Interest / Cost Average Balance Interest Yield / Cost (dollars in thousands) Interest earning assets Loans (1) (2) (3) $ 7,178,255 $ 90,583 5.29 % $ 6,100,831 $ 81,093 5.40 % Securities (1) 1,629,950 10,894 3.08 1,295,902 7,822 2.92 Federal funds sold and other 292,386 496 0.68 407,619 370 0.36 Total interest earning assets 9,100,591 101,973 4.75 7,804,352 89,285 4.73 Non-interest earning assets Cash and due from banks 138,660 119,209 Allowance for credit losses (105,024 ) (96,672 ) Bank owned life insurance 141,844 139,740 Other assets 462,051 432,740 Total assets $ 9,738,122 $ 8,399,369 Interest-bearing liabilities Interest-bearing deposits: Interest-bearing transaction accounts $ 791,501 $ 385 0.19 % $ 626,768 $ 370 0.24 % Savings and money market 3,583,500 2,691 0.30 2,768,656 2,007 0.29 Time certificates of deposit 1,700,412 1,854 0.44 1,584,029 1,552 0.39 Total interest-bearing deposits 6,075,413 4,930 0.32 4,979,453 3,929 0.32 Short-term borrowings 236,197 216 0.37 188,833 214 0.45 Long-term debt 280,356 2,486 3.55 365,152 2,535 2.78 Junior subordinated debt 42,834 443 4.14 36,723 455 4.96 Total interest-bearing liabilities 6,634,800 8,075 0.49 5,570,161 7,133 0.51 Non-interest-bearing liabilities Non-interest-bearing demand deposits 2,045,534 1,898,237 Other liabilities 126,732 124,621 Stockholders' equity 931,056 806,350 Total liabilities and stockholders' equity $ 9,738,122 $ 8,399,369 Net interest income and margin (4) $ 93,898 4.39 % $ 82,152 4.36 % Net interest spread (5) 4.26 % 4.22 % (1) Yields on loans and securities have been adjusted to a tax equivalent basis. The taxable-equivalent adjustment was $6.0 million and $2.9 million for the three months ended June 30, 2014 and 2013, respectively. (2) Net loan fees of $1.0 million and $1.2 million are included in the yield computation for the three months ended June 30, 2014 and 2013, respectively. (3) Includes nonaccrual loans. (4) Net interest margin is computed by dividing net interest income by total average earning assets. (5) Net interest spread represents average yield earned on interest-earning assets less the average rate paid on interest bearing liabilities. 63-------------------------------------------------------------------------------- Table of Contents Six Months Ended June 30, 2014 2013 Average Yield Average Average Balance Interest / Cost Average Balance Interest Yield / Cost (dollars in thousands) Interest earning assets Loans (1) (2) (3) $ 7,036,539 $ 177,387 5.28 % $ 5,856,986 $ 155,818 5.41 % Securities (1) 1,640,750 22,219 3.11 1,289,680 15,980 3.06 Federal funds sold & other 251,551 1,068 0.85 406,229 595 0.29 Total interest earnings assets 8,928,840 200,674 4.76 7,552,895 172,393 4.73 Non-interest earning assets Cash and due from banks 138,091 122,861 Allowance for credit losses (103,099 ) (96,765 ) Bank owned life insurance 141,372 139,220 Other assets 447,654 427,308 Total assets $ 9,552,858 $ 8,145,519 Interest-bearing liabilities Interest-bearing deposits: Interest bearing transaction accounts $ 778,341 $ 768 0.20 % $ 617,766 $ 671 0.22 % Savings and money market 3,518,279 5,254 0.30 2,695,173 3,918 0.29 Time certificates of deposits 1,660,212 3,573 0.43 1,517,154 3,072 0.40 Total interest-bearing deposits 5,956,832 9,595 0.32 4,830,093 7,661 0.32 Short-term borrowings 201,799 345 0.34 183,005 428 0.47 Long-term debt 291,031 5,195 3.57 319,272 5,028 3.15 Junior subordinated debt 42,355 864 4.08 36,475 921 5.05 Total interest-bearing liabilities 6,492,017 15,999 0.49 5,368,845 14,038 0.52 Non-interest-bearing liabilities Non-interest-bearing demand deposits 2,049,806 1,876,772 Other liabilities 102,251 107,407 Stockholders' equity 908,784 792,495 Total liabilities and stockholders' equity $ 9,552,858 $ 8,145,519 Net interest income and margin (4) $ 184,675 4.40 % $ 158,355 4.36 % Net interest spread (5) 4.27 % 4.21 % (1) Yields on loans and securities have been adjusted to a tax equivalent basis. The taxable-equivalent adjustment was $11.7 million and $6.3 million for the six months ended June 30, 2014 and 2013, respectively. (2) Net loan fees of $1.5 million and $3.8 million are included in the yield computation for the six months ended June 30, 2014 and 2013, respectively. (3) Includes nonaccrual loans. (4) Net interest margin is computed by dividing net interest income by total average earning assets. (5) Net interest spread represents average yield earned on interest-earning assets less the average rate paid on interest bearing liabilities. 64-------------------------------------------------------------------------------- Table of Contents Three Months Ended June 30, Six Months Ended June 30, 2014 versus 2013 2014 versus 2013 Increase (Decrease) Due to Changes in (1) Increase (Decrease) Due to Changes in (1) Volume Rate Total Volume Rate Total (in thousands) Interest income: Loans $ 13,596 $ (4,106 ) $ 9,490 $ 29,736 $ (8,167 ) $ 21,569 Investment securities 2,232 840 3,072 4,754 1,485 6,239 Federal funds sold and other (196 ) 322 126 (657 ) 1,130 473 Total interest income 15,632 (2,944 ) 12,688 33,833 (5,552 ) 28,281 Interest expense: Interest bearing transaction accounts 80 (65 ) 15 158 (61 ) 97 Savings and money market 612 72 684 1,229 107 1,336 Time deposits 127 175 302 308 193 501 Short-term borrowings 43 (41 ) 2 32 (115 ) (83 ) Long-term debt (752 ) 703 (49 ) (503 ) 670 167 Junior subordinated debt 63 (75 ) (12 ) 120 (177 ) (57 ) Total interest expense 173 769 942 1,344 617 1,961 Net increase (decrease) $ 15,459 $ (3,713 ) $ 11,746 $ 32,489 $ (6,169 ) $ 26,320 (1) Changes due to both volume and rate have been allocated to volume changes. Comparison of interest income, interest expense and net interest margin The Company's primary source of revenue is interest income. Interest income for the three months ended June 30, 2014 was $102.0 million, an increase of 14.2%, compared to $89.3 million for the three months ended June 30, 2013. For the six months ended June 30, 2014, interest income was $200.7 million, compared to $172.4 million for the six months ended June 30, 2013. This increase was primarily the result of interest income from loans, which increased by $9.5 million and $21.6 million for the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013. Interest income on investment securities increased $3.1 million and $6.2 million for the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013. Average yield on interest earning assets increased 2 and 3 basis points for three and six months ended June 30, 2014, respectively, compared to the same period in 2013, which was primarily the result of an increase in yields on securities. Interest expense for the three months ended June 30, 2014 was $8.1 million, compared to $7.1 million for the three months ended June 30, 2013, an increase of $1.0 million, or 13.2%. For the six months ended June 30, 2014, interest expense was $16.0 million, compared to $14.0 million for the six months ended June 30, 2013. This increase was primarily driven by