Western Alliance Bancorporation Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 20, 2023

Key Takeaways

  • Western Alliance strengthened its balance sheet with CET1 capital rising to 10.6%, insured and collateralized deposits climbing to 82%, and $3.2 billion in high-quality liquid assets.
  • Net interest income increased by $37 million and net interest margin recovered to 3.67%, aided by a 5 bp reduction in funding costs to 2.8%, with Q4 NIM guide of 3.60–3.70%.
  • Deposits grew by $3.2 billion in Q3—fueled by core commercial clients, mortgage warehouse and HOA balances, and regional network contributions—while higher-cost borrowings were paid down.
  • Asset quality remained stable as non-performing assets fell to 0.35% of total assets, net charge-offs were 7 bps, and provision expense held at $12 million with conservative allowance coverage.
  • Mortgage banking revenue declined by $7 million in Q3 as loan origination volume fell 5% amid rising mortgage rates, tempering noninterest income growth.
AI Generated. May Contain Errors.
Earnings Conference Call
Western Alliance Bancorporation Q3 2023
00:00 / 00:00

There are 18 speakers on the call.

Operator

Day, everyone. Welcome to Western Alliance Bancorporation's Third Quarter 2023 Earnings Call. You may also view the presentation today via webcast through the company's website at www.westernalliancebancorporation.com. I'd now like to turn the call over to Myles Ponderlikh, Director of Investor Relations and Corporate Development. Please go ahead.

Speaker 1

Thank you. Welcome to Western Alliance Bank's Q3 2023 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer detailed comments on the financial results. Before I hand the call over to Ken, please note that today's presentation forward looking statements, which are subject to risks, uncertainties and assumptions. Except as required by law, the company does not undertake any obligation to update any forward looking statements.

Speaker 1

For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward looking statements, please refer to the company's SEC filings, Including the Form 8 ks filed yesterday, which are available on the company's website. Now for opening remarks, I'd like to turn the call over to Ken Ducky.

Speaker 2

Thank you, Myles. Good morning, everyone. I'll make some brief comments about our Q3 2023 results, and then I'll turn the call over to Dale. 1 year ago, On our Q3 2022 call, we discussed our plans to temper balance sheet growth to bolster capital and liquidity In order to reinforce our financial foundation and position the bank to navigate to a volatile rate environment, the The events of the spring caused by duration mismatch at several regional banks validated the importance of our strategy and accelerated its implementation through surgical balance sheet repositioning. The recalibration of our business model to enhance overall liquidity and deposit granularity is designed to make the balance sheet unassailable in the event of another significant market disruption.

Speaker 2

As a result, our CET1 capital has grown from 8.7% a year ago to 10.6% today. Our HFI loan to deposit ratio has improved from 94% to 91%. To provide enhanced protection to depositors and cement the stability of our deposit base. Insured and collateralized deposits have risen from 47% at year end to 82%. In order to fortify our liquidity position, we have materially increased our cash and investment securities And now have $3,200,000,000 of high quality liquid asset treasuries.

Speaker 2

Having established strong capital, liquidity and deposit granularity, A sturdy foundation has been laid to deliver earnings improvement going forward. Over the last several quarters, we have prioritized stabilizing and growing deposits as well as optimizing the liability structure by paying down borrowings. This has led to net interest margin growing from our 2nd quarter trough as we have sustained improvement in our funding structure, lowered our adjusted efficiency and produced above peer return on average assets and return on average tangible common equity. Over the next 1 to 2 quarters, we will complete the optimization financial results of our funding structure and be well positioned to deploy excess core deposits into loan growth. In the Q3, Western Alliance profitability, strong liquidity generation and stable asset quality are proof points to the dexterity of our diversified business model.

Speaker 2

Before handing the call over to Dale, I wanted to highlight the drivers of our strong deposit growth in Q3. Core commercial clients, both new and existing, the primary sources contributing to $3,100,000,000 of growth. Mortgage warehouse and HOA pushed growth upward And the regional network posted a 2nd consecutive quarter of vigorous deposit contributions. Overall, deposit costs increased 27 basis points, the overall cost of interest bearing liabilities compressed 5 basis points to 2.8 percent in Q3 as we utilize deposits to pay down higher cost borrowings, which Dale will comment on later. Liquidity came in ratably over the quarter to push down our average borrowings.

Speaker 2

Core commercial deposits cost a marginal 4.04%, including cost of earning credit rates. Cultivating multi product customer relationships remains critical for solidifying and growing client relationships, which has held in the mid-eighty percent range in recent quarters. Our digital consumer channel, A source of liquidity uncorrelated with our core commercial business lines generated approximately $800,000,000 quarter at attractive rates relative to the marginal cost of repaid borrowings. In short, I feel confident in the vitality of our deposit franchise and how it sets up for future success. Now, Dale will take you through our financial performance.

Speaker 3

Thanks, Ken. For the quarter, Western Alliance generated net income of 2 $17,000,000 EPS of $1.97 and pre provision net revenue of $290,000,000 Net interest income increased $37,000,000 during the quarter to 5 recent impairment of earning assets as well as a reduction in higher cost borrowings. Non interest income increased $10,000,000 to 129,000,000 which included approximately $6,500,000 of non recurring pre tax items such as fair value adjustments. AmeriHome was moderately impacted by rising mortgage rates and treasury yields with Worries Banking revenue declining $7,000,000 to $79,000,000 as lot volume fell 5% quarter over quarter production margins compressed slightly to 38 basis points. Non interest expense growth was primarily driven by higher deposit costs software licensing and depreciation expenses.

Speaker 3

Deposit cost of $128,000,000 demonstrated our deposit share gains new customer and previous clients returning funds to the right. Provision expense was $12,000,000 due to stable asset quality and loan growth concentrated in low traded and low loss categories. Our provision modeling remains conservative given the weighting of the Moody's consensus forecast Lastly, our tax rate rose because of discrete nondeductible items in the quarter. We expect our tax rate to fall back to between 20% 21% going forward. Overall, we made substantial progress in increasing on balance sheet liquidity with investments in cash 19% higher quarter over quarter, Mostly from adding more high quality liquid assets.

