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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 September 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, 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 one non-bank subsidiary, LVSP, which holds and manages certain non-performing loans and OREO. On July 1, 2014, all of the outstanding shares of common stock of WAEF, which was previously a subsidiary of WAL, were contributed to WAB by WAL and it is now a subsidiary of the Bank. Financial Result Highlights for the Third Quarter of 2014 Net income available to common stockholders for the Company of $40.6 million, or $0.46 per diluted share, for the third quarter of 2014, compared to $28.2 million, or $0.33 per diluted share, for the third quarter of 2013. For the nine months ended September 30, 2014, net income available to common stockholders was $106.5 million, or $1.22 per diluted share, compared to $82.5 million, or $0.95 per diluted share, for the nine months ended September 30, 2013. 56-------------------------------------------------------------------------------- Table of Contents The significant factors impacting earnings of the Company during the third quarter of 2014 were: • Pre-tax, pre-provision operating earnings (see Non-GAAP Financial Measures beginning on page 61) for the third quarter of 2014 increased $9.7 million to $51.8 million, compared to $42.1 million for the third quarter of 2013. For the comparable nine month periods, pre-tax, pre-provision operating earnings increased $26.1 million to $143.5 million, compared to $117.4 million for the nine months ended September 30, 2013. • The Company experienced loan growth of $1.13 billion to $7.93 billion at September 30, 2014 from $6.80 billion at December 31, 2013. • Other assets acquired through foreclosure declined by $14.9 million to $51.8 million at September 30, 2014 from $66.7 million at December 31, 2013. • The Company increased deposits by $859.4 million to $8.70 billion at September 30, 2014 from $7.84 billion at December 31, 2013. • Provision for credit losses for the third quarter of 2014 was $0.4 million, compared to zero for the third quarter of 2013. Net recoveries increased by $1.3 million to $2.8 million in the third quarter of 2014, compared to $1.5 million for the third quarter of 2013. For the comparable nine month periods, provision for credit losses decreased by $4.5 million to $4.4 million, compared to $8.9 million for the nine months ended September 30, 2013, as net charge-offs declined by $11.2 million to net recoveries of $4.7 million, compared to net charge-offs of $6.5 million for the nine months ended September 30, 2013. • Net interest margin increased to 4.43%, compared to 4.41% for the third quarter of 2013. For the nine months ended September 30, 2014, net interest margin increased to 4.41%, compared to 4.38% for the nine months ended September 30, 2013. • Key asset quality ratios improved at September 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 0.95% at the end of the third quarter of 2014 compared to 1.11% at December 31, 2013. • Tangible book value per share, net of tax, at September 30, 2014 increased by $1.63 to $9.53, 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 nine months ended September 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 September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (in thousands, except per share amounts) Net income available to common stockholders $ 40,566 $ 28,242 $ 106,484 $ 82,493 Earnings per share applicable to common stockholders--basic 0.47 0.33 1.23 0.96 Earnings per share applicable to common stockholders--diluted 0.46 0.33 1.22 0.95 Net interest margin 4.43 % 4.41 % 4.41 % 4.38 % Return on average assets 1.63 1.33 1.47 1.34 Return on average tangible common equity 19.91 17.50 18.66 17.61 September 30, 2014 December 31, 2013 (in thousands) Total assets $ 10,288,824 $ 9,307,342 Loans, net of deferred loan fees and costs 7,929,520 6,801,415 Total deposits 8,697,627 7,838,205 57-------------------------------------------------------------------------------- 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: September 30, 2014 December 31, 2013 (in thousands) Non-accrual loans $ 75,092 $ 75,680 Non-performing assets 220,745 233,509 Non-accrual loans to gross loans 0.95 % 1.11 % Net (recoveries) charge-offs to average loans (1) (0.15 ) 0.14 (1) Annualized for the three months ended September 30, 2014. Actual year-to-date for the twelve months ended December 31, 2013. 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 $10.29 billion at September 30, 2014 from $9.31 billion at December 31, 2013. Total loans, net of deferred loan fees and costs, increased by $1.13 billion, or 16.6%, to $7.93 billion as of September 30, 2014, compared to $6.80 billion as of December 31, 2013. Total deposits increased $859.4 million, or 11.0%, to $8.70 billion as of September 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 September 30, Increase Nine Months Ended September 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in thousands, except per share amounts) Consolidated Income Statement Data: Interest income $ 105,554 $ 92,680 $ 12,874 $ 306,228 $ 265,073 $ 41,155 Interest expense 7,481 8,121 (640 ) 23,480 22,159 1,321 Net interest income 98,073 84,559 13,514 282,748 242,914 39,834 Provision for credit losses 419 - 419 4,426 8,920 (4,494 ) Net interest income after provision for credit losses 97,654 84,559 13,095 278,322 233,994 44,328 Non-interest income 6,226 4,129 2,097 16,834 20,690 (3,856 ) Non-interest expense 50,012 49,675 337 152,177 145,135 7,042 Income from continuing operations before provision for income taxes 53,868 39,013 14,855 142,979 109,549 33,430 Income tax expense 12,949 10,390 2,559 34,279 25,838 8,441 Income from continuing operations 40,919 28,623 12,296 108,700 83,711 24,989 Loss from discontinued operations, net of tax - (29 ) (29 ) (1,158 ) (160 ) 998 Net income $ 40,919 $ 28,594 $ 12,267 $ 107,542 $ 83,551 $ 25,987 Net income available to common stockholders $ 40,566 $ 28,242 $ 12,324 $ 106,484 $ 82,493 $ 23,991 Earnings per share applicable to common stockholders--basic $ 0.47 $ 0.33 $ 0.14 $ 1.23 $ 0.96 $ 0.27 Earnings per share applicable to common stockholders--diluted $ 0.46 $ 0.33 $ 0.13 $ 1.22 $ 0.95 $ 0.27 