the increase in average interest bearing deposits of approximately $1.10 billion from the prior year in the three and six month averages. Despite this increase, the average cost of interest bearing deposits remained flat at 0.32% for the three and six months ended June 30, 2014, compared to the same periods in 2013. Interest paid on short-term borrowings decreased by 8 and 13 basis points for the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013. Interest paid on long-term debt increased by 77 and 42 for the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013. Interest paid on junior subordinated debt decreased by 82 and 97 basis points, respectively, for the three and six months ended June 30, 2014, compared to the same periods in 2013. Net interest income was $93.9 million for the three months ended June 30, 2014, compared to $82.2 million for the three months ended June 30, 2013, an increase of $11.7 million, or 14.3%. For the six months ended June 30, 2014, net interest income was $184.7 million, compared to $158.4 million for the six months ended June 30, 2013. The increase in net interest margin of 3 and 4 basis points for the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013 was mostly due to an increase in our average yield on interest earning assets, primarily in investment securities, and a decrease in the average cost of funds related to short-term borrowings and junior subordinated debt. 65-------------------------------------------------------------------------------- Table of Contents Provision for Credit Losses The provision for credit losses in each period is reflected as a charge against earnings in that period. The provision is equal to the amount required to maintain the allowance for credit losses at a level that is adequate to absorb probable credit losses inherent in the loan portfolio. The provision for credit losses decreased by $3.0 million, to $0.5 million for the three months ended June 30, 2014, compared with $3.5 million for the three months ended June 30, 2013. For the six months ended June 30, 2014, the provision for credit losses was $4.0 million, compared to $8.9 million for the six months ended June 30, 2013. The provision decrease for the three and six months ended June 30, 2014 compared to the same periods in 2013, was primarily due to an improvement in credit quality and historical credit losses as well as recent favorable recovery trends. The Company may establish an additional allowance for credit losses for the PCI loans through a charge to provision for loan losses when impairment is determined as a result of lower than expected cash flows. As of June 30, 2014 and December 31, 2013, the allowance for credit losses on PCI loans was $0.1 million and $0.3 million, respectively. Non-interest Income The following tables present a summary of non-interest income for the periods presented: Three Months Ended June 30, Six Months Ended June 30, Increase Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in thousands) Service charges and fees $ 2,737 $ 2,449 $ 288 $ 5,267 $ 4,983 $ 284 Income from bank owned life insurance 959 1,036 (77 ) 1,908 2,072 (164 ) (Loss) gain on sales of investment securities, net (163 ) (5 ) (158 ) 203 143 60 Unrealized gains (losses) on assets / liabilities measured at fair value, net 235 (3,290 ) 3,525 (1,041 ) (3,761 ) 2,720 Bargain purchase gain from acquisition - 10,044 (10,044 ) - 10,044 (10,044 ) Other fee revenue 860 943 (83 ) 1,968 1,900 68 Other income 1,145 585 560 2,303 1,180 1,123Total non-interest income $ 5,773 $ 11,762 $ (5,989 ) $ 10,608 $ 16,561 $ (5,953 ) Total non-interest income for the three months ended June 30, 2014 compared to the same period in 2013 decreased by $6.0 million, or 50.9%. The decrease primarily relates to the non-recurring bargain purchase gain from the acquisition of Centennial Bank of $10.0 million recognized during the three months ended June 30, 2013. This decrease was offset by the movement in unrealized gains and losses on assets / liabilities measured at fair value, net, which for the three months ended June 30, 2014 was a net gain of $0.2 million, compared to a net loss of $3.3 million for the three months ended June 30, 2013. This $3.5 million increase primarily relates to the junior subordinated debt fair value adjustment gain of $0.1 million for the three months ended June 30, 2014, compared to a loss of $3.2 million for the same period in 2013. The decrease in non-interest income was further offset by an increase in other income of $0.6 million due to an increase in operating lease originations during the period. Total non-interest income for the six months ended June 30, 2014 compared to the same period in 2013 decreased by $6.0 million, or 35.9%. The decrease primarily relates to the non-recurring bargain purchase gain from the acquisition of Centennial Bank of $10.0 million recognized during the six months ended June 30, 2013. This decrease was offset by the movement in unrealized gains and losses on assets / liabilities measured at fair value, net, which for the six months ended June 30, 2014 was a net loss of $1.0 million, compared to a net loss of $3.8 million for the six months ended June 30, 2013. The decrease in the net loss primarily relates to the junior subordinated debt fair value adjustment loss of $0.9 million for the six months ended June 30, 2014, compared to a loss of $3.7 million for the same period in 2013. The $1.1 million increase in other income is primarily due to an increase in other operating lease income as the Company originated more operating leases during the period. 66-------------------------------------------------------------------------------- Table of Contents Non-interest Expense The following table presents a summary of non-interest expenses for the periods presented: Three Months Ended June 30, Six Months Ended June 30, Increase Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in thousands) Salaries and employee benefits $ 31,751 $ 28,100 $ 3,651 $ 61,306 $ 54,675 $ 6,631 Occupancy 4,328 4,753 (425 ) 9,010 9,599 (589 ) Legal, professional and directors' fees 4,192 2,550 1,642 7,831 5,572 2,259 Data processing 2,401 2,175 226 5,075 4,040 1,035 Insurance 2,087 2,096 (9 ) 4,480 4,466 14 Loan and repossessed asset expenses 927 721 206 2,161 2,317 (156 ) Customer service 708 717 (9 ) 1,328 1,360 (32 ) Marketing 506 710 (204 ) 1,065 1,378 (313 ) Net loss (gain) on sales / valuations of repossessed and other assets 184 (1,124 ) 1,308 (2,363 ) (605 ) (1,758 ) Intangible amortization 302 597 (295 ) 899 1,194 (295 ) Merger / restructure expenses 26 2,620 (2,594 ) 183 2,815 (2,632 ) Other expense 5,004 4,616 388 11,190 8,649 2,541 Total non-interest expense $ 52,416 $ 48,531 $ 3,885 $ 102,165 $ 95,460 $ 6,705 Total non-interest expense for the three months ended June 30, 2014 compared to the same period in 2013 increased $3.9 million, or 8.0%. This increase is primarily caused by increases in salaries and employee benefits of $3.7 