(WAL)
Q1 2024 Earnings-Transcript
Operator: Good day, everyone. Welcome to Western Alliance Bancorporation’s First Quarter 2024 Earnings Call. You may also view the presentation today via webcast through the company’s website at www.westernalliancebancorporation.com. I would now like to turn the call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Please go ahead.
Miles Pondelik: Thank you, and welcome to Western Alliance Bank’s first quarter 2024 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; Dale Gibbons, Chief Financial Officer; and Tim Bruckner, our Chief Banking Officer for Regional Banking will join for Q&A. Before I hand the call over to Ken, please note that today’s presentation contains forward-looking statements, which are subject to risks, uncertainties and assumptions, except as required by law. The company does not undertake any obligation to update any forward-looking statements. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, please refer to the company’s SEC filings, including the Form 8-K 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.
Kenneth Vecchione: Good morning, everyone. I’ll make some brief comments about our first quarter earnings before turning the call over to Dale, he will review the financial results in more detail. I’ll come back and discuss the ’24 outlook, and then Tim Bruckner, our Chief Banking Officer, will join us for Q&A. For the last three quarters, the mission of the company has been to reposition the balance sheet and optimize our funding structure to establish an unassailable foundation of higher capital, liquidity and insured and collateralized deposits and further distance us from last launch. Together, these factors should provide a hallmark to better inflate the bank from future industry and market volatility, as well as support more predictable, superior long-term returns.
This quarter, we generated exceptional deposit growth of $6.9 billion that accelerated our repositioning plan at a faster pace than anticipated. We reached our CET1 capital target of 11%, lowered our HFI loan-to-deposit ratio by 10 points to 81%, and increased our already leading insured deposit ratio to 81%. Our liquidity profile was also enhanced by a $6.5 billion increase in unencumbered securities and cash from year end, which also will allow us to pay down — which also allow us to pay down borrowings by $1 billion. In summary, our repositioning goals have largely been accomplished. I’m pleased that during the quarter of outsized liquidity growth, Western Alliance earned $1.72 per share, excluding the increased special assessment from the FDIC, and tangible book value continued to climb despite rate headwinds.
Asset quality remained steady with special mention loans and classified assets declining $139 million in aggregate from Q4. Net charge-offs remained low at only 8 basis points of average loans. Our excellent liquidity positions us to drive stronger loan growth starting in Q2. Loan growth should track proportionately with deposits to maintain our improved loan-to-deposit ratio and allow us to exit 2024 in line with market expectations. Dale will now take you through the financial results.
Dale Gibbons: Thanks, Ken. During the first quarter, Western Alliance generated reported pre-provision net revenue of $247 million, net income of $177 million and earnings per share of $1.60. Excluding the $18 million FDIC special assessment charge, PPNR was $265 million, net income of $191 million and earnings per share was $1.72. Net interest income increased $7 million from Q4 to $599 million from higher average earning asset balances as well as lower average borrowings. Non-interest income of $130 million increased $39 million quarter-over-quarter from consistent performance in mortgage banking, including an improved MSR valuation from a higher balance of servicing rights owned. We look at mortgage revenue holistically because our conservative valuation process when servicing rights are created often results in understated MSR values, which dampened gain on sale revenue.
GAAP non-interest expense was $482 million or $464 million excluding the FDIC special assessment. Deposit costs of $137 million or $6 million above Q4 levels, essentially offsetting the net interest income growth during the quarter and driven by strong deposit growth from both existing and new clients in our HOA and Juris Banking businesses, along with the continued rebound in mortgage warehouse from seasonal lows. Typical seasonal factors as well as the reset of incentive compensation accruals, which were discounted in 2023 were the primary reasons for the increase in salaries and employee benefits in Q1. Provision expense of $15 million resulted from loan growth as well as $9.8 million in net charge-offs, while our economic outlook remains stable.
Lastly, our effective tax rate fell to 23.5% from a temporarily elevated rate last quarter. Loans held for investment grew $403 million to $50.7 billion, while deposits increased $6.9 billion to $62.2 billion at quarter end. As a result, our held-for-investment loan-to-deposit ratio fell to 81% from 91% last quarter. Outsized deposit growth accelerated our liquidity building efforts. Securities and cash increased by $0.4 billion (ph) quarter-over-quarter and allowed for a further $1 billion reduction in borrowings. Finally, tangible book value per share expanded $0.58 for the quarter to $47.30 from retained earnings, which more than offset a modest rate driven increase in our negative AOCI position. Held-for-investment loan growth of $403 million occurred predominantly in C&I categories.
Commercial and industrial growth of $646 million demonstrated noteworthy progress in our regional commercial banking strategy as well as success in both mortgage warehouse and tech and innovation. C&I growth also mitigated a purposeful reduction in commercial real estate. On a year-over-year basis, total loans increased $4.3 billion, almost entirely from C&I production, which has been a point of emphasis for the bank. Outstanding deposit growth of $6.9 billion resulted from broad-based growth and market share gains from our regions, commercial deposit businesses and digital consumer channels. More specifically, our regions contributed approximately $1 billion HOA and digital consumer each over $800 million; Juris Banking over $400 million; and Corporate Trust added $160 million.