Speaker 3

Deposit share gains and balance sheet remixing also pushed wholesale borrowings lower. Cash and cash equivalents alone totaled $3,500,000,000 up from $2,200,000,000 last quarter. With our strong deposit growth and capital levels, We elected to reclassify $1,300,000,000 of non AmeriHome held for sale loans back to held for investment report as organic loan growth has slowed. These transferred loans are short duration, low credit risk assets, which we believe are better served generating interest income for the bank going forward. Remaining loans held for sale consist entirely of AmeriHome residential inventory to be sold to the GSEs Transferred from held for sale.

Speaker 3

Loans held for investment rose $1,600,000,000 to $4,300,000,000 to 9,400,000,000 As Ken mentioned, deposits increased $3,200,000,000 to $54,000,000,000 atquarterend. Mortgage servicing rights increased in part due to the higher rate environment stood at $1,200,000,000 on September 30. Total borrowings declined by $820,000,000 to $9,600,000,000 at quarterend, average borrowings declined nearly $6,000,000,000 quarter over quarter, primarily from the repayment of Federal Home Loan Bank borrowings private equity lines obtained from March earlier this year. Organic helper investment loans grew $240,000,000 primarily C and I and centered around mortgage warehouse, MSR financing and corporate finance with smaller contributions from regional banking. HFI construction and land loan growth of $241,000,000 derived mostly from lot banking loans reclassified from held for sale status.

Speaker 3

Given the national undersupply of homes, we still view the macro backdrop for this product favorably despite the elevated rate environment. Total deposit growth of $3,200,000,000 resulted primarily from an increase in core deposits and also reflects a reduction in wholesale broker deposits of over 400,000,000 core deposit growth was fueled by $1,300,000,000 in non interest bearing DDA growth led by mortgage warehouse and $1,600,000,000 in savings and money market growth. Non interest bearing DDA comprise a third of our total deposits, of which approximately 40% have no cash payment of earnings credits. Quarter to date deposit growth has surpassed $3,000,000,000 so the semiannual seasonality of mortgage warehouse deposits and tax and insurance escrow funds We'll pull this number down as payments are made this quarter. Turning now to debt interest drivers.

Speaker 3

April repricing in a higher rate environment increased the yield on earning assets. Optimization of the liability structure by growing deposits to pay down more to short term borrowings reprioritized adding HQLA to the balance sheet. The yield on total investments expanded 15 basis points to 491, $1,800,000,000 in securities yielding $477,000,000 are also expected to mature by year end with another $2,000,000,000 yielding $498,000,000 maturing in 2024. Similarly, agent buy loans increased 25 basis points to 6.73% the quarter end spot rate of $6.99 In a higher for longer rate environment, we expect to benefit from favorable asset pricing tailwinds. Total fixed convertible loan maturities are expected to average $2,400,000,000 per quarter for the 1st 3 quarters of 2024.

Speaker 3

Importantly, this enabled a $5,900,000,000 reduction in average short term borrowings to 14% of interest bearing liabilities, resulted in a 5 basis point reduction in the overall cost of interest bearing liabilities to 2.8% in the 3rd quarter. As noted on our last earnings call, we believe net interest income and net interest margin reached a cycle trough in the 2nd quarter. Net interest income grew nearly 7% despite a modest contraction in average earning assets and as the margin expanded 25 basis quarter over quarter to 3.67. Considering the impact of future rate changes, our rate risk profile is modestly asset sensitive. Our plus 100 basis point rate shock analysis on a static balance sheet indicates net interest income is expected to lift approximately 4% decrease of similar amount on a minus 100 basis points chart.

Speaker 3

However, considering a more comprehensive review of interest rate risk, We projected 2.2% increase in earnings at risk from a 100 basis point negative shock on a static balance sheet, which is inclusive of estimated declines in ECR related deposit costs. Additionally, in a lower rate environment, mortgage banking acts as a shock absorber to our asset sensitive balance sheet from increased refinance activity and gain on sale margin expansion. Our efficiency ratio of 58.8 percent was 170 basis points higher than in Q2, Through our adjusted efficiency ratio, excluding the impact of DCRs, still 50 basis points to 50% as workers warehouse average balances with DCRs increased $2,400,000,000 to $11,000,000,000 in the 3rd quarter. Lower compensation expense results from normal seasonal factors and mitigated higher software licensing and data processing costs. We still view a mid to upper 40 percent efficiency ratio as indicative of the right medium term level of investments to fund new business initiatives and the ongoing evolution of our risk management framework.

Speaker 3

Pre provision net revenue was $290,000,000 for the quarter. Solid profitability was maintained in Q3 with a stable return on average assets of 1.24% on a larger balance sheet. Return on average tangible common equity of 17.3% was modestly below our Q2 level as our capital level climbed. Our proactive credit mitigation strategy has been effective thus far in normalizing credit environment. Asset quality was stable in Q3 as the aggregate net increase in special mention loans to classified assets was only $9,000,000 quarterly non performing assets declined $22,000,000 to $245,000,000 or to 35 basis points of total assets.

Speaker 3

Quarterly net loan charge offs were $8,000,000 or 7 basis points of average loans compared to $7,400,000 or 6 basis points in the 2nd quarter. Viewed growth in low to no loss categories in conjunction with stable asset quality led to a smaller provision expense Even in a normalized and credit environment, our total funded ACL increased $6,000,000 from the prior quarter to $327,000,000 as HFI growth occurred almost entirely in near zero loss categories, most prominently in mortgage warehouse. As a reminder, even after paying 2 credit linked loans, 22% of our loan portfolio was still protected with any losses incurred to be covered by a third party. The total loan ACLs of funded loans ticked down 2 basis points to 74 basis points, but did increase 13 basis points to 154% of non performing loans. You view our allowance as appropriate, especially when considering the material portion of loans covered by 1st loss credit protection from credit linked notes and low loan loss categories.

