Independent Bank Group, Inc

Greetings and welcome to the Independent Bank Group fourth quarter 2022 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ankita Puri, Executive Vice President and Chief Legal Officer for Independent Bank Group. Thank you. You may begin.

Good morning and welcome to the Independent Bank Group fourth quarter 2022 earnings call. We appreciate you joining us. The related earnings press release and investor presentation can be accessed on our website at ir.ifinancials.com. I would like to remind you that remarks made today may include forward-looking statements. Those statements are subject to risks and uncertainties that could cause actual and expected results to differ. We intend such statements to be covered by Safe Harbor provisions for forward-looking statements. Please see page 5 of the text in the release or page 2 of the slide presentation for our Safe Harbor statement. All comments made during today's call are subject to that statement. Please note that if we give guidance about future results, that guidance is a statement of management's belief at the time the statement is made, and we assume no obligation to publicly update guidance. In this call, we will discuss several financial measures considered to be non-GAAP under the SEC's rules. Reconciliations of these financial measures to the most directly comparable GAAP financial measures are included in our release. I am joined this morning by our Chairman and Chief Executive Officer, David Brooks, our Vice Chairman, Dan Brooks, and our Chief Financial Officer, Paul Langdale. At the end of their remarks, David will open the call to questions. With that, I will turn it over to David.

Thank you, Ankita. Good morning, everyone, and thanks for joining the call. In 2022, we reported full-year adjusted net income of $209.7 million and adjusted earnings per share of $5.02. Reflecting on 2022, we're pleased that our results illustrate the through-cycle nature of our business model of healthy loan growth, strong earnings, and excellent credit quality. We are in four of our nation's strongest markets, and we remain encouraged by the economic fundamentals in both Texas and Colorado. For the fourth quarter, we reported adjusted net income of $49.4 million and adjusted earnings per share of $1.20. During the quarter, we were able to achieve continued loan growth across our markets while simultaneously maintaining resilient credit quality metrics. Though deposit costs remain a near-term headwind, the sustained repricing of our fixed rate book should provide consistent tailwind to the interest income as rates remain elevated over time, even as payoffs and paydowns slow. Notably, we entered the quarter with a deliberate focus on achieving better expense discipline. In pursuit of that objective, we undertook targeted expense reduction initiatives across our business to position the organization for an uncertain economic environment. We will continue to focus on strategically managing expenses into 2023. The strategic focus on discipline is consistent with our longstanding history of confronting macroeconomic challenges early on and conservatively positioning the bank to perform throughout the cycle. We also announced yesterday that our board of directors declared a dividend of 38 cents per share and reauthorized our stock repurchase plan for an aggregate amount of $125 million for 2023. We believe these capital actions are consistent with our owner-led mentality of providing consistent returns to our shareholders. With that overview, I'll now turn the call over to Paul to discuss the financials.

