Western Alliance Bancorporation Q2 2025 Earnings Call Transcript

Quartr
Provided by Quartr
July 18, 2025

Key Takeaways

  • Positive Sentiment: Strong Q2 performance with over $1 billion in sequential loan growth funded by nearly $2 billion of deposit inflows, net interest margin up 6 bps to 3.53%, and PPNR rising 19% from Q1.
  • Positive Sentiment: Raised full-year 2025 guidance to 8–10% net interest income growth and 8–10% noninterest income growth, while reiterating $5 billion loan and $8 billion deposit growth targets.
  • Negative Sentiment: Other real estate owned balances increased by $167 million as the bank repossessed office properties, though management expects to recover value as leasing and net operating income improve.
  • Neutral Sentiment: Long-time CFO Dale Givens will transition to Chief Banking Officer of Deposit Initiatives and Innovation after the new year, with Vishal Gupta set to assume CFO duties following a 90-day handover.
  • Neutral Sentiment: Western Alliance plans to unify six legacy bank division brands under the Western Bank name by year-end, presenting a single national marketing presence.
AI Generated. May Contain Errors.
Earnings Conference Call
Western Alliance Bancorporation Q2 2025
00:00 / 00:00

There are 14 speakers on the call.

Operator

Good day, everyone. Welcome to Western Alliance Bank Corporation's Second Quarter twenty twenty five Earnings Call. You may also view the presentation today via webcast through the company's Web site at www.westernalliancebancorporation.com.

Operator

I would now like to turn the call over to Miles Pondelic, Director of Investor Relations and Corporate Development. Please go ahead.

Speaker 1

Thank you, and welcome to Western Alliance Bank's second quarter twenty twenty five conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer and Dale Givens, Chief Financial Officer. Before I hand the call over to Ken, please note that today's presentation contains 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. 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 eight ks filed yesterday, which are available on the company's website.

Speaker 1

Now for opening remarks, I'd like to turn the call over to Ken Bacchione. Thanks, Myles. Good afternoon, everyone. I'll make some brief comments about our second quarter performance before handing the call over to Dow to discuss our financial results and drivers in more detail. I'll then close off close with some prepared remarks by reviewing our updated 2025 outlook.

Speaker 1

Our chief banking officer for regional banking, Tim Bruckner, will then join us for q and a. But before diving into my prepared comments, I'd like to take a moment to address a planned CFO succession announcement. Dale has been an outstanding CFO for Western Alliance for an impressive twenty two years, which is more than five times longer the average CFO tenure. Throughout his tenure, Dale has been an instrumental leader guiding the bank through both prosperous and challenging times. His unwavering dedication and availability at all hours of the day have made him an invaluable partner and friend to the senior management team.

Speaker 1

After the new year, Dale will transition his CFO responsibilities to Vishal following a thorough transition period. In his new role as chief banking officer of deposit initiatives and innovation, Dale will oversee six stand alone deposit verticals, which generate strong liquidity. His contributions to the company are too numerous to list, but his skill and leadership were particularly evident during my absence at the beginning of the year. The board, the management team, I are very excited to see him thrive in his new leadership role. Someone should pass the tissues over to Dale.

Speaker 1

Vishal will join us early in the fourth quarter, and after a ninety day transition period, he will assume, the CFO responsibilities. Vishal has been a trusted adviser to the company and knows the bank very well. Over the past eight years, I have developed a strong professional relationship with him, and I'm looking forward to fostering the same partnership I have had with Dale. Just feel free to reach out to both Dale and Vishal to congratulate them on their new assignments when you have a moment. Okay.

Speaker 1

Let's get to the financial highlights and the quarter. Western Lines, again, delivered strong financial results, exceeding expectations in the second quarter as strong business momentum drove a meaningful acceleration across a broad array of financial metrics. Sustained success in acquiring new client relationships, supported by our deep sector expertise, fueled strong risk adjusted balance sheet growth, robust net interest income expansion, and enhanced profitability, which resulted in continued earnings growth. We generated over $1,000,000,000 of sequential loan growth for the second straight quarter, which was funded by nearly $2,000,000,000 of quarterly deposit growth. Net interest margin rose six basis points sequentially, rebounding back above 3.5% from robust average earning asset growth and CD repricing tailwinds, which lowered interest bearing deposit costs.

Speaker 1

Asset quality continued to perform as expected as criticized loans declined $118,000,000 in aggregate from Q1. Other real estate owned increased $167,000,000 as we elected to repossess office properties where we can accelerate our normal credit resolution process and see value creation potential due to improving leasing, occupancy and NOI trends. We have already secured an LOI for one property that we expect to be sold by quarter end. Total criticized assets increased negligibly and remained at approximately $1,700,000,000 which we expect to be the high watermark for this credit cycle and to drift downward in coming quarters. Our liquidity position and capital base both remained stout and able to support our solid and improving PPNR, tangible book value and total shareholder return.

Speaker 1

Earlier this week, we announced plans to unify six legacy division bank brands under the Western Bank brand by year end. These brands have operated under the Western Alliance bank charter for over a decade, so this action will simply present a unified marketing presence emblematic of the much larger national bank Western Alliance has become. Importantly, we are encouraged by the inflection in profitability experienced in Q2. Return on average tangible common equity of 14.9% and return on average assets of 1.1% were both notably higher from Q1. We continue to target upper teens return on tangible common equity as our near term profitability north star.

Speaker 1

Dale will now take you through the results in more detail.