Speaker 3

Additionally, A sizable portion of our loan growth has been concentrated in low to no loss products. Our loan portfolio is diversified across grid segments With almost a quarter of it either credit protected, government guaranteed or cash secured and over half of the portfolio is either insured or resistant to economic volatility. Our strong organic capital growth lifted the CET1 ratio to 10.6% or 8.38% when adjusted for AOCI tax affected unrealized held to maturity securities marks. Our tangible common equity to total assets decreased approximately 20 basis points from Q2 to 6.8 percent as the balance sheet expanded modestly, while capital growth was curtailed by our higher AOCI mark. Given the 45 basis point rise in the 5 year treasury during the quarter, AOCI reached Duke's tangible common equity by 732,000,000 Inclusive of our quarterly cash dividend payment of $0.36 per share, our tangible book value per share increased $0.57 in the quarter Q4 $23.66 The quarter over quarter increase resulted from our earnings outpacing industry wide AOCI headwinds stemming from rising rates.

Speaker 3

I'll now turn the call back to Ken.

Speaker 2

Thanks, Dale. Our guidance for the rest of 2023 continues to be informed by the strategies and priorities laid out in our prior earnings call. So as we look forward to Q4, You can expect loans and core deposits are expected to be fairly flat to several $100,000,000 higher in Q4. Net deposit growth will be impacted by normal Q4 seasonal reductions in mortgage browse deposits offset by growth in the regional divisions digital consumer channel. Deposit should still outpace loan growth.

Speaker 2

Going into 2024, we expect loan and deposit growth to return prior guidance. Regarding capital, having closed to 40 basis points of our medium term CET1 target of 11%, We forecast continued although more gradual progress towards this goal, which we remain on track to achieve in 2024. Net interest margin should remain in line with our Q3 level in a range of 3.60 to 3.70, supported by asset pricing tailwinds additional, if more temporary, borrowing repayment opportunities. Our adjusted efficiency ratio, which excludes the impact of deposit costs, Should remain consistent with Q3 levels. Regarding operating PP and R, we expect Q4 to be generally consistent with Q3, Excluding the one time items noted and acknowledging that mortgage banking revenue will be influenced by the impact of the rate environment on mortgage gain on sale.

Speaker 2

Asset quality remains manageable. Projects continue to be supported by sponsors. Based on our conservative underwriting and low advance rates, credit losses are still expected to be 5 to 15 basis points through this economic cycle. At this time, Dale, Tim and I are Happy to take your call questions, sorry.

Operator

Thank you. Floor. Your line is unmuted locally. Our first question comes from Casey Haire of Jefferies. Casey, your line is open.

Operator

Please go ahead.

Speaker 4

Yes, great. Thanks. Good morning, everyone. Maybe first question on the NIM. Can you just walk us through just walk us through, I guess, what the NIM guide presumes in the way of borrowings.

Speaker 4

Obviously, your deposit growth very strong quarter to date. I think, Ken, you mentioned you do expect that to pay down. And so just that would bring the borrowings, which were up Pretty significantly period end versus the average in 3Q. Just wondering where that would end up in the Q4 here.

Speaker 3

Yes. So we have some seasonality within deposit categories that affects this number, but the The direction of borrowings is going to continue to be down. So we paid off several of our more funding sources that we achieved or acquired late in the Q1. And there's a little bit left. I expect We're going to pay down that amount as well.

Speaker 3

So we should continue to see kind of improvement there, where you see we are In terms of reasonably balanced on target for loan to deposit growth this quarter, I think you should see some kind of modest improvement In ending balances as well, and I think the average balances should improve somewhat as well, but not to the degree they did in the Q3 over the second.

Speaker 2

Yes, Cees, as you've seen, we took down our short term borrowings by $870,000,000 But anytime we have any excess liquidity floating around, We use it to pay down borrowings. So the average borrowings declined $6,000,000,000 in the quarter and that helped bring down our lower funding rate.

Speaker 4

Okay, great. And just, Dale, I wanted to follow-up on your comments on the fixed rate asset repricing benefit in the 1st 3 quarters the The $24,000,000 I think you said $2,400,000,000 per quarter. Can you give us a sense of where like what the blended yield is on that and the What that can reprice to? Just trying to quantify what the repricing benefit could be.

Speaker 3

So, I mean, in terms of what the repricing could be, these are coming off at Something in the kind of around the higher 7s. And rates today have spreads of Really not less than 300 basis points, the 3.50 from there. And so I think maybe you don't have another rate increase in there. So I would take that on top

Speaker 4

Okay. So over $7,000,000,000 of loans in the 1st 3 quarters with 100 bps left?

Speaker 3

Approximately.

Speaker 4

Okay. All right. Just last one for me on the expenses. Obviously, that was the one thing that kind of surprised negatively this quarter on the deposit costs. So If so I have the deposit with ECR, the DDA with ECR up 15%, but the deposit costs were up 40%.

Speaker 4

So I'm just trying to like why the disconnect? What was the is there a different pricing dynamic today than there was historically? Just trying to understand that.

Speaker 3

Well, we had higher balances and higher rates and I think the average balance was The average balance was up 28% during the quarter. So it wasn't let me approach it differently. In terms of the spreads that these clients receive, there is virtually no change.

Speaker 4

Okay. So all right. So we don't have the average balances. It's just period end was up 15%. The averages was up

Operator

Thank you. Our next question comes from Steven Alexopoulos of JPMorgan. Stephen, your line is open. Please proceed.

Speaker 5

Hi, everybody. I want to start regarding getting back to the $500,000,000 per quarter loan growth target at $2,000,000,000 deposit growth In 2024, once you guys get to the mid-eighty percent loan to deposit ratio target, what's more likely that you guys dial up the loan growth expectation at that point or that you dialed down the deposit growth?

Speaker 3

You'll see it on the asset side. You'll see that that will be the The lever that will be used.

Speaker 5

Okay. So you're thinking to keep the $2,000,000,000 deposit target intact the and then dial up expectations for asset growth.