58-------------------------------------------------------------------------------- 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 stockholders for certain significant activities or transactions that, in management's opinion, do not reflect recurring period-to-period comparisons of the Company's performance. Management believes presentation of these non-GAAP financial measures provides useful supplemental information that is essential to a complete understanding of the operating results of the Company's core businesses. Since the presentation of these non-GAAP performance measures and their impact differ between companies, 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 nine months ended September 30, 2014 and 2013: Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (in thousands) Total non-interest income $ 6,226 $ 4,129 $ 16,834 $ 20,690 Less: Gain (loss) on sales of investment securities, net 181 (1,679 ) 384 (1,537 ) Unrealized gains (losses) on assets and liabilities measured at fair value, net 896 (7 ) (145 ) (3,865 ) Bargain purchase gain from acquisition - - - 10,044 Loss on extinguishment of debt (502 ) - (502 ) - Legal settlements - - - 38 Total operating non-interest income 5,651 5,815 17,097 16,010 Add: net interest income 98,073 84,559 282,748 242,914 Net operating revenue $ 103,724 $ 90,374 $ 299,845 $ 258,924 Total non-interest expense $ 50,012 $ 49,675 $ 152,177 $ 145,135 Less: Net (gain) loss on sales / valuations of repossessed and other assets (1,956 ) 371 (4,319 ) (234 ) Merger / restructure expenses 15 1,018 198 3,833 Total operating non-interest expense $ 51,953 $ 48,286 $ 156,298 $ 141,536 Pre-tax, pre-provision operating earnings $ 51,771 $ 42,088 $ 143,547 $ 117,388 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. 59-------------------------------------------------------------------------------- Table of Contents September 30, 2014 December 31, 2013 (dollars and shares in thousands) Total stockholders' equity $ 1,003,122 $ 855,498 Less: Goodwill and intangible assets, net 26,194 27,374 Total tangible stockholders' equity 976,928 828,124 Less: Preferred stock 141,000 141,000 Total tangible common equity 835,928 687,124 Add: Deferred tax - attributed to intangible assets 1,138 1,452 Total tangible common equity, net of tax $ 837,066 $ 688,576 Total assets $ 10,288,824 $ 9,307,342 Less: Goodwill and intangible assets, net 26,194 27,374 Tangible assets 10,262,630 9,279,968 Add: Deferred tax - attributed to intangible assets 1,138 1,452 Total tangible assets, net of tax $ 10,263,768 $ 9,281,420 Tangible equity ratio 9.5 % 8.9 % Tangible common equity ratio 8.2 7.4 Return on tangible common equity 19.6 18.3 Common shares outstanding 87,849 87,186 Tangible book value per share, net of tax $ 9.53 $ 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 September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (dollars in thousands) Total operating non-interest expense $ 51,953 $ 48,286 $ 156,298 $ 141,536 Divided by: Total net interest income $ 98,073 $ 84,559 $ 282,748 $ 242,914 Add: Tax equivalent interest adjustment 6,348 3,272 18,082 9,583 Operating non-interest income 5,651 5,815 17,097 16,010 Net operating revenue - tax equivalent basis $ 110,072 $ 93,646 $ 317,927 $ 268,507 Efficiency ratio - tax equivalent basis 47.2 % 51.6 % 49.2 % 52.7 % 60-------------------------------------------------------------------------------- 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 an important regulatory metric for assessing asset quality. September 30, 2014 December 31, 2013 (dollars and shares in thousands) Stockholders' equity $ 1,003,122 $ 855,498 Less: Accumulated other comprehensive income (loss) 9,483 (21,546 ) Non-qualifying goodwill and intangibles 25,056 25,991 Disallowed unrealized losses on equity securities 1,011 8,059 Add: Qualifying trust preferred securities 48,442 48,485 Tier 1 capital (regulatory) $ 1,016,014 $ 891,479 Less: Qualifying trust preferred securities 48,442 48,485 Preferred stock 141,000 141,000 Tier 1 common equity $ 826,572 $ 701,994 Divided by: Risk-weighted assets (regulatory) $ 9,216,875 $ 8,016,500 Tier 1 common equity ratio 9.0 % 8.8 % September 30, 2014 December 31, 2013 (dollars in thousands) Classified assets $ 241,790 $ 270,375 Divide: Tier 1 capital (regulatory) 1,016,014 891,479 Plus: Allowance for credit losses 109,161 100,050 Total Tier 1 capital plus allowance for credit losses $ 1,125,175 $ 991,529 Classified assets to Tier 1 capital plus allowance 21.5 % 27.3 % 61-------------------------------------------------------------------------------- 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 TEB and interest expense for the periods indicated: Three Months Ended September 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) $ 7,644,908 $ 94,436 5.18 % $ 6,306,394 $ 83,994 5.44 % Securities (1) 1,575,706 10,535 3.11 1,303,318 8,286 3.01 Federal funds sold and other 203,068 583 1.15 364,580 400 0.44 Total interest earning assets 9,423,682 105,554 4.75 7,974,292 92,680 4.81 Non-interest earning assets Cash and due from banks 137,608 119,209 Allowance for credit losses (107,038 ) (96,672 ) Bank owned life insurance 142,717 139,740 Other assets 458,315 492,035 Total assets $ 10,055,284 $ 8,628,604 Interest-bearing liabilities Interest-bearing deposits: Interest-bearing transaction accounts $ 810,260 $ 400 0.20 % $ 641,695 $ 376 0.23 % Savings and money market 3,659,887 2,809 0.31 2,828,113 2,172 0.31 Time certificates of deposit 1,763,830 1,963 0.45 1,675,482 1,684 0.40 Total interest-bearing deposits 6,233,977 5,172 0.33 5,145,290 4,232 0.33 Borrowings 391,888 1,866 1.90 574,767 3,429 2.39 Junior subordinated debt 42,701 443 4.15 39,920 460 4.61 Total interest-bearing liabilities 6,668,566 7,481 0.45 5,759,977 8,121 0.56 Non-interest-bearing liabilities Non-interest-bearing demand deposits 2,241,366 1,931,127 Other liabilities 155,875 114,750 Stockholders' equity 989,477 822,750 Total liabilities and stockholders' equity $ 10,055,284 $ 8,628,604 Net interest income and margin (4) $ 98,073 4.43 % $ 84,559 4.41 % Net interest spread (5) 4.30 % 4.25 % (1) Yields on loans and securities have been adjusted to a TEB. The taxable-equivalent adjustment was $6.3 million and $3.3 million for the three months ended September 30, 2014 and 2013, respectively. (2) Net loan fees of $1.0 million and $1.8 million are included in the yield computation for the three months ended September 30, 2014 and 2013, respectively. (3) Includes nonaccrual loans. (4) Net interest margin is computed by dividing net interest income by total average earning assets. (5) Net interest spread represents average yield earned on interest-earning assets less the average rate paid on interest bearing liabilities. 