Mortgage warehouse deposits reacquired the $3.5 billion and fully replace Q4 outflows as our DDA deposit balance at March 31 surpassed where we were at September 30. Overall, in a more stable rate environment, we are experiencing minimal mix shift of existing client funds into higher cost deposits. Turning now to our net interest drivers. Held-for-investment loan yields increased 12 basis points due to the higher rate environment. Loan growth was weighted towards the end of the quarter as demonstrated by period-end loan balances exceeding average balances by $1 billion. The yield on total securities decreased 33 basis points to 4.66% from our efforts to significantly enhance our liquidity profile, which resulted in a total high-quality liquid securities increasing $4.8 billion from Q4.
In addition, the proportion of average interest earning assets invested in securities and cash increased 23% from 21% in the fourth quarter as a result of these repositioning efforts, which have largely been completed. These efforts position us well to deploy incremental funds to higher-yielding commercial loans earlier than initially expected as well as to manage the cost of deposits lower ahead of the Fed rate cut. The cost of total interest-bearing deposits expanded 11 basis points, while the total cost of funds was flat at 2.82% as average short-term borrowings declined $1.8 billion to 8% of average interest-bearing liabilities. In aggregate, net interest income increased approximately $7 million, while net interest margin of 3.60% compressed 5 basis points due to the earning asset mix shift and securities we discussed.
Additionally, adjusting for the increased FDIC special assessment and deposit costs, our adjusted efficiency ratio for the quarter was 54.4%, which also reflected higher seasonal costs. Deposit costs moved up only $6 million or 4.6% quarter-over-quarter, even though average balances of ECR-related deposits grew $1.4 billion or 7%. Asset quality metrics continue to remain steady and are reflective of our ongoing forward-looking portfolio monitoring and proactive credit mitigation strategy, which produced low realized losses. In aggregate, special mention loans and classified assets declined $139 million from Q4. Non-performing assets increased $126 million to $407 million or 53 basis points of total assets, as we execute our strategy to accelerate resolution for this subset of loans and proactively address them before reaching maturity.
Notably, about two-thirds of our NPLs are paying as agreed with regard to debt service obligations. As stated previously, we’ve largely avoided the largest urban centers for commercial real estate lending that have experienced more value contraction in the nation at large. We see that in our submarkets, which we watch closely, our borrowers projections continue to perform better with more stable appraisals than other markets. Quarterly net loan charge-offs were $9.8 million or 8 basis points of average loans provision expense of $15.2 million covered net charge-offs and provided reserves in concert with loan growth. Our allowance for funded loans increased $4 million from the prior quarter to $340 million and the allowance for credit loss ratio to funded loans of 74 basis points was stable, covering 94% of non-performing loans.
The valuation of NPLs, which primarily consists of real estate secured credits are confirmed by fair value appraisals and collateral. Our CET1 ratio again grew 20 points to 11% or 10% when adjusted for our negative AOCI position, which is 160 basis points higher year-over-year and 230 basis points above our Q3 2022 level when our repositioning efforts began. Our tangible common equity-to-total assets ratio moved down approximately 50 basis points from Q4 to 6.8%, as asset growth in low-risk categories exceeded organic capital accretion from higher earnings. Tangible book value per share increased $0.58 from December 31 to $47.30 for retained earnings growth outpacing the higher AOCI offset. Our consistent upward trajectory and tangible book value per share has outpaced peers by over 4 times since 2013, including strong growth in 2023.
I’ll now hand the call back to Ken.
Kenneth Vecchione: Okay. Thanks, Dale. We have transformed the bank several times in the company’s history. Starting as a Las Vegas Bank in 1994 and expanding into Arizona and California in 2003. In 2010, after the GFC, during which we were landlocked in some of the most stressed markets nationally, we began our diversification strategy into national business lines, with HOA and mortgage warehouse that created diversity, growth and sustainable earnings without undue risk. In 2015 and 2016, we added Bridge Bank to enter into the tech and innovation economy, and that purchased the hotel franchise finance business, which provides expertise and deep industry knowledge, enabling us to become a leader in that vertical. In 2018 and ’19, the bank entered, developed and launched three specialty deposit verticals: settlement services, business escrow services and corporate trust that expanded the business diversification strategy and produce access to new deposit sources.
In 2023, we launched a digital consumer deposit strategy to gain access to a granular deposit base. Now in 2024, the company has worked hard to reposition and fortify its balance sheet and liquidity. Informed by the events of last March, the management team continues to optimize funding, significantly improved capital and carry higher levels of insured and collateralized deposits to form a solid, sturdy balance sheet, which can be used as the foundation to reignite earnings, grow the balance sheet and generate organic capital while ensuring asset quality remains safe and protected. So what does WAL look like in the future? Well, using and reinforcing the disciplines I just mentioned, Western Alliance has and will continue to have risk management architecture that will enhance the company’s guardrails as we continue to develop new organic avenues for growth to deliver consistent upper teens return on tangible common equity and sustainable earnings growth that maintains historical capital accumulation at multiples higher than other banks.
