Enterprise Financial Services Corp Q4 FY2022 Earnings Call

At this time, I would like to welcome everyone to the Enterprise Financial Services Corp. Fourth Quarter 2022 Earnings Conference Call. Thank you. I will now turn the call over to Jim Lally, President and CEO. You may begin.

Thank you, Colby, and thank you all very much for joining us this morning, and welcome to our 2022 fourth quarter earnings call. Joining me this morning is Keene Turner, EFSC's Chief Financial Officer and Chief Operating Officer; and Scott Goodman, President of Enterprise Bank & Trust. Before we begin, I would like to remind everybody on the call that a copy of the release and the company presentation can be found on our website. The presentation and earnings release were furnished on SEC Form 8-K yesterday. Please refer to Slide 2 of the presentation titled Forward-Looking Statements in our most recent 10-K and 10-Q for reasons why actual results may vary from any forward-looking statements that we make today. Throughout 2022, we stressed our commitment to building partnerships with our clients, the execution of our strategic initiatives, and our diversified business platform. This cadence of consistency produced record results for both the fourth quarter and for the entire year. The financial highlights for the fourth quarter begin on Slide 3. We capped the year with tremendous momentum, both for loan growth as well as earnings. We earned $1.58 per share for the fourth quarter which resulted in a 1.83% return on average assets and a 23% return on tangible common equity. This is inclusive of our tangible common equity to tangible assets ratio expanding during the quarter and we closed the year at 8.43%. Additionally, our robust earnings helped to contribute approximately $2 per share to our tangible book value during the fourth quarter which closed at $28.67 per share. Turning to Slide 4. You can see that we had an outstanding quarter with respect to loan growth. On an annualized basis, we were able to grow the loan portfolio by 16%. Moreover, the diversification on which we have focused was on full display as just about every market and business line contributed to these outstanding results. Scott will provide much more color about these markets and businesses in his comments. Our posture on deposits has not changed. We continue to actively manage deposit rates and focus on the relationship aspect of this side of our business. The goal is to find the appropriate balance between retention, growth, competitiveness, and stability. I'm really pleased with how this has played out as evidenced by the de minimis amount of runoff, a relatively low cost of total deposits, and a stable DDA percentage right around 42%. This level of discipline, coupled with the rise in short-term interest rates, resulted in a net interest margin expansion of 56 basis points. Our credit statistics remain outstanding as both non-performing loans to total loans and non-performing assets to total assets improved from the very low levels that we reported at the end of the third quarter. We did record a modest provision expense in the quarter due to our strong loan growth outpacing the risk reduction in the portfolio during the fourth quarter. Slide 5 provides a recap of our highlights for the full year. On a fully diluted basis, we earned $5.31 per share in 2022, an increase of 38% from 2021. We grew portfolio loans at a rate of 11% for the year, with contributions from all of our regions and businesses. Along with our balance sheet performance, this growth supported our record financial results. Our pre-provision net revenue expanded 25% over the prior period. This helped drive a pre-provision net revenue return on average assets that easily surpassed 2% to end 2022. All in all, 2022 was an incredible year for EFSC. We entered the year with a focused mindset of delivering consistent results. The record earnings per share that we produced is a product of a well-executed plan that focused on diversified revenue growth, disciplined pricing within our deposit base, consistent credit and pricing fundamentals, patient and thoughtful capital and investment management, and responsible expense management. As we turn the page and head into 2023, our areas of focus which are found on Slide 6 have not changed. Despite the continual change of our operating environment which includes ongoing short-term rate increases, intense deposit competition and the likelihood of a mild recession, we are confident in our ability to perform at the high level that we have become accustomed to. The conversations we've had with our clients give us confidence that 2023 should be another outstanding year for EFSC. For the most part, backlogs and order books of the operating companies that we serve are strong with corporate balance sheets that provide ample room for continued growth. They are still dealing with some of the same issues that have become commonplace such as sufficient competent labor and reliable supply chains. However, we do not see these issues as derailers to the success of these businesses. We feel good about the continued growth of our investor CRE business due to the many projects that have broken ground in late 2021 and throughout 2022. New projects have been slower to materialize as the sharp rise in interest rates requires owner developers to recalibrate their input metrics inclusive of additional equity. On the deposit side of things, we believe that we will continue to see a bit of pressure on rates throughout the year. There's always a lag on rate increases, especially for higher balance commercial accounts. We've been hard at work throughout much of 2022 identifying specifically where we need to make proactive movements to preserve these highly valued relationships and feel very good about where they stand. With that said, I feel very confident that we can fund our expected loan growth with the various deposit generators that we currently have. With that, I would like to turn the call over to Scott Goodman, President of Enterprise Bank & Trust for his insights about our markets and business lines. Scott?