million, legal, professional and directors' fees of $1.6 million, and the change from a net gain to a net loss on sales / valuations of repossessed and other assets, which increased non-interest expense by $1.3 million from the three months ended June 30, 2013. The increase in the salaries and employee benefits is due to employment growth to support continued asset growth and information technology initiatives. The increase in legal, professional and directors' fees relates primarily to information technology initiatives. These increases are offset by the decrease in merger / restructure expenses of $2.6 million, which were associated with the acquisition of Centennial Bank during the three months ended June 30, 2013. Total non-interest expense for the six months ended June 30, 2014 compared to the same period in 2013 increased $6.7 million, or 7.0%. This increase is primarily caused by increases in salaries and employee benefits of $6.6 million, legal, professional and directors' fees of $2.3 million, data processing of $1.0 million, and other expense of $2.5 million. The reasons for the increases in salaries and employee benefits and legal, professional and directors' fees are the same as for the comparable three month periods discussed above. The increase in data processing fees also relates to information technology initiatives and the largest increase in other expense relates to operating lease depreciation as a result of the increase in operating lease originations from the same period in 2013. These increases are offset by the decrease in merger / restructure expenses of $2.6 million related to the acquisition of Centennial Bank during the second quarter 2013 and the $1.8 million decrease in net gain on sales / valuations of repossessed and other assets due to a decrease in OREO sales from the six months ended June 30, 2013. Discontinued Operations The Company has discontinued its affinity credit card business and has presented these activities as discontinued operations. The following table summarizes the operating results of the discontinued operations for the periods indicated: Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 (in thousands) Operating revenue $ (214 ) $ 1,132 $ (358 ) $ 2,271 Non-interest expenses (511 ) (1,424 ) (1,369 ) (2,498 ) Loss before income taxes (725 ) (292 ) (1,727 ) (227 ) Income tax benefit (221 ) (123 ) (569 ) (96 ) Net loss $ (504 ) $ (169 ) $ (1,158 ) $ (131 ) 67-------------------------------------------------------------------------------- Table of Contents Business Segment Results On December 31, 2013, the Company consolidated its three bank subsidiaries under one charter, Western Alliance Bank. As a result, the Company has redefined its operating segments to reflect the new organizational and internal reporting structure. Prior year segment information has not been recast to conform to the new segmentation methodology due to the impracticability of restating segments because of the change in legal structure at December 31, 2013. The new operating segments are as follows: Arizona, Nevada, California, National Business Lines and Corporate & Other. Arizona reported net income of $10.5 million and $18.2 million for the three and six months ended June 30, 2014, respectively. At June 30, 2014, total loans were $2.13 billion, an increase of $98.7 million during the quarter and an increase of $106.3 million during the year. In addition, total deposits at June 30, 2014 were $2.12 billion, an increase of $53.0 million during the quarter and an increase of $115.2 million during the year. Nevada reported net income of $11.5 million and $22.2 million for the three and six months ended June 30, 2014, respectively. Total loans decreased $41.2 million during the quarter and decreased $71.8 million during the year to $1.68 billion at June 30, 2014. In addition, during the same period, total deposits grew by $135.7 million and $265.2 million, respectively, to $3.19 billion at June 30, 2014. California reported net income of $8.1 million and $14.1 million for the three and six months ended June 30, 2014, respectively. At June 30, 2014, total loans were$1.69 billion, an increase of $31.7 million during the quarter and an increase of $79.6 million during the year. In addition, second quarter total deposits were $2.06 billion, an increase of $145.4 million during the quarter and an increase of $116.2 million during the year. National Business Lines reported net income of $4.2 million and $7.6 million for the three and six months ended June 30, 2014, respectively. Total loans increased by $330.3 million during the quarter and increased $600.9 million during the year to $1.95 billion at June 30, 2014. In addition, during the same period, total deposits increased by $13.5 million and $118.3 million, respectively, to $886.3 million at June 30, 2014. BALANCE SHEET ANALYSIS Total assets increased $716.2 million, or 7.7%, to $10.02 billion at June 30, 2014, compared to $9.31 billion at December 31, 2013. The increase in assets primarily relates to the increase in loans of $743.2 million, or 10.9%, to $7.54 billion. Total liabilities increased $614.1 million, or 7.3%, to $9.07 billion at June 30, 2014, compared to $8.45 billion at December 31, 2013. The increase in liabilities is due to the increase in total deposits of $631.3 million, or 8.1%, to $8.47 billion. Total stockholders' equity increased by $102.2 million, or 11.9%, to $957.7 million at June 30, 2014, compared to $855.5 million at December 31, 2013. The increase in stockholders' equity is the result of net income available to common stockholders of $65.9 million for the six months ended June 30, 2014, the movement of AOCI due to the decrease in unrealized losses on AFS securities, and the transfer of all of the Company's HTM securities to AFS during the quarter, which resulted in an increase to AOCI of $7.3 million at June 30, 2014. In addition, to support the Company's continued growth, we raised $2.6 million in net proceeds from the issuance of 115,866 shares of common stock through our ATM public offering. Investment securities Investment securities are classified at the time of acquisition as either HTM, AFS, or trading based upon various factors, including asset/liability management strategies, liquidity and profitability objectives, and regulatory requirements. HTM securities are carried at amortized cost, adjusted for amortization of premiums or accretion of discounts. AFS securities are securities that may be sold prior to maturity based upon asset/liability management decisions. Investment securities identified as AFS are carried at fair value. Unrealized gains or losses on AFS securities are recorded as AOCI in stockholders' equity. Amortization of premiums or accretion of discounts on MBS is periodically adjusted for estimated prepayments. Investment securities measured at fair value are reported at fair value, with unrealized gains and losses included in current period earnings. The investment