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spk01: Good day, everyone. Welcome to Western Alliance Band Corporation's fourth 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 Pondelick, Director of Investor Relations and Corporative Development.
spk17: Go ahead.
spk05: Thank you. Welcome to Western Alliance Bank's fourth quarter 2022 conference call. Our speakers today are Ken Vecchione, 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 actual results to differ materially from any forward-looking statements, 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 Becchione.
spk06: Thanks, Miles. Good morning, everyone. I'd like to provide an overview of our 2022 performance and then preface our approach to 2023 before Dale reviews the bank's financials. financial performance. I should also mention that Tim Bruckner, our chief credit officer, is also in the room with us today. Western Alliance had a strong year in 2022. Our diversified national commercial bank grew loans 28%, deposits by nearly 13%, and posted record net revenue and net income growth of 30% and 17.6% respectively. We accomplished all this while maintaining strong and stable asset quality as net charge-offs to average loans were approximately 0% for the year, while non-performing assets to total assets improved to 14 basis points. The balance sheet is well-positioned to weather an evolving environment as 27% of the loan portfolio is credit-protected and 53% of the loans can be classified as insured or economically resistant. Our goal is to emerge from this slowing or recessionary environment as a top-performing asset quality bank in our peer group, a position we currently occupy. For 2023, the higher interest rate environment and slowing economy will generate headwinds for the banking industry. As I mentioned on our Q3 earnings call, Wohl is focused on bolstering CET1 levels, restraining loan originations with deposit growth, outpacing loan growth, while maintaining leading asset quality and growing year-over-year earnings. We are pleased with the substantial progress made towards this goal. Our CET1 ratio ended the year at 9.32%, which was over 60 basis points higher than the previous quarter. Arriving capital was driven by purposeful, reducing, sorry, Arriving capital was driven by purposeful facility, reducing approximately $1.8 billion in certain low margin, low deposit categories such as capital call and subscription lines and corporate finance implications. Without these actions, quarterly health for investment loans would have grown $1.5 billion and generated incremental interest income. Our ongoing investments in diversified deposit businesses should provide liquidity in excess of loan growth. Q4 ending deposits declined $1.9 billion from last quarter, while average deposits declined by only $295 billion quarter over quarter. This decline was primarily driven by short-term seasonal tax and insurance escrow deposit outflows in the mortgage warehouse group, which has since recovered, with Q1 quarter-to-date average deposit balances up more than $2.4 billion from year-end. Previous investments in our settlement services, business escrow, and HOA deposit businesses, as well as the soon-to-be-launched corporate trust platform, combined with several other initiatives we look to allow, provide meaningful opportunities to gather incremental deposits this year. We look for predictable balance sheet growth to improve NIM and grow net interest income in 2023. After Dale's comments, I will discuss our 2023 outlook in more detail.
spk03: Thanks again. For the year, Western Alliance produced record net revenues of $2.5 billion Net income over $1 billion and EPS of $9.70. Fourteenth consecutive year of rising earnings. Maintained interest-leading performance with return on average assets and return on average tangible common equity of 162.25% respectively through tangible book value per share to $40.25, 6.4% higher year over year. As I mentioned, we previously identified a near-term priority of bolstering our key capital ratios. We're pleased with the substantial progress made toward this goal with our CET1 ratio increasing over 60 basis points to 9.3 in Q4. This strategy led us to proactively restrain balance sheet growth without inhibiting record net interest income and earnings. Over the year, net interest income increased 43% to $2.2 billion. Our diversified deposit franchises are focused on generating attractive core funding that drives net interest income and EPS higher. rather than purely minimizing deposit basis to maximize the interest margin. Non-interest income declined $80 million to $325 million as a result of ongoing softness in the mortgage industry. However, improved mortgage-related revenue in Q4 and the pending withdrawal of a large money center bank from the correspondent mortgage business suggests gain-on-sale margins and core servicing income could be in the very early stages of stabilizing. Finally, asset quality remains stable and strong if classified and non-performing assets as a percentage of total assets are still lower than pre-pandemic levels. All has dramatically transformed its business over the last decade to become a national commercial bank focused on deep segment expertise, underwriting specialization, and greater business diversification. For the year, Western Alliance recorded net charge-offs of just $1.5 million, or less than one basis point of average loans. Turning to fourth quarter trends and business drivers, Western Alliance generated net income of $293 million, EPS of $267 million, and pre-provision net revenue of $368 million. Operating EPS was $274 million or $995 million for all of 2022. Total net revenue was $701 million, an increase of $37 million during the quarter, or 25% year over year. Net interest income increased 6% from Q3 to $640 million was primarily driven by NIM expansion, but also benefited from higher average earning asset balances. During the quarter, the company completed a credit-linked note transaction, bringing 2022 issuances to total $579 million. As of year-end, the company is protected from first credit losses on reference pools of loans totaling $12 billion. Overall, non-interest income remained essentially flat from the prior quarter at $61.5 million, as mortgage banking-related revenue increased $9 million to approximately $47 million. This increase was partially offset by a $9.2 million mark-to-market charge included in other income. Non-interest expense increased 9% or $27 million, resulting in an efficiency ratio of approximately 47%, primarily due to higher deposit costs related to earnings credits. The efficiency ratio was adjusted to classify deposit costs as interest expense, and 40% as remaining operating expenses were essentially flat. Turning now to net interest drivers, our asset-sensitive balance sheet benefited from the rising rate environment. Interest investment yields increased 79 basis points from the prior quarter to 4.45%, as variable rate securities repriced higher. On a linked quarter basis, loan yields increased 86 basis points to 570 with an end-of-quarter spot rate of 6.26. Loans