We are excited that the repositioning strategy has been largely completed. We have fortified our balance sheet, which we will — which will allow the company to generate earnings velocity through the back half of 2024 and into 2025. To that end, from our first quarter results, we updated our 2024 guidance as follows: continued thoughtful balance sheet growth at a slightly higher level building on the momentum of Q1 and more focused on deploying incremental liquidity into sound, safe and thoughtful loans. Our current loan-to-deposit ratio provides flexibility to selectively make more loans as opportunities arise. For the full year, loans are expected to grow $4 billion up from $2 billion, given the new client wins in current pipelines. We also expect deposits to end the year up $11 billion, which is $3 billion above our previous consensus.
Turning to capital. We expect our CET1 ratio to remain steady at or near 11%, capturing the forecasted increase in loan volume. Regarding net interest income, we reaffirm our 5% to 10% growth expectation from Q4 2023’s annualized jumping off point and are tracking to the upper end of this range. Our rate outlook includes two 25 basis point cuts in the back half of the year and a higher for longer rate environment without rate cuts by the FRB, we would expect NIM to incrementally benefit by mid-single digit basis points from loans repricing in an elevated rate environment. Our expectation is that net interest margin will trough in Q2, but the full quarter effect of our liquidity build — I’m sorry, with the full effect of our liquidity build, while net interest income will continue to move higher from Q1 levels.
NIM should ascend due to repricing of existing loans and new loan originations, which all should generate a full year NIM in the low 350s. Non-interest income should increase 10% to 20% from an adjusted 2023 baseline level of $397 million. Mortgage banking-related income remains somewhat dependent on the rate environment and mortgage volume, but we are encouraged by the resilience of the Q1 results. Non-interest expense, inclusive of ECR-related deposit costs is now expected to rise 6% to 9% from an annualized adjusted Q4 baseline of $1.74 billion, primarily from the accelerated ECR-related deposit growth we achieved in Q1, which helped the company reach liquidity targets earlier than expected. In aggregate, these factors should enable Western Alliance to consistently grow PPNR throughout the year and establish a higher baseline headed into 2025.
Asset quality continues to remain steady and is performing as expected with continued sponsor support of projects. Our full year net charge-off guidance remains 10 basis points to 15 basis points of average loans. At this time, Dale, Tim and I look forward to answering your questions.
Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from the line of Jared Shaw with Barclays. Jared, please go ahead.
Jared Shaw: Hey. Good morning, guys.
Kenneth Vecchione: Good morning.
Jared Shaw: Thanks. Looking at the guidance with the expense growth primarily coming from the ECR. I guess, why? Why wouldn’t that also help drive a higher expectation for NII? You’re saying looking at the higher end of that, but if — with this big deposit growth and the opportunity for loan growth, I guess, what’s — are we giving up all of that spread early stages to the ECR?
Dale Gibbons: No. It will help drive NII. The issue is that, that growth came in kind of ratably over the first quarter. We haven’t [indiscernible] up to the degree we can, the origination of good quality credit to disperse those additional funds. That’s going to take a process within, say, the second quarter. So it will catch up. But the second quarter is a little bit of a pivot point whereby we’re going to look for higher asset growth than we had in Q1 and that’s going to hold the second quarter back a bit.
Kenneth Vecchione: The prior guide — let me just add, the prior guide included four rate cuts, which have now been revised to two cuts. To offset that, we’ve also increased our loan growth from $500 million a quarter to $1 billion a quarter and that’s what helps our net interest income throughout the rest of the year continue to grow quarter-to-quarter.
Jared Shaw: Okay. All right. Thanks for that. I guess maybe shifting a little to the capital and now that you’re at the target floor of 11%. How should we be thinking about the desire to grow that from here? And can you give an update on how the credit-linked notes impact that going forward and sort of the timing on that?
Kenneth Vecchione: Yeah. So we see capital remaining modestly at or above 11% for the remainder of the year. Increasing loan growth above trend will absorb the excess capital formation for the rest of the year. I will note that since we started our repositioning strategy on capital from Q3 of 2023, we’ve increased the CET1 ratio of 230 basis points without raising capital. We do have a couple of CLNs embedded into these numbers and the runoff of the CLN is very modest year-over-year.
Dale Gibbons: Yeah. As you recall, we collapsed two of our CLNs last year in mortgage warehouse and capital calls (ph). We’ve got a few residentials that are — that don’t have substitution credits in them. So they are just running off. We’re gaining about 40 basis points to 50 basis points in CET1 from that.
Operator: Thank you. The next question comes from the line of Casey Haire with Jefferies. Casey, please go ahead.
Casey Haire: Great. Thanks. Good morning, guys. Question on the loan and deposit growth. Just wondering how you guys got to those numbers. I mean you guys have demonstrated that you’re capable of putting up stronger growth than that. And just wondering, if it’s conservative or if you’re just looking to manage the growth and have an eye on, obviously, the $100 billion line, so just some color there?