62-------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2014 2013 Average Yield Average Average Balance Interest / Cost Average Balance Interest Yield / Cost ($ in thousands) Interest earning assets Loans (1), (2), (3) $ 7,241,557 $ 271,823 5.24 % $ 6,008,435 $ 239,812 5.42 % Securities (1) 1,618,830 32,754 3.11 1,294,273 24,266 3.05 Federal funds sold & other 235,213 1,651 0.94 392,193 995 0.34 Total interest earnings assets 9,095,600 306,228 4.75 7,694,901 265,073 4.76 Non-interest earning assets Cash and due from banks 138,898 130,258 Allowance for credit losses (104,427 ) (97,238 ) Bank owned life insurance 141,825 139,687 Other assets 450,259 440,660 Total assets $ 9,722,155 $ 8,308,268 Interest-bearing liabilities Interest-bearing deposits: Interest bearing transaction accounts $ 789,098 $ 1,169 0.20 % $ 625,830 $ 1,047 0.22 % Savings and money market 3,566,000 8,063 0.30 2,739,973 6,090 0.30 Time certificates of deposits 1,695,130 5,535 0.44 1,570,510 4,756 0.40 Total interest-bearing deposits 6,050,228 14,767 0.33 4,936,313 11,893 0.32 Borrowings 458,814 7,406 2.15 526,046 8,885 2.25 Junior subordinated debt 42,471 1,307 4.10 37,636 1,381 4.90 Total interest-bearing liabilities 6,551,513 23,480 0.48 5,499,995 22,159 0.54 Non-interest-bearing liabilities Non-interest-bearing demand deposits 2,114,361 1,895,090 Other liabilities 120,300 110,716 Stockholders' equity 935,981 802,467 Total liabilities and stockholders' equity $ 9,722,155 $ 8,308,268 Net interest income and margin (4) $ 282,748 4.41 % $ 242,914 4.38 % Net interest spread (5) 4.27 % 4.22 % (1) Yields on loans and securities have been adjusted to a TEB. The taxable-equivalent adjustment was $18.1 million and $9.6 million for the nine months ended September 30, 2014 and 2013, respectively. (2) Net loan fees of $2.5 million and $5.6 million are included in the yield computation for the nine months ended September 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 Three Months Ended September 30, Nine Months Ended September 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 $ 16,534 $ (6,092 ) $ 10,442 $ 46,287 $ (14,276 ) $ 32,011 Investment securities 1,821 428 2,249 6,567 1,921 8,488 Federal funds sold and other (464 ) 647 183 (1,102 ) 1,758 656 Total interest income 17,891 (5,017 ) 12,874 51,752 (10,597 ) 41,155 Interest expense: Interest bearing transaction accounts 83 (59 ) 24 242 (120 ) 122 Savings and money market 638 (1 ) 637 1,868 105 1,973 Time deposits 98 181 279 407 372 779 Short-term borrowings (115 ) (2,086 ) (2,201 ) (26 ) (2,257 ) (2,283 ) Long-term debt (727 ) 1,365 638 (1,423 ) 2,227 804 Junior subordinated debt 29 (46 ) (17 ) 150 (224 ) (74 ) Total interest expense 6 (646 ) (640 ) 1,218 103 1,321 Net increase (decrease) $ 17,885 $ (4,371 ) $ 13,514 $ 50,534 $ (10,700 ) $ 39,834 (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 September 30, 2014 was $105.6 million, an increase of 13.9%, compared to $92.7 million for the three months ended September 30, 2013. For the nine months ended September 30, 2014, interest income was $306.2 million, compared to $265.1 million for the nine months ended September 30, 2013. This increase was primarily the result of interest income from loans, which increased by $10.4 million and $32.0 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. Interest income on investment securities increased $2.2 million and $8.5 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. Average yield on interest earning assets decreased 6 and 1 basis points for three and nine months ended September 30, 2014, respectively, compared to the same period in 2013, which was the result of a decrease in yields on loans. Interest expense for the three months ended September 30, 2014 was $7.5 million, compared to $8.1 million for the three months ended September 30, 2013, a decrease of $0.6 million, or 7.9%. For the nine months ended September 30, 2014, interest expense was $23.5 million, compared to $22.2 million for the nine months ended September 30, 2013. The decrease in interest expense for the three-month comparable periods was the result of lower outstanding borrowings and interest rates on borrowings during the period. This decrease was partially offset by an increase in interest expense related to deposits due to a $1.09 billion increase in average interest bearing deposits. The increase in interest expense for the nine-month comparable periods was driven by the increase in average interest bearing deposits of $1.11 billion from the prior year. Despite this increase, the average cost of interest bearing deposits remained flat at 0.33% for the three months ended September 30, 2014 and 2013 and only increased 1 basis point from 0.32% for the nine months ended September 30, 2013. Interest paid on borrowings decreased by 49 and 10 basis points for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013. Interest paid on junior subordinated debt decreased by 46 and 80 basis points, respectively, for the three and nine months ended September 30, 2014, compared to the same periods in 2013. Net interest income was $98.1 million for the three months ended September 30, 2014, compared to $84.6 million for the three months ended September 30, 2013, an increase of $13.5 million, or 16.0%. For the nine months ended September 30, 2014, net interest income was $282.7 million, compared to $242.9 million for the nine months ended September 30, 2013. The increase in net interest margin of 2 and 3 basis points for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013 was mostly due to a decrease in the average cost of funds related to short-term borrowings and junior subordinated debt. 64-------------------------------------------------------------------------------- Table of Contents Provision for Credit Losses The provision for credit losses in each period is reflected as a reduction in 