Thanks, David, and good morning, everyone. As David mentioned, full year 2022 adjusted net income was $209.7 million, or $5.02 per share, and fourth quarter adjusted net income was $49.4 million, or $1.20 per share. There were several one-time items during the quarter embedded in the non-interest expense line that I'll discuss momentarily. Net interest income before provision decreased by 3.7% or $5.5 million from the prior quarter to $141.8 million. While interest income increased by $16.1 million from the prior quarter, funding costs increased by $21.6 million versus Q3. This more pronounced increase in funding costs drove the bulk of the differential in net interest income over the linked quarter as the FOMC raised rates 275 basis points in the last 155 days of the year. The increase in interest income versus Q3 was driven by floating rate loans repricing as well as net loan growth combined with new production funded during the quarter to replace normal amortization, paydowns, and payoffs. Payoffs and paydowns slowed modestly in the fourth quarter, but the consistent repricing of maturing loans should continue to provide a sustained tailwind to interest income, even as deposit costs are expected to peak shortly after the FOMC reaches the expected terminal rate. Our assumptions for modeling NII in 2023 include a peak in the Fed funds rate toward the end of the first quarter consistent with the FOMC's dot plot, we expect the Fed funds rate to subsequently hold flat through year end. In this scenario, our NII line should benefit from sustained fixed rate repricing dynamics throughout the year, even as deposit costs present a near-term challenge. The overall yield on interest earning assets jumped from 4.30% in the third quarter to 4.67% in the fourth quarter, an increase of 37 basis points. The core average loan yield net of accretion and PPP income was 5.01% in the fourth quarter, up 39 basis points from 4.62% in the third quarter. The total cost of all deposits was 112 basis points in the fourth quarter, compared to 57 basis points in the third quarter, an increase of 55 basis points. The cost of all interest-bearing liabilities was 181 basis points in the fourth quarter, up from 102 basis points in the third quarter, an increase of 79 basis points. As slide 20 shows, we have been successful in playing both defense and incremental offense in our core deposit book, maintaining branch deposit balances despite a slight shift of non-interest-bearing balances to interest-bearing balances. Year-to-date fluctuation in specialty verticals is mostly a function of managing liquidity needs strategically in the current interest rate environment. Deposit competition remains intense as we near the Fed funds terminal rate. And we will continue to remain nimble and opportunistic in funding the balance sheet. Deposits are likely to continue to be a headwind to near-term NII growth until the terminal rate is reached. Still, over the medium term, our loan books should continue to serve as a tailwind even after deposit costs peak. Provision for credit losses was $2.8 million for the fourth quarter. And looking ahead, we are budgeting for provision that represents about 1% of net loan growth. This assumes all else being held equal in the CECL model and no material changes to the macroeconomic forecast and other model factors. Non-interest income decreased by $2.3 million compared to the third quarter, which was mostly driven by lower net revenue from our mortgage businesses due to lower mortgage volumes across the industry as well as lower other income. For the first quarter, we expect mortgage fee income to remain flat at current levels. Adjusted non-interest expense was $88.3 million for the fourth quarter, which was down approximately $386,000 from the length quarter. Adjusted non-interest expense excludes approximately $10.4 million of one-time charges related to the targeted expense reduction initiatives undertaken during the fourth quarter. Of this, $7.1 million is related to severance and accelerated stock listing, and $3.3 million is related to the write-off of certain assets related to discontinued technology projects, as well as the termination of a correspondent banking relationship. The fourth quarter's expense reduction initiatives will help us achieve our goal of holding the quarterly expense run rate flat through 2023. As we enter the new year, we remain focused on strategically managing the expense line, and we will explore additional opportunities to realize savings over the coming quarters. Slide 22 shows consolidated capital levels over time. All capital ratios, including the TCE ratio, increased slightly from the linked quarters. and capital levels remain well above regulatory, well-capitalized minimums. These are all the comments I have today, so with that, I'll turn the call over to Dan.

Thanks, Paul. Loan sale for investment increased to $13.6 billion in the fourth quarter, up from $13.3 billion in the linked quarter. Loan growth, excluding mortgage warehouse and PPP loans, totaled $320 million, or 9.6% annualized for the quarter. New production during the quarter was well distributed, both geographically and by product type, and we continue to underwrite with the same discipline that has guided us through past economic cycles. Average mortgage warehouse purchase loans decreased to $297.1 million in the fourth quarter, down from $402.2 million in the prior quarter. Volatility and interest rate increases more broadly have resulted in decreased demand, lowered volumes, and shorter hold times across the mortgage industry. Our expectation is for this business to remain flat at current levels through early 2023. Credit quality metrics saw a notable improvement during the quarter with several large commercial credits achieving final resolution with minimal losses. Total non-performing assets decreased to $64.1 million, or 0.35% of total assets at quarter end. Other real estate owned was flat at $23.9 million during the quarter. That charge-offs totaled just two basis points annualized during the quarter. Our loan book continues to be bolstered by a multi-decade history of strong underwriting, as well as the underlying strength of our markets in Texas and Colorado. Even so, we are continually stressing our portfolio for the impacts of higher rates and mindful of the evolving macroeconomic situation. Currently, we remain very confident in the strength of our underwriting and the ability of our borrowers to navigate the current environment, and we remain ever vigilant against emerging risks in the economy as we enter 2023. These are all the comments I have related to the loan portfolio this morning, so with that, I'll turn it back over to David. Thanks, Dan. As we enter 2023, we continue to be very encouraged by the strength and resilience of our markets across Texas and Colorado, and we have been pleased to see sustained demand for high-quality business from our longtime customers, even as the FOMC approaches the expected terminal rate. This sustained borrowed demand, combined with our strategic focus on the discipline management of our expense base, helps fuel our continued pursuit of through-cycle performance and healthy growth. Our priority remains to deliver value to our shareholders by running a high-performance, purpose-driven company dedicated to serving our customers and communities each day. Thanks again for taking time to join us today. We'll now open the call to questions. Operator?

