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spk07: Welcome to the Western Alliance Band Corporation's third quarter 2022 earnings call. You may also view the presentation today via webcast through the company's website at www.westernalliancebandcorporation.com. I would now like to turn the call over to Myles Pondlick, Director of Investor Relations and Corporate Development. Please go ahead.
spk16: Thank you. Welcome to Western Alliance. Thanks. third quarter 2022 conference call. Our speakers today are Ken Becchione, President and Chief Executive Officer, and Dale Gibbons, 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 more complete discussion of the risks and uncertainties that could cause accidents, Please refer to the company's SEC filings, including the Form 8K filed yesterday, which are available on the company's website. Now, for opening remarks, I'd like to turn the call over to Ken Vecchione.
spk02: Thanks, Miles. This quarter, the company continued its strong financial performance as our diversified National Commercial Bank again delivered record net interest income, PPNR, and earnings, complemented by strong deposit and loan growth, supporting higher net interest margin with stable asset quality. For the third quarter, Western Alliance generated record total net revenues of $664 million, net income of $264 million, and EPS of $2.42. Earnings were propelled by accelerating net interest income quarterly growth of $77 million, or 15% from the prior quarter, to $602 million as the rising rate environment expanded our net interest margin 24 basis points to 3.78%. We maintain industry-leading performance with return on average assets and return on average tangible common equity of 1.53% and 24.9% respectively, which will continue to support building capital levels in the quarters to come. Sound balance sheet expansion continued with quarterly loan growth of $3.6 billion, or 7.5% quarter-over-quarter, and deposits rose by $1.9 billion, or 3.5% quarterly. mostly from non-interest-bearing DDA accounts. Loan demand remained healthy with 27% of growth coming from our regional banking divisions and 50% from national business lines. Deposit growth of $1.9 billion trailed strong loan growth this quarter. In Q3, our regional banking divisions contributed 32% of deposit growth and our specialized deposit franchises added 63%. We are proud that one of our new deposit business lines, Business Escrow Services, is gaining meaningful traction and contributed $424 million this quarter. We expect Business Escrow Services, settlement services, and other deposit initiatives to meaningfully contribute to growth and continue to enhance our funding profile in 2023. Mortgage banking-related income declined $35 million as the origination market continues to face major market disruptions. The speed and level to which rates have climbed have greatly reduced refinance activity and strained affordability in the purchase market. Servicing revenue was negatively impacted by a $22 million MSR hedge loss driven by volatility that spiked towards the back end of the quarter. We have positioned AmeriHome to profitably operate in a lower origination market, focused on becoming the industry's leading low-cost operator and have implemented a strategy to prioritize profitability against volume market share. Finally, asset quality continues to remain in great shape, and we do not see issues on the horizon. For the quarter, Wall recorded net loan recoveries of $1.9 billion, or negative two basis points. And year-to-date, we are in a net recovery position. At this point, Dale will take you through our financial performance.
spk04: For the quarter, Western Alliance generated net income of $264 million, EPS $242 million, and PPNR of $358 million. Excluding a $2.8 million mark-to-mark loss on preferred securities and a $4 million charge related to severance and other compensation charges primarily at AmeriHome, her EPS was $2.47, a 13% higher on a linked quarter annualized basis. Additionally, loan growth of $1.3 billion in excess of consensus added approximately $10 million in incremental provisions, which is front-loaded due to CECL. Total provision expense of $28.5 million also captures our somewhat softer outlook on the economy. Total net revenue of $664 million was an increase of $44 million during the quarter and $115 million or 21% year-over-year. Net interest income increased by 15% from Q2 to $602 million was driven by loan growth and further NIM expansion. Overall non-interest income declined $33 million to $62 million from the prior quarter due to lower mortgage banking-related income, which fell $35 million to $37.5 million. Gain on sale revenue was $14.5 million due to lower purchase volumes, while servicing fell to $23 million as volatility rose, which led to an MSR hedge loss late in the quarter. While the mortgage industry has made strides in right-sizing overcapacity to adjust to lower volumes in a higher-rate environment, this process is ongoing and normalized margins have not yet returned. Non-interest expense increased 13.7% or $37 million, resulting in an efficiency ratio of 45.5%, primarily due to higher deposit costs related to earnings credits. If the efficiency ratio was adjusted to reclassify deposit costs as interest expense, it would be 40.5%, as remaining operating expenses were flat. Turning now to net interest drivers, our growing asset-sensitive balance sheet benefited from the rising rate environment. Investment yields increased 72 basis points from the prior quarter to 366 as variable rate securities repriced. On a link quarter basis, loan yields increased 65 basis points with an end-of-quarter spot rate of 543. Loans held for sale benefited from rising mortgage rates and increased 88 basis points to 487. Total funding costs, including borrowings and deposits, increased 50 basis points to 88 basis points with a spot rate of 112 as the average rates and balances for deposits rose. Short-term borrowings and credit link notes also climbed. Long-term debt expense increased $13.5 million this quarter due to a $940 million in total CLNs we have issued program to date, which has preserved nearly $400 million in equity capital and minimized stock issuance. The higher interest expense and low capital issuance also provides credit protection on 24% of our loan book. As mentioned earlier, net interest income growth of $77 million, or 15% linked quarter, benefited from average interest earning asset growth of $3.8 billion and NIM expansion of 24 basis points to $378. Interest income grew 32% more quarter over quarter than our total funding costs, inclusive of ECR expenses. as we remain asset sensitive. Our rate shock analysis shows that with a 100 basis point