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 was $0.4 million for the three months ended September 30, 2014, compared with zero for the three months ended September 30, 2013. For the nine months ended September 30, 2014, the provision for credit losses was $4.4 million, compared to $8.9 million for the nine months ended September 30, 2013. The provision increase for the three months ended September 30, 2013 was primarily related to loan growth. The decrease in provision for the nine months ended September 30, 2014 compared to the same period 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 provision for loan losses when impairment is determined as a result of lower than expected cash flows. As of September 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 September 30, Nine Months Ended September 30, Increase Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (inthousands) Service charges and fees $ 2,434 $ 2,425 $ 9 $ 7,701 $ 7,408 $ 293 Income from bank owned life insurance 1,136 1,832 (696 ) 3,044 3,904 (860 ) Gain (loss) on sales of investment securities, net 181 (1,679 ) 1,860 384 (1,537 ) 1,921 Unrealized gains (losses) on assets and liabilities measured at fair value, net 896 (7 ) 903 (145 ) (3,865 ) (3,720 ) Bargain purchase gain from acquisition - - - - 10,044 (10,044 ) Loss on extinguishment of debt (502 ) - (502 ) (502 ) - (502 ) Other fee revenue 892 1,015 (123 ) 2,860 2,915 (55 ) Other income 1,189 543 646 3,492 1,821 1,671Total non-interest income $ 6,226 $ 4,129 $ 2,097 $ 16,834 $ 20,690 $ (11,296 ) Total non-interest income for the three months ended September 30, 2014 compared to the same period in 2013 increased by $2.1 million, or 50.8%. This increase primarily relates to the net gain on sale of investment securities, unrealized gains on assets and liabilities measured at fair value, and other income which were offset by the decrease income from BOLI and loss on extinguishment of debt. The change from a net loss of $1.7 million on sales of investment securities for the three months ended September 30, 2013 to a net gain of $0.2 million for the three months ended September 30, 2014 relates to improved market conditions. The increase in net unrealized gains on assets and liabilities measured at fair value is primarily due to the fair value adjustment gain for junior subordinated debt of $0.9 million for the three months ended September 30, 2014, which did not occur in the three months ended September 30, 2013. These increases are offset by the decrease in income from BOLI of $0.7 million due to fewer death benefit claims for the three months ended September 30, 2014, compared to the same period in 2013. The increases are also offset by the loss on extinguishment of debt of $0.5 million, which is the result of the Company's purchase of $6.5 million of its Senior Note principal during the three months ended September 30, 2014. Total non-interest income for the nine months ended September 30, 2014 compared to the same period in 2013 decreased by $11.3 million, or 54.6%. The decrease primarily is due to the bargain purchase gain from the acquisition of Centennial Bank which was offset by the increases in net gain (loss) on sales of investment securities, net unrealized gain (losses) on assets and liabilities measured at fair value, and other income. The non-recurring bargain purchase gain from the acquisition of Centennial Bank of $10.0 million during the nine months ended September 30, 2013 was not present in the same period 2014 resulting in decreased non-interest income. This decrease was offset by the increase to non-interest income from the net gain on sale of investments during the nine months ended September 30, 2014 of $0.4 million, compared to a net loss of $1.5 million during the same period in 2013, which is also the result of improved market conditions. Also offsetting the decreases in non-interest income is the $3.7 million for the decrease in net unrealized losses on assets and liabilities measured at fair value, which relates to the fair value adjustment loss for junior subordinated debt of $0.1 million for the nine months ended September 30, 2014, compared to a loss of $3.2 million for the same period in 2013. 65-------------------------------------------------------------------------------- Table of Contents Non-interest Expense The following table presents a summary of non-interest expenses for the periods presented: Three Months Ended September 30, Nine Months Ended September 30, Increase Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in thousands) Salaries and employee benefits $ 32,230 $ 28,689 $ 3,541 $ 93,536 $ 83,363 $ 10,173 Occupancy 4,500 4,901 (401 ) 13,510 14,500 (990 ) Legal, professional and directors' fees 3,022 3,438 (416 ) 10,853 9,010 1,843 Data processing 2,109 1,872 237 7,184 5,912 1,272 Insurance 1,996 1,884 112 6,476 6,350 126 Loan and repossessed asset expenses 1,007 1,136 (129 ) 3,168 3,453 (285 ) Customer service 888 677 211 2,216 2,037 179 Marketing 378 585 (207 ) 1,443 1,962 (519 ) Intangible amortization 281 597 (316 ) 1,180 1,791 (611 ) Net (gain) loss on sales / valuations of repossessed and other assets (1,956 ) 371 (2,327 ) (4,319 ) (234 ) (4,085 ) Merger / restructure expenses 15 1,018 (1,003 ) 198 3,833 (3,635 ) Other expense 5,542 4,507 1,035 16,732 13,158 3,574 Total non-interest expense $ 50,012 $ 49,675 $ 337 $ 152,177 $ 145,135 $ 7,042 Total non-interest expense for the three months ended September 30, 2014 compared to the same period in 2013 increased $0.3 million, or 0.7%. This increase is primarily the result of an increase in salaries and employee benefits and other expense offset by the decrease in net gain on sale / valuation of repossessed and other assets and merger / restructure expenses. The increase in the salaries and employee benefits is due primarily to employment growth to support continued asset growth. The increase in other expense during the quarter primarily relates to a $0.7 million increase from the write-off of an internal software development project that the Company is no longer pursuing. These increases are offset by the net gain on sales / valuations of repossessed and other assets of $2.0 million during the quarter, which decreased non-interest expense by $2.3 million, and primarily relates to an increase in sales of other real estate