Thank you. At this time, we'll be conducting a question-and-answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Brad Millsaps with Piper Sandler. Please proceed with your question.

Hey, good morning.

Hey, good morning, Brett. Thanks for taking my questions. Maybe Paul wanted to start with the margin and net interest income. you know, you kind of offered a lot of color there on kind of how you guys are thinking about it, just, you know, maybe bigger picture. Do you think most of the significant margin compression is behind you? And, you know, is there a chance that, you know, you could start to see, you know, maybe NII begin to trend up maybe in the back half of the year based on some of the fixed rate asset reprice you have? Just kind of want to get a better sense of you know, kind of how you're thinking about the trajectory of the NIM and NII as you move through 23.

That's exactly the right way to think about it, Brad. As we went into the fourth quarter, we were really trying to play incremental defense and offense in the deposit book. So if you look at page 20 in our slide deck, we were really focused on ensuring we were able to grow those branch deposit balances, even though we knew there would be a bit of remix from non-interest bearing to interest bearing. We were successful in doing that and preserving our contingent liquidity options going into 2023. So as we look through the directionality of NIM in 2023, we expect it to bottom out at current levels, flat to down just a couple of basis points for the first quarter. And then we should see that dramatic inflection in the second quarter accelerating through the third quarter as those fixed rate repricing dynamics should offer us some significant lift in NIM for the year.

Thank you. And just maybe as my follow-up on the fixed rate loan repricing, where are you seeing those new loans and those loans repriced to in terms of rate? Just want to kind of get a sense of the potential pickup and, you know, maybe David or Dan, how are those new rates, you know, maybe impacting, you know, loan demand out there in terms of, you know, what I think you've, you know, sort of guided to, you know, seven, eight-ish percent type loan growth. Just kind of curious what, how those rates are impacting the appetite out there. Sure.

Brad, this is David. I'll talk back from a high level. We're seeing rates come on in the mid-7s, upper 7s now in the current environment. And we expect that will slow. The Fed will likely accomplish their purpose of slowing the economy. So that's kind of in our thinking that overall loan growth will slow a bit. As we head into 2023 here, one of the things, and I think you're alluding to it, I'll let Dan speak to this, but one of the challenges will be if there are loans in the low fours rolling to the mid sevens or upper sevens or eights, if the Fed continues on here, then that may pose one-off challenges for certain borrowers and cash flows and things. I'll let Dan speak to the credit aspect of it. Hey, good morning, Brad. Yeah, I think really I would think about it this way. Conservative underwriting on the front end is really the best defense against that risk, and so we have put material interest rate shock tests in our underwriting even four years ago when rates were in the fours, and now they're rolling up for maturity. But we're looking at every credit that's maturing this and the next year and stressing it for impact on higher rates. Our early look at those has been that we see very few issues for the few credits where a conversation will be required. We'll do what we always have, and we'll get in front of it with our borrowers early on.

Great. I'll hop back into the queue. Thank you. Hey, thanks, Brad. Thanks, Brad.

Thank you. Our next question comes from the line of Brady Gailey with KBW. Please proceed with your question.

Hey, thanks. Good morning, guys. more break so if lung growth is going to slow a bit here you know what what does that mean for 2023 are we thinking more of like a mid single digit level potentially for this year well you know it's seasonal as well so it's a little tricky to try to to forecast I think

you know, six to eight percent, which is guidance we gave, you know, at the end of the third quarter, still looks about right to us for the entire year. But it may be a little slower here in the first quarter. Just, you know, a lot of people are looking around here trying to figure out what their plan is for 23. We've got good demand and good pipeline, but I expect, based on what we know today, Brady, that, you know, we probably start out with a mid-single digit here in the first quarter and then you know, accelerate a little bit, you know, a little bit, emphasis on little, to, you know, in that six, seven, you know, maybe 8% range. And, you know, look, there's a wide range of possibilities for 2023 and what happens with the economy. And, you know, as we've said over and over again, I don't want to, you know, say it ad nauseum, maybe we do, but, you know, the markets we're in should give us some insulation, right? Even if it's a pretty difficult,

overall economic slowdown we still expect our loans will grow and then it just becomes a magnitude of how much okay all right and then the decisions that were made on the expense base um what was the impact of those decisions like how much annualized expenses were taken out of the of the banks