held for sale benefited from rising mortgage rates and increased 76 basis points to 563. Irrespective of the Federal Reserve's rate trajectory, our net interest income will continue to benefit from an average of $2.5 billion of loans maturing or repricing higher each quarter in 2023. Fixed-rate loans are being replaced with loans that yield over 2% higher, while variable-rate loans are repricing at a spread of 50 basis points wider on average. Total funding costs, including borrowings and deposits, increased 69 basis points to 157 as the use of CDs and short-term borrowings increased as a proportion of average interest-bearing liabilities. Net interest income growth of 38 million, or 6%, on a linked quarter basis was powered by a 20 basis point NIM expansion and a modest increase in average interest earning assets. The increase in total interest income continues to be greater than the change in total funding costs, including ECR expenses, demonstrating our continued asset sensitivity. Our rate shock analysis shows that with a plus 100 basis point shock on a static balance sheet, net interest income is expected to lift over 3%. Using the same scenario on a growth balance sheet, we would expect net interest income to grow over 20%. Good rates decline as some are projecting that might happen later this year. On a growth balance sheet, net interest income still rises coincident with our decreasing asset sensitivity profile. Our efficiency ratio increased 140 basis points to approximately 47%. After reclassifying deposit costs as interest expense, adjusted efficiency was essentially flat at 40%, again demonstrating the high operating leverage of the company. Deposit costs increased $26 million from the prior quarter due to higher earnings credit rates on deposits, but at a slower rate than Q3, as earnings credit rate paying demand deposits declined. Pre-provision net revenue climbed 3% to a record $368 million, a 14% increase year-over-year. resulted in return on average tangible common equity, excluding all other comprehensive income, 23% for the quarter, or 80 basis points higher than last quarter. Customer Alliance's leading organic capital generation and continued strong performance provide significant flexibility to fund balance sheet growth, build capital ratios, and meet credit demands. Loans held for investment decreased from $339 million to $51.2 billion, and deposits declined 1.9 billion to 53.6 at year-end, primarily driven by short-term seasonal mortgage warehouse factors. Total borrowings fell 16 million over the prior quarter, primarily from a decline in short-term borrowings, offset by issuance of 95 million in credit-linked loans on a reference pool of residential loans. Finally, tangible book value per share increased $3.09, or 8% over the prior quarter, and 6% year-over-year to $40.25, organic earnings along with reduced drag from available to sell securities marks recorded in a OCI order that loan growth is impacted by our purposeful decision to temper certain CNI loan categories such as equity fund resources and to a lesser extent over finance by approximately 1.8 billion in total these reductions in our loans would have grown 220 million by the total loans held for investment growth of $1.5 billion on a lead quarter basis. Non-CNI growth was driven by $651 million from sponsor-backed commercial real estate, $390 million from construction, and $250 million from residential. Additionally, the breadth of our business lines generated healthy loan demand in regional banking, which was $696 million higher than Q3. Self-franchise finance rose $315 million, and tech and innovation was up 140. We are well positioned to maintain prudent growth through a more uncertain economic environment given our diversified loan mix between national business lines, residential real estate, and regional banking. Over the last three years, 68% of our robust loan growth has come from low to no loss categories, which now account for 53% of our entire portfolio. Furthermore, we have structured additional loss prevention as 27% of loans are credit protected, which should fortify our industry-leading asset quality. According to deposits, competition for funding picked up during the quarter, and larger-than-expected seasonal factors combined to temporarily reduce deposit balances. Early deposits declined $1.9 billion, primarily driven by short-term seasonal escrow deposit outflows in our mortgage warehouse group, which are... included in non-interest-bearing deposits, but subject to earnings credit rates. As I mentioned, these seasonal factors have reversed since year-end, with mortgage warehouse Q1 quarter-to-date average balances already at more than $2 billion from year-end, or 15% higher from the same period year-over-year. Additionally, quarter-to-date average balances for total deposits are at more than $2.4 billion from 12-31, and approximately $660 million greater than 4Q's average balance. The mortgage warehouse comprised 65% of the reduction in non-interest-bearing DDA. End-of-year seasonality is evident in the lead quarter decline in average deposits of only $295 million versus the more pronounced decline on a period-end basis. Increased competition for liquidity in a higher-rate environment drove an 11% increase in total interest-bearing deposits, including a $1.9 billion growth in CDs. Interest-bearing demand deposits grew $1.2 billion from last quarter, in part from migration from non-interest-bearing DDA. The diversified deposit franchise continues to provide meaningful opportunities to generate attractive funding to support loan growth. Among our scalable national business lines, we are pleased with the continuing momentum in settlement services and homeowners associations. We've produced link quarter growth of $680 million and nearly $300 million, respectively. Going forward, we expect continued growth for our deposit business lines, including business escrow services, to continue to generate attractive deposits, fund ongoing balance sheet growth, and soften the impact of elevated rates on overall funding costs. Our asset quality remains strong and stable. Classified assets and non-performing assets as a percentage of the total are still lower than pre-pandemic levels. Total classified assets increased 8 million in Q4 to 58 basis points of total assets, only two basis points higher than Q3. Total non-performing assets to total assets were down one basis point from last quarter to 14. The prospects for greater economic volatility continue to evolve. We believe our underwriting discipline, borne out through our national business line strategies, has prepared us well for additional credit stress that may accompany a greater macro headwinds. However, we have not observed any preliminary signs of material uptick in credit migration trends and we also expect to steadily reduce our exposure to the more sensitive loan categories this year. We found asset quality decisions will dictate our thoughtful loan growth trajectory and enable us to maintain profitability despite heightened economic uncertainty. Quarterly net charge-offs of $1.8 million in