owned properties. Merger / restructure expenses decreased by $1.0 million as these expenses relate to the acquisition of Centennial Bank during 2013. Total non-interest expense for the nine months ended September 30, 2014 compared to the same period in 2013 increased $7.0 million, or 4.9%. This increase is primarily caused by increases in salaries and employee benefits, legal, professional and directors' fees, data processing, and other expense offset by the decrease in net gain on sale / valuation of repossessed and other assets, merger / restructure expense, and occupancy expense. The increases in salaries and employee benefits is due to employment growth to support continued asset growth. The increase in legal, professional and directors' fees and data processing primarily relates to information technology initiatives. The increase in other expense primarily relates to a $0.7 million increase related to the write-off of an internal software development project that the Company is no longer pursuing, a $0.6 million increase in off balance sheet provision, and an overall increase in general operational expenses. These increases are offset by the $4.1 million decrease in non-interest expense from the increase in the net gain on sales / valuations of repossessed and other assets due to an increase in other real estate owned property sales compared to the nine months ended September 30, 2013. Merger / restructure expenses decreased by $3.6 million as these expenses relate to the acquisition of Centennial Bank during 2013. Further, occupancy decreased $1.0 million due to a decrease in rent and repairs and maintenance expenses. 66-------------------------------------------------------------------------------- Table of Contents Discontinued Operations The Company discontinued its affinity credit card business and has presented these activities as discontinued operations. During the three months ended September 30, 2014, the Company shut down its remaining affinity credit card operations. Therefore, no discontinued operations have been reported for the quarter. The following table summarizes the operating results of the discontinued operations for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (in thousands) Operating revenue $ - $ 1,105 $ (358 ) $ 3,376 Non-interest expenses - (1,155 ) (1,369 ) (3,653 ) Loss before income taxes - (50 ) (1,727 ) (277 ) Income tax benefit - (21 ) (569 ) (117 ) Net loss $ - $ (29 ) $ (1,158 ) $ (160 ) 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. The realignment of the Company's segments resulted in significant differences from the old segmentation methodology. Consequently, the Company determined that recasting prior year segment information to conform to the new segmentation methodology would be impracticable due to the substantial time and cost that would be involved in recasting this information. Also, given the incomparability of the reporting segments between periods, the Company determined that disclosure of the reportable segment information for the period ended September 30, 2014, as previously reported under the old basis, would not be beneficial to the reader as it does not assist the reader in better understanding the Company's performance, assessing its prospects for future net cash flows or making more informed judgments about the Company as a whole, which are the primary objectives of ASC 280-10. The new operating segments are as follows: Arizona, Nevada, California, CBL and Corporate & Other. Arizona reported a gross loan balance of $2.20 billion at September 30, 2014, an increase of $73.9 million during the quarter and an increase of $180.3 million during the nine months ended September 30, 2014. In addition, total deposits at September 30, 2014 were $2.08 billion, a decrease of $38.0 million during the quarter and an increase of $77.1 million during the nine months ended September 30, 2014. Pre-tax income was $14.8 million and $44.7 million for the three and nine months ended September 30, 2014, respectively. Nevada reported a gross loan balance of $1.68 billion at September 30, 2014, a decrease of $2.5 million during the quarter and a decrease of $74.3 million during the nine months ended September 30, 2014. In addition, total deposits at September 30, 2014 were $3.19 billion, an increase of $6.0 million during the quarter and an increase of $271.2 million during the nine months ended September 30, 2014. Pre-tax income was $21.2 million and $55.4 million for the three and nine months ended September 30, 2014, respectively. California reported a gross loan balance of $1.73 billion at September 30, 2014, an increase of $30.9 million during the quarter and an increase of $110.5 million during the nine months ended September 30, 2014. In addition, total deposits at September 30, 2014 were $2.35 billion, an increase of $288.8 million during the quarter and an increase of $405.1 million during the nine months ended September 30, 2014. Pre-tax income was $13.4 million and $37.8 million for the three and nine months ended September 30, 2014, respectively. CBL reported a gross loan balance of $2.26 billion at September 30, 2014, an increase of $313.4 million during the quarter and an increase of $914.3 million during the nine months ended September 30, 2014. In addition, total deposits at September 30, 2014 were $906.0 million, an increase of $19.7 million during the quarter and an increase of $138.1 million during the nine months ended September 30, 2014. Pre-tax income was $9.6 million and $21.7 million for the three and nine months ended September 30, 2014, respectively. 