So Brady, this was really a prerequisite for us to meet our expense guidance of holding expenses flat from that run rate. So if you think about expenses heading into 2023, I would expect them to remain in that $89 to $90 million a quarter range. And this was a crucial part of heading off some of the expense headwinds we're going to have in terms of increased FDIC assessment and things like that in 2023. Good talk. any should we expect you guys to consider continued uh you know changes in the expense base or do you feel kind of good with where expenses are at this point we're going to continue to look you know across the footprint for opportunities to have targeted reduction of expenses i wouldn't expect anything programmatic like we did in the fourth quarter but obviously as we as we navigate what David mentioned is shaping up to be a very uncertain economic environment, we want to be really mindful and disciplined about managing the expense base on an ongoing basis.

All right. And then, so the 125 million of buybacks, you know, the stocks at one nine, a tangible book value, um, tangible common equity is kind of in the high 7% range. Do you expect to be, you know, active on that one 25 this year?

I think a lot of that depends, Brady, on what happens with the markets and the economy and stock prices, but we'll be opportunistic and continue to look for opportunities to buy our stock at attractive prices. I'd say that Obviously, we're all watching to see what's going to happen. Capital is precious. We do like the way our balance sheet is held up with tangible equity, as you mentioned, still in the upper sevens. That's quite different than a number of banks in our peer group. You have three handles and four handles on their tangible capital ratio. So we do think we've got some room and we'll be opportunistic, but we're not anxious to give away capital in this environment either.

All right. And then last question for me is just, I know you guys have been focused on improving the profitability profile of the bank. Any color on where you would like to get ROA or ROE or efficiency ratio or whatever metric you're focused on? Any color on what the targeted profitability ratios are for independent? Sure.

Again, every question I guess we answer, and I'll quit saying it in a minute, Brady, but every question we answer is, you know, in light of everything we don't know about 2023 to come. And so our discussion around here has been about being nimble in everything we do from expense-based to growth to, you know, the credit side, all of that, just being nimble, watching what is coming our way and reacting accordingly. But you asked a question last quarter, and I appreciated it, which is, you know, You guys have historically been a high-performing bank. Your numbers right now wouldn't fit in that category, and what are you going to do about it? That's not exactly how you asked it, but it was – I think the answer is, Brady, you can't turn a ship on a dime, so to speak. So we've been undertaking the things that we believe will return us to the kinds of metrics that we want to be at, that we have traditionally been at, So I would expect that our return on tangible common equity to be mid-teens and up from there and our ROAs to be in the 120s and 130s and rising. We won't be there in the first quarter of this year given the continued decline. you know, pressure on deposit rates and things. But I think when you get to the back half of this year, Brady, those are the kinds of numbers, you know, come third quarter, fourth quarter, we should be able to generate given our base economic assumptions of what's going to happen this year. So I think, you know, if you had a ROA in the 120s and 130s and returned on tangible equity in the 15 to 18 range, that would be where we've been traditionally and where we expect to be back to Biden this year.

Okay, great. Thanks for all the color, guys. Yeah, thanks, Greg.

Thank you. Our next question comes from Michael Rose with Raymond James. Please proceed with your question.

Hey, good morning, everyone. Thanks for taking my questions. Just wanted to go back to slide 20. I appreciate the color here, but the loan-to-deposit ratio at the warehouse is is creeping up there a little bit. Just, you know, can you walk us through in more specific detail some of the strategies? Yeah, I know there's a push-pull with the, you know, non-primary sources of deposit funding, but, you know, can you just update on some of the initiatives you have in place? And, you know, maybe if you've changed incentive structure or, you know, just anything that you're doing more specifically on the deposit side to, you know, kind of balance, you know, that loan-to-deposit ratio with the funding needs as you continue to grow. Thanks.