Speaker 2

Thank you, Ken, for your kind words and tissues. I hope they'd ask for more. Looking closer at the income statement, net interest income of almost $700,000,000 grew 7.2% quarter over quarter or nearly 29% annualized, driving PPNR up of $331,000,000 for the quarter, which equates to a 19% increase from Q1. Strong organic loan growth and higher average securities balances produced average earning asset growth of 17.3% on a linked quarter annualized basis. Non interest income rose 16.4% quarter over quarter to $148,000,000 Mortgage loan production volume increased 25% from last year and the gain on sale margin edged up one basis point from the prior quarter to 20, resulting in mortgage banking revenue of approximately $78,000,000 Overall, we characterize core mortgage banking revenue as still tracking to flat year over year performance.

Speaker 2

In response to the volatility that ensued from proposed tariffs early in Q2, the company undertook a hedging initiative to mitigate earnings volatility by purchasing variable rate securities. As spreads tightened, we sold these securities, which produced $8,000,000 of the total $11,000,000 gain of securities gains realized during the quarter, negating hedging losses at AmeriHome. Non interest expense increased $14,000,000 from the prior quarter to $515,000,000 mostly from the seasonal rebound in average ECR related deposits, which drove the $11,000,000 increase in deposit costs from Q1. Net interest income, inclusive of deposit costs, however, grew 7% from the prior quarter to $36,000,000 Overall, we delivered solid operating leverage this quarter with net revenue growing nearly 9%, which outpaced sub-three percent growth in noninterest expense. Provision expense of $40,000,000 resulted from organic loan growth and a replenishment of approximately $30,000,000 of net charge offs.

Speaker 2

In our financial statements, you'll also notice a new line item for net income attributable to non controlling interest that captures the pretax dividend impact from our recently issued REIT preferred shares. Turning to our net interest drivers, continued improvement in interest bearing deposit costs and overall liability funding outpaced slightly lower loan yields. The securities portfolio yield increased 18 basis points to 4.81 from the prior quarter, resulting in greater liquidity deployment into higher yielding floating rate securities. The HFI loan yield decreased just three basis points to 6.17%, reflecting a mix shift away from higher yielding construction into C and I. The cost of interest bearing deposits declined seven basis points to threenineteen from CD costs compressing 22 basis points as well as our ongoing efforts to manage IBD rates lower absent additional FOMC rate cuts.

Speaker 2

For the month of June, the average IBD rate was also three nineteen, but we expect continued improvement from the deposit mix shifting away from CDs. As mentioned earlier, net interest income rose 47,000,000 from Q1 to $698,000,000 from strong loan growth as average earning assets increased $3,300,000,000 Net interest margin expanded six basis points to 3.53% as the reduction in funding costs exceeded the one basis point reduction in total earning asset yield. Non interest expense increased $14,000,000 or 3% quarter over quarter as deposit costs rose $10,600,000 due to the normal seasonal rebuild in mortgage warehouse deposits, which pushed average balances higher. Our adjusted efficiency ratio of 52% improved from 56 in Q1 as we continue to achieve positive operating leverage from revenue growth outpacing deposit costs, operating expenses non deposit costs operating expenses, which includes the incremental cost we're incurring in anticipation of becoming a large financial institution. We remain asset sensitive on a net interest income basis, but essentially interest rate neutral on an earnings at risk basis in a ramp scenario.

Speaker 2

This offset is supported by a material projected ECR related deposit cost decline this year and an increase in mortgage banking revenue in this scenario based upon our rate cut forecast. Our updated rate forecast calls for two twenty five basis point rate cuts each in September and December. The balance sheet increased $3,700,000,000 from Q1 to $86,700,000,000 in total assets, which reflected strong HFI loan and deposit growth of $1,200,000,000 and 1,800,000 respectively. Borrowings increased $1,900,000,000 due to the higher average HFS loan and securities portfolio balances in excess of deposit growth. Finally, total equity grew to $7,400,000,000 and tangible book value per share, applying 15% year over year.

Speaker 2

HFI loans grew $1,200,000,000 quarterly with end of period balances $1,000,000,000 greater than average levels in the quarter. C and I continues to lead this loan momentum contributing over two thirds of the quarterly growth from both regional and national businesses. Regional banking produced over $660,000,000 of loan growth with C and I contributions from in market commercial banking and innovation and technology banking, while homebuilder finance drove the CRE increase for the bank. With quarterly loan growth of over $150,000,000 in innovation and tech, we continue to experience gathering momentum in banking, the innovation economy nationally, following competitor disruptions over the past two years. National business lines provided the remainder of the growth with mortgage warehouse and note finance being the primary contributors.

Speaker 2

Note finance remains a key area where our private credit relationships provide complementary opportunities with non bank partners. Deposits grew $1,800,000,000 in Q2, inclusive of a $300,000,000 decline in wholesale brokered deposits. Solid growth was achieved in non interest bearing and savings and money market products. Mortgage warehouse seasonal inflows were the primary drivers of higher non interest bearing balances, but we also generated another quarter of non interest bearing non ECR balances of $140,000,000 at a sub or 7.5% annual rate. CDs were also higher quarter over quarter, but we expect runoffs to occur going forward.