rise over 12 months and on a static balance sheet, net interest income is expected to lift 6%. Using the same scenario on a growth balance sheet, we expect net interest income to grow over 15%. Reviewing the effect of a 200 basis point shock on a growth balance sheet, net interest income is expected to rise over 25% over the 12 months from the current run rate. Our efficiency ratio increased 270 basis points to 45.5. After reclassifying deposit costs as interest expense, it improved from 41.1% in the second quarter to 40.5 in the third, demonstrating the high operating leverage of the company. Deposit costs increased $38 million from the prior quarter due to higher earnings credit rates on deposits of $15.9 billion, of which $11.3 billion is in non-interest-bearing DDAs. Pre-provision net revenue rose to a record $358 million during the quarter, a 14% increase from the same period last year, and an increase of $7 million or 2% from the prior quarter. This resulted in PPNR ROA of 208, a decline of 11 basis points compared to 219 last quarter. Wall's leading organic capital generation produces approximately 45 basis points and CET1 capital on a static balance sheet per quarter. and provides significant financial flexibility to fund balance sheet growth or build capital ratios. Balance sheet momentum continued during the quarter as loans held for investment increased $3.6 billion to $52.2 billion and deposit growth of $1.9 billion brought balances to $55.6 billion at quarter end. Mortgage servicing rights balances increased $218 million during the quarter to $1 billion in part from declining prepayment speeds. Total borrowings increased $1.1 billion over the prior quarter to $7.2 billion, primarily due to an increase in short-term borrowings to fund loan growth and excess of deposit expansion. Tangible book value per share increased $0.49, or 1.3% over the prior quarter, to $37.16, primarily due to strong organic earnings that offset unrealized marks on available for sale securities recorded in AOCI. Tangible book value increased 7.2% over the prior year. This quarter, we generated sound organic growth for our national business lines and regional banking divisions. Loans held for investment grew $3.6 billion, driven by $1.6 billion in C&I loans, $893 million in sponsored back-to-market real estate, and $766 million in residential real estate. C&I growth was driven by $534 million in tech and innovation, $392 million in warehouse lending, and $350 million in capital call lending. 43% of our loan growth this quarter came from our core very low to no loss national business lines. According to deposits, we continue to experience growth across our diversified funding channels. This quarter, our regional banking divisions generated approximately 32% of our net deposit growth, while special deposit NBLs drove the remainder. In total, deposits grew 1.9 billion or 13.9% annualized in the third quarter, with non-interest-bearing DDA up $1.2 billion, CDs $533 million, and savings and money market $176. Non-interest-bearing DDAs now comprise 45% of our total deposit mix, of which 55%, or $13.6 billion, have no associated earnings credit rate. Our diversified deposit franchise continues to provide ample opportunities to generate attractive funding to support loan growth, with warehouse lending up 1.2 billion, regional banking divisions up 604, and business escrow services up 424 million. Business escrow services has continued to establish new relationships with large corporate acquirers, attorneys, and private investment firms that support the growth ramp this quarter. Going forward, we expect our scalable national deposit businesses, such as HOA, Settlement Services, and business escrow to continue to generate attractive deposits to fund ongoing balance sheet growth and temper the impact of elevated rates on our overall funding costs. Our asset quality remains stable and strong as classified and non-performing assets as a percentage of total assets are still lower than pre-pandemic levels. Total classified assets increased 39 million in Q3 to 385 million, or 56 basis points of total assets. Subsequent to quarter end, approximately half of this increase in classified has been resolved, and we see nothing to demonstrate a trend. Total non-performing assets and total assets remain stable at 15 basis points, and we've realized net recoveries of $1.9 million. Special mention loans decreased $5 million during the quarter to 60 basis points of funded loans, which represents a further decline from already historical lows last quarter. As the prospects for additional economic volatility continue to evolve, we believe our underwriting discipline, borne out through our national business line strategies, has prepared us for any credit stress that may accompany additional macro headwinds. However, we have not observed any preliminary signs of credit migration or client pressure. We believe our safe and sound asset quality decisions will dictate our thoughtful, diversified loan growth trajectory and enable us to navigate through heightened economic uncertainty. Approximately 55% of our loans are now in low to no loss categories, and 24% of the portfolio is credit protected through government guarantees, CLN first loss, or is cash secured. Quarterly net recoveries were $1.9 million, two basis points of average loan, which brought us to a net recovery position on a year-to-date basis. Our total loan ACL increased $29 million from the prior quarter to $356 million in It is now greater than our pandemic high watermark that was set in 2020. Year-to-date, our ACL has increased by $66 million. Total ACL defunded loans remain flat quarter-over-quarter at 68 basis points, while our ACL's non-performing loans rose from 385% in the prior quarter to 396% this quarter. Adjusting for the $10.8 billion of loans covered by credit link notes, where ample first loss coverage is assumed by a third party, the ASL coverage ratio rises to 86 basis points. We believe these superior asset quality trends are sustainable throughout economic cycles due to Western Alliance's deliberate post-GFC business transformation strategy to become a national commercial bank focused on deep underwriting specialization and greater business diversification. Walt's national reach and deep segment expertise enables selective relationships with the strongest counterparties on their most attractive projects with superior company risk management. During the global financial crisis, 67% of Western Alliance's losses came from loan categories comprising 44% of the 2009 loan portfolio, which today makes up less than 6% in total loans. Western Alliance has spent the last decade working to minimize these risks and diversify the business. We