the quarter are one basis point of average loans of the full year 2022 net charge-offs to $1.5 million. Those quarterly charge-offs have been stable at approximately $2 million per quarter for the past year, while net charge-off variances result from volatility and recoveries. Raising expense for credit losses was $3.1 million, primarily due to uncertainty surrounding a percentage recession offset by risk-weighted asset optimization efforts, sale of corporate finance indications, and reducing capital call and subscription line exposure. The base case is for a mild recession with the allowance for credit loss assumptions weighted toward the community's consensus forecast, which has shifted toward increasing the recessionary and more conservative scenario. Total loan ACL to funded loans was 69 basis points, while our ACL to non-accrual loans was 420% at year end. Suggesting for the $12 billion of loans covered by credit-linked notes where ample first-loss coverage is assumed by a third party. The ACL coverage rises to 89 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. Going back to that time period, nearly 70% of losses Western Alliance incurred during the Great Financial Crisis came from loan categories comprising 44% of the 2009 loan portfolio. Today, those categories make up less than 6% of total loans. In contrast, 87% of the current portfolio is insured and resilient categories. The insured category consists of credit-protected, government-guaranteed, and cash-secured loans. Resistant loans are categories that have historically low or low loan losses. Both categories have experienced de minimis losses since 2014. Resilient loans are supported by strong collateral and counterparties, as well as our underwriting expertise. This category might experience some great migration. Realized losses are minimal due to limited recovery, uncovered collateral risk with average losses of only two basis points and a maximum quarterly annualized loss of just 16 basis points. 13% of the portfolio we blew is more sensitive to economic growth. However, lending in this category has been focused on unique subsegments that offer the highest risk-adjusted returns and where we leverage our sector knowledge and underwriting capabilities to maintain superior relative asset quality. Since 2014, these loans have experienced a maximum quarterly annualized loss rate of only 71 basis points with average losses of 5. Our exceptional post-GFC asset quality has been highlighted by minimal net charge-offs of only $29 million since the beginning of 2014. Comparing our performance to the 32 publicly held banks with assets between $25 and $150 billion based in the United States, we realized the lowest average net charge-offs and the lowest quarterly annualized maximum charge-offs as a percentage of total loans over the same time period. The past decade has been a period of relatively low credit stress. Our leading performance in low average losses, and more importantly, the lowest loss volatility among peers, bodes well as to how Western Alliance will outperform peers if and when credit stress becomes more acute. On our last earnings call, we discussed our renewed focus to rebuild capital and have made strong progress so far. Our tangible common equity and total assets ratio of 6.5%, Common Equity Tier 1 of 9.3 were both materially higher quarter over quarter. In our industry-leading return on equity and assets, we continue to generate significant capital to fund organic growth and to lift well-capitalized regulatory ratios. The strong capital generation during this quarter is the equivalent of issuing approximately 5.5 million shares. As previously mentioned, TBV per share increased $3.00 $40.25, and since 2013, has grown 4.3 times faster than the peer group. We believe our business diversification, excellent asset quality, and ability to generate solid operating leverage will continue in a softer economy and validate our franchise as a high-performing, all-weather growth bank.
spk02: Back to Ken. Thanks, Dale.
spk06: I was pleased with the management team's ability to adapt to the changing interest rate and economic environment to produce record operating results in 2022. Thoughtful balance sheet growth in conjunction with executional focus positioned the bank to capitalize on venture's income sensitivity while simultaneously growing both sides of the balance sheet with industry-leading performance. As the quality remains solid and stable with no signs of elevated stress. Looking forward for the full year of 2023, we expect continued careful balance sheet growth driven by a diversified business model with a flexible origination mix designed to maximize net interest income. We expect loans held for investment to grow between 10% and 15% and deposits to grow between 13% and 17%. Our specialized deposit franchises generate funds for more economically agnostic and secondarily strong sectors, with often significant deposit growth opportunities in excess of loan growth. We also expect improved interest expense on the marginal deposits raised, as we add fewer term deposits in favor of more interest-bearing deposits. The interest margin is expected to expand between $4 and $4.10 as it moves in concert with Fed Fund actions. Favorable earning asset repricing dynamics quarter will support NIM even if the Fed pauses hikes this year. The manager's income is expected to grow between 20% and 25% for the year in a rising rate environment and to exceed growth in ECR-related deposit costs. The adjusted efficiency ratio for the year should remain in the low 40s as we will continue to invest in risk management, technology, and new business lines to take advantage of the attractive growth opportunities we see in front of us. In aggregate, we expect pre-provision net revenue growth of 11% to 15%. Excellent asset quality should remain intact, but we could return to more globalized losses if the economy enters into a recession. Our goal remains to prudently bolster key capital ratios in light of macro environment with a CET1 ratio of between 9.75% and 10%. Our bank's industry-leading return on average tangible common equity produces significant organic capital of approximately 45 basis points of CET1 net of dividends per quarter. It provides us with significant flexibility to achieve our strategic objectives, grow capital ratios, unbalance cheap growth, or undertake other capital actions. At this time, Dale, Tim, and I are happy to take your questions.
spk17: We will now begin the QA session.
spk01: If you would like to ask a question, please press star followed by one on your touchstone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly to allow questions to generate in queue. The first question comes from the line of Casey here with Jefferies. Please proceed.
spk12: Thanks. Good morning, guys. No way I caught all that guide, Ken, but I did hear the NIM guide. I think you said 4 to 4.1%. I'm assuming that's for the year. Can you just give us sort of the progression, how you see it trending throughout the year and exiting the year, and what Fed forecast are you guys assuming? Thank you.