Kenneth Vecchione: Yeah. So Casey, while we continue to remain cautious about the future economic activity, and we have deemphasized certain asset classes, we do believe that we can actively grow loans $1 billion per quarter. And we feel rather comfortable with that based on the pipeline that get reviewed on a weekly basis. So we are deemphasizing certain areas, as you would expect, CRE office, residential, general construction, a little cautious on multifamily, we also see better opportunities in warehouse lending group and the SAR (ph) lending, the regional C&I business is beginning to take hold, resource lending and maybe lot banking also give us the best risk reward dynamics on the loan side. So if we could do better than $1 billion we will, as long as it’s safe, sound, and thoughtful growth and the economic environment hasn’t changed.
But right now, we feel comfortable with $1 billion. As it relates to the deposit guide, we certainly had a monster quarter at $6.9 billion. A lot of that came in because of our, we think, because of our better service levels, and we had a number of market share wins as well as a number of our new deposit verticals have really begun to take hold. Settlement services had a good quarter. Corporate Trust is growing. HOA had its best quarter ever. It was monsters. Okay. And in fact, we think we are now the leader in HOA deposits in the industry. And then the region also had a very good quarter as well for $1 billion. So taking together, all that informs us that we think we’re comfortable growing positive $2 billion a quarter for the rest of the year.
I will say, something we’re proud of here, when you look back over a year, we’ve grown total deposits by $14.3 billion. If you take out $1 billion for broker deposits, we grew $13 billion in a year. And that kind of gives us the confidence level to say that $2 billion seems very reasonable and practical.
Casey Haire: Yeah. Okay. And then, just switching to the expense front. Just to clarify, does the expense guide do include the $17 million FDIC assessment for this year? And then, if I layer in your guide, it looks like it’s delivering an efficiency ratio in the low 60s. That’s obviously with the deposit costs, but it’s obviously running a little bit higher than what you’ve been guiding to in the past. I think it’s been around 50%. So just wondering what’s the new expectation on that front.
Dale Gibbons: Yeah. I would look for something in kind of the mid-50s. We were 54% for the first quarter as you saw there. There were some seasonality in costs, which we talked about a little bit primarily related to compensation and FICA. But we do believe that we can get that number back to the beginning with a four again. And — but we would hope to have better performance, I think that was much stronger from AmeriHome in that process. We do think that there’s a significant kind of pent-up demand with AmeriHome and that there’s a lot of people that do want to move out of their house, but they’re kind of — they’re in love with their mortgage rate presently. As the — when we have that hit down at the FOMC commentary after this CPI in January that it really kind of came back and we saw a lot more activities and saw that in our numbers.
So with that, on the denominator side, more steady situation on the numerator side regarding their ECRs, we think that number can trail down over time. But for now, I keep it in the mid-50s.
Kenneth Vecchione: Casey, on the FDIC special assessment, that’s not in our numbers and our guide and our adjusted efficiency is going to be in the low 50s as we work that down towards the high 40s, but that’s what I would say, okay.
Casey Haire: Great. Thank you.
Operator: Thank you. The next question comes from the line of Steven Alexopoulos with JPMorgan. Steven, please go ahead.
Steven Alexopoulos: Hi, everybody. I want to start…
Kenneth Vecchione: Steven, can you get a little closer to the phone. You’ll probably get muted.
Steven Alexopoulos: Yeah. Could you hear me now?
Kenneth Vecchione: Much better. Thank you.
Steven Alexopoulos: Okay. So let me start on the deposit side. Ken, I thought you said, you thought you could grow deposits $2 billion per quarter. Is that right because that would take you above the $11 billion for the year?
Kenneth Vecchione: Well, on average, $2 billion a quarter, but Q4 is a little softer as you’ve seen last quarter where the warehouse lending deposits roll out. So we think that’s more of a private guide. Basically, we’re just trying to tell you — think about the end number of $11 billion is where we think we’ll end up.
Steven Alexopoulos: Got it. Okay. It’s funny, Ken. I’ve asked you, I don’t know, maybe two or three calls in a row. Once you get to your targets, how should we think about Western Alliance and growth desire appetite, where you could be long term. So if we think about if we average this out, you’ll probably one $2 billion, one $3 billion (ph) per quarter loans and deposits run rate, so call it $5 billion per year for each. Is that about adjusting for the loan-to-deposit ratio, is that how we should think about this now that you’re at target, maybe that $5 billion-ish growth per year balance sheet?
Kenneth Vecchione: So we’ve got a number of levers to pull and we have a great deal of optionality. So first thing I’d say is, the way we’re thinking about it is, from here, whatever liquidity we bring in, whatever deposit growth we bring in, we would like to put out at about 80% loan-to-deposit ratio. So we could stay between that 80% to 85% level. And that’s what we’re going to try to target going forward. It will take a little time to build up that loan growth engine because obviously, if we’re telling you $2 billion in deposits and $1 billion in loans, that’s not 80%, but we’re getting that back up again. You’ve got to get the deals done. You’ve got to get it documented. You’ve got to have clients put their cash in before we put our funding in, and that will just build up as we go throughout 2024 and into 2025.