view a primary impediment to a higher stock valuation as misplaced concern about the credit risk heading into a likely recession. Cumulative net charge-offs for the past decade have totaled only $27 million against $356 million in current reserves. Fifty-five percent of our loan book is in low to no-loss categories. Lastly, the intended consequence of the credit link notes issuance has 24 percent of the whole portfolio credit protected. We know of no other bank that can make this claim. Excellent asset quality has been a hallmark of the new wall. Rapid improvement drove ratios to the top quartile, where they have essentially held even through the height of the pandemic. Classified and non-accrual loans continue to hold the low peers, while charge-offs have been minimal with the net recovery recognized here today. Non-accruals and net charge-offs have consistently ranked as one among the best in the industry, and with classified loans in the top quartile even during the pandemic, Our credit risk mitigation expertise shined during 2020 and 2021 and will be critical if the economy leans further. A hallmark of Wall's business model is that greater diversification leads to sustained superior earnings growth with reduced volatility. Similar to a traditional Sharpe ratio for stock returns, our risk-adjusted net income growth has been excellent relative to other large peers. Among the 33 domestic publicly held, publicly traded banks in the U.S. with assets between $25 and $150 billion, Wall has produced the highest risk-adjusted average net income growth. While we weren't the leader in earnings growth or the lowest in earnings volatility separately, our combined strong and steady growth has produced the top risk-adjusted return. Given our industry-leading return on equity and assets, we continue to generate significant capital to fund organic growth and maintain well-capitalized regulatory ratios. Our tangible common equity to total assets of 5.9% and common equity tier one ratio of 8.7 are both slightly lower than quarter over quarter. With AOCI dynamics impacting tangible book value ratios across the industry, we utilize our ATM to strengthen capital in addition to our solid earnings. We do not anticipate any share issuance will be needed as CET1 builds throughout next year. Finally, inclusive of our quarterly cash dividend payment of $0.36 per share, our tangible book value per share increased $0.49, or 1.3% quarter per quarter, to $0.3716, which is slightly above our T1 level. Notably, our tangible book value has grown 19.4% annually since 2013, three and a half times the rate of the peer group. I'll hand the call back to Ken for closing comments.
spk02: Thanks, Dale. I was pleased with the management team's ability to adapt to the changing interest rate and economic environment to produce record operating results. Thoughtful balance sheet growth in conjunction with operating and executional focus positioned the bank to capitalize on net interest income sensitivity while simultaneously growing both sides of the balance sheet with industry-leading performance. Our superior operating leverage offset the decline in mortgage banking income. Asset quality remains stable and solid with no signs of elevated stress. Organic earnings should grow capital as we reposition the company for slower growth ahead of a potential slowdown. So let me tell you what you can expect going forward here. Given the uncertain future economic and operating environment, we believe it's prudent to prioritize more measured but still double-digit loan growth, targeting up to $1.5 billion per quarter. We plan to surgically reduce loan growth through increased pricing and tighter credit criteria while de-emphasizing loan growth not accompanied by high-quality deposits. Deposits are expected to grow at approximately $2 billion a quarter. This will lower our loan-to-deposit ratio over time, which currently stands at 94%. Our goal over the next year is to bolster key capital ratios back to pre-AmeriHome levels, including 10% CET1. Our bank industry-leading return on average tangible common equity produces significant organic capital of approximately 45 basis points of CET1 net of dividends per quarter, which provides us with significant flexibility to grow capital ratios and fund the balance sheet growth. We expect to achieve our 10% CET target by mid-2023, aided by restrained balance sheet growth and risk-weighted asset optimization programs. Manager's margin is expected to continue to expand in Q4 at a similar pace to Q3, given the anticipated rising rate environment. We expect continued quarterly expansion of NIM and growth in manager's income throughout 2023, even after the Fed pauses rate increases as fixed rate securities and loans reprice and balance sheet growth continues. Total revenue should continue to climb due to strong net interest income with the drag from mortgage banking likely to moderate, assuming muted volatility. Our expense ratio, excluding the impact of deposit costs, should remain in the low 40s given inherent operating leverage of our business. As the quality remains well positioned and ranks among the industry's best, the technical recession we believe we have entered may move some key ratios slightly higher, but we do not anticipate any material deterioration that would change our above-peer standing. In conclusion, we continue to see an EPS of 980 for 2022 as a launching pad from which 2023 EPS can ascend. At this time, we're happy to take your questions, and I should have also said that Tim Bruckner, our Chief Credit Officer, is with us here today as well.
spk07: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press the star key followed by the number one on your touchtone phone. You will hear a three-tone prompt acknowledging your request, and your question will be polled in the order that they were received. Should you wish to decline from the polling process, please press the star key followed by the number two. If you're using a speakerphone, please lift the handset before pressing any keys.
spk14: One moment for your first question.
spk07: Your first question is from Kay Sierra from Jeffries. Please go ahead.
spk08: Yeah, thanks. Good morning, guys. Good morning. I was hoping to get some color on the comments about NIM expanding through next year. Obviously, it sounds like you're going to be a little bit more selective on the loan growth front, which could help on the yield side. but it does obviously seem a little bit tougher on the deposit betas and the funding pressure there. So what kind of, and I know you guys don't manage to deposit betas, but what kind of deposit beta is in your forecast that is still allowing you to drive NIM expansion through next year?