securities portfolio of the Company is utilized as collateral for borrowings, required collateral for public deposits and customer repurchase agreements, and to manage liquidity, capital and interest rate risk. 68-------------------------------------------------------------------------------- Table of Contents The following table summarizes the carrying value of the investment securities portfolio at June 30, 2014 and December 31, 2013: June 30, 2014 December 31, 2013 (in thousands) U.S. government sponsored agency securities $ 17,911 $ 46,975 Municipal obligations 305,282 299,244 Preferred stock 73,219 61,484 Mutual funds 38,054 36,532 Residential MBS issued by GSEs 950,062 1,024,457 Commercial MBS issued by GSEs 2,084 - Private label residential MBS 35,250 36,099 Private label commercial MBS 5,395 5,433 Trust preferred securities 25,582 23,805 CRA investments 23,930 24,882 Collateralized debt obligations 7,356 50 Corporate debt securities 95,940 97,777 Total investment securities $ 1,580,065 $ 1,656,738 In May 2014, the Company's investment committee reassessed the Company's holdings in CDOs, and gave management the discretion to sell CDOs and to reinvest in higher investment grade securities. This change in intent, prior to maturity or recovery, necessitated a reclassification of all HTM securities to AFS. At the date of transfer, the securities had a total amortized cost of $275.3 million and fair value of $289.6 million. The Company recognized an unrealized gain of $9.0 million, net of tax, in AOCI at the date of the transfer. Gross unrealized losses at June 30, 2014 are primarily caused by interest rate fluctuations, credit spread widening and reduced liquidity in applicable markets. The Company has reviewed securities on which there is an unrealized loss in accordance with its accounting policy for OTTI securities described in "Note 2. Investment Securities" to the Consolidated Financial Statements contained herein. There were no impairment charges recorded during the three and six months ended June 30, 2014 and 2013. The Company does not consider any securities to be other-than-temporarily impaired as of June 30, 2014 and December 31, 2013. However, the Company cannot guarantee that additional OTTI will not occur in future periods. Loans The table below summarizes the distribution of the Company's loans at the end of each of the periods indicated: June 30, 2014 December 31, 2013 (in thousands) Commercial and industrial $ 2,804,819 $ 2,236,740 Commercial real estate - non-owner occupied 1,940,017 1,843,415 Commercial real estate - owner occupied 1,604,986 1,561,862 Construction and land development 612,415 537,231 Residential real estate 328,115 350,312 Commercial leases 222,887 235,968 Consumer 40,948 45,153 Net deferred loan fees and costs (9,620 ) (9,266 ) Loans, net of deferred fees and costs 7,544,567 6,801,415 Allowance for credit losses (105,937 ) (100,050 ) Total $ 7,438,630 $ 6,701,365 69-------------------------------------------------------------------------------- Table of Contents Concentrations of Lending Activities The Company's lending activities, including those within its National Business Lines, are driven in large part by the customers served in the market areas where the Company has branch offices in the states of Arizona, Nevada and California. As of June 30, 2014 and December 31, 2013, approximately 63% and 60%, respectively, of the customers in the Company's National Business Lines are located in these markets. The Company monitors concentrations within five broad categories: geography, industry, product, call report classifications, and collateral. The Company grants commercial, construction, real estate and consumer loans to customers through branch offices located in the Company's primary markets. The Company's business is concentrated in these areas and the loan portfolio includes significant credit exposure to the CRE market of these areas. As of June 30, 2014 and December 31, 2013, CRE related loans accounted for approximately 55% and 58% of total loans and approximately 1% and 2%, respectively, of CRE related loans are secured by undeveloped land. Substantially all of these loans are secured by first liens with an initial loan to value ratio of generally not more than 75%. Approximately 45% and 46% of these CRE loans, excluding construction and land loans, were owner occupied at June 30, 2014 and December 31, 2013, respectively. In addition, approximately 3% and 4% of total loans were unsecured as of June 30, 2014 and December 31, 2013, respectively. The Company is a participant in certain Shared National Credit loans, which make up approximately 7% and 5% of total loans as of June 30, 2014 and December 31, 2013, respectively. Impaired loans A loan is identified as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the original loan agreement. Generally, impaired loans are classified as nonaccrual. However, in certain instances, impaired loans may continue on an accrual basis, such as loans classified as impaired due to doubt regarding collectability according to contractual terms, that are both fully secured by collateral and are current in their interest and principal payments. Impaired loans are measured for reserve requirements in accordance with ASC 310 based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral less applicable disposition costs if the loan is collateral dependent. The amount of an impairment reserve, if any, and any subsequent changes are charged against the allowance for credit losses. Total nonaccrual loans and loans past due 90 days or more and still accruing decreased by $9.9 million, or 12.8%, at June 30, 2014 to $67.3 million from $77.2 million at December 31, 2013. June 30, 2014 December 31, 2013 (dollars in thousands) Total nonaccrual loans $ 64,345 $ 75,680 Loans past due 90 days or more on accrual status 3,001 1,534 Total nonperforming loans 67,346 77,214 Troubled debt restructured loans 89,703 89,576 Other impaired loans 6,821 11,587 Total impaired loans $ 163,870 $ 178,377 Other assets acquired through foreclosure, net $ 59,292 $ 66,719 Nonaccrual loans to gross loans 0.85 % 1.11 % Loans past due 90 days or more on accrual status to total loans 0.04 0.02 Interest income received on nonaccrual loans $ 565 $ 626 Interest income that would have been recorded under the original terms of nonaccrual loans 312 1,626 70-------------------------------------------------------------------------------- Table of Contents The composition of nonaccrual loans was as follows as of the dates indicated: At June 30, 2014 At December 31, 2013 Nonaccrual Percent of Nonaccrual Percent of Balance Percent Total Loans Balance Percent Total Loans (dollars in thousands) Commercial and industrial $ 2,634 4.09 % 0.03 % $ 3,753 4.96 % 0.06 % Commercial real estate 46,582 72.40 0.62 54,856 72.48 0.80 Construction and land development 2,161 3.36 0.03 4,525 5.98 0.07 Residential real estate 12,767 19.84 0.17 12,480 16.49 0.18 Consumer 201 