spk06: So on the Fed forecast, we actually have only one rate increase at the beginning of the year. That's about a week from now for 25 basis points on the upside. We also have two rate decreases, both 25 basis points, placed into our Q4 forecast. We're probably less confident about those rate declines, but we think it's a good prudent thing to do in order to manage our efficiency ratio and not have expenses run ahead of potential revenue increases. So that's the rate forecast. On MIM, we expect it to grow slowly through the year. Between 4 and 4.10 is pretty tight for us. So, you know, probably crosses over for a little more towards the end of Q1 into Q2 and then just grows generally from there.
spk12: Okay. And within that deposit growth guide, which I think you said 13 and 17, any sense, I'm assuming there's a lot of negative mix shift baked into that, but any sense of where DDA is? as a percentage of total deposits can settle versus that, you know, I think we're low 40s today?
spk06: I'll sort of let Dale answer that second half of the question, but deposit size is between 13% and 17%. That's, you know, $7 billion to $9 billion, right? And just to be clear, what we're trying to do is grow deposits at a rate faster than loan growth, and that's what we mentioned on Q3. In terms of growth areas for us, in terms of businesses, they may give you some confidence around the deposits. Our HOA business in 2022 grew a billion three, and we kind of see that still being the same. We also see growth coming from our settlement services and our business escrow services lines of business. And those we invested in, in 2018 and 19 with a stronger rollout as we got into 2020. And those businesses did rather well. Certainly Settlement Services did rather well in 2022. And then the rest is kind of in terms of deposit growth will come from the regions.
spk03: It's pretty difficult in today's environment to garner new non-interest-bearing deposit relationships. But as we indicated, we have seen a recovery of approximately half of the DDA that declined in the fourth quarter, primarily related to mortgage banking operations, and the seasonal drop is 4Q. So I'm going to stick with that, that we think we can hold about half of what came down in the fourth quarter. But again, what we're focused on from here is how do we, you know, sustaining our deposit growth trajectory, and then putting on loans that have, you know, plus 300 or more spread between them. And that can drive net interest income, you know, kind of regardless of what the debt does.
spk12: Okay, great. And just kind of tying this all together, you guys talked about the 980 number this year. You got there. The street has you at 1075 for 23. You know, do you feel like – I can input all the components and work it through, but I'm just wondering – Do you feel like that 1075 is doable with this guide?
spk06: Casey, what I'd say is our PPNR guide is between 11% and 15%. From there, you have to take a viewpoint on what you think is going to happen in the economy in terms of determining the provision. You know, the provision will naturally grow because of our balance sheet growth. We're not seeing any cracks in asset quality. It looks pretty good, but, you know, listening to a number of the talking heads, many people think towards the back half of 2023 we'll see some weakening in asset quality. Again, we haven't seen any of that. So you're going to need to make your own assumptions regarding charge offset. on top of provisioning. But the PPNR guide is between 11% and 15% for next year.
spk12: Understood. The last one for me, just the loan deposit growth, is that average or period end?
spk03: So we talked about kind of both of those numbers. But from here, I expect us to recover about half of the DDA decline in the fourth quarter by period end.
spk02: Okay, thank you. Thank you.
spk01: The next question comes from the line of Brad Misaps with Piper Sandler. Please proceed.
spk11: Hey, good afternoon. Hey, thanks for taking my questions. I appreciate all the call around guidance. Maybe I wanted to maybe delve into credit a little bit more. You gave a lot of color, but just kind of curious, you know, with everything, you know, that's going on, all the uncertainty, just, you know, can you talk a little bit more about what were the drivers of the, you know, $3 million, you know, provision this quarter? I understand that a lot of movement within risk-weighted assets, you didn't have a lot of loan growth, but it would just seem that, you know, most outlooks have worsened in the $3 million provision. Might seem a little light, maybe relative to the environment, but just wanted to get some more color there, particularly maybe as it relates to 2023. Yeah.
spk06: Well, let's start with, you know, if you work backwards from the $3 million and add on to that the sale of the corporate finance indications, which we sold, plus the fact that this is a quarter where we didn't grow and we took down our EFR balances, when you kind of reverse engineer it, we would have been closer to what we posted in previous quarters. So the $3 million really represents and that of those actions. Dale, you want to talk about the CECL stuff?
spk03: Yeah, so, you know, we subscribe to kind of Moody's kind of performance, and that has, as we indicated, kind of gradually deteriorated. Like I said, you know, we're not seeing that. You know, for us, the most significant variable is really what happens on the commercial real estate metric. I think for most banks, this probably has to do with unemployment. And when you look at where they are projecting a decline on the consensus, and then we also consider S4, those levels are still kind of well above what our advance rates are on commercial real estate transactions. And so while they pick up a little bit in terms of loss, it's not as dramatic as maybe some other institutions might realize.
spk02: Great.
spk11: And as you think about areas that you want to grow in in 2023 in terms of loan portfolio, would those be areas in your mind? I mean, you mentioned wanting to grow in less risky areas. Maybe areas that have more risk would have maybe more variable rate loans. Just kind of curious how to think about the areas that you want to grow in vis-a-vis kind of how that might impact provisioning.
spk06: So I'll say our loan pipeline still remains active. I would see us growing a little more in note financing, bill to rent, multifamily looks strong as well as industrial. You'll see some pickup from construction loans that we did in previous quarters that are beginning to fund up. And hotel financing will be active as we look going forward.
spk03: I also think residential could be interesting. You know, what we don't want to do is get in front of, you know, a Fed action and, you know, kind of decrease asset sensitivity until there's more clarity in terms of where rates are headed. But I do believe that mortgage rates that begin with a seven is probably going to be something that's going to work out over time.
spk02: Great. Thanks, guys. I'll hop back in queue.