Speaker 2

Regional banking deposits were up nearly $800,000,000 from the prior quarter, demonstrating continued relationship momentum within footprint commercial clients. National business lines posted a $650,000,000 quarterly increase, primarily from the normal rebuild and mortgage warehouse as well as steady growth in our consumer digital channel. Specialty escrow deposits continue to add to our growth as well, contributing nearly $300,000,000 of deposits in Q2. Of note, our digital asset banking program generated $400,000,000 of quarterly growth as we provide services for blockchain payments. Turning to asset quality.

Speaker 2

Criticized loans declined $118,000,000 quarterly and benefited from special mentioned loans decreasing 16,000,000 classified accruing loans declining $77,000,000 and non accruing loans falling 24,000,000 As Ken explained earlier, other real estate owned increased $167,000,000 as we took possession of a handful of office properties we have been closely monitoring for some time. We do not expect these properties to have an adverse effect on financial results as their aggregate operating revenues exceed expenses. We expect steady movement toward resolution and to begin dispositions this year of this portfolio. Stabilizing leasing and occupancy rates as well as improving net operating income on these properties reinforce our confidence that we will recover our recovering values as indicated by the positive cash flow from these assets. All in, criticized assets rose $50,000,000 from March 31.

Speaker 2

As we achieve resolution of these assets, we would expect total criticized assets to begin to decline in the current quarter. Quarterly net loan charge offs were approximately $30,000,000 or 22 basis points of average loans. Provision expense of $40,000,000 added to reserves in concert with loan growth and to cover charge offs. Our ACL for funded loans moved $6,000,000 higher from the prior quarter to $395,000,000 The total loan ACL for funded loans ratio nudged up one basis point from the prior quarter to 78. On Slide 14, you can see Western Alliance's concentration and low loss loan categories skews our ACL ratio lower relative to peers, reflecting the portfolio's lower embedded loss content.

Speaker 2

The top chart is our updated adjusted total loan ACL walk, which illustrates how credit enhancements such as credit linked notes and structurally low risk segments like fund banking, our low loan LTV and high FICO residential portfolio and mortgage warehouse elevate our normalized reserve coverage from 78 basis points to 135. Bottom table demonstrates that applying an industry median loan mix to our portfolio while still using our reserve allocations by loan type, but reducing our outsized proportions of loans in lower risk categories like mortgage warehouse and residential and increasing our proportion of loans at higher risk categories like consumer, our allowance would exceed 1% today. Our CET1 capital ranks near median peer levels. If you add our lower adverse AOCI marks and the ACL, our adjusted capital ratio is 11%, which is flat since the prior quarter and ranks slightly above the median for our asset peer group on a one quarter lag basis. We remain confident in our capacity to absorb any losses in concert with steady loan growth as we view this adjusted capital as the total amount available to absorb losses and support balance sheet growth.

Speaker 2

Our CET1 ratio rose to 11.2% despite our loan growth and SMSR sales provided some RWA relief. Our tangible common equity to total assets ratio was unchanged at 7.2%. Tangible book value per share increased $1.77 from Q1 to $55.87 as a function of retained earnings. Consistent upward growth in tangible book value per share remains a hallmark of Western Alliance and has exceeded peers by over 7x for the past decade. Our strong track record in compounding tangible book value per share stems from sustained reinvestments in our diversified and dynamic business model, which has consistently produced top tier balance sheet profitability and growth for more than ten years.

Speaker 2

This has led to excellent revenue growth and operating leverage, strong ROTCE and EPS growth as well as leading tangible book value per share accumulation. Ultimately, these are the drivers of long term superior total shareholder return. Additionally, the metrics in the bottom row that track the last four quarters, which are NIM, efficiency and ROTCE, are poised to improve from here. I'll return the call back to Ken.

Speaker 1

Thanks, Dale. Okay. Let's talk about our 2025 guidance. We reiterate our loan and deposit growth outlooks of $5,000,000,000 and $8,000,000,000 respectively, based on healthy pipelines remaining intact despite recent tariff related noise. Regarding capital, we expect our CET1 ratio to hold above 11%, balancing our loan growth outlook with improving capital generation from an increasing return on tangible common equity.

Speaker 1

We are revising our net interest income outlook higher to 8% to 10% growth as our projection for 02/25 basis point rate cuts have shifted back to September and later in Q4. As our loan portfolio is more variable rate weighted, delayed rate cuts combined with sustained strong loan growth should lift net interest income. Additionally, net interest margin for the full year should approximate twenty twenty four's upper 3.5% level. We are also revising our noninterest income outlook higher to 8% to 10% growth. We are pleased with the momentum in cultivating holistic relationships with our customers and the traction we've made in earning more commercial banking fees.

Speaker 1

Higher interest rates should also benefit servicing income and support MSR valuations. Noninterest expense is now expected to be 1% to 4% for the year. ECR related deposit costs are now projected to land between $550,000,000 and $590,000,000 for the year and between $170 and $180,000,000 in Q3. ECR revision is attributed to a more backloaded rate cut forecast. Our improved revenue outlook should also drive higher associated incentive compensation.

Speaker 1

Operating expenses are now expected to be $1,495,000,000 to $1,515,000,000 for the full year. Asset quality should continue to perform as expected with full year net charge offs of approximately 20 basis points, while criticized assets are expected to decline over the next several quarters. Finally, we are maintaining our full year 2025 effective tax rate forecast of approximately 20%. At this time, Dale, Tim, and I, will take your questions.

Operator

Thank you. We will now begin the question and answer session. Session. Our first question today comes from Chris McGratty with KBW. Please go ahead, Chris.

Operator

Your line is now open.