67-------------------------------------------------------------------------------- Table of Contents BALANCE SHEET ANALYSIS Total assets increased $981.5 million, or 10.5%, to $10.29 billion at September 30, 2014, compared to $9.31 billion at December 31, 2013. The increase in assets primarily relates to the increase in loans of $1.13 billion, or 16.6%, to $7.93 billion. Total liabilities increased $833.9 million, or 9.9%, to $9.29 billion at September 30, 2014, compared to $8.45 billion at December 31, 2013. The increase in liabilities is due to the increase in total deposits of $859.4 million, or 11.0%, to $8.70 billion. Total stockholders' equity increased by $147.6 million, or 17.3%, to $1.00 billion at September 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 $106.5 million for the nine months ended September 30, 2014, the movement of AOCI due to the increase in unrealized gains on AFS securities from a loss position, and the transfer of all of the Company's HTM securities to AFS during the second quarter 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. The following table summarizes the carrying value of the investment securities portfolio at September 30, 2014 and December 31, 2013: September 30, 2014 December 31, 2013 (in thousands) U.S. government sponsored agency securities $ 17,994 $ 46,975 Municipal obligations 307,395 299,244 Preferred stock 82,227 61,484 Mutual funds 37,814 36,532 Residential MBS issued by GSEs 909,887 1,024,457 Commercial MBS issued by GSEs 2,117 - Private label residential MBS 53,645 36,099 Private label commercial MBS 5,336 5,433 Trust preferred securities 26,220 23,805 CRA investments 23,990 24,882 Collateralized debt obligations 8,053 50 Corporate debt securities 96,946 97,777 Total investment securities $ 1,571,624 $ 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 grade investment 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 September 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 68-------------------------------------------------------------------------------- Table of Contents Financial Statements contained herein. There were no impairment charges recorded during the three and nine months ended September 30, 2014 and 2013. The Company does not consider any securities to be other-than-temporarily impaired as of September 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: September 30, 2014 December 31, 2013 (in thousands) Commercial and industrial $ 3,074,465 $ 2,236,740 Commercial real estate - non-owner occupied 1,998,887 1,843,415 Commercial real estate - owner occupied 1,621,877 1,561,862 Construction and land development 677,141 537,231 Residential real estate 316,939 350,312 Commercial leases 217,684 235,968 Consumer 32,996 45,153 Net deferred loan fees and costs (10,469 ) (9,266 ) Loans, net of deferred fees and costs 7,929,520 6,801,415 Allowance for credit losses (109,161 ) (100,050 ) Total $ 7,820,359 $ 6,701,365 Concentrations of Lending Activities The Company's lending activities, including those within its CBL, 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 September 30, 2014 and December 31, 2013, approximately 84% and 88%, respectively, of the Company's customers are located in these markets. The Company monitors concentrations within five broad categories: geography, industry, product, call report classifications, and collateral. The Company's loan portfolio includes significant credit exposure to the CRE market. As of September 30, 2014 and December 31, 2013, CRE related loans accounted for approximately 54% and 58% of total loans, respectively. 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 September 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 September 30, 2014 and December 31, 2013, respectively. Impaired loans A loan is identified as impaired when it is no longer probable that interest and principal will 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 if full repayment of all principal and interest is expected and the loan is both well secured and in the process of collection. 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 increased by $1.5 million, or 1.9%, at September 30, 2014 to $78.7 million from $77.2 million at December 31, 2013. 69-------------------------------------------------------------------------------- Table of Contents September 30, 2014 December 31, 2013 (dollars in thousands) Total nonaccrual loans $ 75,092 $ 75,680 Loans past due 90 days or more on accrual status 3,558 1,534 Total nonperforming loans 78,650 77,214 Troubled debt restructured loans 90,308 89,576 Other impaired loans 15,212 11,587 Total impaired loans $ 184,170 $ 178,377 Other assets acquired through foreclosure, net $ 51,787 $ 66,719 Nonaccrual loans to gross loans 0.95 % 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 for the three and nine months ended September 30, 2014 was $0.6 million and $1.7 million, respectively, compared to $0.3 million and $1.3 million for the three and nine months ended September 30, 2013, respectively. Interest income that would have been recorded under the original terms of nonaccrual loans for the three and nine months ended September 30, 2014 was $0.3 million and $1.6 million, respectively, compared to $1.3 million and $3.8 million, for the three and nine months ended September 30, 2013, respectively. The composition of nonaccrual loans was as follows as of the dates indicated: At September 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 $ 2,463 3.28 % 0.03 % $ 3,753 4.96 % 0.06 % Commercial real estate 55,313 73.65 0.71 54,856 72.48 0.80 Construction and land development 5,533 7.37 0.07 4,525 5.98 0.07 Residential real estate 11,448 15.25 0.14 12,480 16.49 0.18 Consumer 335 0.45 - 66 0.09 - Total nonaccrual loans $ 75,092 100.00 % 0.95 % $ 75,680 100.00 % 1.11 % As of September 30, 2014 and December 31, 2013, nonaccrual loans totaled $75.1 million and $75.7 million, respectively. Nonaccrual loans by segment at September 30, 2014 were $32.5 million for Arizona, $21.1 million for Nevada, $3.8 million for California, $0.3 million for CBL and $17.4 million for Corporate & Other. Nonaccrual loans as a percentage of total gross loans were 0.95% and 1.11% at September 30, 2014 and December 31, 2013, respectively. Nonaccrual loans as a percentage of each segment's total gross loans at September 30, 2014 were 1.47% for Arizona, 1.26% for Nevada, 0.22% for California, 0.01% for CBL and 32.30% 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 September 30, 2014 and December 31, 2013, the aggregate amount of loans classified as impaired was $184.2 million and $178.4 million, respectively, a net increase of 3.2%. The total specific allowance for loan losses related to these loans was $17.5 million and $5.3 million at September 30, 2014 and December 31, 2013, respectively. As of September 30, 2014 and December 31, 2013, the Company had $90.3 million and $89.6 million, respectively, in loans classified as accruing restructured loans. Impaired loans by segment at September 30, 2014 were $63.4 million for Arizona, $66.7 million for Nevada and $10.0 million for California. Additionally, CBL and Corporate & Other held $0.3 million and $43.8 million, respectively, of impaired loans at September 30, 2014. 