Sure. Thanks for the question, Michael. I will say this, you know, we were very deliberate in the fourth quarter about preventing runoff in our core deposit book. And we were successful at doing that in defending with rate some of our core deposit relationships that we've had. As a relationship bank, we're always keen to make sure that if we have to pay for deposits, we're paying it to our customers and we're taking care of them. That being said, we have incentivized the teams with very explicit deposit goals heading into 2023. It's an all-hands-on-deck approach in terms of ensuring that everyone is focused on making sure that we keep our costs down on the deposit side of the house as much as possible. Our expectation heading into the first quarter is that as the Fed hits the terminal rate, we'll see the deposit cost pressures abate, and we'll be able to, especially as the curve points a little bit further down in both the brokerage and the FHLB, arenas will be able to selectively take some different tenors of deposit there. We obviously want to keep the deposit book short, but we're going to be opportunistic in using the significant capacity we have in both the broker, the specialty, and the other wholesale verticals in order to maximize our rate outlook on deposits for 2023.

Okay, that's helpful. And then just maybe separately, just on the loan growth outlook, you know, obviously keeping the guide just about the same, but it does seem from the tone that, you know, maybe things are going to get a little bit more challenging just with, you know, rates, as you mentioned, David, and the fours going up to the seven or eights. And, you know, how much of the, you know, the growth is kind of intentionally maybe pulling back a little bit, just given uncertainty in the economy? Or is it truly just, you know, rates moving a lot higher and, you know, your customers may be looking for alternative options out there for funding their own growth. And then just separately, if you can just give us an update. I know this has been a multi-year process, but where you stand on some of the CNI initiatives. It looks like growth was double-digit annualized, but if you back out the energy loans, it looks to be a little bit softer. So I know a lot in there, but just any color would be great. Thanks. Yeah, thanks, Michael.

I may not remember all the questions about it in that question, so you may have to help me remember some of them. But yes, we believe overall at the highest level, the amount of economic activity and the amount of deal flow is going to slow. It is already slowing. Deals, income-producing real estate investments don't pencil as well at 8% as they do at 4%. So that's going to be a bit of a drag. The positive side of that has been the payoffs and refinancings and sales of assets and all that have slowed. So therefore, we're going to have the payoff headwind that we had, you know, the last couple of years. So we won't have to generate as many loans to net, you know, that mid 5, 6, 8, 7, 8% that we expect for the year. So that's it at a high level. You know, we continue to be committed to, you know, diversifying our balance sheet. You mentioned the energy loans. We think that's a positive. For us, we're seeing great opportunities there. You know, we still only about 4% of our overall loan book in energy, so we think that's, you know, an area that can continue to grow a little bit as we go forward. And we'll continue to look at other, you know, lines of business, but it's not, you know, it's not as easy as just, you know, It's not as easy as snapping your fingers and making it happen. But yes, we're committed to continue to diversify our lines of business. But your other one comment, Michael, was embedded around are we intentionally being cautious? And the answer to that is yes. In this environment, heading into the uncertainties ahead, there's no easy button here. And as longtime shareholders and owners of this company, we've been running for 35 years. And we're not going to start in our 35th year, 36th year here, looking for an easy button to go, oh gosh, let's go hire a team and book a bunch of this kind of loan or this kind of loan. And obviously our credit size is being lower. Generally, our hold size is being well lower than our peer averages. Those are things that are core to our credit philosophy and risk management philosophy. And we're not going to change that in our 36th year. And yes, there are avenues, Michael, out there, which some banks may take where you can go book a lot of really big loans or you can get into lines of business that you haven't been in historically. And we just think that's a uniquely bad thing to do at this point in the cycle. So we're not going to be doing those kinds of things. We're going to be growing our loan book with our customers and our markets and continue to watch our risk.

Okay, great. Maybe one last one for me. I'm going to try. I don't think you're going to answer it, but I know you guys are involved in the Stanford Group litigation, which another bank in the southeast just settled. Just wanted to get any comments from you, see if there's any update. I know a trial for one of the classes is set for February 27th. Again, I don't think you comment, but I thought I'd try. Thanks.

Hey, thanks for the question, Michael. You're correct. We don't comment on pending litigation, as you know. But we always assess what's in the best interest of our company and our shareholders, as I said a moment ago. There are details on this specific case that you asked about in our normal public disclosures and filings, and you can read up on that as well, and we'll continue to update that quarterly.

Great. Thanks for taking my question.

Thank you. Our next question comes from the line of Brett Rabbitton with Hugdy Group. Please proceed with your question.