spk17: Thank you.
spk01: The next question comes from Delano Steven, Alex Postles, with JP Morgan. Please proceed.
spk07: Hi, everybody. I wanted to start on the deposit side. In terms of the deposit growth, the 13% to 17%, could you talk more about how you see the mix evolving through the year? And particularly, I'm curious how much of the growth do you plan on getting from ECR deposits, time deposits, It's obviously a fairly aggressive deposit growth guide.
spk03: Yeah, so like we said, I mean, in terms of actual kind of core non-interest-bearing DDA, if we could hold that flat, I think that would be a win. And I think the larger ponderance is going to be in interest-bearing money market accounts, and those come in different varieties in terms of spreads that we offer. depending on the relationship and whether there's credit tied to it as well. I do think that the CD side is probably going to increase a bit more than it has, but probably to a lesser, at a lower rate than what we've grown recently. And then interest-bearing checking is where I think is also going to be kind of a strong growth area. much of our HOA deposits kind of flows into that category at this point in time. So at the end, the DDA I think you're going to see is still going to probably diminish as a proportion of total. The growth there is going to be in ECR-related big chunk in the money market accounts and a little bit more in CDs.
spk07: Got it. So Dale, if we follow that through of interest-bearing deposit costs for $197 this quarter, Where do you see that moving to by 4Q23, you know, in terms of what you need to get in terms of this NIM being stabled up a bit? What are you assuming deposit costs rise through, interest bearing?
spk03: So, I mean, it really depends a bit on your rate forecast, but what we see is that interest bearing deposit costs, you know, right now, and if I throw deposit costs in there from ECR, You know, we grew during the fourth quarter. Net interest income was up about $39 million. If I add the interest expense plus the ECR charges, gave up about three-quarters of that. I think that that range is probably going to more or less be intact. So I think we're going to incrementally improve net interest income, including ECR debits against it, but at a diminished rate than what we saw the past couple of quarters.
spk07: Okay. When I look at where some of your peer regional banks have come out this quarter in terms of what they're paying on deposits, many of them have barely budged on some of these categories. I'm curious, what's the conversation you have with prospects, and is this just a massive opportunity for you to bring over new households, businesses, and do you see this more of a consumer or business opportunity? Thanks.
spk06: We're a commercial bank, so we don't have much in the way of consumer deposits. And so our deposits are going to be floating at the marginal higher end of interest expense, but we focus on net interest income, and we have the ability to take those deposits and put them in 100% beta loans and hence make the spread on it. And so that's been the conversation. We're seeing larger clients move some of their money to us and having conversations about moving money to us. We like that. And, you know, what's really a little bit different for us in terms of how we approach business, we started the change somewhere in the middle of Q3 of last year, is, you know, we used to lead with loans, and now we lead with a deposit conversation. And we're very clear that there will be no credit extended unless there's a very strong deposit relationship. And that conversation has been well received by our client base.
spk07: Thanks for taking my questions.
spk01: Thank you. The next question is from the line of Ibram Pumwala with Bank of America. Please proceed.
spk00: Good morning. Yes, a few follow-up questions. Maybe one, I'm not sure if you already mentioned this. Apologies. Just around the expense outlook, everything about core expenses. So just remind us in terms of the growth that you are thinking about as part of your PPNR guidance and also the one key seasonality that we should be thinking about.
spk06: Sorry, I didn't hear that last part. What was the one thing we should be thinking about?
spk00: Did you hear that part? The first quarter seasonality, like I'm assuming like first quarter historically is marked the high water mark for the efficiency. I'm just wondering if there should be a seasonal lift in expenses that we should be baking in.
spk06: So I'll take the second part of that first. The answer is yes, our expenses tend to pop up a little bit more in Q1. But overall, our efficiency ratio we're targeting is in the low 40s, which we've always targeted. And we have one of the leading efficiency ratios in the industry. We kind of feel that that's the right place to be. It allows us to continue to make the appropriate investments in the bank on both risk management and technology as we continue to get bigger and bigger, but it also allows us to invest in new products and new businesses. For the last several years, we've been investing, as I said, in settlement services, in business escrow services. We've got a new initiative we just recently launched in deposits that we're not ready yet to talk about, we built last year that's off to a good, strong start. So keeping the efficiency ratio in the low 40s allows us to generate the operating leverage we want, also invest money today for future performance.
spk00: Got it. And what does that imply just in terms of how we think about just the expense growth for the year? Is it high single digits?
spk03: You know, it's going to be high single digits, might be low double. You know, if you look at kind of the PPNR element, you know, 11 to 15, holding the efficiency ratio basically flat, flat as to where we are, could provide for, you know, a little more room. But what we're going to do is, you know, we're watching this closely. I mean... And so as things, you know, we authorize, you know, FTE as we continue to demonstrate performance on growth of the balance sheet, we're going to have revenue need our expense expansion.
spk06: I want to make sure we're not talking across each other. So my commentary was on the adjusted efficiency ratio without deposit costs, because Dale just talked about that, putting it towards net interest income. So on the adjusted efficiency ratio without the rise in deposit costs, that's what we think will be in the low 40s. Okay.
spk00: Noted. And just, go ahead. Yeah, and I guess maybe a separate question. Going back to credit, and I understand the macro uncertainty, but when you look at your PPNR guidance that you've given, even assuming provisions near 2020, would imply earnings at about $10.50. I'm just wondering, is there anything around the loan book that causes that hesitation when you think about EPS outlook for this year relative to your guidance? And obviously, you expressed comfort with the asset quality of the book. So I'm just wondering what would be the scenario in which that $10.50 EPS plus or minus would not be achievable?