70-------------------------------------------------------------------------------- Table of Contents The following tables present a breakdown of total impaired loans and the related specific reserves for the periods indicated: September 30, 2014 Percent of Impaired Percent of Reserve Total Balance Percent Total Loans Balance Percent Allowance (dollars in thousands) Commercial and industrial $ 20,629 11.20 % 0.26 % $ 3,758 21.53 % 3.44 % Commercial real estate 114,758 62.31 1.44 8,098 46.39 7.42 Construction and land development 22,963 12.47 0.29 3,505 20.08 3.21 Residential real estate 25,313 13.74 0.32 2,044 11.71 1.87 Consumer 507 0.28 0.01 51 0.29 0.05 Total impaired loans $ 184,170 100.00 % 2.32 % $ 17,456 100.00 % 15.99 % 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 % As discussed in Note 3. Loans, Leases and Allowance for Credit Losses, the presentation of certain impaired loans and the related allowance for credit losses on these loans has been revised to reflect the FDIC's preferred presentation. 71-------------------------------------------------------------------------------- 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 September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (dollars in thousands) Allowance for credit losses: Balance at beginning of period $ 105,937 $ 96,323 $ 100,050 $ 95,427 Provisions charged to operating expenses: Commercial and industrial 1,779 354 5,323 5,514 Commercial real estate (1,945 ) (278 ) (967 ) 3,026 Construction and land development 1,710 (533 ) 3,433 (1,442 ) Residential real estate (1,043 ) (247 ) (2,394 ) 1,748 Consumer (82 ) 704 (969 ) 74 Total Provision 419 - 4,426 8,920 Recoveries of loans previously charged-off: Commercial and industrial 1,053 2,242 3,229 4,440 Commercial real estate 1,779 422 3,587 1,997 Construction and land development 182 966 891 1,787 Residential real estate 768 430 1,635 1,548 Consumer 34 726 395 751 Total recoveries 3,816 4,786 9,737 10,523 Loans charged-off: Commercial and industrial (110 ) (544 ) (2,626 ) (3,379 ) Commercial real estate (193 ) (864 ) (694 ) (6,142 ) Construction and land development - - (78 ) (852 ) Residential real estate (423 ) (1,138 ) (1,352 ) (5,641 ) Consumer (285 ) (712 ) (302 ) (1,005 ) Total charged-off (1,011 ) (3,258 ) (5,052 ) (17,019 ) Net recoveries (charge-offs) 2,805 1,528 4,685 (6,496 ) Balance at end of period $ 109,161 $ 97,851 $ 109,161 $ 97,851 Net recoveries (charge-offs) to average loans outstanding-annualized 0.15 % 0.10 % 0.09 % (0.14 )% Allowance for credit losses to gross loans 1.38 1.53 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. September 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 $ 45,583 41.8 % 41.5 % $ 39,657 39.7 % 36.3 % Commercial real estate 33,990 31.1 45.6 % 32,064 32.0 50.0 Construction and land development 18,765 17.2 8.5 % 14,519 14.5 7.9 Residential real estate 9,529 8.7 4.0 % 11,640 11.6 5.1 Consumer 1,294 1.2 0.4 % 2,170 2.2 0.7 Total $ 109,161 100.0 % 100.0 % $ 100,050 100.0 % 100.0 % The allowance for credit losses as a percentage of total loans decreased to 1.38% at September 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 72-------------------------------------------------------------------------------- Table of Contents 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. 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 September 30, 2014 Number of Percent of Loans Loan Balance Percent Total Loans (dollars in thousands) Commercial and industrial 71 $ 22,122 21.51 % 0.28 % Commercial real estate 52 59,730 58.08 0.75 Construction and land development 4 13,521 13.15 0.17 Residential real estate 15 7,007 6.81 0.09 Consumer 8 464 0.45 0.01 Total 150 $ 102,844 100.00 % 1.30 % 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. 73-------------------------------------------------------------------------------- Table of Contents Other Assets Acquired Through Foreclosure The following table represents the changes in other assets acquired through (or in lieu of) foreclosure: Three Months Ended September 30, 2014 2013 Valuation Valuation Gross Balance Allowance Net Balance Gross Balance Allowance Net Balance (in thousands) Balance, beginning of the period $ 74,643 $ (15,351 ) $ 59,292 $ 102,923 $ (26,424 ) $ 76,499 Transfers to other assets acquired through foreclosure, net 2,737 - 2,737 2,737 - 2,737 Proceeds from sale of other real estate owned and repossessed assets, net (11,811 ) 982 (10,829 ) (3,411 ) 1,055 (2,356 ) Valuation adjustments, net - (882 ) (882 ) - (697 ) (697 ) Gains, net (1) 1,469 - 1,469 292 - 292 Balance, end of period $ 67,038 $ (15,251 ) $ 51,787 $ 102,541 $ (26,066 ) $ 76,475 Nine Months Ended September 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 9,156 - 9,156 14,010 - 14,010 Additions from acquisition of Centennial Bank - - - 5,622 - 5,622 Proceeds from sale of other real estate owned and repossessed assets, net (33,187 ) 7,626 (25,561 ) (32,953 ) 12,440 (20,513 ) Valuation adjustments, net - (1,175 ) (1,175 ) - (2,279 ) (2,279 ) Gains, net (2) 2,648 - 2,648 2,388 - 2,388 Balance, end of period $ 67,038 $ (15,251 ) $ 51,787 $ 102,541 $ (26,066 ) $ 76,475 (1) Includes gains related to initial transfers to other assets of zero and $62 thousand during the three months ended September 30, 2014 and 2013, respectively, pursuant to accounting guidance. (2) Includes gains related to initial transfers to other assets of zero and $407 thousand during the nine months ended September 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. At September 30, 2014, the Company held approximately 64 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 $3.0 million as of September 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 nine months ended September 30, 2014, there were no events or circumstances that indicated an interim impairment test of goodwill or other intangible assets was necessary. 