Hey, guys. Good morning. Hey, Brett. Good morning. Wanted to first circle back to fee income. And, you know, you mentioned that you think mortgage banking will be flat in the first quarter. Wanted to see, you know, one, if you think, you know, obviously the market's hoping for a pivot, you know, as well. We'll see, but wanted to see if past that you felt like there could be some optimism for that to maybe pick up a little bit. And then also, you know, the decline in the other bucket due to the correspondent piece, if that had fully run its course or if there could be any additional atrophy related to that. And then if you just basically saw any other opportunities to maybe have growth in fee income lines of business.

Let me say from a high level, let Paul comment on some specifics, Brad, of your question. But at a high level, our view of the mortgage business right now is that it's hitting its lows and will linger there for a prolonged period of time. So in our numbers and assumptions, we don't have any increase or acceleration in 23. Obviously, that would be great for everyone if it happened, but in our decision making in the fourth quarter of last year about around our cost base included our view that it was going to be a very difficult year in mortgage. We've got great teams running both of those businesses and we feel good about it long term, but we think it's going to be very hard in 23 and maybe longer. And until we see real evidence that there's some environment that will allow a return to the normal kind of volumes. We don't make that in any of our forecasts. In terms of the correspondent and specific things you asked about, I'll let Paul comment.

Yeah, Brett, that was just a one-time charge related to the severing of a correspondent banking relationship that won't recur in future quarters. And as far as the other fee income items, we expect them to remain relatively stable over the coming quarters.

Okay, that's helpful. And then wanted to make sure I understood, you know, kind of the flavor, so to speak, of the commentary around the cost of funds from here. And it sounds, if I'm getting it right, it sounds like you feel like you've maybe taken a big chunk of the pain, so to speak, in what it took to keep deposits and to keep relationships on balance sheet and maybe the deposit beta, so to speak, you know might might slow on a relative basis going forward um is that a fair assessment that you feel like you've taken some of the lion's share of the pain in terms of the cost of funds increase and maybe any thoughts on how we should think about the deposit data from here sure brett we've been very deliberate in making sure that we play defense in our core customer base and consistent with our history as a relationship bank that's been a focus of ours

I think there's still going to be continued pressure on deposit costs near term until the Fed hits the terminal rate. Our expectation, though, is that once the Fed hits the terminal rate, we should see some significant abatement of pressure on deposit costs that help us in the back half of the year.

Okay, fair enough. And then maybe a question for Dan. You guys mentioned You look at the commercial real estate loan portfolio, and I think a lot of investors are worried about commercial real estate. And maybe there's a couple credits to think about from a loan repricing perspective that you'll get in front of. Wanted just to hear, if you look at slide, I think it's 17, your credit has historically been much better than peers. Wanted to hear maybe what you might worry about in terms of the environment maybe not even your own loan portfolio, but just the environment around commercial real estate, if it's rents, if it's something else, if it's the change in rates, what's the big factor you're kind of concerned about for the environment? Yeah, Brett, great question.

I think in general, let me say it this way, it might help you as you think about certain asset classes that we think are under pressure and will continue to be under pressure this year, spec industrial, spec office, activity in the last couple of years. And as a rule, we've just stayed away from that type of lending in keeping with our core principles here. I would say in general, people are watching certainly occupancies in the office space. I think rents certainly continue to be pretty solid, it seems, on the multifamily side. So I don't think there are any primary concerns there that we're seeing. But in general, I think we're just continuing to be very vigilant about stressing our portfolios for the rate increases and then mindful about what could happen in a downturn. And I think in general, again, our structure with granular book, which is limits exposure on any individual credit and The way we've underwritten those with the same standards we have over the last three decades, I think, positions us as good as we can be. And while we're watching that, I think we feel very good about our portfolio at the present and continuing to monitor what that would look like. I guess that's the way I would answer that for you. Yeah, and I would say, too, at a high level, Brett, this is David, at a high level, Brett, one of the things is we thought about these strategies loans rolling five years in that were underwritten at 4% interest rates. One of the things that has really helped in our markets, if you're thinking about the markets that we're in and the in-migration of people, whether it's office or multifamily or professional office buildings, the demand and the rents have increased materially in the last five years. So the cash flow that we underwrote five years ago are much higher today in almost every property. And that goes to our philosophy of doing high quality property in great locations and great markets. It just has risen, if you will, with the tide of the economic activity in our markets. So that's making it actually much better than we had feared maybe six months ago as we began the process of going, oh gosh, re-underwriting these credits. So the great markets we're in, and also Dan and his team have done a great job of avoiding kind of the hot idea. And so spec industrial, office warehouse, that kind of space has been across the country around every airport and everything, given what's going on with Amazon and delivery and all that has been just built by the tens of millions of square feet. And look, we're a little cautious around that as an example. We think there could be some pain in that if we have a significant economic slowdown. So we just have not, you know, bet the farm, so to speak, on any one asset class. You know, multifamily is great. It's strong here. But, you know, even then, you have to be cautious not to overbuild submarkets within these, you know, good markets. Those are the kinds of things we think about and talk about.