Speaker 3

Great. Thanks. Thanks for the question. I want to start on the CFO transition. It feels like a big moment for the company.

Speaker 3

I'm interested, Dale, Ken, a little bit on the timing. Dale, what you plan on kind of focusing your efforts on, you know, the background of of the new, of your successor, and ultimately, broader succession conversation.

Speaker 4

So I know a lot's in there, but, love to hear your thoughts.

Speaker 2

Sure. Well, I can't say how thrilled enough I am about this, this organizational change, which I had suggested. Augmenting the skill set of the team is gonna will make us more versatile. We'll capitalize on new opportunities, and it's gonna free up my time to immerse myself in the array of deposit services we offer. Every single one of them appears to be at an inflection point in their growth trajectory.

Speaker 2

We are in the midst of a sea change in some of our business lines, not unlike when Moses parted one of them. And I got it and I see pathways opened. I see obstacles being removed. And I'm not just referring to Genius or the digital asset space, but also executive orders and changes at the FTC. The time to move on them is right now, and I'm just delighted to be stepping into that.

Speaker 1

I'll just add one other thing. It's important to note that this transition does not signal a change in the direction for the bank. Our focus remains steadfast on achieving organic growth up to and through the $100,000,000,000 large financial institution level, and that's where our focus will be on the next eighteen months. Back to you, Chris, if you're there.

Speaker 3

Oh, sorry about that. I just wanted to, you know, extend our thoughts. And, you know, Dale, you've done a great job navigating this company with the team. I guess my follow-up would be on the back half, the deposit growth, the $8,000,000,000 to get to the $8,000,000,000 Can you help us reconcile getting there? I think Q4 is typically slow, which I think implies Q3 is going be pretty big.

Speaker 3

Any color on

Speaker 2

the cadence of deposit flows? Sure. Sure. One of the things that we did was to our deposit growth this the past two quarters is we have through pricing pared down some of the more volatile mortgage warehouse funds and which has really been the driver of what you're referring to on the seasonal kind of dip that we've had, particularly in the mortgage warehouse deposits in the fourth quarter. So that's going to be more muted.

Speaker 2

And so we're not expecting that that's going to we need to necessarily cover that. So we're on track, we see, for the our $8,000,000,000 target.

Speaker 1

Yes. I'd add that year to date, we're up about $1,000,000,000 And some of the things that Dale will be addressing, specifically in the digital asset banking, should also increase deposits as we go forward. It had a good quarter this quarter and grew $400,000,000. And our technology and innovation group also had an incredibly strong quarter with their balances rising nearly $600,000,000. And I think that, is proof positive that staying reliable and accessible, in that market both on the loan and the deposit side has begun to pay dividends for us.

Speaker 3

Great. Thanks again.

Speaker 1

You got it, Chris.

Operator

Thank you. Our next question comes from Jared Shaw with Barclays. Please go ahead.

Speaker 5

Hey, good morning. Thanks for the question. Dale, congratulations on the new role as well. Maybe looking at the fee income and looking at the guide for fee income, where what are some of the broader assumptions, I guess, underneath that in terms of mortgage? You had said earlier, I guess, still looking at flat year over year.

Speaker 5

Is that where is the growth going to be coming from, I guess, on the fee side?

Speaker 1

Yes. So we anticipate a rise in fee income in the back part of the year driven by an increase in generally mortgage related revenue from seasonal activities and also commercial banking activities linked to the growth in our C and I business. All in, the mortgage business is forecasted to have the same flat year over year revenue growth. And we do that as a way to focus on our commercial banking activities, which will generate the bulk of earnings, not only fee income, but the bulk of earnings for the bank so that investors can feel comfortable that the year over year growth is coming from these commercial banking activities, while the mortgage business being flat at the moment will be prepared or be available to deliver alpha in terms of earnings if and when interest rates get cut and that mortgage volume begins to rise. When that happens, then we have an interesting decision to make here around the table, and that will be, do we put some of those, alpha earnings back into the business to support future growth?

Speaker 1

Or do we let it fall to the bottom line, grow net income, improve our returns on average assets and intangible common equity and or have different options for capital deployment?

Speaker 2

The mortgage industry had a muted spring selling season, as a result of one of the higher rate environment and also the volatility perhaps introduced from the tariff activity. And, I don't think that that destroyed that demand. It just postponed it to some degree. So I think some of it, as things stabilize, might come forward. And again, everyone is projecting that we're going to have some rate relief sometime later in 2025.

Speaker 5

Okay. Thanks. And then I guess on the expenses, my follow-up, when we look at the higher guide on expenses ex ECR, what's driving that? Is incremental new investments to support some of these initiatives? And then I guess, if we do see relief on category four thresholds, is there an opportunity to maybe see that come in lower than the range?

Speaker 5

Or what's sort of the investment cycle moving to category four looking like?

Speaker 1

Yes. Yes. You've got two questions in there. First, let me just say, for q two, our total expenses only rose by 2.9% or $14,000,000 of which nearly $11,000,000 of the $14,000,000 were deposit related costs. So our operating expenses were rather flat Q1 to Q2, okay?

Speaker 1

And this modest rise actually improved our efficiency ratio by 400 basis points quarter over quarter to 51.8%. I should say adjusted efficiency ratio is the way we look at it. Now going forward in the rest of the year, yes, I think we've been very clear that we we are have going to spend about $35,000,000 cash spend in 2025 and another $35,000,000 in 2026, which is embedded in our numbers. The operating expense number is about 30,000,000 of that $65,000,000 that will be in the year. And that will be a little bit more back end loaded as we prepare to cross over $100,000,000,000 Now as it relates to tailoring, okay, we've been closely following the tailoring conversations and their potential impact on the bank.