And then if we do better than that, meaning a higher deposits or the loans stay in that $1 billion-plus range, then we’ll use some of that incremental liquidity, and we’ll use it to pay down borrowings, and that will also mute the growth of the balance sheet. Dale, do you want to add anything to that?
Dale Gibbons: Yeah. I mean to say it another way, I expect that we can exceed those numbers, Steve, a bit because we’ve been paying down borrowings coincident with growing deposits faster than your $5 billion a year number.
Operator: Thank you. The next question comes from the line of Chris McGratty with KBW. Chris, please go ahead.
Chris McGratty: All right. Good morning. Ken, Dale, it feels like the $100 billion has obviously got a ton of attention. It feels like you’ve more or less addressed every piece of it. Obviously, there’s ongoing regulation, but liquidity expenses, capital is that a message you’re trying to send with the last actions over the last few quarters?
Kenneth Vecchione: Yeah. So we are taking actions today and preparing to cross over $100 billion in a few years, okay? The improvements we’ve made in our risk management architecture, both on capital analysis, liquidity analysis and planning indicated to us that it was better to build that liquidity reservoir early on, and we wanted to get that done and we’ve accomplished that. The other thing was let’s get capital out of the way. We think 11% around that number is the right number going forward, so we’ve done all that. But behind the scenes also, Chris, is a lot more in risk management build that has to occur, that’s been basically built into the company over the last couple of years. So where we are today, we’ll say we’re about 75% of the way to us being ready to be $100 billion.
$100 billion is just a number for us. We’re not looking to get there sooner. It all depends on, again, the economy and the opportunities that we have in front of us. But what we don’t want to happen is we don’t want to be stopped when we hit that level. So we want to grow in an unencumbered way. In the meantime, the risk architecture that we’re putting into the company is paying dividends and somehow a return and how we think and manage the company. So we’re happy that we’re doing that as well.
Chris McGratty: Okay. Great. Thank you.
Operator: Thank you. The next question comes from the line of Bernard Von Gizycki with Deutsche Bank. Your line is now open.
Bernard Von Gizycki: Hi, good morning. So you guys had a nice quarter with fees, but you didn’t change the full year non-interest income guide outlook. You noted mortgage will be dependent on rates, but you were encouraged by the resilient results. How should we think about maybe the seasonality after 1Q for the different fee lines for the rest of the year. Additionally, equity investments have picked up the past two quarters. Wondering if you could provide any color there and how you think it should trend for the rest of the year?
Kenneth Vecchione: So there are a couple of questions inside of that, and I’ll take a shot at it and Dale will fill in if I miss anything. But a good portion of the fee income comes from mortgage, I would say that mortgage hangs around the hoop for the next couple of quarters, similar to that of Q1. And of course, Q4 for mortgage is always liner because of seasonal reasons. The gains you mentioned on the warrants, that’s very consistent with the prior quarter. It consists of valuing over 500 physicians every quarter. And as the tech business grows, we expect there to be more positioned to be valued. And right now, we don’t see a retracement in value at this time, and we think the way we’re valuing it based on where the tech industry is — we’re valuing it at the lower point of the cycle. Dale, would you add anything?
Dale Gibbons: Yeah. Just a couple of things. So other seasonality implications. So HOA, their best quarter is Q1 and that helped contributed to our nearly $7 billion increase there as well as the recovery in kind of mortgage warehouse deposits. So I would expect that future quarters are going to be lower than what we put out in the first quarter. And in terms of our guidance, we are tracking towards the upper end of our guide, that’s in the book regarding net interest income. But frankly, we’re a little above the midpoint for noninterest income as well.
Bernard Von Gizycki: Okay. Got it. And Dale, I think you noted earlier that you don’t expect much deposit mix shift from here. Obviously, the quarter was great with the amount of deposits you brought in, but mix shift was obviously favorable mostly the non-interest-bearing. And then obviously, in the interest-bearing, there is less focus on the higher cost CDs. When you think about rest of the year, you kind of said the minimal mix. Where are you kind of thinking for the additional $4 billion, would be kind of similar as we kind of look out to the outside quarters?
Dale Gibbons: Well, if I put on my optimistic hat, I mean we’re really doing some creative things in the regions, which would be a primary source of where we might get non-interest-bearing deposits. And I would hope that we could actually show growth there. We certainly saw growth in the first quarter, and we’re looking for that to continue. As you — maybe the trends you alluded to in terms of CDs, I think that, that is going to continue to taper off as we run through 2024. And of course, the preponderance of the growth is going to come in money market.
Operator: Thank you. The next question comes from the line of Ben Gerlinger with Citi. Your line is now open.
Ben Gerlinger: Hey. Good morning, guys. Sorry about any background noise, I had to step out. I just had a question in terms of the ECR. I know you guys lowered the cut expectations to kind of two in the latter half of this year. But just kind of thinking philosophically, if we have two more in the early part of next year, so a total of four just kind of pushed it out six months. Do you think next year’s expenses could actually be flat, if not down?
Dale Gibbons: Yeah. I think that could certainly be the case. Also would probably help with revenue significantly on AmeriHome as we discussed as well.