Speaker 3

Yes, this is Ken.

Speaker 2

I think so. I think Some of the investments that we've made in a number of our deposit centric business lines will continue to propel deposits forward along the guide that we gave. And as we recalibrate to a mid-80s loan to deposit ratio. We will then turn off the loan growth machine. We've proven here over time that we can generate sound thoughtful reasonable loan growth with very little asset quality problems.

Speaker 5

Got it. Okay. And then, going back to Casey's question on expenses, excluding the ECR related deposit costs, Which flow through, so if we put those aside, how are you guys thinking about expense growth over the next year?

Speaker 2

So running from Q3 to Q4 expenses absent the deposits cost will be relatively flat. And as we enter into 2024, There will be marginal expense growth and that marginal expense growth will be predicated on continuing to invest in new products, new services, new business lines, continuing to build out our risk management framework. The The hallmark of Western Lines has been this continuous investment through all cycles to kind of grow the business for future quarters years. And so as long as the risk return and the investment returns are there, we'll continue to do that.

Speaker 5

Got it. So from an efficiency ratio perspective, are you thinking that we'll have improvement through 2024 or that will keep about where you end in the 4th quarter?

Speaker 2

Yes. I'd say about where we landed in the Q4. Back to your first question, As we probably exit the 2nd quarter and we achieve our loan to deposit ratio, we'll be able to step on the accelerator of loan growth And that will generate higher interest income, which should provide the denominator of that equation to grow at a faster pace. Right now, if you're modeling, I would say keep it consistent with Q4.

Speaker 5

Right. But it sounds like revenue set to accelerate here with the margin being more stable, like you said, more loan growth coming in next year, but We should think you're going to spend more of that, at least at this structure, right? Because it seems like the setup is efficiency ratio improvement next year, But you're saying at least at this point don't expect

Speaker 3

that? Well, I think it is set up that way, but it's

Speaker 6

a little bit deferred in

Speaker 3

terms of when that takes place because of the reasons talking about that we're going to be sluggish on having the loan growth really kind of match to 85% of the deposit growth as we continue to pull that number, The LDR number down for a couple of more quarters.

Speaker 5

Got it. Okay. Thanks for taking my questions.

Speaker 2

Thanks, Steve.

Operator

Our next question comes from Chris McGratty of KBW. Chris, your line is open. Please go ahead.

Speaker 3

Great. Thanks. Dale and Ken, I want to go about that one a little bit different. The you're already at your You're going to

Speaker 7

be at your 11% target within a couple

Speaker 3

of quarters, if not 1 to 2 quarters.

Speaker 7

What are you I can't

Speaker 3

not sure I'm prepared to ask this, but like Wouldn't you be thinking about a share buyback at some point next year given the capital accumulation and your stock price?

Speaker 2

Yes. I think that's a fair question to ask. I think there are a couple of things that will inform our decision. 1, as we continue to grow

Speaker 3

and we continue to get closer and closer

Speaker 2

to the $100,000,000,000 threshold, we have to take into account the AOCI charge that will be applied against it. And so we want to continue to grow our CET1 ratio. Really 11% is the target. It's not the goal and we expect to grow through that, all right. That's 1.

Speaker 2

And number 2, You'll see the CET1 ratio moderate in the back half of the year in terms of growth because we'll probably step on the accelerator For loan growth, once we achieve our loan to deposit ratio.

Speaker 3

And one of the reasons our The reason we've climbed so quickly

Speaker 2

is because we have really curtailed

Speaker 3

our risk weighted asset increases and that will pick up again as loan growth reaccelerates.

Speaker 2

I mean, we I just for the numbers sake, we've improved our CET1 ratio 190 basis points Since we went on this risk weighted asset diet and really paid a lot more attention to that and we slowed our loan growth and with our organic earnings, We're able to move that number rather quickly from a year ago, which was 8.7% to where we are now at 10.6%.

Speaker 3

Okay. That makes sense. It feels like there's a combination of maybe both that could be considered in the back half of the year as the OCI mark narrows And you get through your targets. It feels like a little bit of both.

Speaker 2

Okay. Okay, that's fair.

Speaker 3

And then maybe a bigger picture question. I was just going to say, even if we're higher for longer on rates, we will see that AOCI mark decline simply because the duration of the portfolio with Under 5 years is going to continue to come down.

Speaker 2

Chris, just to help out, I'd say to you and the rest of the folks on the line, No. We're looking to build a very strong foundational balance sheet here, all right, and not be sucked into any of the problems that you saw In the Q1 with a number of banks having their duration mismatched. And we just want to never go through that again or if we have to Have a minimal effect on us. And that's where our intent is to continue to raise capital levels and also to build our liquidity.

Speaker 3

Great. And maybe just one follow-up. I think you've talked about a mid teens ROE Through the cycle, I guess updated thoughts on that given higher for longer? Well, I think there's so as our loan to deposit ratio continues to show Kind of where we're headed, we are going to have more high quality liquid assets. I think we can over time, our expense ratio can fall into the 40s on an adjusted basis.

Speaker 3

And so I think high teens, works for us kind of intermediate to longer term.

Operator

Thank you. Our next question comes from Bernard von Gisinski of Deutsche Bank. Bernard, your line is open. Please go ahead.

Speaker 8

Yes. Hi, good morning. So just on deposit costs, maybe I can ask you a little differently. But when you think of how your ECR related deposit growth based on your guidance expectations could go for 2024, If rates are steady from here throughout 2024 versus if we do see rate cuts in the second half of twenty twenty four, How would you think the deposit costs could migrate under those 2 different rate paths?

Speaker 3

Well, ECRs are going to have a very high beta. They have on the way up, and we expect them to have a high beta on the way down. And so if we get rate cuts, we'll be able to I think we'll be able to push those down kind of almost in lockstep. In addition, some of these ECRs that are effective Fed funds plus some number of basis points. And part of the reason why I think pressure really came on the industry overall on deposits is because of the competition from the bond market.