74-------------------------------------------------------------------------------- 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. For the nine months ended September 30, 2014 and 2013, the Company's effective tax rate was 23.97% and 23.59%, respectively. The increase in the effective tax rate for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 is due primarily to the bargain purchase gain related to the Centennial Bank acquisition recorded in the second quarter of 2013 with no similar benefit recorded in 2014. The full impact of this effective tax rate increase was offset by the increase in the projected tax-exempt income for the year compared to the prior year. 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 September 30, 2014, total deposits were $8.70 billion, compared to $7.84 billion at December 31, 2013. Total deposit growth of $859.4 million, or 11.0%, was primarily driven by an increase in savings and money market deposits of $374.6 million and an increase in certificate of deposits of $338.5 million. WAB is a member of CDARS and ICS, which provide mechanisms for obtaining FDIC insurance on large deposits. At September 30, 2014, the Company had $665.2 million of CDARS deposits and $406.2 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 September 30, 2014 and December 31, 2013, the Company had $261.8 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 September 30, 2014 2013 Average Balance Rate Average Balance Rate (dollars in thousands) Interest checking (NOW) $ 810,260 0.20 % $ 641,695 0.23 % Savings and money market 3,659,887 0.31 2,828,113 0.31 Time 1,763,830 0.45 1,675,482 0.40 Total interest-bearing deposits 6,233,977 0.33 5,145,290 0.33 Non-interest-bearing demand deposits 2,241,366 - 1,931,127 - Total deposits $ 8,475,343 0.24 % $ 7,076,417 0.24 % 75-------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2014 2013 Average Balance Rate Average Balance Rate (dollars in thousands) Interest checking (NOW) $ 789,098 0.20 % $ 625,830 0.22 % Savings and money market 3,566,000 0.30 2,739,973 0.30 Time 1,695,130 0.44 1,570,510 0.40 Total interest-bearing deposits 6,050,228 0.33 4,936,313 0.32 Non-interest-bearing demand deposits 2,114,361 - 1,895,090 - Total deposits $ 8,164,589 0.24 % $ 6,831,403 0.23 % 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, collateralized 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 September 30, 2014, total short-term borrowed funds consisted of $53.0 million of customer repurchases and FHLB advances of $62.6 million. In addition, Senior Notes have a remaining principal balance of $58.4 million and a carrying value of $58.1 million, maturing in August 2015. 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 September 30, 2014, there was $210.1 million of FHLB advances classified as long-term. 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 $41.8 million at September 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 funds credit lines with correspondent 76-------------------------------------------------------------------------------- Table of Contents banks totaling $100.0 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 September 30, 2014, there were no amounts drawn on the lines of credit or the federal funds credit lines. In addition, loans and securities are pledged to the FHLB, providing $1.53 billion in borrowing capacity, with outstanding borrowings and letters of credit of $272.1 million and $391.2 million, respectively, leaving $867.9 million in available credit as of September 30, 2014. Loans and securities pledged to the FRB discount window provided $1.13 billion in borrowing capacity. As of September 30, 2014, there were no outstanding borrowings from the FRB, thus our available credit totaled $1.13 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 September 30, 2014, there was $999.5 million in liquid assets, comprised of $259.2 million in cash, cash equivalents, and money market investments and $740.3 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. The parent 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 WAB 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 stockholders, 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 subsidiary 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 September 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 nine months ended September 30, 2014 and 2013, net cash provided by operating activities was $107.1 million and $123.8 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 nine months ended September 30, 2014 and 2013, was $1.12 billion and $388.3 million, respectively. The increase from purchases or pay downs of securities, net for the nine months ended September 30, 2014 was $128.0 million, compared to a decrease of $147.6 million at September 30, 2013. Net cash provided by financing activities has been impacted significantly by increased deposit levels. During the nine months ended September 30, 2014 and 2013, deposits increased $859.8 million and $482.0 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 an individual customer 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 September 30, 2014, we had $665.2 million of CDARS and $406.2 million of ICS deposits, compared to $518.0 million of CDARS and $355.3 million of ICS deposits at December 31, 2013. As of September 30, 2014, we had $261.8 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 77-------------------------------------------------------------------------------- Table of Contents 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 $40.0 million, $2.5 million and $1.5 million during the nine months ended September 30, 2014, respectively. Subsequent to quarter end, on October 27, 2014, a $20.0 million dividend from WAB to WAL was approved and subsequently paid. 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 September 30, 2014 and December 31, 2013, the Company and WAB met all capital adequacy requirements to which they are subject. As of September 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 September 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) September 30, 2014 Total Capital (to Risk Weighted Assets) $ 1,127,299 12.2 % $ 739,212 8.0 % $ 924,016 10.0 % Tier 1 Capital (to Risk Weighted Assets) 1,016,014 11.0 369,460 4.0 554,189 6.0 Leverage Ratio (to Average Assets) 1,016,014 10.1 402,382 4.0 502,977 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 78-------------------------------------------------------------------------------- Table of Contents |