Kenneth Vecchione: Another way, we were talking about it earlier — I was going to say any future rate cuts into 2025 will help fund any inflation we have in the base. And I think that’s what you’re suggesting.
Dale Gibbons: Just one more point, getting to Ken’s comment earlier about optionality, one thing that this pool of liquidity gives us to enable us to do is to really one off some of our higher cost ECRs now which we are undertaking to push them down. And so we can get in front of FOMC action with lower funding costs. You saw that a little bit in Q4 to Q3 where the average ECR actually declined slightly. We’d like to see more of that, of course.
Ben Gerlinger: Got you. That’s great. And it’s nice to see WAL get back to the kind of the powerhouse that used to be in terms of growth potential. Kind of with that though, have you guys thought about any sort of potential M&A? Not necessarily over 100, but just bolt-on technology or any kind of FinTechs, just any sort of capital deployment outside of the share repurchase?
Kenneth Vecchione: So it’s still for us a little premature to think about M&A. And I would say, given the prospects that we see in front of us, we’d like to take any excess capital that we have and put it into organic growth, we think that would serve us best.
Operator: Thank you. The next question comes from the line of Matthew Clark with Piper Sandler. Matthew, please go ahead.
Matthew Clark: Hey, thanks. Good morning, everyone. On your interest-bearing deposit costs, I think you’re up 11 bps this quarter. I think the prior quarter up 7 bps. Can you give us a spot rate on interest-bearing deposits and what’s your outlook there? Is it fair to assume that, that rate of change will start to slow here and maybe stabilize next quarter or two?
Dale Gibbons: Yeah. We’re looking at really kind of stability across the board, both on asset repricing and on kind of liabilities here. There hasn’t been since it’s obviously been since last September kind of the last kind of rate changes we were talking about in July. It’s really kind of tapered off and the volatility is very stable. As I mentioned earlier, I think you see that net interest income going up for approximately the same amount as earnings credit costs rose. So there’s no great disparities between spot rates and kind of average rates presently.
Kenneth Vecchione: Well, what I’d add is that while deposit costs went up, we got rid of $1 billion in borrowings, and our overall cost of funds stays flat quarter-to-quarter. So when you think about what happened for the quarter relative to net interest margin, our loan yields went up 12 basis points. Our deposit costs went up 11. We paid down debt. And really the bottom line here is the margin dropped a little bit because of the excess liquidity we brought in that we’re keeping on the balance sheet in cash and in investment securities.
Matthew Clark: Yeah. Got it. Okay. And then just last one for me. The uptick in classified assets and non-performers. Can you just speak to what drove those increases and kind of the plan for resolution there?
Timothy Bruckner: Yeah. Sure. Tim Bruckner, I’ll take that. So first, I’ll just say the majority is related to secured investor real estate loans. This really results as a function of how we manage our portfolio. So we — as we’ve taken every opportunity to tell all of our constituents, we press hard for re-margining and have since early in the rate increase cycle, that drives the resolution. So the classified loans will move up as we reach the endpoint of the negotiation that doesn’t result in an effective re-margin. We then take those loans and we ledger the balance appropriately based on the value of the asset. We apply all principal and interest payments received to reduce that loan balance. I think it’s important to note on our books that two-thirds of these are current in terms of payments being made. So we’re not waiting for a delinquency to take our action here.
Kenneth Vecchione: And all the ones we moved in this quarter were all paying.
Timothy Bruckner: Correct, Ken. Thank you.
Operator: Thank you. The next question comes from the line of Timur Braziler with Wells Fargo. Your line is now open.
Timur Braziler: Hi. Thanks. Maybe just following up on that last line of questioning. Could you just talk us through the interplay between non-performing loan migration and the allowance. I guess I was a little surprised to see NPLs move higher, while overall allowance level is pretty much flat quarter-on-quarter?
Timothy Bruckner: Sure. Tim, again. I think it’s important to note in this context that the majority, we have a very small charge-off every quarter, the majority of the charge that we took this quarter was really associated with adjusting the balances of those loans as they migrate, so that we have plenty of coverage based on current appraised value of the asset less the cost of liquidity. So we move fairly aggressively into non-performing. We adjust our balance as opposed to placing just reserves on that.
Timur Braziler: Migration itself doesn’t necessarily…
Timothy Bruckner: Absolutely, right. And so when we talk about our philosophy here, we’re a low loan-to-cost lender. When you look at office, underwritten office 58%, 59% is where we’re at. So we look at this in the economy of credit underwriting collateral, our collateral position creates character increase support from sponsorship and that’s what we see demonstrated. So it carries through that we typically have very low loan to carrying values throughout the entire — throughout the process. Where we get close, we make an adjustment, take a charge and stay in balance.
Dale Gibbons: Our charge-off rate for the quarter annualized was 8 basis points, which is only about maybe a fifth or a fourth (ph) of what the industry is. On a reserve level at 74 basis points in the appendix of the earnings release, we walk that up to the 130 level considering the things that we have that we do that others don’t do, like a higher levels of residential real estate as well as CLNs we talked about a little bit. And so we think that’s actually a pretty strong level at 74 basis points. So if you take 8 basis points into 74, you’ve got nine years of loss coverage within there, while our duration of our loan book is under four.