Speaker 3

So as People are comfortable that the FOMC is done with whatever rate increases they're going to contemplate. I do think that that's going to relax some of the pressure on deposit costs for the industry kind of writ large. And I think that may give us an opportunity To tweak some of those adjustment figures that we might have on some of those ECRs.

Speaker 2

Yes. Down gated the rate side. And I'd also add, For us, we expect another 25 basis points in Q4 with several cuts towards the back end of next year. So deposit costs will rise and fall along with those rate cuts. But if you're talking about total dollars, also keep in mind, If we exceed our guide, which we have in the last two quarters, you'll see the volume aspect take hold and you'll see dollar wise the ECRs rise.

Speaker 2

So It's going to

Speaker 3

be a little bit of

Speaker 2

a rate volume mix as we go forward.

Speaker 3

In addition, what Ken was looking to earlier in terms of these deposit initiatives We think that we have some of these will grow more quickly than what our warehouse deposits, which is kind of heavy ECR dependent have done That would give us a broader distribution and more diversification on our funding structure.

Speaker 8

Great. And I appreciate that color. Maybe just on Office CRE, I know your credit's been really good. But if I look at the 3Q exposure, I believe it increased from $2,300,000,000 in 2Q to $2,600,000,000 Just wondering any color you could provide on the increase and if there is any loan sales.

Speaker 9

Yes. Again, hi, Tim Bruckner here. I can take that. Any increase would have been in flight balance increases, fund up of tenant improvements, it'd be good news money with signed leases. We didn't increase new exposure in office.

Speaker 3

Yes. I'll just say as long

Speaker 2

as you brought that up, remember, 89% of our office portfolio sits in suburban locations only 3% sits in central business districts, about 7% sits in midtown. And our office book Represents new construction or new vintage Class A in core submarkets. So again, we go with experienced sponsors, proven track records in adding value and repositioning. Our LTV there is about 60%.

Speaker 8

Great. Thanks for taking my questions.

Operator

Thank you. Our next question comes from Brandon King of Truist Securities. Brandon, your line is open. Please proceed.

Speaker 10

Hey, good morning. Good morning. So I wanted to follow-up Wanted to follow-up on the topic of ECR deposits. And just to confirm, are you expecting that composition of DDAs, the DDA based ECR deposits, are you expecting that to march higher Over the course of next

Speaker 3

year? Well, I think the acquisition of DDA Funds In this elevated rate environment is quite challenging. So I mean the DDA that we had increased in the 3rd quarter was kind of overwhelmingly, a mortgage warehouse. So and I think that straight flat out DDA, I mean, we have had success in knowing the regions during the quarter as well to some degree. But yes, and I think most of the deposits we're going to be getting Are going to be in either interest bearing checking or money market accounts.

Speaker 10

Okay. Got it. Makes sense. And then I wanted to talk about the shift from the held for sale loans to held for investment and particularly the lot banking loans. Could you walk us through the original thought process of designating those held for sale and then elaborate more on the decision of putting those back as held for investment?

Speaker 2

Yes. Let me take that. So this was a liquidity decision, right? So in Q2, we grew our total deposits deposits by $441,000,000 So otherwise, we would have grown it by $3,700,000,000 And back From Q1, we put some loans into HFS in order to be ready to create additional pools of liquidity, Which aren't needed. And so we move these loans from HFS back into HFI.

Speaker 2

And regarding your Lot banking question that you alluded to there. Generally, our lot banking programs are all on schedule with the builders. And really the builders cannot afford to lose any of this inventory and lose control of their for sale demand. So again, this is a mark. This is a segment of loans category that we like a great deal and has a very good risk reward attribute to it and we've never since we've been doing it here at the bank suffered a loss on that.

Speaker 10

Got it. That's all I had. Thanks for taking my questions.

Speaker 3

Thank you.

Operator

Thank you. Our next question is from Ebrahim Poonawala of Bank of America. Ebrahim, your line is open. Please go ahead.

Speaker 11

Hey, good morning. Just maybe, Dale, when we think about the $2,000,000,000 per quarter deposit outlook for next Just talk to us the source of that deposit growth, where that's coming at? And what is your assumption around the rate at which the deposits are coming on. Is it meaningfully below so far? Just some color around how we should think about that and Just how that's probably going to impact your NII name outlook until rates get cut?

Speaker 11

Thanks.

Speaker 2

So I'll take the first half of that and toss it over to Dale for the second half. But regarding where is the source of deposit strength coming from, Next year, I think you'll see first of all, you'll see it from some of our traditional lines. HOA will have is projected to have a good year next year. Warehouse LendingNote Financing generally is traditionally strong year after year. The critical item there is what happens in the mortgage industry that it could accelerate a little bit more if rates pull back and we'll see a little bit more deposit growth there.

Speaker 2

But into next year, we are looking for a number of our newer business lines to contribute In greater sums than they previously have, namely our settlement service business, our business escrow services business And our Corporate Trust business. Those 3 should have above growth rate to prior year's history here And should really contribute. But I'll also say that the regions, this is the 2nd quarter in a row of the regions I've had very solid growth and what we like most about the regions, it's a little more granular, okay. It's not big and chunky as some of the other parts of our business. And last but not least, we've had tremendous success with our consumer, our digital consumer platform And that has really exceeded any of our wildest imaginations in terms of the numbers we initially forecasted for it.

Speaker 2

And that too will continue throughout 2024.

Speaker 3

So the large preponderance of the pricing that we're getting for new business ranges from the 3s and that's really in the regions to the 5s and that includes some of the things we talked about earlier in mortgage warehouse and as debate in some of these other channels. I think we're going to be kind of in the middle there. We weighted average something with in the 4s And I think that's probably a good target for 2024.

Speaker 11

Got it. That's helpful. And maybe, Dale, sorry if I missed it, just in terms of your outlook, given this way mortgage rates are at 8%, how are you thinking about What origination gain on sale fees can look could look like in the absence of any rate relief?