spk02: Okay, so we'll tag team this. Let me start off, then I'll throw it over to Dale. I just want to make sure we're clear that for Q4 and through 2023, we are projecting a growing and vibrant net interest income using the consensus FOMC forecast. So net interest income and NIM will continue to grow into 2023 even after the FOMC concludes raising rates. And we feel comfortable with this forecast for several reasons. Number one, The increased or excess liquidity that we're going to get from having deposits grow faster than loan growth will drive federal home loan bank borrowings downward, lowering funding costs. Second, current and future loan growth is being priced to higher levels as we've seen liquidity withdrawn from the banking system. Third item is $1.5 billion of loans repriced every quarter. with about 50% rolling over at higher spreads. And our fixed rate securities and loans totaling $800 million also repriced quarterly, which we see we think we can get some benefit from. The other thing I would say is since my return to the company, taking over as CEO, we focused on net interest income rather than net interest margin rate. And focusing on net interest income allows us to also produce the EPS results that we have achieved. And so in our mind, what we have done is going forward, we have priced 100% deposit data with 100% loan data. And we kind of see the spreads, which have been materially increasing for us, certainly since the beginning of Q3, but even before that, to carry us for the rest of the year. Dale, you want to add anything to that?
spk04: Sure, Casey, so we have lower levels of interest-bearing deposits and other funding sources, borrowings and CLNs than we do in terms of interest asset earning loans and securities. That's primarily because of our DDA that has no ECR. I mentioned that is $13.6 billion. And so we're okay bringing on high beta funding so long as it's going into 100% beta assets. And we're going to continue to see that. I think some of the other institutions have been challenged because they've actually held back on their deposit raising those deposit costs. They have consumer or something else, and they believe that it's going to withstand that, and then they've been surprised. And so now they have betas in excess of 100, at least for some accounts. We haven't been there. We know what our funding looks like. We haven't relied that we can kind of sneak things by. And so we have been, our pricing is right there in terms of where it needs to be. And what we're seeing in terms of our spot rates, you know, kind of confirms this. So for example, on our loan yield, our spot rate at the end of the second quarter was 451. At the end of the third quarter was 543 of 92 basis points. Meanwhile, for our funding costs, our deposit slide building costs was up from 63 to 112. So up 51 basis points. And again, what we had during the, Second and third quarter is we had loan yields tempered because the floors were still active. That's not the case anymore. And so we see that picking up. And then we're going to have more dollars rolling over in terms of, you know, maturities. And right now those fixed rate loans are about 300 basis points below the current offer rate that we would do today. That is going to reprice more than what we're going to see on liabilities because liability repricing for us hasn't lagged.
spk02: Hey, Case, I'm going to give you a quick story I think everyone on the phone will like, and then I'm going to ask you for a pop quiz here, okay? We turned down 31 loans in our senior loan committee. Those were loans $25 million or greater, not because of credit. We like to credit a great deal, but we turned them down because of pricing. Either the initial price wasn't high enough or the step downs were coming down too quickly or we didn't like the floors and we decided to move the floors up. And so here's your pop quiz. How did we do against 31 loans? We went back to the borrowers and asked them if they would accept the higher pricing level.
spk14: Not very well.
spk02: Wrong. We went 100 for 100. 31 for 31. So they all took the higher price. 31 people came back and said yes to the higher price. You're right. And that told us a few things. One, it makes us almost feel like you put your house on the market on day one and you sell it. First thing you say is, oh, my God, I... They sold it too cheaply. So what we really determined from that, and that was over a couple-week period when we went back and looked at the 31 loans. But what we really determined was liquidity is leaving the system, right? And one of the things that's natural for us and what's different for our bank versus others is that we try to be a bank for all seasons, and we try to remain open for all seasons. Now, that may mean that we tighten credit criteria, which we have. It may mean that we ask for more equity in the deals, which we have. And it may mean that we're asking for higher pricing. But we remain open. And one of the things, one of the reasons you see the volume, the loan volume continue to come in above what our previous guide has been is because we've developed this loyalty and people come to us because they know they can get a deal done. And the incremental short-term cost or higher cost of funding is It doesn't compare to the longer-term value that they're getting. So I just wanted to, you asked a simple question and we decided to give you a long answer.
spk08: Yeah, no, no, no, appreciate it. Okay, just on the 10% CT1 target by mid-year, so is there anything, you're going to do that organically, right, just moderating the long growth? Or is there, and without the ATM... Is there any, like, bond book runoff? Is that part of it or anything else that helped you get there in short order?
spk02: Well, there are a few things that we're doing. Certainly just repositioning our loan growth to up to $1.5 billion is going to help us probably grow net 12 to 14 basis points per quarter. We generally do 45 basis points of organic growth. subtract out for the one and a half billion dollars, and that's how you get to 12 or so basis points quarter by quarter. The other thing is Tim Bruckner sitting here with us, but he's led this re-optimization or optimization of our risk-weighted assets specifically around unfunded commitments, and we expect that to grow as well. There may be a CLN note that you'll see a deal happen, maybe this quarter or maybe in quarters one or two, And it's the combination of those things and a bunch of other smaller activities that I just don't think are worthwhile going through at this time that drive us to a 10% level Q2, we think latest Q3. And it's all without, you asked a very specific question, it's all without hitting the ATM.
spk14: Okay, very good. Thanks. I'll step back. Thanks, guys. Your next question comes from Ethan Carvalho from Bank of America.
spk07: Please go ahead.
spk00: Hey, Ibrahim here. I guess just maybe going back to comments around $2 billion plus in deposit growth, some perspective around your comfort around there. Obviously, there's a lot of concern around the industry, around deposit pricing, deposit growth. So, like, your conviction level in meeting those deposit growth numbers, and then should we think about its impact on deposit costs and makes shift as we think through 2023?