Okay, that's really helpful. Thanks so much. Thanks, Brent.

Thank you. Our next question comes from the line of Brandon King with Truist Securities. Please proceed with your question.

Hey, good morning. Good morning, Brent. Good morning. So, yes, could you please talk a little more about your confidence in the assumptions that deposit rates will peak soon after a Fed pause? In particular, in an environment where we could be in a higher for longer rate environment, it could still be long off there and a lot of your competitors are still fighting and scratching for deposits.

Sure, Brandon. And back to what I had mentioned on a previous answer to a question, we were deliberate in getting in front of the rate increases. So we wanted to make sure we could retain our core deposit relationships, those relationships that we've had for sometimes upwards of three decades. And the way that we did that is we were very focused on making sure we paid a higher rate as the Fed was hiking, not waiting for the noise after the Fed hit the terminal rate. And then, as you mentioned, scratching and clawing and trying to play hand-to-hand combat for deposits against our competitors who are trying to take our customers. So we've been more generous on the front end with deposit increases for those core customers with the expectation that once the Fed does hit and hold at the terminal rate, that that should provide us some alleviation of pressure on deposit rates as we continue to see that higher for longer environment that you mentioned.

Okay. And does that also, are you also assuming that kind of the non-DDA, non-interest bearing mix stays kind of constant from here, or are you also assuming kind of a mixed shift from non-interest bearing to interest bearing as well?

We're expecting a very slight mixed shift in our forward forecasting. but it's not very meaningful.

Okay.

Okay. And then a question on expenses, just as far as how you evaluate the expense run rate going forward, how do you feel about kind of your current head count? And do you still see potentially room for there to get more efficient going forward?

Look, I think costs, Brandon, are going to be on everyone's plate in 2023. And so everyone's going to be, you know, our industry has been through a unique time where, you know, from PPP revenues to liquidity and system keeping interest rate, deposit costs down, et cetera. We've had a season here the last two or three years where, you know, costs haven't, people have been able to invest as we have in our infrastructure and building out business lines and things like that. But we're entering a time now where, you know, If we're going to have an economic slowdown, rates are going to level out at a higher level, then the only other lever that financial institutions are going to have is their cost base. And so we took a hard look at ours in the fourth quarter and trying to position ourselves to be nimble and be able to react to what could come our way in 2023. I think other banks will do similarly. as the rates level out here in the second quarter. I think our head count is, you know, right where we need it to be. We've invested in a lot of businesses. We have the best teams out customer facing teams we've ever had. And we're going to take great care of our customers. We're going to grow with our customers in our markets and, you know, we'll invest and hire more people as we see the need to do it. So we're, But I think right now, we're right where we need to be and looking good here as we go into 23.

OK.

Thanks for taking my questions.

Hey, thanks Brent.

Thank you. Ladies and gentlemen, as a reminder, if you'd like to join the question queue, please press star 1 on your telephone keypad. Our next question comes from the line of Matt Olney with Stevens Inc. Please proceed with your question.

Thanks. Good morning. I want to go back to the outlook for the NII, and I appreciate all the comments on the funding. On the other side, you mentioned the loan repricing tailwinds that should provide some offsetting benefits. Any more color you'd give us on how quickly this book will turn? I'm just trying to appreciate why this would be offsetting some of the funding. headwinds as you move into, I think you said, 2Q of 23 in the back half would offset some of the funding headwinds. Thanks.