0.31 - 66 0.09 - Total nonaccrual loans $ 64,345 100.00 % 0.85 % $ 75,680 100.00 % 1.11 % As of June 30, 2014 and December 31, 2013, nonaccrual loans totaled $64.3 million and $75.7 million, respectively. Nonaccrual loans by segment at June 30, 2014 were $27.8 million for Arizona, $14.7 million for Nevada, $3.9 million for California, $0.2 million for National Business Lines and $17.8 million for Corporate & Other. Nonaccrual loans as a percentage of total gross loans were 0.85% and 1.11% at June 30, 2014 and December 31, 2013, respectively. Nonaccrual loans as a percentage of each segment's total gross loans at June 30, 2014 were 1.30% for Arizona, 0.88% for Nevada, 0.23% for California, 0.01% for National Business Lines and 21.00% for Corporate & Other. Troubled Debt Restructured Loans A TDR loan is a loan, for reasons related to a borrower's financial difficulties, that is granted a concession that the lender would not otherwise consider. The loan terms that have been modified or restructured due to a borrower's financial situation include, but are not limited to, a reduction in the stated interest rate, an extension of the maturity or renewal of the loan at an interest rate below current market, a reduction in the face amount of the debt, a reduction in accrued interest, extensions, deferrals, renewals and rewrites. A TDR loan is also considered impaired. Generally, a loan that is modified at an effective market rate of interest is no longer disclosed as a TDR in years subsequent to the restructuring if it is performing based on the terms specified by the restructuring agreement. However, such loans continue to be considered impaired. As of June 30, 2014 and December 31, 2013, the aggregate amount of loans classified as impaired was $163.9 million and $178.4 million, respectively, a net decrease of 8.1%. The total specific allowance for loan losses related to these loans was $3.5 million and $5.3 million at June 30, 2014 and December 31, 2013, respectively. As of June 30, 2014 and December 31, 2013, the Company had $89.7 million and $89.6 million, respectively, in loans classified as accruing restructured loans. Impaired loans by segment at June 30, 2014 were $47.0 million for Arizona, $57.3 million for Nevada and $13.4 million for California. Additionally, National Business Lines and Corporate & Other held $0.2 million and $46.0 million, respectively, of impaired loans at June 30, 2014. 71-------------------------------------------------------------------------------- Table of Contents The following tables present a breakdown of total impaired loans and the related specific reserves for the periods indicated: June 30, 2014 Impaired Percent of Reserve Percent of Balance Percent Total Loans Balance Percent Total Allowance (dollars in thousands) Commercial and industrial $ 16,088 9.82 % 0.21 % $ 457 13.03 % 0.43 % Commercial real estate 100,440 61.29 1.33 2,021 57.62 1.91 Construction and land development 20,147 12.29 0.27 - - - Residential real estate 26,593 16.23 0.35 1,026 29.26 0.97 Consumer 602 0.37 0.01 3 0.09 - Total impaired loans $ 163,870 100.00 % 2.17 % $ 3,507 100.00 % 3.31 % December 31, 2013 Impaired Percent of Reserve Percent of Balance Percent Total Loans Balance Percent Total Allowance (dollars in thousands) Commercial and industrial $ 17,341 9.72 % 0.25 % $ 772 14.62 % 0.77 % Commercial real estate 111,054 62.26 1.63 2,523 47.78 2.52 Construction and land development 23,069 12.93 0.34 85 1.61 0.08 Residential real estate 26,376 14.79 0.39 1,896 35.91 1.90 Consumer 537 0.30 0.01 4 0.08 - Total impaired loans $ 178,377 100.00 % 2.62 % $ 5,280 100.00 % 5.27 % 72-------------------------------------------------------------------------------- Table of Contents Allowance for Credit Losses The following table summarizes the activity in our allowance for credit losses for the period indicated: Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 (dollars inthousands) Allowance for credit losses: Balance at beginning of period $ 103,899 $ 95,494 $ 100,050 $ 95,427 Provisions charged to operating expenses: Commercial and industrial 3,152 2,506 3,544 5,160 Commercial real estate (1,422 ) 1,440 978 3,304 Construction and land development (247 ) (1,307 ) 1,723 (909 ) Residential real estate (861 ) 713 (1,351 ) 1,995 Consumer (115 ) 129 (887 ) (630 ) Total Provision 507 3,481 4,007 8,920 Recoveries of loans previously charged-off: Commercial and industrial 1,254 1,757 2,176 2,198 Commercial real estate 1,248 633 1,808 1,575 Construction and land development 498 120 709 821 Residential real estate 314 549 867 1,118 Consumer 191 11 361 25 Total recoveries 3,505 3,070 5,921 5,737 Loans charged-off: Commercial and industrial (1,038 ) (1,065 ) (2,516 ) (2,835 ) Commercial real estate (330 ) (2,391 ) (501 ) (5,278 ) Construction and land development (78 ) (238 ) (78 ) (852 ) Residential real estate (523 ) (2,010 ) (929 ) (4,503 ) Consumer (5 ) (18 ) (17 ) (293 ) Total charged-off (1,974 ) (5,722 ) (4,041 ) (13,761 ) Net recoveries (charge-offs) 1,531 (2,652 ) 1,880 (8,024 ) Balance at end of period $ 105,937 $ 96,323 $ 105,937 $ 96,323 Net recoveries (charge-offs) to average loans outstanding-annualized 0.09 % (0.17 )% 0.05 % (0.27 )% Allowance for credit losses to gross loans 1.40 1.50 The following table summarizes the allocation of the allowance for credit losses by loan type. However, allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories. June 30, 2014 December 31, 2013 % of Total % of Total Allowance Allowance for Credit % of Loans to for Credit % of Loans to Amount Losses Gross Loans Amount Losses Gross Loans (dollars in thousands) Commercial and industrial $ 42,861 40.5 % 40.2 % $ 39,657 39.7 % 36.3 % Commercial real estate 34,349 32.4 46.9 % 32,064 32.0 50.0 Construction and land development 16,873 15.9 8.1 % 14,519 14.5 7.9 Residential real estate 10,227 9.7 4.3 % 11,640 11.6 5.1 Consumer 1,627 1.5 0.5 % 2,170 2.2 0.7 Total $ 105,937 100.0 % 100.0 % $ 100,050 100.0 % 100.0 % The allowance for credit losses as a percentage of total loans decreased to 1.40% at June 30, 2014 from 1.47% at December 31, 2013. The total balance of the allowance for credit losses has increased due to the increase in the size of its loan portfolio; however, the increase in the allowance is not proportional to the increase in the portfolio as the Company has experienced improved credit quality in its portfolio as well as a change in portfolio mix toward higher rated credits. 