spk02: We're going to split this one up and tag team it as well. I'll take the volume side. Dale will take the cost side. And so if I heard you clearly enough, and correct me if I'm wrong here, you really want to know what gives us the confidence around the the $2 billion, right? Well, you know, we've been running that and then some on that if you go back looking at our history. But we've got several deposit franchises that are very strong. We have our HOA business, okay? That's strong. Settlement services is something we started to build in 2018. We rolled out in 2019. It now has $3 billion of deposits. And so going back a couple years, When I say everyone, I mean other banks said, gee, we don't want any more deposits. We always said, no, deposit franchises will really determine what our market capitalization will be in the future and how well we perform. So we rolled out settlement services. We rolled out business escrow services. We also have a tech business that produces $3 of deposits for every $1 in loans. Warehouse lending... has also been a very strong provider of deposit growth. And I want to bring you back to AmeriHome for a moment. This is very important. When we bought AmeriHome, we said we bought it because we saw an emerging regional bank. In the seven quarters that we've owned AmeriHome, we've taken AmeriHome's deposits from a standing start of zero to $7 billion. $7 billion in seven quarters. Now, I would tell you not to extrapolate that going forward, but it goes to show you that that $7 billion really sits on the bank side of the company and has been generating that incremental interest income from us. So those are the growth channels.
spk04: Do you want to take the cost side down? Yeah, so on the cost side, I'll note, we talked about that we brought in $420 million in deposits from business escrow services. Well, $300 million of that is in... non-ECR DDA. So that should help us, you know, on the cost side, and we're getting traction there. I got to tell you, we've got an application pending with the OCC to commence a corporate trust operation. We think that that is likely to kick off this particular time. We hired a team from Wells Fargo after they sold their operation, and we think that's going to be a source of funding for us also, kind of going forward. And then in terms of deposits, so again, You know, we're there that we're not trying to necessarily wrestle, you know, that everything has to come in, you know, it's super cheap, you know, you know, standard rates or, you know, and not market rates. But we have the ability, and we've demonstrated this, to bring in funds consistently. I would say our pipelines going forward are at least as good as what they've been the past couple of quarters. And it has been a little harder than we thought. We did exceed loan growth versus deposit growth. We're right-sizing that from Q4 forward.
spk02: Let me just tie it back to a question that Casey asked as well and tie it back to net interest income. If you don't have loan growth, it's harder to bring in deposit growth because that deposit growth is coming in at a very high incremental cost to it. We have the ability to grow loans in excess of $1.5 billion, and you've seen that, right? And so the fact that we can match off deposit growth at a marginal rate with 100% beta to it, compared to 100% beta on the loan side, allows us to make the spread, and as we've said, we've increased those spreads. So that's what kind of gives us the benefits. And again, I'll point you right back to and I don't think we get enough credit for this, and I'm going to start hopping on it, that our business model is different than almost every other bank's business model, and this is what our model allows us to do.
spk00: Got it. As far as there are no purposes, I'm fine with that. And I guess just another follow-up question, Dale. You talked about credit costs. When you look at the ACL 86 basis points, what is that embedding in terms of the macro, understanding your portfolio is very different If the economy is headed into a recession, where do you see that reserve ratio building? Because that's the other piece of downside EPS risk as we think about the next few quarters.
spk04: Yeah, so we use the Moody's model like I think most do. We take weights. The preponderance is on the kind of consensus. And then we have a much heavier weight on S4 versus S1. And so, you know, as those numbers have become kind of, you know, more impaired as they did in third quarter over second, you know, it did pull up a little bit more in terms of what an appropriate ACL would be. You know, I would say, you know, we're not expecting charge-offs to occur. And, you know, so long as we are right side up on LTVs, And we're a low LTV lender across the board. Our residential book was underwritten at 65 and is now probably under 60% in terms of LTV. Our commercial real estate is done anywhere from 45 to about 65%. And so we feel strongly that, and the Moody's model show this, that, you know, unless there's something really severe happening, we're going to be able to do well in that. If I go back to the pandemic, you know, we, so, you know, the hotel book and hotels clearly took a direct hit from travel during 2020 and 2021. And people were throwing numbers back at me in terms of what we're looking at in terms of losses. We didn't lose a dime in hotels the entire time. Because we had good sponsorship, low loan-to-value, and the type of loans we were doing. We weren't doing central business big boxes, you know, where people weren't coming anymore and that have very brittle cost structures in terms of not a lot of flexibility. These are like select service deals, like a residence in, and then, you know, the hotels, they close every other floor to hold their costs down. And that worked, and it worked for us.
spk00: And just to make sure, Ken, I heard you correctly. I think you mentioned fully at EPS 980 until it's about 277, 278 exit EPS run rate for fourth quarter. Do you believe you can draw things off of that in any way?
spk04: I'm sorry, I didn't hear it clearly. Yeah, if I heard you correctly, Ibrahim, I mean, yes, we think that the 980 is a period from, you know, that we can, that's a fourth quarter number implicitly, obviously, and that from there, you know, given what we expect to happen in terms of, you know, you know, of continued loan growth, a little bit more tempered than maybe what the street has had us at, but margin expansion, which is the opposite of what the street has had us at, that we can continue to sustain that throughout 2023. Again, this is the backdrop of what the FOMC actions are going to be as predicted in the futures curve.
spk00: Understood. Thanks for taking my questions.
spk13: Thanks. You're welcome.
spk07: Your next question is from Steven Alexopoulos from JP Morgan. Please go ahead.
spk15: Hi, everybody. I wanted to start on the deposit cost side.
spk02: If I include the cost of... Steve, you've got to talk off. Steve, we can't really hear you. Can you pick up the receiver or get closer to the phone? We're just not hearing you clearly.
spk15: Is that any better? Much better. Okay. Okay. On the deposit cost side, if I include the cost of the earnings credit-related deposits and the cost of total, we calculate these change by about 61 basis points quarter-over-quarter. Earning assets are up 71 basis points, so from a spread view, it's up about 10. Looking at it through that lens, how do you see that spread trending over the next few quarters?