Speaker 1

I'll say first, we're in favor of moving the LFI category for threshold to $250,000,000 or having it at least indexed to inflation. This adjustment would allow us to navigate through the threshold more deliberately while permitting the bank to continue its organic growth journey, right? In the short run, the other benefits to moving the LFI threshold to 250,000,000,000 would be to free up technology resources to support our product line and service improvement development, and it also would enable us to help build out some of our AI functions and features at a at a faster pace. But one of the things that we have to balance here is, just because we hear the scuttlebutt that category four will be moved up to a higher number, we cannot stop doing what we're doing because we anticipate crossing over the 100,000,000,000 threshold somewhere in early twenty twenty seven, q one, maybe q two. If we postpone or slow that down and the LFI threshold is not raised, then we put ourselves at risk of impeding our total loan and deposit growth.

Speaker 1

So at this point, we have to continue as if that the LFI threshold raise is not going to happen. But once it does, and we hope it does, then we'll adjust our spending accordingly. So I hope that answers your questions there.

Speaker 2

Yes. That's great detail. Thank you.

Operator

Thank you. Our next question comes from Matthew Clark with Piper Sandler. Please go ahead,

Speaker 6

Thank you for the questions and congrats Dale. Can you just hone in on the margin a little bit, just give us a spot rate on deposits at the June? I think you gave it last quarter, but didn't see it this time around. And what's your kind of blended beta assumption through the cycle if you include non maturity deposits that you touched on in the deck?

Speaker 2

Yes. So we see that our margin is going to continue to inflect positively from here, both on a reported basis as well as an adjusted basis, including kind of the CRPs going forward. Yes.

Speaker 1

I would say that on a spot rate at the moment, investments our investment book is running higher than our average rate for the second quarter. We also see deposits and borrowings being down a few basis points as well. And so I think that gives some confidence to our guide that the net interest margin will stay or grow from the level it was at the end of Q2.

Speaker 2

We had a notable increase in the securities yield. That's not done. And, I think that's going to be also an impetus for expansion on both of our margin metrics.

Speaker 6

Got it. Got it. And then on the fee income side, in terms of the lift you're expecting there, part of it's coming from commercial banking income. I think it's a line item you no longer disclose, but can you just maybe update us on how much that contributes to fee income and how that might have changed from the prior quarter?

Speaker 1

The question is how much how much is coming from commercial banking versus, the mortgage? Is that the question?

Speaker 6

Yeah. Yeah. It's a you know, it's probably embedded in, you know, the service charge line now, I guess. But I was just trying to get a sense for the magnitude of commercial banking fees and fee income just to try to get a sense of how much that's growing.

Speaker 1

Yeah. The mortgage business is going to stay flat year over year, which is about $328,000,000 We generated revenues in '24 and the same amount in '25. And non interest and other non interest income, which is what you want to know, probably will rise in the order of 20 plus percent year over year.

Speaker 2

Yeah. Commercial banking related income is 15% of our revenue presently in the income.

Speaker 6

Perfect. Thank you.

Operator

Thank you. Our next question comes from Timur Braziler with Wells Fargo. Please go ahead.

Speaker 4

Hi, good morning.

Speaker 6

Starting

Speaker 2

on the funding side, just maybe provide a little

Speaker 4

bit more color to the rationale on growing the borrowings as much

Speaker 2

as you did to deploy that into the bond book.

Speaker 4

And I think, Dale, you just said that bond yields

Speaker 1

are

Speaker 4

higher today than where the average book is,

Speaker 2

and that's not done yet.

Speaker 4

Is that implying that the strategy of lowering our borrowings to put into the bond book maybe continues here into the back end of the year?

Speaker 2

Yeah. We we what we've seen is is, you know, spreads widened in the wake of, Liberation Day. And, and as a result, you know, we're not incurring any interest rate risk here. We're not incurring any credit risk here because these are our treasury obligations. But we see, a, I don't know, a lack of continuity or similarity within that space.

Speaker 2

And so we're augmenting returns, at this time related to that. And I would that's going to be based upon market conditions, but certainly, presently, it's working.

Speaker 4

Okay. And then the increase in OREO, just some more color there. How many properties? Can you provide any color on just kind of the carrying cost LTVs here? And I'm wondering if some of the increased cost or increased expense guide is related to the higher carry cost of of OREO?

Speaker 1

Yeah. This is Ken. So so we took in five properties, and, let me give you the big picture on what we're trying to do here. Right now, those properties generate the revenues that the properties generate are in excess of the expenses. So yes, expenses show up in the expense line, the revenues show up in the fee income line.

Speaker 1

But net net, it's a positive carrying number to the overall performance. Now what we'll do here is a couple of things. We have found that the sooner that we could take these properties in, manage them ourselves, we've had much more success in leasing them up and improving the occupancy rates as well as getting better rental rates, and that's what we did. The fact that, revenues will grow in excess of expense also gives us the opportunity, if we need to, to fund improvements in these properties to bring them up to competitive levels in the cities that they're in. So it gives us that flexibility as well.