73-------------------------------------------------------------------------------- Table of Contents Potential Problem Loans The Company classifies loans consistent with federal banking regulations using a nine category grading system. These loan grades are described in further detail in "Item 1. Business" of the Company's Annual Report Form 10-K for the year ended December 31, 2013. The following table presents information regarding potential problem loans, consisting of loans graded special mention, substandard, doubtful, and loss, but still performing, and excluding acquired loans: At June 30, 2014 Number of Percent of Loans Loan Balance Percent Total Loans (dollars in thousands) Commercial and industrial 66 $ 20,504 15.41 % 0.27 % Commercial real estate 67 91,240 68.59 1.21 Construction and land development 7 14,023 10.54 0.19 Residential real estate 14 6,738 5.07 0.09 Consumer 11 518 0.39 0.01 Total 165 $ 133,023 100.00 % 1.77 % At December 31, 2013 Number of Percent of Loans Loan Balance Percent Total Loans (dollars in thousands) Commercial and industrial 68 $ 15,532 14.05 % 0.23 % Commercial real estate 63 71,390 64.55 1.05 Construction and land development 7 13,357 12.08 0.20 Residential real estate 20 8,988 8.13 0.13 Consumer 17 1,317 1.19 0.02 Total 175 $ 110,584 100.00 % 1.63 % Total potential problem loans are primarily secured by real estate. 74-------------------------------------------------------------------------------- Table of Contents Other Assets Acquired Through Foreclosure The following table represents the changes in other assets acquired through foreclosure: Three Months Ended June 30, 2014 2013 Valuation Valuation Gross Balance Allowance Net Balance Gross Balance Allowance Net Balance (in thousands) Balance, beginning of the period $ 72,226 $ (15,776 ) $ 56,450 $ 108,418 $ (30,497 ) $ 77,921 Transfers to other assets acquired through foreclosure, net 4,309 - 4,309 4,664 - 4,664 Additions from acquisition of Centennial Bank - - - 5,622 - 5,622 Proceeds from sale of other real estate owned and repossessed assets, net (1,903 ) 683 (1,220 ) (17,422 ) 4,639 (12,783 ) Valuation adjustments, net - (258 ) (258 ) - (566 ) (566 ) Gains, net (1) 11 - 11 1,641 - 1,641 Balance, end of period $ 74,643 $ (15,351 ) $ 59,292 $ 102,923 $ (26,424 ) $ 76,499 Six Months Ended June 30, 2014 2013 Valuation Valuation Gross Balance Allowance Net Balance Gross Balance Allowance Net Balance (in thousands) Balance, beginning of the period $ 88,421 $ (21,702 ) $ 66,719 $ 113,474 $ (36,227 ) $ 77,247 Transfers to other assets acquired through foreclosure, net 6,419 - 6,419 11,273 - 11,273 Additions from acquisition of Centennial Bank - - - 5,622 - 5,622 Proceeds from sale of other real estate owned and repossessed assets, net (21,376 ) 6,644 (14,732 ) (29,542 ) 11,385 (18,157 ) Valuation adjustments, net - (293 ) (293 ) - (1,582 ) (1,582 ) Gains, net (2) 1,179 - 1,179 2,096 - 2,096 Balance, end of period $ 74,643 $ (15,351 ) $ 59,292 $ 102,923 $ (26,424 ) $ 76,499 (1) Includes gains related to initial transfers to other assets of zero and $23 thousand during the three months ended June 30, 2014 and 2013, respectively, pursuant to accounting guidance. (2) Includes gains related to initial transfers to other assets of zero and $345 thousand during the six months ended June 30, 2014 and 2013, respectively, pursuant to accounting guidance. Other assets acquired through foreclosure consist primarily of properties acquired as a result of, or in-lieu-of, foreclosure. Properties or other assets (primarily repossessed assets formerly leased) are classified as OREO and other repossessed property and are reported at the lower of carrying value or fair value, less estimated costs to sell the property. Costs relating to the development or improvement of the assets are capitalized and costs relating to holding the assets are charged to expense. The Company had $59.3 million and $66.7 million of such assets at June 30, 2014 and December 31, 2013, respectively. At June 30, 2014, the Company held approximately 65 properties, compared to 70 at December 31, 2013. When significant adjustments were based on unobservable inputs, such as when a current appraised value is not available or management determines the fair value of the collateral is further impaired below appraised value and there is no observable market price, the resulting fair value measurement has been categorized as a Level 3 measurement. Goodwill and Other Intangible Assets Goodwill represents the excess consideration paid for net assets acquired in a business combination over their fair value and is subsequently evaluated for impairment at least annually. The Company has goodwill of $23.2 million and other intangibles, which consist primarily of core deposit intangibles, of $3.3 million as of June 30, 2014. The Company performs its annual goodwill and intangibles impairment tests as of October 1 each year, or more often if events or circumstances indicate that the carrying value may not be recoverable. During the three and six months ended June 30, 2014, there were no events or circumstances that indicated an interim impairment test of goodwill or other intangible assets was necessary. 75-------------------------------------------------------------------------------- Table of Contents Deferred Tax Asset Western Alliance Bancorporation and its subsidiaries, other than BW Real Estate, Inc., file a consolidated federal tax return. Due to tax regulations and GAAP, several items of income and expense are recognized in different periods for tax return purposes than for financial reporting purposes. These items represent temporary differences. Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and tax credit carryovers and deferred tax liabilities are recognized for taxable temporary differences. A temporary difference is the difference between the reported amounts of an asset or liability and its tax basis. A deferred tax asset is reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax asset will not be realized. Deferred tax assets and liabilities are adjusted for the effect of changes in tax laws and rates on the date of enactment. Although realization is not assured, the Company believes that the realization of the net deferred tax asset is more likely than not based on expectations as to future taxable income and based on available tax planning strategies within the meaning of ASC 740 that could be implemented if necessary to prevent a carryover from expiring. See "Note 10. Income Taxes" to the Consolidated Financial Statements for further discussion on income taxes. Deposits Deposits are the primary source for funding the Company's asset growth. At June 30, 2014, total deposits were $8.47 billion, compared to $7.84 billion at December 31, 2013. Total deposit growth of $631.3 million, or 8.1%, was primarily driven by an increase in savings and money market deposits of $327.0 million. WAB is a member of CDARS and ICS, which provide mechanisms for obtaining FDIC insurance on large deposits. At June 30, 2014, the Company had $662.8 million of CDARS deposits and $381.3 million of ICS deposits. At December 31, 2013, the Company had $518.0 million of CDARS deposits and $355.3 million of ICS deposits. At June 30, 2014 and December 31, 2013, the Company had $175.8 million and $174.2 million of wholesale brokered deposits, respectively. The average balances and weighted average rates paid on deposits are presented below: Three Months Ended June 30, 2014 2013 Average