spk04: Probably most likely parallel. I mean, I think we have a little bit more momentum in the loan side because they were held back, but because of floors, but yes, we're comfortable with a parallel shift there. Also, we're getting better pricing on the loan side, and I don't think that there's much more to go on funding cost increases.
spk15: Okay. On the ECR deposits, how much of the $2 billion per quarter growth do you assume will come from that, and how should we think about that cost moving forward?
spk04: We're not expecting that our deposit structure on the liability side is going to be improving at all. And so what we've dialed in is growth predominantly in either interest bearing or in ECR related. I do think that we've got opportunities to bring some other stuff in, as I mentioned with business escrow services and some of these others. But that is not a major factor in terms of moving that needle. I think we're going to be paying for deposits.
spk15: Okay. And then finally, in terms of pulling back the lending a bit, which categories are you planning to de-emphasize here? Thanks.
spk02: Yeah, good question there, Steve. And so, as I said, we've tried to do this in a very searchable way. So we're going to pull back our resi loan growth. This quarter was 750. I would expect that to drop to under 250 in Q4 and then drop to under $100 million going forward. But just to refresh memory for those on the phone, it wasn't too long ago that we had $6 billion sitting in liquidity at 10 basis points. And so building up a residential book seemed to be the appropriate thing to do back then. We're not going to be emphasizing it now going forward. The other places you'll see us be more circumspect on is in the capital call and subscription line space. We really haven't seen the cross-lending portfolio company opportunities that we hoped to have materialized, but they did not. And so we're going to pull back there. That business eats up a lot of our unfunded lines, our unfunded commitments. That's why Tim Bruckner is working on that in terms of the optimization. And I said, I guess I would say the other thing is, you know, we continue to stay close to all our clients and no loan gets approved, certainly at the most senior level in this company, without a significant deposit relationship coming over. And we've made that a big focus as well. And therefore, if you're not bringing over deposits, then some of our loan growth will slow naturally. But quite frankly, as a entrepreneurial bank that has always outperformed on the loan growth side, this is a challenge for us, to a certain extent, to be more surgical on where we're going to grow. Now, we think we can do that, and we think we could keep the loan growth to under $1.5 billion, and that kind of connects back to the CET1 ratio of why we're trying to also move it up to 10%. We're not getting credit for the loan growth, Steve. And people are saying, well, you're probably lending into a recession. We just will pull back and we'll look for higher yields on all that. Got it.
spk13: Okay.
spk14: Thanks for taking my questions. Your next question comes from Brad Millsaps from Piper Sandler. Please go ahead. Hey, good afternoon. Good afternoon, Brad. Good afternoon.
spk11: Ken, I think I heard you mention that you thought the efficiency ratio would stay in the low 40s, sort of X the impact of ECR deposit costs. I want to make sure I heard that correctly. I saw there were some small severance costs in the quarter and wondering what the benefit from those might be going forward. And then finally, because you're pulling back on growth, does that mean we should maybe think about pulling back on the expense growth as well, just trying to get a sense of kind of the expenses X the ECR?
spk02: Yeah, so you did hear me correctly that X deposit costs, the efficiency ratio should stay in the low 40s. Brad, if we don't keep it there, I mean, look, we can take it down, but we're not going to do that for several reasons. And I think I've been clear about this on previous calls. Number one, we're preparing for the day that we grow over the $100 billion threshold. And we always need to continue to invest in risk management and technology, which we're doing. We also are continuing to invest in new products and new services and new rollouts. And Dale mentioned one. He actually got a little ahead of what I was going to say about that on the corporate trust. I was going to wait until we brought in some deposits. But we've built that into our expense base next year as well, which is a new product or a new business line. So it's important for us to continue to build up these new business lines, and that's why we're going to keep it in the low 40s. that will help us or that will not deter our growth in total EPS as we roll into 2023. There were a couple components to your question. Did I answer all of them?
spk11: Yes. Yeah, I think so. And then maybe as my follow-up question to Dale, just on the ECR deposits again, do you see a change in the pace of that beta or the you know, rate in which those costs are going up. Do you see that accelerating? I'm sure it's not decelerating, but just kind of curious your thought around, you know, just kind of the pace of that change going forward.
spk04: You know, I don't. I mean, you know, out of the gate, you know, we had some that were a little more sluggish than others. But this has been the most widely telegraphed rate rise scenario, I think, in history. And no one is not aware of it, not at Western Reliance anyway. and uh and so yeah so we're they're fully participating they're basically moving in lockstep with fomc or you know effective fed funds okay great thank you your next question comes from pimer brazil from wells fargo please go ahead hi good morning um maybe looking at
spk05: Looking at the MSR hedge loss this quarter, can you just help us kind of frame our thoughts around that? You know, is that kind of going to continue in the fourth quarter, just given the pace of rates? Was that a little bit more idiosyncratic with just the shift in volume? And any color on kind of broader direction for AmeriHome kind of gain on sale revenue would be greatly appreciated.