spk06: So as you know how CECL works, it really comes down to the end of the year and then the outlook into 2024. So if Moody should turn more bearish as we put on loans, you're increasing your provision for the life of that loan, not for the risk that's in the book. And so that's why we've been a little bit more reticent on voting where we think EPS numbers are. and then stay more on the PPNR side. Those are the things that we can control. On NASA quality, again, we're not seeing any issues at this moment. I would point you to a little bit of the last two slides in the presentation where we think we've been able to grow in a loan growth in a very prudent way and keep our charge-offs down. And I would remind you that 54% of the book is either insured or resilient or resistant categories.
spk00: Correct. If I may just follow up, when we think about the loan growth, 10% to 15% for this year, a lot of macro uncertainty. Should we be worried in terms of the quality of loans that you're putting on the balance sheet right now at this point in the cycle? Just from a client selection standpoint, is there a risk of adverse selection? No.
spk06: So, you know, we're not going to grow for growth's sake, right? So the asset quality is incredibly important. In my opening comments, one of the things I want to get rid of is any connection to the GFC 2007 and 2008 and 2009. I want no connection to that. We are a completely different company. So we want to grow above trend, yet at the same time we want to have above trend asset quality or best-in-class asset quality. We're working on doing both. So we're not going to sacrifice the asset quality for higher loan growth. Having said that, after going through our reviews, we think the range that we gave of 10% to 15% allows us to grow the loan book without growing into a recession and also protect or can remain with stable and strong asset quality?
spk03: We will pivot as necessary as, you know, new facts and situations emerge. I mean, we did this during the pandemic. One of the few banks that sustained a growth trajectory during that point in time. And where did we go? We weren't sure how, is it two years or is it four years to a vaccine? So we went into a capital call and, you know, a low LTV residential. Never lost a dime on either of those. And so we're going to be nimble about what about our, you know, using the flexibility of our business model to sustain earnings performance improvement over time.
spk17: Thank you for taking my questions.
spk01: Thank you. The next question comes from the line of Brandon King with Truist. Please proceed.
spk15: Hey, I wanted to touch on loan yields. I know, Ken, you mentioned last quarter seeing loan committee turn down 31 loans initially and getting better pricing. So I want to get a sense of what the outlook was for loan spreads going into this year and if you're still getting the same reception from clients.
spk06: I'll give you another story to that, too. So our loan yields are holding in from that last conversation we had when we did our Q3 earnings. Dale mentioned spreads are up about, on average, 50 basis points. And we're not getting a lot of pushback on pricing. I don't have any numbers for you, but I can tell you when we say no to a loan, that has good asset quality and good pricing, we usually are saying no because it's not generating the deposits that we want to accompany that loan. And what we're seeing is when we turn down those loans, those loans have been returning to the Senior Loan Committee now with greater deposits. So, what we're encouraged about is that the pricing is holding and our determination to see more deposits accompany the loans has been following through from our credit committee.
spk02: Okay. That's helpful.
spk15: As far as the risk-weighted asset optimization, is that process complete, or is there still some work to do going into this year?
spk06: Tim, Mark can take a shot at that one. He's been running the process.
spk04: Yeah, thanks, Ken. That is ongoing, and it's definitely a part of our culture, so something that we'll continue to do. There's definitely remaining benefit to be achieved through optimization. Some of that's in the targeted growth portfolio mix, and some of it is just structural with our clients. But ongoing improvements still expected. Thank you.
spk15: Got it, got it. And then just lastly, on the mortgage warehouse deposits to understand the seasonality in the fourth quarter, and that's came back in this quarter to date. But should we expect a similar kind of magnitude as far as seasonality in the fourth quarter of like this year and going forward?
spk03: What is more pronounced in the fourth quarter of 22 than we've ever seen before? And I think some of the reasons for that So we have some of our accounts that relate to taxes and insurance, and others are principal and interest. So the taxes and insurance we expected to decline largely because of California property taxes are due in 4Q. The P&I payments tend to have much more interim month ebb and flow, but not so much kind of seasonal elements. And that changed a bit this time. From our view, I think there were very few refinancings and almost very few sales of residential real estate that took place in December. And so as a result of that, when somebody pays off, let's say somebody pays off a loan or has it refinanced on, say, the 5th of December, what will show up for us is we'll get a deposit including that principal of that loan and that then is remitted to one of the GSEs two weeks later. Well, that didn't happen, and so I do think that you can make your own projection about what December of 23 is going to look like, but the dearth of activity in the month of December, which I know is seasonal trough anyway, but it was certainly more significant than usual, and that contributed to this, and that seems to be turning even now. Now, is this an early turn in terms of kind of the spring buying and selling season?
spk02: I'm not sure. Okay, thanks for taking my questions.
spk17: Thank you.
spk01: The next question comes from the line of Andrew Terrell with Stevens. Please proceed.
spk10: Hey, good morning. Looking at the capital call loans down around a billion for this quarter, is that the pace of runoff we should expect out of the book over the next couple of quarters? And I know there are some associated CLNs against the portfolio. I guess, do those securities remain in place as the capital call portfolio comes down, or would the CLNs fall commensurate with the reference pool?
spk04: Tim Bruckner again. I'll take the first part of your question on the portfolio runoff. Answer is no. That's not to be expected. That was driven by a handful of large transactions we elected to exit for return reasons. As we move into the coming quarters, we won't see similar dollar amounts of runoff at all.