Speaker 1

And the last thing I'll say is when we take in these properties to REO, they're at current valuation values less liquidation costs. So by taking them in now, these properties will not impact charge off behavior unless there is a significant decline in the revenues or the valuations in those markets, and we just don't see that now. So it also helps stabilize charge offs as well. So for all those reasons and the fact that we feel more comfortable running these properties ourselves rather than having them wait and sit out there in a substandard category, we're able to take them in quicker and be more proactive with it.

Speaker 4

Great. And just maybe if I can one more, just as that pertains to the allowance, I know you guys get this question quite often, but now if you look kind of at the nonperforming asset coverage ratio, it's closer to 60%. Is there any consideration in increasing the allowance just given the increase in non performing assets? And I guess just how are you thinking about that from a kind of an investor perception standpoint versus what's actually coming in through the results?

Speaker 7

Yes. Well, let me start

Speaker 2

on this, and then I think Tim can pick it up. So just talking about the reserve to NPAs. If there were to be a charge or recovery in one of these OREO properties, it would not touch the allowance. The allowance is only for the loan book. These are already written down, these properties that Ken's alluding to, as is appraised value less disposition costs.

Speaker 2

They're rock bottom, they're cash flow positive. We don't really see any risk there, but even if there were, it wouldn't affect the ACL number. It's really less relative to the loan growth that we've talked about kind of what our reserve levels are.

Speaker 8

Yes. Thanks, Dale. The ACL, we have a lot of constituents in the ACL and the foundation of the ACL is build up from the asset value. Our assets in the the build the ACL are predominantly real estate secured assets. They're valued with conservative values.

Speaker 8

As those assets get distressed, we value more frequently. And as as Dale just said, less the disposition cost. So with the clear line of sight that we have into the assets in our portfolio and our strategy around the disposition of those assets, there's we're absolutely comfortable with the values that we're carrying in our ACL.

Speaker 1

I might as well chime in to make it three for three. Not only do we believe our ACL reserve is not only adequate in its construction, but when you add it to CET1 inclusive of AOCI, adjusted other comprehensive income, otherwise known as adjusted CET1, we are above our peer group median, peer group being 50,000,000,000 to $250,000,000,000 And so I think that's the way we look at it. Are we appropriately capitalized? Yes. We are.

Speaker 1

And reserved? Yes. We are. And what you're seeing in the reporting so far to date, we're seeing a number of banks beginning to lower their reserve ratios and and not increase them. We're we're keeping our steady at this moment.

Speaker 2

Great. Thank you for the I

Speaker 1

think we expected this question.

Operator

Thank you. Our next question comes from David Smith with Truist Securities. Please go ahead, David.

Speaker 9

Thank you. Can you help us understand the moving parts behind the deposit cost outlook? The 15% to 20% sequential increase in 3Q looks about in line with what we saw in 3Q last year, but the full year outlook seems to imply a 30% or 40% or so decline in 4Q, which is twice as big as what we saw in 4Q of last year, even though there was a benefit from falling rates last year. I think you just said that you lowered some of the more high cost, more seasonal mortgage warehouse deposits, which seems like it would dampen the seasonality, if anything. So if you could help us understand the cadence and the moving pieces behind that outlook, please.

Speaker 2

Well, a couple of things going on. So so we we have, you know, our ECRs don't aren't only from the mortgage warehouse piece. Our HOA group pays ECRs at, frankly, at lower rates than than the MW sector. And so and that's continuing to and and so that's kind of part of what we're doing. We're also we're also showing that, you know, we do have, you know, a rate a rate decrease in September and another one in December.

Speaker 2

So that kind of adds to that as well.

Speaker 9

Okay. So you're still expecting a mix shift overall towards out of the mortgage warehouse towards the HOA and escrow and other lower ECR deposits?

Speaker 2

We are. We are. There's other areas that also we're optimistic about what our near term prospects are. Some of the ones that I was alluding to a little bit in my comments earlier in terms of the digital space, our corporate trust operation. I mean, we've only been at corporate trust for two years.

Speaker 2

And I'm not a lead table kind of person because we don't have a lot of businesses that would they actually produce lead tables for, but we're the seventh largest CLO trustee in the world, in a very short period of time, and and, frankly, with bright prospects.

Speaker 9

Thank you.

Operator

Thank you. Our next question comes from Ebrahim Poonawala with Bank of America. Please go ahead.

Speaker 7

Hey. Good morning. I guess just wanted to follow-up, Ken and Dale, on the topic of, one, Dale's Dale's new role sort of overseeing all these deposit strategies, and you've emphasized some of the regulatory changes. We're seeing, movement on sort of the Digital Assets Act or Genius Act today. There there a case to be made that all of this combined should lead to a significant pickup on the deposit growth front relative to where we've been over the last six, twelve months for this year?

Speaker 7

And I'm just wondering, is there a pickup that we should anticipate? And obviously, you've not given 26 guidance, but I'm trying to figure out if there's an infection there in terms of where things are going.

Speaker 2

I think we have an opportunity to execute on these, you know, changes that you're alluding to, Ebrahim, and and and grow these businesses, you know, faster than they have in the in the recent past. I'm not sure that's going to drive total deposits a lot higher as Ken indicated that what we're also looking at this LFI hurdle at $100,000,000,000 and we don't want to cross over that until we're ready. But we have opportunities within the deposit mix, both in terms of some broker costs as well as additional maybe mortgage warehouse that has an elevated ECR, whereby we could swap that out and should continue to push our NIM and our adjusted NIM higher throughout our forecast horizon.