Balance Rate Average Balance Rate (dollars in thousands) Interest checking (NOW) $ 791,501 0.19 % $ 626,768 0.24 % Savings and money market 3,583,500 0.30 2,768,656 0.29 Time 1,700,412 0.44 1,584,029 0.39 Total interest-bearing deposits 6,075,413 0.32 4,979,453 0.32 Non-interest-bearing demand deposits 2,045,534 - 1,898,237 - Total deposits $ 8,120,947 0.24 % $ 6,877,690 0.23 % Six Months Ended June 30, 2014 2013 Average Balance Rate Average Balance Rate (dollars in thousands) Interest checking (NOW) $ 778,341 0.20 % $ 617,766 0.22 % Savings and money market 3,518,279 0.30 2,695,173 0.29 Time 1,660,212 0.43 1,517,154 0.40 Total interest-bearing deposits 5,956,832 0.32 4,830,093 0.32 Non-interest-bearing demand deposits 2,049,806 - 1,876,772 - Total deposits $ 8,006,638 0.24 % $ 6,706,865 0.23 % 76-------------------------------------------------------------------------------- Table of Contents Short-Term Borrowed Funds The Company from time to time utilizes short-term borrowed funds to support short-term liquidity needs generally created by increased loan demand. The majority of these short-term borrowed funds consist of advances from the FHLB and/or FRB, federal funds purchased and customer repurchase agreements. The Company's borrowing capacity with the FHLB and FRB is determined based on collateral pledged, generally consisting of securities and loans. In addition, the Company has borrowing capacity from other sources, pledged by securities, including securities sold under agreements to repurchase, which are reflected at the amount of cash received in connection with the transaction, and may require additional collateral based on the fair value of the underlying securities. At June 30, 2014, total short-term borrowed funds consisted of $53.7 million of customer repurchases and FHLB advances of $61.9 million. At December 31, 2013, total short-term borrowed funds consisted of $71.2 million of customer repurchases, a revolving line of credit of $3.0 million and FHLB advances of $25.9 million. Long-Term Debt At June 30, 2014, there was $211.2 million of FHLB advances classified as long-term and $64.9 million of outstanding Senior Note principal, whose carrying value of $64.4 million reflects a discount of $0.5 million. At December 31, 2013, long-term debt consisted of FHLB advances of $248.0 million and $64.9 million of outstanding Senior Note principal with a carrying value of $64.2 million. Junior Subordinated Debt The Company measures the balance of junior subordinated debt at fair value, which was $42.7 million at June 30, 2014 and $41.9 million at December 31, 2013. Critical Accounting Policies Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions. The critical accounting policies upon which the Company's financial condition and results of operations depend, and which involve the most complex subjective decisions or assessments, are included in the discussion entitled "Critical Accounting Policies" in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013, and all amendments thereto, as filed with the SEC. There were no material changes to the critical accounting policies disclosed in the Annual Report on Form 10-K. Liquidity Liquidity is the ongoing ability to accommodate liability maturities and deposit withdrawals, fund asset growth and business operations and meet contractual obligations through unconstrained access to funding at reasonable market rates. Liquidity management involves forecasting funding requirements and maintaining sufficient capacity to meet the needs and accommodate fluctuations in asset and liability levels due to changes in our business operations or unanticipated events. The ability to have readily available funds sufficient to repay fully maturing liabilities is of primary importance to depositors, creditors and regulators. Our liquidity, represented by cash and amounts due from banks, federal funds sold and non-pledged marketable securities, is a result of our operating, investing and financing activities and related cash flows. In order to ensure funds are available when necessary, on at least a quarterly basis, we project the amount of funds that will be required, and we strive to maintain relationships with a diversified customer base. Liquidity requirements can also be met through short-term borrowings or the disposition of short-term assets. The Company has unsecured Federal Reserve Funds credit lines with correspondent banks totaling $120.0 million and other lines of credit with correspondent banks totaling $70.0 million, of which $25.0 million is secured and $45.0 million is unsecured. As of June 30, 2014, there were no amounts drawn on the secured line of credit or the Federal Reserve Funds credit lines. In addition, loans and securities are pledged to the FHLB, providing $1.50 billion in borrowing capacity, with outstanding borrowings and letters of credit of $272.2 million and $226.1 million, respectively, leaving $1.00 billion in available credit as of June 30, 2014. Loans and securities pledged to the FRB discount window provided $1.05 billion in borrowing capacity. As of June 30, 2014, there were no outstanding borrowings from the FRB, thus our available credit totaled $1.05 billion. The Company has a formal liquidity policy and, in the opinion of management, our liquid assets are considered adequate to meet cash flow needs for loan funding and deposit cash withdrawals for the next 90-120 days. At June 30, 2014, there was $1.13 billion in liquid assets, comprised of $380.7 million in cash and cash equivalents and $752.1 million in unpledged marketable securities. At December 31, 2013, the Company maintained $1.25 billion in liquid assets, comprised of $309.7 million of cash and cash equivalents and $938.0 million of unpledged marketable securities. 77-------------------------------------------------------------------------------- Table of Contents The holding company maintains additional liquidity that would be sufficient to fund its operations and certain non-bank affiliate operations for an extended period should funding from normal sources be disrupted. Since deposits are taken by the bank operating subsidiary and not by the parent company, parent company liquidity is not dependent on the bank operating subsidiary's deposit balances. In our analysis of parent company liquidity, we assume that the parent company is unable to generate funds from additional debt or equity issuances, receives no dividend income from subsidiaries and does not pay dividends to shareholders, while continuing to make nondiscretionary payments needed to maintain operations and repayment of contractual principal and interest payments owed by the parent company and affiliated companies. Under this scenario, the amount of time the parent company and its non-bank subsidiaries can operate and meet all obligations before the current liquid assets are exhausted is considered as part of the parent company liquidity analysis. Management believes the Parent maintains