spk03: We do have a CLN on the – I appreciate you remembering that – on the capital call and subscription lines. That CLN, as opposed to the residential ones, which are closed, so it's a specific pool of loans, and as those loans pay off or whatever, that's done and the CLN runs down. This one is a substitution ability, so it lasts for three years. So we have the ability to, if something comes out of that, we can put something else in it. That CLN is a fraction of our total capital call and subscription lines. So it doesn't really have much of an effect there. It was really done for, as Tim indicated, for return purposes, not so much for capital management because we've already taken a portion of those down to 20% through that process.
spk10: Okay. Got it. And then, Dale, do you have what the MSR valuation change was this quarter? And then any thoughts on just run rate for mortgage servicing and then gain on sale income?
spk03: Yeah, we had no change in the valuation of the MSR in Q4. So what that means is that the hedging basically very materially completely offset what was taking place in terms of market rate. So there wasn't any valuation adjustment that had happened. Kind of going forward, You know, I think there maybe is going to be some MSR dispositions that take place, and so is that going to have an effect on the market? But at the same time, I think there's a little more stability in terms of what people expect around refinance behavior, and so that could kind of extend the lives and the confidence in terms of what those servicing rights are worth.
spk06: I would add that as you look quarter to quarter, I would think about the total mortgage income being relatively flat to Q4. I think that was your specific question. And while too early to call a trend, I would say that the first 20 or so days into January, we are encouraged by margins rising in the business as that large money-centered bank has of the correspondence lending market. And so we've got our fingers crossed that that continues to move forward. But at this point, so that's positive. That's an emerging opportunity, we think. But right now, I would keep Q1's mortgage income relatively flat to Q4's.
spk10: Okay, got it. And then if I could just sneak one in on that, the last point, just the competitive dynamics in the correspondent business. Perhaps that does create some tail end to the gain on sale margin, but does the exit of a larger competitor give you greater opportunities to grow the balance sheet at all?
spk06: We're going to still manage the balance sheet relative to our capital CT1 goals of getting towards 975 to 10%. As you know, MSRs, if they grow in an outsized way, versus our internal capital generation become punitive. So, you know, we will be sellers of MSRs throughout the year. And with that, we also hope if we sell to non-banks that we keep deposits that are accompanied with these MSRs, as well as possibly even providing MSR financing to the buyers. And that was always our premise as investors. when we bought AmeriHome.
spk10: Understood. Okay. Thanks for the questions.
spk01: Thank you. The next question comes from the line of Chris McGrady with KBW. Please proceed.
spk16: Oh, great. Thanks. Hey, Dale, the capital build in the quarter, I think the way I'm thinking about it, many thought you would build capital. Some thought you'd build reserves. I'm interested kind of in your dynamic, how you're thinking about building one versus the other. And could you just remind us, 10% is the target. I think prior commentaries, you get there by mid-year. But with recent efforts and maybe some more, any change in timeline there?
spk03: So, I mean, it really starts with the reserve. So, you know, we look at our loans, our exposures, and overlay that with, you know, what Moody says and our own interpretation of kind of, you know, market sentiment outlook. And we, you know, derive, you know, gap compliance, you know, kind of seasonal numbers. And I realize that ratio is lower than some others in this space. And I think you don't have to look any further than our asset quality in terms of, you know, charge off behavior and changes in terms of kind of what's transpired there. I mean, we have, you know, in the slide deck, we have kind of our segmentation in terms of, you know, credit protected, resistant, resilient, and then the more sensitive fees. And that is just a small fraction. One-eighth of our loan book is something that we think is going to have some, you know, perhaps volatility. Another measure that we look at is you take your ACL and divide that by annual charge-offs. We had zero this year, but even if you took a couple of basis points on it and divide that into 60 basis points, you're going to get 30 years of charge-offs. I know this is better than most years, but the average duration of our loan book is under four. All sorts of ways we look at it and we think our reserve works as is. So now it's about what do we talk about in terms of what falls down to the bottom line in terms of tangible common equity. I wouldn't move up our timeline at all. I think 60 basis points is a fairly significant move for one quarter, but we're going to do both. We're going to grow capital and we're going to grow our balance sheet at the same time. sustain an improving trajectory in terms of net interest income and sustain our returns while our capital continues to climb toward the high nines later this year.
spk06: Chris, to be very specific, I think you can look for us to be in that capital range of $9.75 to $10, so it's the back end of the year. We got a real jump on Q4 by opportunistically selling some some loans and then being able to move quickly in the EFR space. That's our capital call and subscription line. So quite frankly, we're pretty proud that we were able to move the capital 60 bps in one quarter. But I think you can look towards the back end of the year for those numbers.
spk16: And that's, Ken, that's all organically, right? There's no more CLNs assumed in that?
spk03: We don't have any CLNs assumed in there and certainly no ATM either. Okay.
spk02: Thanks, Del.
spk17: Thank you.
spk01: The next question comes from the line of David Smith with Anonymous. You may proceed.
spk02: There.
spk08: Can you share the run rate for the ETR and deposit costs as of 12-31? What that would be on kind of a full quarter basis?
spk03: I wouldn't say that it materially changed from where we were for the quarterly number. It didn't grow quite as much as maybe some had anticipated because the dollars came down in terms of ECR deposits. I think that we can track from the fourth quarter number overlay what you think is going to happen in terms of in terms of FOMC actions and what you think is going to happen on the balance sheet in those particular categories. That should work. Okay. We check the dollars we have in there with one of those.
spk08: Okay. And in terms of the mortgage warehouse deposit book, Can you share the breakdown between non-interest bearing and interest bearing there? Is it notably different from what the mix was for the bank as a whole as of the fourth quarter?
spk03: So most of the mortgage warehouse deposits are in DDA with an ECR, and that is the preponderance of all the ECR dollars that we have.