Timothy Bruckner: Yeah. I’d add more than anything. When we look at this category, it’s performing as expected and moving to resolution as expected.
Timur Braziler: Okay. And then maybe as my follow-up, just looking at the securities purchases this quarter, can you give us the bridge just to get a sense of what that blended effect will look like in 2Q?
Kenneth Vecchione: We didn’t hear that clearly enough.
Timur Braziler: For the securities purchases made during the quarter, just trying to get a sense of what the rate was on those purchases to get an idea of what the blended rate in the second quarter will look like?
Dale Gibbons: Yeah. So the rate that we have on average for the quarter, which you saw that down 33 basis points from the 460, that should be fairly consistent with what’s been done. The purchases that were done were fairly short term. We expect to maybe roll out of some of that and keep maybe more at the Federal reserve as well. So that’s probably a little bit of a stronger profile.
Operator: Thank you. The next question comes from the line of David Smith with Autonomous Research. Your line is now open.
David Smith: Could you just confirm what you think your true asset sensitivity is today? The 10-K said that a 100 basis point higher shock would boost NII by 3%. And I thought I heard you saying earlier that the NII guide is towards the high end, but the better loan growth is being offset by there being two fewer cuts in the model, which would imply liability sensitivity. So if you just expand on that? I know that NII is just one piece for you with the deposit costs and the mortgage income benefiting from lower rates. But just strictly for the NII, like how you view the impact of a higher or lower Fed today?
Dale Gibbons: Yeah. Correct. I mean NII is going to be increasing in a higher rate environment. And you saw that a little bit here, even though it’s a stable environment. We did have a bit of a slope upward in yields as net interest income was up $7 million. What’s changed, though, is that we’re really looking more at what we call earnings at risk, so it considers the NII, it considers the ECR and then also considers what might happen in the AmeriHome context. And if I put all those together, we would prefer a lower rate environment rather than higher because it’s kind of the additional leverage pickup we would get in AmeriHome in particular. But yes, NII solely would still increase in the rising rate environment and declining in the lower one.
David Smith: Okay. And then just in terms of the NII guide staying the same, although maybe you think the higher end of the range, how that works with there being fewer cuts and the better outlook for loan growth?
Dale Gibbons: Yeah, it’s up. Yeah. I mean, as — fewer rate cuts, that results in a higher number. Because we’re not going to get the compression on the way down and then kind of the volume will then — we kind of talked about, as we deploy the $7 billion in deposits that we got in Q1 and what were the addition of these $4 million that we’re looking for, for the rest of the year into at least on a prospective basis, into higher yielding assets rather than into kind of short-term securities to satisfy high quality liquid asset requirements.
Kenneth Vecchione: It will build quarter-over-quarter with a slight improvement in Q2 as we put loans out and then it begins to grow stronger in Q3 and Q4.
Operator: Thank you. The next question comes from the line of Brandon King with Truist Securities. Brandon, please go ahead.
Brandon King: Hey. So I understand NIM is close to trough in the second quarter just given the HOA build at the end of the first quarter. But could you quantify particularly how much NIM compression you’re expecting for the second quarter?
Dale Gibbons: Yeah. So we dipped down five in Q1 from Q4, you saw that. I think that we can give down another 10 million on higher volumes.
Brandon King: Okay. And then the expectation is that as you — throughout the second half of the year, you’re rate stay, I guess, stable from here that mid-single digit expansion quarter-over-quarter. That’s correct, right?
Dale Gibbons: Yeah. We look for it to increase because the marginal spread that we’re going to pick up between deposits and loans say, we’re lending out at 80% of the increase in deposits, that’s going to be accretive to the margin overall.
Operator: Thank you. The next question comes from the line of Gary Tenner with D.A. Davidson. Your line is now open.
Gary Tenner: Thanks. Good morning. I had another follow-up on the credit side of things. If I look at the total classified increase a little over $100 million in the quarter, the investor CRE side, inclusive of lower hotel and an increase in office was basically flat, but the delta was a little more on the C&I side. So I just wonder if you could comment about within the C&I book, what you’re experiencing there, were any particular business lines that were weaker and got more movement this quarter?
Timothy Bruckner: Sure. Thanks. Tim, again. Okay. Our portfolio remains stable. We remain vigilant in this elevated interest rate environment, but we’re really seeing stable performance across all the segments. Outside of the more pronounced movements that we’ve talked about in office, really any other movements that we see are idiosyncratic and related to a specific business, not a trend in a portfolio.
Gary Tenner: Okay. Thanks, Tim. And then just one question on the income statement. The service charge line down to about half versus the fourth quarter and kind of where you run previous to that. Can you remind us what happened there and thoughts going forward?
Dale Gibbons: Yeah. We’ve had elevated service charges here for a little bit. They came down in Q1. I think they’re going to remain lower until we have more follow-on execution of some things we’re doing in service charges in basically the regions.
Operator: Thank you. The next question comes from the line of Jon Arfstrom with RBC. Jon, please go ahead.