spk02: Yeah, let me give you the broader direction and tell you what we are planning for in 2023. So we are using the Q3 total mortgage servicing revenues of $37 million as our base going forward throughout 2023. We hope to do much better than that, but for our planning purposes, $37 million is the base as we go forward. So that's, I think, the first thing. Regarding the $22 million vol hit that we had, our models, when we model things, we model out the life of the loan for 30 years, all the cash flows, and then we discount it back. And we hedge that in our model, but we hedge it out to 18 months. After that, there's not enough liquidity in some of the hedging instruments. And so we took a little bit of a hit in the volatility going out above 18 months. Now, what I should say, and we should have said in the opening statements here, we pulled back half of that in the MSR valuations. We have outside firms look at the MSR valuations. And so while we took the $22 million hit, we pulled back about $10 million of that. So the net impact was $12 million. But we're also doing something different in the business We continue to right-size that business. We're probably down about 29% in total people count there. So we're trying to make sure we are the low-cost operator in that space. And we're not trying to win share for share purposes only. We're trying to win profitable share. So the volume of corresponding loans that we purchase will be less profitable. But we are pushing and hopefully the market will see this and also follow that the margins will increase. And so far, early results, early Q4, that strategy is beginning to work.
spk05: Okay. That's great, Collar. I appreciate that. Thank you. And then maybe just going back to one of Dale's comments when talking on asset quality, You mentioned that provisions kind of capture a softer view of the economy. I know you're pulling back on some lending verticals, but that doesn't seem credit related. I guess as you look out across your landscape, what are those softer areas that you're kind of focusing on here?
spk02: You mean softer or the more opportunistic areas? Actually, I'll let Tim answer.
spk06: I think even we signal that we saw some headwinds in the economy, where have we pulled back, or where will we respond? Is that correct? Yes, that's correct. Okay, great. So a year ago, we started adding a real heavy stress to everything development, construction-related, and commercial real estate. Okay, so that's one. We had tempered our underwriting. We've maintained that. We've become more conservative in advance and underwritten with a significantly heavier interest rate stress. I think that's positioned as well in that segment. On the investor dependence side, starting in October and November of last year, we significantly stressed our enterprise valuation methodology. So those two areas are areas that, given our portfolio weighting, would receive more stress, and we adjusted early.
spk02: We've also broken our portfolio down. We did this coming out of last year into four major categories. The insurable portfolio, which Dale referenced, which is about 24% of our portfolio is credit-protected, insured, or has a government guarantee to it. We have economic... resilient, economic, resistant, and then we have economic sensitive. And we've been de-emphasizing the economic sensitive loan categories and staying with the other three, actually basically the insurable category and the economic resistant categories. We've been spending more of our time in terms of our lending pursuits.
spk05: Got it. And then just as a follow-up question, You know, you guys have certainly outpaced the market when it comes to warehouse lending, and I know a good component of that is just kind of tapping into the AmeriHome network. I guess how big of an opportunity is left there, and maybe just broader thoughts around warehouse would be appreciated.
spk02: Yeah, so when we say warehouse lending, we've got a couple of components to that. One is the traditional warehouse lending, but also embedded in warehouse lending is our note financing opportunity. That's note on note financing. where we'll see LTVs of about maybe 40% or lower, and we'll be in a first position. The note financing business is really very strong at this point. And so it's helping lift the warehouse lending side a little bit. But to be honest with you, we're still seeing a lot of good growth coming in warehouse lending. And there I would say is that we're taking some market share as other people are pulling back. and as other people are struggling to deliver the type of service we deliver. We're also seeing MSR lending is embedded in that group, too, and that has a lot of interest from borrowers, and we have some comfort level that we can grow that throughout 2023. Great.
spk14: Thank you for the call. I appreciate it.
spk07: Your next question comes from Chris McGrady from KBW.
spk03: Please go ahead. Great, thanks. Dale, I want to go back to the loan and deposit repricing if I could. I'm moving a little slow today. Can you just repeat kind of the comments about incremental betas on both sides of the balance sheet? I'm just trying to make sure I get what the messaging is on repricing of assets and liabilities.
spk04: So if I look at our spot rates, we have a greater momentum coming from Q2 and then Q3 that isn't captured in the average rates on the loan side more significantly than it is on the funding side. And I think that's because, in part, the loans were held back because of floors, and nothing is close to a floor today. And so I think that carries us in terms of what that looks like going forward. And so as long as we have a loan beta from here that is you know no lower than the loan the deposit beta and we're anticipating deposit betas to be very high we're going to continue to to what to do well um and especially if we can reprice things higher as as ken mentioned you know with these with these 31 returns that we had from our senior loan committee all of which came back with yeah we'll take we'll take the underwriting even at a higher cost so so we think we're well situated to carry that. Now, for the fourth quarter, you know, I mean, I think, you know, we're dialing in 75 and then 50, and then we don't have anything in 2020, 2023. I think maybe there's going to be a little bit of a tail. But with that kind of a profile and with, you know, really the repricing we're doing on our loan book that isn't – I don't see that in our funding book because our funding book is already really fully moving in lockstep. Now, we do have some benefit opportunities like we had in – in 3Q where $300 million of our DDA was not ECR related. I think some of those things are going to kick in, but we don't have to do that. All we have to do is have our loan betas be no lower than our deposit betas. The loan book and with the securities book, which is demonstrating variable rate as well largely, we're going to be able to continue to have expansion of net interest margin and then couple that with, you know, a more modest expansion of the balance sheet.
spk03: You said a very high deposit. Did you put a number on that for kind of future betas?
spk04: Yeah, I didn't. No, I mean, really, as Ken mentioned, that's not our management thing. We're not trying to optimize betas. We're trying to optimize net interest income and PPNR. Okay.
spk03: Okay. Last one, just to make sure I understand, the 980 that you reiterated, is that, just remind me, is that full year net income, you know, earnings per share, or is that fourth quarter annualized? Just trying to get the right starting off point.
spk04: Yeah, that's the full year of, you know, kind of what, you know, an operating income would be, correct.
spk13: Okay. Thanks.
spk14: Your next question comes from Andrew Terrell from Stevens, Inc.
spk07: Please go ahead.