adequate liquidity capacity to operate without additional funding from new sources for over 12 months. WAB maintains sufficient funding capacity to address large increases in funding requirements, such as deposit outflows. This capacity is comprised of liquidity derived from a reduction in asset levels and various secured funding sources. On a long-term basis, the Company's liquidity will be met by changing the relative distribution of our asset portfolios (for example, by reducing investment or loan volumes, or selling or encumbering assets). Further, the Company can increase liquidity by soliciting higher levels of deposit accounts through promotional activities and/or borrowing from correspondent banks, the FHLB of San Francisco and the FRB. At June 30, 2014, our long-term liquidity needs primarily relate to funds required to support loan originations and commitments and deposit withdrawals, which can be met by cash flows from investment payments and maturities, and investment sales, if necessary. The Company's liquidity is comprised of three primary classifications: 1) cash flows provided by operating activities; 2) cash flows used in investing activities; and 3) cash flows provided by financing activities. Net cash provided by or used in operating activities consists primarily of net income, adjusted for changes in certain other asset and liability accounts and certain non-cash income and expense items, such as the provision for credit losses, investment and other amortization and depreciation. For the six months ended June 30, 2014 and 2013, net cash provided by operating activities was $60.5 million and $86.5 million, respectively. Our primary investing activities are the origination of real estate and commercial loans and the purchase and sale of securities. Our net cash provided by and used in investing activities has been primarily influenced by our loan and securities activities. The net increase in loans for the six months ended June 30, 2014 and 2013, was $719.7 million and $336.7 million, respectively. The increase from purchases or pay downs of securities, net for the six months ended June 30, 2014 was $119.5 million, compared to a decrease of $52.2 million at June 30, 2013. Net cash provided by financing activities has been impacted significantly by increased deposit levels. During the six months ended June 30, 2014 and 2013, deposits increased $631.6 million and $207.6 million, respectively. Fluctuations in core deposit levels may increase our need for liquidity as certificates of deposit mature or are withdrawn before maturity, and as non-maturity deposits, such as checking and savings account balances, are withdrawn. Additionally, we are exposed to the risk that customers with large deposit balances will withdraw all or a portion of such deposits, due in part to the FDIC limitations on the amount of insurance coverage provided to depositors. To mitigate the uninsured deposit risk, we have joined the CDARS and ICS, a program that allows customers to invest up to $50.0 million in certificates of deposit or money market accounts through one participating financial institution, with the entire amount being covered by FDIC insurance. As of June 30, 2014, we had $662.8 million of CDARS and $381.3 million of ICS deposits, compared to $518.0 million of CDARS and $355.3 million of ICS deposits at December 31, 2013. As of June 30, 2014, we had $175.8 million of wholesale brokered deposits outstanding. Brokered deposits are generally considered to be deposits that have been received from a third party that is acting on behalf of that party's customer. Often, a broker will direct a customer's deposits to the banking institution offering the highest interest rate available. Federal banking laws and regulations place restrictions on depository institutions regarding brokered deposits because of the general concern that these deposits are at a greater risk of being withdrawn and placed on deposit at another institution offering a higher interest rate, thus posing liquidity risk for institutions that gather brokered deposits in significant amounts. The Company does not anticipate using brokered deposits as a significant liquidity source in the near future. Federal and state banking regulations place certain restrictions on dividends paid. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the bank. Dividends paid by WAB to the Parent would be prohibited if the effect thereof would cause the bank's capital to be reduced below applicable minimum capital requirements. WAB, LVSP and WAEF paid dividends to the Parent in the amount of $32.0 million, $2.5 million and $1.5 million during the six months ended June 30, 2014, respectively. 78-------------------------------------------------------------------------------- Table of Contents Capital Resources The Company and WAB are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements could trigger certain mandatory or discretionary actions that, if undertaken, could have a direct material effect on the Company's business and financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and WAB must meet specific capital guidelines that involve qualitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and WAB to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets, and of Tier I leverage to average assets. As of June 30, 2014 and December 31, 2013, the Company and WAB met all capital adequacy requirements to which they are subject. As of June 30, 2014 and December 31, 2013, the Company WAB met the minimum capital ratio requirements necessary to be classified as well-capitalized, as defined by the banking agencies. To be categorized as well-capitalized, an entity must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table below. Federal banking regulators have proposed revisions to the bank capital requirement standards known as Basel III. Basel III strengthens bank capital requirements and introduces new regulatory requirements on bank liquidity and bank leverage. Based on the Company's assessment of these proposed regulations, as of June 30, 2014, the Company and WAB met the requirements necessary to be classified as well-capitalized under the proposed regulation. The actual capital amounts and ratios for the Company are presented in the following tables as of the periods indicated: Minimum For Well-Capitalized Actual Adequately-Capitalized Requirements Requirements Amount Ratio Amount Ratio Amount Ratio (dollars in thousands) June 30, 2014 Total Capital (to Risk Weighted Assets) $ 1,081,087 12.5 % $ 691,896 8.0 % $ 864,870 10.0 % Tier 1 Capital (to Risk Weighted Assets) 973,027 11.2 347,510 4.0 521,264 6.0 Leverage Ratio (to Average Assets) 973,027 10.0 389,211 4.0 486,514 5.0 December 31, 2013 Total Capital (to Risk Weighted Assets) $ 991,461 12.4 % $ 639,652 8.0 % $ 799,565 10.0 % Tier 1 Capital (to Risk Weighted Assets) 891,479 11.1 321,254 4.0 481,881 6.0 Leverage Ratio (to Average Assets) 891,479 9.8 363,869 4.0 454,836 5.0 |