Sure, Matt. Thanks for the question. As David, to echo a theme that David spoke to, there are a lot of potential outcomes for the broader economy in 2023. And obviously, the macroeconomic picture is going to influence the payoff and paydown trends. But that being said, we have a Tad Piper- bulk of our book is those fixed rate five year CRE loans and the contractual maturities for those will continue to provide a tailwind even in an environment with Tad Piper- subdued payoffs or pay downs. As we look back on the fourth quarter, we did see payoffs and pay down slow a little bit. Tad Piper- Some of that is typically a seasonally slower Q4 that we see, but some of it is a slowing of pay downs more broadly. our expectation is to see some blend of the 3Q and 4Q rates on a go-forward basis from a payoff and paydown perspective. So we are optimistic that we will continue to have a pretty good lift from the repricing of those fixed rate loans, especially as contractual maturities happen over the course of the next four to eight quarters.

Okay. Appreciate that, Paul. And then I guess, David, in the past, you've talked about the bank's goal of achieving the positive operating leverage every year and and looking to 2023 is that still a reasonable goal to achieve this operating leverage given the macro headwinds that you're facing and the industry is facing we believe it is uh matt given again everything we know today we believe it is we think our costs uh we've got a very good handle on our cost structure now

And we'll continue to look, as Paul said, for ways to incrementally improve. We're taking a hard look at all our contracts and, you know, all those things that, you know, you would expect a bank like ours to do, you know, on an ongoing basis. So we'll continue to look for things like that. That will be helpful, I guess, as we fight. But there are so many things, as Paul mentioned, from FDIC to contracts and contractual increases in pricing and things like that. And obviously, you know, increases merit and pay increases to our teams and all of that, you know, we're creating the headwinds. So we tried to get ahead of it in the fourth quarter by, you know, having some cost reductions across the company and then, you know, position ourselves to hold the line here, if you will, in 2023. But it's a continued not only focus of ours, Matt, but it's a commitment we have to our shareholders to continue to improve the operating leverage of the company.

Okay. Appreciate that, David. And then I guess lastly, for a credit question for Dan, I think there was a sale of non-accrual loan in the fourth quarter. Would appreciate any comments you have on the market appetite for loan purchases and how did the pricing of that loan sell compared to the appraised value? Thanks.

Yeah, good question. As you noted there, we did have an opportunity to move out to non-performing credits, large ones, large for us anyways. We tend to have small ones, which is a good thing. But we also had some additional small ones. And one of those was in a note sale. It was an energy loan in particular. I would say the percentage of discount, which I think is what you're really looking for there, is going to depend on the asset, right? Real estate assets, if you're selling those notes, could be different than CNI assets or others. And I would say relative to the value that we saw on that and the balance on it, it was a slight discount really off of what we would have expected at that point. I'm certain that other banks may be looking at or have done the same things and Again, depending on the asset class and the condition of the credit, it very much depends on those variables when you're trying to determine that.

Got it.

Okay. Thanks, guys.

Okay. Thanks a lot, Matt.

Thank you. Our next question is a follow-up from the line of Brett Robertson with Hubdy Group. Please proceed with your question.

Yeah, hey, I just want to follow up on that repricing of loans question. I think last quarter you originated $326 million of commercial real estate and had $950 million reprice. Paul, you happen to have those numbers maybe for the fourth quarter, and I think that the CRE portfolio has a three-year duration. I was just curious if that was still kind of an effective number.

Those are the duration assumptions that we're using. As far as repricing is concerned, the bulk production in Q3 was higher than it was in Q4. I don't have the exact number off the top of my head, Brad, but I would estimate that it was about 20% less. Again, some of that is seasonality, and some of that was an additional slowing of repayments as the Fed sprinted up the forward curve. Our expectation, though, is for the future forward rate of the fixed rate repricing to be somewhat blended between what we saw in Q3 and Q4. Okay.

Thanks. Appreciate it.

Thank you. Ladies and gentlemen, that concludes our question and answer session. I'll turn the floor back to Mr. Brooks for final comments.

Yes, I appreciate everyone being on the call today and the active back and forth. I feel really incrementally positive as we enter 2023. I think we're well positioned versus our operating leverage versus our ability to continue to grow the company. And I think we're well positioned for whatever happens and excited to take on the challenges ahead. Thanks everyone for being on today and I hope everyone has a great day.