Speaker 2

Yes. Thanks. I'll take that one. As we look forward Q3 to Q4, Mortgage servicing income should be sustained quarter to quarter, maybe even a slight growth as our MSR balances grow. In Q4, you generally have a seasonal fall off with that happens.

Speaker 2

I think it may be a little more acute with the higher rates that we see here presently.

Operator

Thank you. Our next question comes from Matthew Clark of Piper Sandler. Matthew, your line is open. Please go ahead.

Speaker 12

Thank you. Just a few questions around credit or maybe 1 or 2 here. The Just the reduction in special mention non accruals, can you speak to how these credits were resolved? Did most of them cure or did you push them out of the bank? Just trying to get a

Speaker 13

sense for the workout process.

Speaker 9

Sure. Yes. Tim Bruckner again. So I'm going to take the non accrual nonperforming first. About half of the improvement In that area is payout or pay down, okay.

Speaker 9

The other half would be upgrade to performing categories. With regard to special mention, we base our credit culture on early elevation. And so we use that category very much as a transitional category. So as we signaled on the prior calls, we completed deep portfolio review. We move assets Into that category and then we press for speedy resolution.

Speaker 9

So with respect to the movements in and out, those are dictated then by our strategy, which generally involves required re margin the

Speaker 12

expenses. Can you speak to the investments you may still need to make to become or be considered $100,000,000,000 plus bank assuming you get treated like 1 beforehand other

Speaker 2

regulators. Yes. I think the second part of that question is right on, which is most banks In our size category, we'll start to be treated like a $100,000,000,000 bank well before you get there and you've got to build that framework in advance. And that framework is beginning to look and feel a little more sophisticated around capital stress testing, around liquidity, stress testing, and the framework that kind of evolves around that. As we get We'll have to make more investments into reporting that the larger banks over $100,000,000,000 will have to do.

Speaker 2

We believe that starting it early and kind of building it into the run rate because then there's going to be cost that you're going to have to have to Continue with the not only the development, but the reporting and the management and the monitoring. We're trying to build it in now and kind of build out towards that. Thank

Operator

you. Our next question comes from Gary Tenner of D. A. Davidson. Gary, your line is open.

Operator

Please go ahead.

Speaker 2

Thanks. Good morning. A couple

Speaker 6

of questions. In terms of the ECR deposits. Can you give us the average for that in the quarter versus the 17.1 percent quarter end?

Speaker 3

We'll get back to you on that one.

Speaker 2

Okay. Thank you. And then

Speaker 6

in terms of your comments on kind of 2024 expenses any kind of marginal growth. Is that inclusive of the FDIC special assessment kicks in in the Q1?

Speaker 3

We're considering the special assessment, which hasn't been defined yet in terms of exactly how it's going to come out. I mean, I think it could be revised. Yes, we're going to that excludes that. We think that's just really kind of below the line and I think that's how the Street will treat it.

Speaker 6

Okay. And then last question. In terms of Ken, when you were kind of rolling through the Q4 outlook and You mentioned net charge offs. If I heard you correctly, you kind of also suggested net charge offs through the economic cycle in the 5 to 15 basis point range Beyond just the Q4, did I hear that correctly?

Speaker 2

That's correct.

Operator

Our next question comes from Andrew Terrell of Stephens. Andrew, your line is open. Please proceed.

Speaker 7

Thanks. Good morning. Just one quick one for me. I wanted to ask on Page 11 of the presentation, the earnings at risk disclosure the you provide, in the down 100% scenario, the up 2.2% for earnings there. Can you talk about just your comfortability with that level?

Speaker 7

Is that where you would like the company to holistically be at? Or any changes the you'd like to make to that position. And then can you also talk about what the underlying mortgage assumptions are in the Dow 100 scenario From a gain on sale margin and volume perspective?

Speaker 3

So, they're not dramatically different. We do think margins would increase. I mean, if you look at kind of what happened during going into the pandemic where margins basically tripled during that period of time. We're comfortable with this in terms of kind of a decline and That we're a little bit better off, a little tighter on net interest income, but stronger in terms of expenses related to those ECRs as well as AmeriHome revenue. A 100 basis point decline is not enough to gen up a meaningful refinance business, but we do think it would help on the purchase side, in terms of what we'd be seeing on volume.

Speaker 3

The And if we went down 200 basis points, we really think that that's going to open a window for a fair amount of refinancing that's been done over, let's say, the past year, As well as have something close enough that you'll get more refinance activity on a cash out basis, somebody moving from 4% to a 6% Rather than all the way up to something in the mid to higher 7s.

Speaker 7

Okay. Thanks for taking the question.

Speaker 3

Thanks.

Operator

Thank you. Our next question comes from Timur Braziler of Wells Fargo. Timur, your line is open. Please go ahead.

Speaker 13

Hi, good morning. One more on ECR for me. I guess as you look at 4th quarter specifically, how much the impact of that DDA growth is expected to stick around? And then should we see a commensurate reduction in ECR During the Q4, if DDA balances do go down.

Speaker 2

Yes. You should I mean, the volatility in deposits in Q4 is around the mortgage warehouse business, which carries most of the ECR credits. And as that volume drops, you should see a corresponding decline E and B ECRs in the operating expense line.

Speaker 13

Okay. And I guess just given the seasonality in the warehouse business, How likely is it that $1,300,000,000 of BDA growth that's on the 3rd quarter, how much of that actually rolls off with that seasonality next quarter?

Speaker 3

I think there are 2 things going on. So the growth that we had in the 3rd quarter was a baseline improvement, which I think that has lagged the same power. The decline we're going to see In the Q4 is from taxes and insurance escrow funds explicitly. So while That will come down in the Q4. We expect to retain the higher deposit levels kind of moving forward into 2024.

Speaker 3

So we should see a more pronounced rebound coming into the Q into Q1 than the decline that we see in Q4.

Speaker 13

Okay. That's understood. Thank you. And then last quarter, you had made point to mention that the borrowings that are being paid down are quite expensive. I think the number was SOFR plus 200.