Speaker 7

That's helpful. And I guess just on the topic of LFI, would the Fed moving the LFI threshold higher to, I think Ken mentioned, maybe to $250,000,000,000 Is that enough or would you want to see a change to sort of the legislation? I think Dodd Frank had a threshold that moved from 50 to 100 back in 2018, 2019. Like, would you want to see that or just the Fed moving that through sort of the proposal process enough for you to start thinking about things differently?

Speaker 1

I yeah. I I was gonna say, if they move with the two fifty, that gives us plenty of room to flex our muscles at a faster pace. First, I'll say there are some things that we like as we approach LFI readiness, and we're going to do them anyway. But this would give us a lot more room to grow at a faster pace. As I said, it also changes around the priority order in our technology stack of what we wanna do and allows us to focus a little faster on AI developments and more so on improvements either in our product and service offerings we have today or bring in new products and services that we would do.

Speaker 1

So, yeah, it would be a a net benefit to us if they were to, move it upwards. If they only moved it up to, say, one forty or one fifty for indexing, as some people I've read have suggested, that would still give us a benefit, but it would say to us that if and when we were ready to do an acquisition of another bank, we'd still need to be ready to be LFI ready because just an acquisition of a third of our current size would just put us about right at that revised 140, 150 level. But we're hopeful and, again, we hear this a lot from other people, not not directly from the from the regulators themselves, that the consideration of two fifty, is in play. And if so, it would be beneficial to us.

Speaker 7

That's helpful, Kennen. You think the Fed can move on this? You don't need an act of Congress here at all in terms of making this happen. Correct?

Speaker 2

No. Not not in terms of not in terms of these levels. You know, I I wouldn't wanna wait for Congress to do something there.

Speaker 7

Great. Got it. Thank you.

Operator

Thank you. Our next question comes from Casey Haire with Autonomous Research. Go ahead.

Speaker 10

Great. Thanks. Good morning, guys. Dale, congrats on the new role. I got some fun questions for you, but I do want to follow-up on credit.

Speaker 10

So you guys obviously sound pretty optimistic that things are going to get better, but we've heard that before in the fourth quarter, right, with the San Diego office. Is there anything you can disclose around the size of the marks? And then also, you know, what gives you so much confidence that this this migration is behind you?

Speaker 2

Well, Casey, just to kind of reflect a little bit, this is the first time that we've called that we believe we're at a top. You know, we've said we previously, we've said, you know, things are are, you know, steady ish, but we never said we think that this is the definitive kind of peak of where

Speaker 10

we

Speaker 2

are. And so what that looks like kind of going forward. What we're seeing in terms of kind of lease up activity, dispositions by other institutions, we think that things are stabilizing. And like I said, in these particular properties, it all comes down to what do you have. We've taken these back.

Speaker 2

They're making money. So that should continue to support what's transpiring in terms of valuation. In addition, you had a big spike up in some of the in the cap rates back when a lot of concern about a recession, which seems to have largely abated. And as a result of that, if these cap rates come down, that should improve not just the appraisal process, but the valuations in the markets itself.

Speaker 10

Okay. All right. Well, I and then you guys talk about this being a, you know, a shorter duration book primarily. We're we're not really seeing these balances amortized lower. You know, they're they're about the same size that they were two years ago.

Speaker 10

So what is what is what is happening? Like, when do we start to see this this this loan portfolio, taper out?

Speaker 8

Hi. I'll take that. First on on San Diego, we've we've taken every opportunity to describe the market that we played in here as not being Central I think I think we've often said, you know, 85 to 90% is outside of Central Business District. That San Diego asset happened to be the area that we deviated from that.

Speaker 8

So if I if I didn't say that clearly on prior calls, I'll I'll say that now. So that truly is uncharacteristic of the portfolio. We've also said that these these assets were bridge assets. This isn't a perm portfolio. This this was not structured going in as a perm portfolio.

Speaker 8

So these assets re reside. They're they're sponsor backed with institutional sponsorship, and they they have resided in funds alongside of other other assets. So the assets are in footprint predominantly. They're in our backyard. They're assets that we know that we're highly familiar with.

Speaker 8

And and in the repositioning, that goes with the with the fund. So if the if the fund isn't funding its portfolio, we take those assets, get them repositioned, get them on a faster path. So we're we're confident because we know the assets, because we have the assets marked at what we feel are conservative values less the disposition cost, and we've got a plan and strategy on each of the assets that we can see unfold out in front of us.

Speaker 10

Got you. Just one more on the loan growth front. I know you guys are about the halfway mark of your guide two quarters in. Historically, the second half has been very strong for you. Just how are pipelines?

Speaker 10

Is there an opportunity to do better than that $5,000,000,000 And how do you expect loan yields to play out in the back half?

Speaker 1

On the loan growth, I would say that we're not going to move off of a $5,000,000,000 guide. We're tracking to that. I think we're at a run rate that's above on your annualized our number for the second quarter growth. We're at a run rate that's above other reporting banks and above the industry. So 5,000,000,000 seems to be the appropriate level.

Speaker 1

And you'll see loan yields come down a little bit as you go through the course of the year just because, as Dale mentioned, we're forecasting a September rate cut of 25 and then one in December. So naturally, you'll see our loan yields follow that path.

Operator

Thank you. Our next question comes from Andrew Torell with Stephens. Please go ahead. Your line is now open.