spk08: Got it. Okay, thank you. And lastly, in terms of the RWA benefit that you got from the reduction equity fund resources, could you expand on that a little bit? I imagine that it must not be zero risk weighting, but given the kind of the risk those loans tend to have, it must be a pretty low risk weighting, I would have thought.
spk03: The general construct of providing, you know, credit link note, is to provide protection, i.e. first loss taken by a third party. So we get funds in, we sell a bond to a third party, and they get that interest on that bond less any losses that arise from this reference pool. So on the EFR loans, these subscription lines, they're normally 100% risk-weighted. But because we've sold a note to a third party and they assume first loss, the first 12.5% of losses in that portfolio, they pay. And actually, we already have their money, so we control how much they get back because we only pay them back less any losses incurred. And because of that architecture whereby you have moved the now kind of this structured product to a AA or better category, basically treated as a 20% risk-weighted asset. So no matter what type of asset you come from, you end up at 20. So residential, you start at 50, end at 20. Capital call and warehouse, you start at 100, and you still end up at 20.
spk08: Okay, got it. So without the CLM, though, the risk rating is 100. Got it.
spk02: That's good to know. Thank you.
spk17: Thank you.
spk01: The next question comes from Delano to Mayor Brazilea. With Wells Fargo, please proceed.
spk14: Hi, good afternoon. Just a couple follow-ups. With deposit growth expecting to exceed loan growth in 23, what's the excess funding going to be used for? Is the primary focus initially to pay down some of this near-term borrowing, or is that excess funding going to be layered into the securities book?
spk06: It could be either or, but our first goal would probably be to lower our borrowings and take down that cost. Okay, great.
spk14: And then, again, following up on the large bank exiting the correspondence space, and thank you for that. mentioning the bank by name, but pretty large player in the space. What happens to that market share? Is that market share kind of split amongst the rest of the constituents, and are you expecting AmeriHomes portion to grow, or are you more or less kind of ring-fencing that and keeping the existing business as is with kind of competitors maybe getting more of that market share that's up for grabs?
spk06: So I think like some of the other competitors, they balance market share with gain on sale margin. And that's what we do. So if we can hold our existing market share and grow the gain on sale margin, that works for us. And that's sort of where we've been. And I think that's what the industry is trying to do. There seems to be a little discipline going on here. but without mentioning that bank that left, it's early days, and we'll wait and see, and we'll clearly have more color on it as we get through the end of the first quarter.
spk03: During the third quarter, which is when margins dropped, we did a little experiment whereby we pulled back in terms of activity and purchase volume, and we saw margins move up a little bit in that scenario, and I'm not sure that's the reason why, but they basically stayed at a at a somewhat elevated place from how far they had fallen to in the fourth quarter. So I don't know. We're encouraged by that, and we'll see what happens. Got it.
spk02: Thank you.
spk01: Thank you. The next question comes from the line of John Arshroom with RBC. Please proceed.
spk13: Thanks. Hello, everyone. John, a question for you on the chart you have on the slide 18, the economically resilient portfolio positioning. That's a mouthful. Sorry. What do you expect that mix to look like in one to two years from now? I guess another way is where's the emphasis in terms of your growth drivers? from where we're starting today.
spk02: Hi, Tim Bruckner.
spk04: You will see us focus growth particularly through any potential or real recession in areas that are resistant to recession. At the same time, you'll see us reduce our exposures in some of the more sensitive areas. So we will do that more with precision than with a broad brush, but specifically getting, lowering exposure, getting out of industries that are particularly sensitive, and then really the resistant areas, that's taking to our netting. When we talk about growth there, We're talking about relationship growth. So these are with sponsors that we know, not just at the lender level, but at the top of the house. And we're growing specifically at low loan to value, high amount of sponsor investment in the deal. What we're doing differently though right now, we can do it, we can be more selective, is we're being very selective about the sub markets as well that we're in if it's real estate related. And that's where we're growing.
spk13: Okay. Okay. Got it. Dale, question for you. The PPNR growth of 11 to 15% may be obvious, but what do you see as the key risks? Meaning what brings you closer to 11 or below 11 and what could put you at the higher end?
spk03: Well, I mean, first and foremost, we see our task in front of us is sustaining deposit growth. With deposit growth, we've got the balance sheet leverage. We believe we have opportunity in the asset side to deploy this at significant spreads, which will drive NII, obviously driving PPNR, and, of course, avoiding much in terms of the provision costs other than you know, the higher balances. So I think that's the number one thing, you know, sustaining our deposit growth. And we've got a number of initiatives and some of them are coming to fruition, I think, now. And we think we're, you know, we're going to be, you know, be on track.
spk13: Qualitative reserve size. Any help you can give us on that? How big is the qualitative piece of your reserve?
spk02: Yeah, I can. As far as you're talking about the qualitative adjustments on the ACM rate, about 5%.
spk13: Okay. And then, Ken, just one for you. How are you judged? How are you guys judged? Is it tangible book failure growth? Is it EPS? Is it credit? Where are you guys most focused in terms of the financial metrics that we look at for the coming year? Thanks.
spk06: As it relates to performance, it's sort of up and down both the income statement and the balance sheet as as determined by our short-term, our STI compensation, EPS, loan growth, deposit growth, asset quality, operational quality, and the growth in our capital base. In terms of the LTI, of course, it's share price, and the share price is motivated by the growth in EPS. And so those are the things that...
spk02: we focus on. Okay. All right. Thank you.
spk17: Thank you.
spk01: There are no additional questions at this time. I will now hand the call over to Ken Vekanani for closed remarks.
spk06: Hi. Thank you all for joining us today, and we look forward to talking to you about the Q1 results in the next couple of months.
spk02: Thanks. That has concluded today's conference call. Thank you. You may now disconnect your line.
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