Speaker 13

I'm just wondering with the remaining borrowings left. What's some of the higher cost borrowings that we should continue to see coming down over the next couple of quarters? How much of that expense of borrowings are still left on balance sheet. Yes.

Speaker 3

As of quarter end, we still had $500,000,000 that is an S plus 2. I expect that will be paid off this quarter, and there's also a little bit of an average balance benefit Because not all of the payoffs that were done in the Q3, they were I'll call it ratably over the quarter. And so some of that benefit is not recognized in the 3rd

Speaker 13

Okay. And then lastly for me, just on the mention of HQLA and tying that back into the one $100,000,000,000 threshold. I know you've been growing HQLA now for a couple of quarters, but is any of that build in relation to that $100,000,000,000 threshold and I guess what's the remixing of the bond book look like with additional HQLA purchases and How punitive might that be in this rate environment?

Speaker 3

Well, I think it is all related and there is maybe a gentle slope In terms of HQLA looking for kind of the $100,000,000,000 number over time, which obviously we're not close to. But I think that's part of it. I think part of it is as well as we pull down the loan to deposit ratio, those funds are going to be invested in something with higher levels of liquidity like we've talked about. So it is I don't want it to appear that's not a big step variable here. It's going to be a gentle climb into higher levels of high quality liquid assets over the next couple of years.

Operator

Our next question comes from David Chiaverini of Wedbush Securities. David, your line is open. Please go ahead.

Speaker 7

Hi, thanks.

Speaker 14

Had a follow-up on the rate sensitivity. So in an environment where the Fed does pivot and we see 100 basis points of rate cuts. I see NII down 4%, But clearly on the ECR side, we should see some cuts there as well or declines there. How should we think about the PPNR impact of 100 basis 2 point cut in rates.

Speaker 3

Well, if you go to PPNR, that's really going to be your earnings at risk. So you're going to see Lower levels of expenses like you identified, but you're also going to see higher levels of revenue from AmeriHome, the mortgage operation. And so on an EAR basis, this really is we're really talking about a kind of a PPNR kind of framework and that would pick up.

Speaker 14

Got it. Thanks for that. And then shifting over to a follow-up on credit quality. You mentioned about the roughly $2,500,000,000 of quarterly CRE maturities next year. How can you talk about the health of your borrowers and their ability to withstand higher rates as these loans mature and reprice higher.

Speaker 9

Sure. So firstly, I think That discussion was in the context of the investment.

Speaker 3

Well, it was $2,400,000 but it was of total loans.

Speaker 9

Yes, total loans, not just CRE. So our CRE is entirely Floating rate 1. I think that's important. And

Speaker 7

is

Speaker 9

Entirely, for the not central business district. So when we underwrite an office, We underwrite suburban office. And so we've already dealt with the role, so to speak, because the interest rates have already come up and we've already the grading decisions and then we've already executed our strategy. And at this point, over 75% Of that portfolio, we've either affirmed the structure that exists or we've restructured and re margined in the present environment.

Speaker 14

Great. Thanks very much.

Speaker 2

Thanks.

Operator

Our next question comes from David Smith of Autonomous. David, your line is open. Please proceed.

Speaker 15

With end of deposit outlook for the Q4, can you give us some more details on what's embedded about the mortgage warehouse decline? If we take the regional deposit growth of $1,500,000,000 $800,000,000 digital consumer this past quarter, that would imply something like $2,000,000,000 reduction or so in mortgage warehouse. Does that sound reasonable?

Speaker 2

Yes, that sounds very reasonable. So that's what's going to happen in mortgage warehouse and then you would have the digital consumer platform, the regions and some of the specialty lines picking up that flat to kind of

Speaker 3

get us back to even. Just so I'll say this is kind of important.

Speaker 2

We've made a strategic change with our warehouse lending business over the last year or so Where we used to have more P and I accounts, which saw a lot more volatility month to month, we moved more to tax and insurance accounts, Right. Same clients, different liquidity deposits. And so you don't see the big swings month to month, but you do get them the Towards the middle of the year and towards the end of the year when they drop down and then have to rebuild up. So as these balances build up, they'll build up Starting on December 1, thereabouts, this year and they'll build up for the next 6 months going out into 2024. So this should have a little more stability.

Speaker 2

That's just a change that we made here.

Speaker 15

Thank you. And given how much of the ECR balances are in mortgage warehouse, is it possible that we could see deposit costs down quarter on quarter in Q4 or is that going to happen too late in the quarter?

Speaker 2

No. I think you could see it down in Q4. Absolutely.

Speaker 15

And just thinking about the NIM guide of 3.6% to 3.7% against 3.67% in the 3rd quarter, You've got the tailwinds of the fixed loan repricing. You've got some more borrowing pay down. It seems like more tailwinds. I just I'm wondering if you could break out some more of the headwinds you see there that are going to stop it from elevating higher than 3.7?

Speaker 2

Yes. So you also saw that we had

Speaker 3

an increase in our cash position at quarter end relative to the last quarter and the average balance for the quarter. And so that is going to consume some of that otherwise opportunity to have a higher yield, higher spread.

Speaker 15

And lastly on capital, are you saying you think CET1 ratio could decline in absolute terms as you step up loan growth in the second half next year or it will just continue to grow more slowly?

Speaker 2

We don't expect it decline, as I said, the target is 11% and then we'll push through that target. We just expect it to grow at a slower pace Once we cross over or cross through 11%.

Speaker 15

Are there any more inorganic levers you can pull here after like the CLN repayments? Or is it basically going to be a function of earnings and asset growth from here?

Speaker 2

It's going to be a function of earnings and continuing to watch our risk weighted assets and making sure we optimize that Quarter to quarter.

Speaker 15

All right. Thank you.

Speaker 2

Thank you.

Operator

Thank you. Our next question is from Brody Preston of UBS. Brody, your line is open. Please go ahead.