Speaker 11

Hey, good morning. And Dale, congrats on the new role. Just a question on kind of the OREO and also kind of a point on the criticized loans. But just following the move this quarter, mean, the way you describe it, it sounds like it's an advantageous situation for you guys to take these in. Should we expect, you know, we could see more OREO built throughout the throughout the year into 2026 even?

Speaker 11

Or have you guys kind of identified all the properties that make sense from that standpoint?

Speaker 8

Sure. Thanks. We expect to see this flat to declining as as we move forward. So, we will move assets out. If additional assets come in, we expect that the pace of moving assets out will outpace that.

Speaker 8

Again, we've been working the same portfolio. It's, as we've discussed, predominantly office. In fact, it's all office. And and we're familiar down to the asset level at the most senior levels of our management. So the the management's fully engaged in the strategy.

Speaker 8

We know the assets well, and we've got a clear line of sight here.

Speaker 11

Okay. I appreciate it. And then on the on the San Diego loan that was put in OREO in April year, I think at the time, you you mentioned that the occupancy had improved. I think it was mid-40s up to mid-60s in very short timeframe. Was hoping you could just refresh us on the status of that individual property, whether occupancy has continued to improve there.

Speaker 11

Just any more color you can provide.

Speaker 1

Yeah. So the occupancy is up to 71% now. And we took that in at the very October. So that's a good working example of getting our hands around that property and and, being very constructive around leasing it up, around rental rates. And that's what gives us some of the confidence that, we could go ahead and and do it with the other properties, and we are beginning to do it with the other properties.

Operator

Thank you. Our next question comes from Bernard von Gazzicki with Deutsche Bank. Please go ahead.

Speaker 12

Hey, guys. Good morning. Just a modeling question. Just on the insurance cost, you have initiatives to pass them back to large depositors after previously absorbing them. The insurance costs were down slightly during the quarter.

Speaker 12

I know you can charge them through service charges if they want to keep the insurance. Any color on migration? Are there still accounts you need to pass cost to, or has this been mostly taken care of?

Speaker 2

It's largely behind us, I think, in terms of kind of the migration of what we're pushing back. Your mix matters there, too. Was pleased to see that with our deposits climbing, it actually fell a little bit. Part of that is we've been paying down brokered deposits every quarter consecutively, including in Q2 here. There's an elevated cost associated with those.

Speaker 2

If you swap out broker deposits for non broker, you're going to see a lower FDIC charge

Speaker 5

from that alone.

Speaker 12

And then just another modeling question, just on the equity investments. The $3,000,000 gains during the quarter, was that mostly related to the reversal of losses from 1Q? Or just any color or expectations you expect for those losses to accrue back? Or anything you can just share for expectations in the second half for equity investment line?

Speaker 2

That wasn't a recovery of a prior charge, but we see we don't see anything there that leads us to believe that they're that we're going to be slower than what we've been historically. There's a loose correlation with market valuations, as you see you tend to see more liquidity events from, say, a public company or even a private one that now has an elevated valuation from looking at other public companies. That tends to move it forward also. And if anything, we're in that kind of environment presently.

Operator

Thank you. Our next question comes from Anthony Elian with JPMorgan. Please go ahead.

Speaker 13

Hi, everyone. Dale, congrats on the new role, and I look forward to working with Vishal when he joins. My first question, you raised the outlook for ECR deposit costs two consecutive quarters now. I get that the rate outlook is volatile, but if we don't get any rate cuts in the second half, could you size up the impact to ECR deposit cost expense, assuming the same dollars of ECR deposit growth?

Speaker 2

Maybe we can pick that up on the later call, kind of with that kind of detail. But yes, we can assess that.

Speaker 13

Fair enough. Okay.

Speaker 1

Go then just keep my thoughts

Speaker 7

ahead.

Speaker 2

Was just going keep

Speaker 1

in mind that our adjusted net interest margin, which includes the deposit costs, we have it projected to rise for the year. So when you talk about deposit costs and you talk about rate movement when you get to the call later on, keep in mind that if there is no rate reduction in the back half of the year, that means our net interest income is also going to be higher as well. So you can't look at any one item in isolation and say what will it do to expenses. You got to look at it as what will it do to PPNR. That's all I'd say.

Speaker 13

Thank you. And then my follow-up from Ebrahim's question earlier on the deposit opportunities. Dale, you noted in the prepared remarks you saw 400,000,000 quarterly deposit growth in the digital asset segment and that's without the impacts from the Genius Act that passed yesterday. I know you've previously said that digital assets are about 2% of the company's deposits, but how large could you see that concentration getting to over time? And then is all the infrastructure in place to support additional deposit growth from the digital asset segment and from the deposit segments that you'll be leading up?

Speaker 13

Thank you.

Speaker 2

Yes. So we have a limit right now of 4% on that category. I could see that moving higher. I got to tell you one thing we're not going to do is we're not going to compromise our diversification even with a fast moving track on or a particular business line, digital or something else. So we think having that balance is really important in terms of our funding architecture.

Speaker 2

But I think there's room to have that continue to move forward. Like I said, I'm really enthusiastic about kind of what I see on the horizon in this space and others among these business lines. And I think that will give us optionality in terms of pushing out more expensive funds, having growth liquidity to be able to continue good underwriting on our loan portfolio.

Operator

Thank you. We have no further questions, and so I'll turn the call back over to Ken Vecchione for closing remarks.

Speaker 1

Okay. Well, thank you very much for your time and attention today. We look forward to our next earnings call, and have a great day and a good weekend. Thank you all.

Operator

Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.

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