Jon Arfstrom: Thanks. Good morning. A couple of quick ones here. Dale, you used the term on the mortgage-related deposits that you reacquired $3.5 billion, that was a big chunk of the growth. What do you mean by that and are you kind of signaling the deposits flatten out or maybe decline a bit in Q2, just so we understand that?
Dale Gibbons: Well, what I mean is that — so the mortgage warehouse deposits primarily come from two sources. One is principal and interest, and those are on a monthly cycle as we get fixed funds in from mortgage payments and then we remit them to the GSEs some three weeks later. And so you get this kind of intra-month kind of sign way. Regarding the taxes and insurance, though, that’s a longer cycle. And particularly, I think taxes are usually semiannual, some are annual. And so we have a dip from tax payments, property taxes in both deposits and it’s very pronounced in the fourth quarter. That’s what really drove that number lower from where we were at September 30. And so we say reacquired in terms of those funds have been depleted as they’re paid to the taxing agencies and then they start building up again and they built up quickly.
And frankly, we brought in some other clients there, too, which kind of helped to boost it up because really it wouldn’t have recovered quite that quickly, you have to be in the second quarter to do it, but that didn’t happen.
Kenneth Vecchione: What we announced in Q4 came back in Q1, Jon, a little stronger than we thought because we had some market share wins at the end of last year that began to finance fund up in Q1 and that’s what Dale means.
Jon Arfstrom: Yeah. Okay. Thanks on that. It’s just bigger than I thought, and that helps me understand that. Ken, you mentioned very early in your prepared comments on the upper teen return on tangible as your goal. How do you view the sustainability of that? I mean if you can do that, the stock goes up, but is that the key metric you look at and what do you think about sustainability of that longer term?
Kenneth Vecchione: Yeah. Well, we wouldn’t have put it in there, if we didn’t think that we had a high confidence level of getting there, it will build up through 2024. And again, everything we talked about on the last earnings call and this one is about the earnings — exit or velocity rate out of ’24 into 2025. Now that return could actually spike up in the event that the Fed does take some more actions and reduces rates, and then you’ll see a greater share of fee income comes from AmeriHome. Right now, we kind of have that at a basic steady state of where it is today. But rates come down, say, 100 basis points over the next four quarters or whatever, you can see AmeriHome really gearing up and reducing far more income and generating a higher return on equity for the entire company.
Operator: Thank you. The next question comes from the line of Erik Zwick with Hovde Group. Your line is now open.
Erik Zwick: Good morning, everyone. A quick follow-up question, maybe kind of a multipart question regarding your loans that are secured by real estate collateral. First, I’m just curious how often are the individual property valuations refreshed and what percentage of your portfolio has received updated valuations, say, in the past six months. And the reason I guess I’m asking is that CRE transaction volume has — in certain markets has been somewhat muted in recent quarters, and that can potentially obscure or slow market recognition of changes in values in either direction, right, up or down. But with current concerns that higher rates have put pressure on values, and how comfortable are you that the valuations you’re currently using and reserving against a reflective of current market valuations?
Timothy Bruckner: Sure. Thanks. That’s a good question. I’ll take it. Tim, again. Okay. So a couple of things just to level set, we’re a bridge and construction lender in commercial real estate, okay? So there isn’t a scenario here where we have term loans that we’re waiting for a maturity to look at or that are benefiting from a long-term fixed rate that was put in place in a different environment. These are floating rate loans. And we value them against appraisal and performance on an ongoing basis. All of our documentation includes terms for reappraisal and re-margin. So those thoughts around value are critical to us and that isn’t something that we wait for it to fall or a maturity to handle. Additionally, we have substantial submarket data that we track to track trends and value.
But in advance of that, we’re tracking the trends in submarket occupancy, so that we can really understand how that will translate to the value in situations when there’s limited market sale activity.
Erik Zwick: Thanks, Tim. I appreciate your color. That’s all for me today.
Operator: Thank you. The final question comes from the line of Zach Westerlind with UBS. Zack, please go ahead.
Zach Westerlind: Hi. Just a quick follow-up on the ECR. Dale, I know you said that you guys are trying to get ahead of those kind of higher cost accounts. Do you think that the beta on the ECR rate on the way down when the Fed start cutting, do you think that could be equal to or exceed the beta that we saw on the way up?
Dale Gibbons: I mean you have to kind of segment that into what types of ECRs there are. Within the mortgage warehouse side, yes, I think we’re going to be at or near 100%, perhaps even over 100% for some clients. But in total, it will be lower than that as we use ECRs for HOA deposits as well. And so those started at a much lower rate to begin with. So I do think that we’ll be at least as fast as we were on the way up, on the way down and maybe in some cases even a bit better.
Zach Westerlind: Understood. Thank you.
Operator: Thank you. I would now like to hand the call over to Ken Vecchione for closing remarks.
Kenneth Vecchione: Thanks, everyone. Look, we think we had a good quarter. We’re very pleased with the balance sheet repositioning as we stated, and we look forward to the next call to tell you more about our progress. Thanks again for spending some time with us today.
Operator: This concludes today’s conference call. Thank you for your participation. You may now disconnect your lines.