Speaker 16

I wanted to follow-up to make sure I was following the warehouse commentary And we're trying to piece it together from last quarter. So I think we were you're up $3,000,000,000 in July during the last conference call and it looks like you ended up 1,600,000,000 For this quarter, and so it came down at the end of the quarter, and then we're expecting another CAD 2,000,000,000 the potential runoff from there in the 4th quarter just on a seasonal kind of low point. Am I following that math correctly, Dale?

Speaker 3

So as Tim was alluding to earlier, what we have there's the funds escrow funds from a mortgage warehouse client are bifurcated into 2 pieces. 1 is taxes and insurance. That's the one that we think is more attractive because it's a little more stable profile. And the other was principal and interest. Principal and interest is on a monthly cycle.

Speaker 3

The funds build up and then somewhere around the 20th, 24th of the month, the They get spun out to the government sponsored enterprises. The other ones build up for 6 months, something even longer than that. And then their pace is the taxing authority. So the preponderance of our portfolio comes from California. So California taxes, I think, are due in like November or something like this.

Speaker 3

And so you're going to see that come down. So what you saw earlier You're going to have a higher number in principal and interest that then comes back down. So even though that number came down from where it was maybe in mid July to the end of September, the actual balance trend is actually still positive growing during that particular time. We're just hitting at a high point the on the monthly sine wave that you get on P and I payments. So that trend looks strong because of the balance from quarter end to quarter end What we're saying is the balance from quarter end to quarter end for the Q4 is going to be down, not because of P and I, which looks good, But because of P and I and not because of client impairment, just simply because that's the cycle in terms of how those funds are distributed.

Speaker 16

Got it. Okay. I appreciate the clarification. And then I wanted just to ask on the spot loan yields. I think if I'm remembering the slide correctly, it was 6.99 On the spot rate, for the yield, which I guess I wanted to relate that to the residential portfolio to kind of get towards that spot yield.

Speaker 16

It implies that you have to get more expansion in that residential yield. And so how should we be thinking about residential loan yields going forward?

Speaker 3

Well, I don't think residential loan yields are going to move much. I mean, the CPRs on that stuff today are 5%, kind of about the lowest I know anyone's ever seen. And so that's just kind of generally bleeding off. That said, This is kind of the point on why we mentioned, hey, we have about $2,500,000,000 of loans rolling off repricing every quarter. The And so that could come up.

Speaker 3

Now a small piece of that is going to be residential, but the rest of it as well. So if you say the residential and those loans are again are coming the That's something that begins with an 8. I mean, they're basically it looks so for today, add 3 to 3.5 to that. So those run off And are being replaced at kind of notably higher rates and even the variable rate ones are being replaced at higher spreads because of maybe uncertainty in the economy and Can you guys still hear

Speaker 2

me? Yes. Can you did you hear Dale's answer, Brody?

Speaker 16

The Yes, it just cut out there for a minute. Now I guess that makes sense. It's just that the loan yields jumped up a bit this quarter on the resi book and that's it kind of caught me by surprise.

Speaker 3

Well, we did some modest dispositions of residential loans.

Operator

The audio with Brody there.

Speaker 3

Okay.

Operator

Sorry, our final question of today comes from Jon Arfstrom of RBC Capital Markets. Jon, your line is open. Please go ahead.

Speaker 17

Thanks. We're going to get out of the weeds here for a second. Are you signaling flat EPS for the 4th quarter? Just when I look at the guidance on Slide 19, is that what you're signaling?

Speaker 9

Yes. So we're signaling

Speaker 2

flat PPNR with some sensitivity to the gain on sale from the mortgage business Depending on the backup on rates that you're seeing here. That's what we're signaling.

Speaker 17

Okay. Okay. So that's Difficult for us to model, but you're saying PPNR excluding that, it's going to be relatively stable. Okay.

Speaker 2

Yes. I think that's a better answer. Yes.

Speaker 17

Ken, what yes. Okay. Okay. And then what's your level of confidence in loan growth returning in early 2024? Dale mentioned your organic loan growth has slowed, but what's your level of confidence in getting that greater than $500,000,000 a quarter back in the run rate?

Speaker 2

Yes. If you're talking about getting it back, say starting in Q3 or towards the end of Q2, I'm confident about that. Yes. We have enough channels the To bring in that loan growth, I will say subject to macroeconomic events, right, subject to the economy the So it's not loan growth for loan growth sake. If we don't like the credit, we're not lending against it.

Speaker 2

But Everything being equal, we have a high degree of confidence in this company to grow loans in excess of $500,000,000 and loan growth will follow the deposit growth that we've laid out. Right.

Speaker 17

Okay. How about as you look to 2024? I mean, it seems like you have a couple of quarters left, maybe 1 or 2 left to do what you need to do on funding. I'm assuming that means that the margin starts to especially if the Fed is done, I'm assuming that means the margin starts to lift In early 2024, which means PPNR also starts to lift in early 2024. Is that am I looking at that the right way?

Speaker 2

So for us, we've got a rate increase in December, which will carry into the The first two quarters of 2024. At the end of the second quarter, we have 3 rate decreases modeled in there the back end of the year. So you got to keep that in mind. But as we think about 2024, as I said with deposits following the $2,000,000,000 guide and loans growing at a moderate pace, which is at $500,000,000 We see sort of the dexterity and Agility of the national business line framework and the regional growth gives us confidence in that balance sheet construction Going forward. So that's sort of what we're seeing along with stable asset quality as we go into 2024.

Speaker 17

Yes, I'm just I'm looking at the $8 consensus number and it feels to me like it's good. It puts you at 5 times earnings, but your stock is down 8%. And I'm just curious if I'm missing anything when I think through your kind of medium term to longer term outlook.

Speaker 2

I'm also surprised that the stock is down 8%. We were very pleased with this quarter. And relative to other banks that have reported, I thought we did fairly well. And we're not ready to give full 'twenty four guidance, but I think you can take what we said directionally correct and model from there. All right.

Speaker 17

$8 for me. Anyway, all right. Thank you. See you in November.

Speaker 3

Okay. Thanks, John.

Operator

Ken Vakoni of the team for any closing remarks.

Speaker 2

Yes. Thank you all for your questions and your participation.

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