spk09: Hey, good morning. Most of them might have been asked and addressed already, but Dale, can you remind us just expectation for the size of the average loans held for sale portfolio? And then do you have the spot rate on that book at the end of the quarter?
spk04: Yeah, the spot rate on that book was 529. And we think that balance is going to be modestly lower than where we ended at 930.
spk14: Okay, perfect. Thank you. Your next question comes from Brandon King from Truist Security.
spk07: Please go ahead.
spk10: Hey, just one question for me. I understand, you know, I... sees benefits when rates are rising. But I'm curious, what are the actions you've taken in the event that, you know, we have a recession and theoretically rates will fall? Just curious if there have been any actions that you've taken place to kind of protect against that in the future.
spk04: Yeah. So, you know, one thing that really helped us during the pandemic is we are active and basically mandate anything that is in a syndicated situation led by somebody else that we get loaned for us. And so we did that, and that held up our loan yields much better than some others and kind of improved our net interest income. We're still doing that today. They're really, I would say, largely ineffective at this point in time because you put a floor in, maybe that floor is 100 basis points lower than the current rate based upon the variable rate instrument there. And then if it's going up another 150 in the next 90 days – It's going to be way out of the money. But if we hold at higher rates for, say, like a year, we'll be able to reprice a lot of those floors much closer to the current rate, which will give us a lot of insulation in terms of what that would be like. The other thing I would say is, you know, my gosh, I mean, in a lower rate environment, you know, I think the mortgage market is, you know, is going to get jump-started, and we're certainly ready for that also.
spk14: Okay.
spk10: And no other, I guess, hedges or interest rate collars being put on the balance sheet? Has that been contemplated as well?
spk04: You know, we always debate that. We put some term kind of hedges on, some fixed swaps, you know, back when rates were in the, you know, low couple-digit basis points. You know, so we'll evaluate that at that time. But, again, that's just to mitigate kind of the downturn. Okay.
spk14: Thanks for taking my question.
spk07: Your next question is from John Arstrom from RBC Capital Markets. Please go ahead. Hey, thanks.
spk01: How are you guys doing?
spk02: Good, John.
spk01: Good, good. Just a few cleanup questions. One on Chris McGrady's question on the run rate deal. I know it's kind of nitpicky, but If you take the annualized 980, you get to 245 for the fourth quarter. I think you're saying that's too low, but we kind of have to stretch to get to 980. Just clarify that for us on the 980 number. What do you mean by that?
spk04: So the 980 is the full year operating EPS. So you have to be above. Maybe I misunderstood Chris's question a little bit. You have to be above that. That's going to take you to kind of the 270 range or somewhere in there.
spk01: be able to do that yeah for the fourth quarter and you're saying that's the jumping off point for 23. yes yeah okay um i've had a couple questions i think people know i'm the last guy on the call maybe but um can you talk about the ecr expenses and talk about the efficiency ratio with ecr and how you want us to think about that expense in the model
spk04: Well, so we're showing, you know, we're showing it both ways. I mean, to me, you know, if it, you know, looks, acts, and, you know, smells like something, maybe that's what you should call it. I think it really acts like interest expense. That's not really how the gap maps it geographically. So here we are. So, you know, we look at it both ways. I do think that taking it out and considering it as interest expense gives one a much better view in terms of, one, is the bank, you know, asset sensitive or not? How is revenue distributed? rising in interest income relative to expense. And we're still higher, not as much higher as if we keep it in expense. And then you look at your operating kind of architecture and we're in the low 40s if you just eliminate it completely. And I think those are kind of both appropriate. As Ken said, I think our efficiency ratio going forward in roughly the same position of the low 40s is appropriate. And again, we're looking for continued improvement on net interest income growth relative to interest expense, including deposit costs.
spk02: John, I'd add only one thing to that. You'll see deposit costs rise in Q4 again. near maybe the same level as Q3, but as we begin to enter into 2023, that rise will be tempered, and it won't be as noticeable as we go through 2023 based on the FOMC projected rate increases.
spk01: Yeah, okay, okay. I just have two more if I can. Just kind of on that topic, when do you think the margin is? starts to top out kind of when or where, because I look back in my models and I know your business is a little different, but you were in the, you were, you know, approaching the high fours in the last hiking cycle. And I'm just curious if that's just out of the question and, and just the timing on when you think this all might peak.
spk02: So again, uh, everything is predicated, uh, at least right now for us on what the FOMC is going to do, which for us is, uh, 75 bits in, uh, uh, in a couple of weeks. followed by 50. That's what's in our forecast. We actually don't have anything in there at all, any upward actions in 2023. But we see in terms of the NIM, the rate, we see that continuing to rise quarter to quarter. It may flatten a little bit out towards the very end of the year, but right now we even still have that kind of rising as a nice slope.
spk01: uh throughout the year uh in excess of what we see in uh consensus yeah but but certainly lower than lower than the you know historical highs that you alluded to yeah yeah okay okay all right and then the last one i have you know i like what you guys are doing but i have to ask this when when you go 31 for 31 on higher pricing i mean i understand that's a positive but you could take it the other way as well um it you know it could could cause you to question
spk02: you know pricing and the competitive environment as well but what what are what is that what do you really learn from that that 31 for 31 what does that say about the competitive environment and maybe what did you learn from that thanks yeah thanks john um on the competitive side uh it's telling us that uh other banks other competitors have pulled back probably for several reasons uh first and foremost we think it's because they don't have that deposit base that we have or that fresh liquidity coming into their bank, number one. Number two, they may be more regionalized in their lending or they may be just more product niche focused. We have the ability to deploy
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