Thank you, Jim, and good morning, everyone. As you'll see on Slide number 7, loans at year-end totaled just over $9.7 billion, representing an 11.3% increase from the prior year, net of PPP. Although, $984 million of core growth was well diversified across the major loan categories as detailed on Slide number 8. Strong growth in C&I reflects continued success in attracting new operating company relationships across our footprint. Specialty business lines contributed a similar level of growth overall as C&I and also continue to perform consistently. Growth in commercial real estate, while more modest overall generally reflects an intentional approach to partner and go deeper with a select set of strong investors and developers in each market rather than chase projects or transactions. Q4 was a period of strong loan growth as reflected on Slide number 9 with contributions by nearly all markets and lines of business. Originations for the quarter were up nearly 15% from the prior period. Q4 is typically a seasonally strong loan production quarter for us but this was further bolstered by wins on a number of larger new C&I relationships and nice performance out of the gate by our new team in Dallas. The specialty lending units contributed roughly one-third of the growth this quarter with an aggregate increase of $141 million. SBA finished strong, posting growth of $43 million in the quarter despite the continuing headwinds of higher short-term rates. The team is focused on proactive steps to moderate payoff activity with existing borrowers and continued consistency in our product offering to the market with a relatively stable pipeline heading into 2023. Life insurance premium finance had a seasonally strong quarter, based on the timing of premium renewals in the book. But growth has been further accelerated by additional new referral partners in 2022, including new opportunities from the legacy First Choice book which we've been able to nurture and grow. Tax credit also executed well with $52 million of quarterly growth, pushing the total to $73 million or 15% for the year. Strong quarter mainly reflects advances on the existing projects in process along with several new ones. The necessity for affordable housing and the continued adoption of these programs by more states should provide continuity of our opportunity pipeline in this business looking forward. Sponsor Finance posted a small decline in the portfolio for the quarter, mainly relating to slightly lower origination activity and some churn in the existing book due to the sale of platform companies. Year-over-year growth for this business has been quite strong at $127 million or 25%. Much of the activity in this channel is timing contingent due to the aspects of the M&A process and the lower origination volume reflects some delayed closings which will carry over into Q1. In general, though, the pipeline of new deals for the specialty remains healthy and active. Turning now to the regional results which are on Slide 10. Our Midwestern markets of St. Louis and Kansas City grew $99 million in Q4, posting year-over-year growth of 9.4%. Both markets experienced a modest increase in revolving line outstandings and had solid new origination activity in the quarter. Notably, we onboarded several new middle market C&I relationships along with a nice volume of refinance and new commercial real estate development loans in the Kansas City market. Our Southwestern markets grew by $81 million for the quarter, resulting in solid year-over-year growth of 14.6%. This includes $27 million in growth from our new Texas team, bringing their production to $43 million for 2022. This office which opened mid-year is off to a strong start and has a nice balance of both new C&I and commercial real estate clients. The Arizona team also had some nice closings this period including a large retail center for a new investor relationship and a development loan for a large, well-known community-based organization serving children in the Phoenix Metro under a new market tax credit structure. In Southern California, we grew $51 million in the quarter and are building nice momentum heading into 2023. We continue to execute a strategy in this market of expanding the legacy relationships from predecessor banks and developing a larger C&I portfolio through talent acquisitions. This period, we onboarded several new C&I relationships, assisted a large legacy franchise operator with an acquisition and materially expanded a credit facility with a legacy CRE investor. Moving now to deposits which are on Slides number 11 and 12. Total deposit balances were down $229 million for the quarter and $515 million or 4.5% year-over-year. Breaking this down, non-interest-bearing accounts were stable for the quarter and up year-over-year. The declines were really isolated to the interest-bearing categories, with the majority of the funds being a limited number of higher-cost transactional accounts or idle balances of larger businesses. As you heard from Jim, we've taken an intentional approach of selectively managing our deposit pricing to prioritize retention, deepen our key relationships and attract new ones. We've also developed a number of competitive deposit options for clients and our bankers are having proactive conversations to mitigate outflows. The deposit breakdown on Slide number 13 provides some clarity by region. Larger impacts tend to be within our more concentrated C&I markets and legacy portfolios. In the Midwest, for example, a large portion of their $281 million decline for the quarter is attributable to a single upper middle market company that we had assisted with a Main Street loan. Upon recent repayment of the Main Street loan, we were unable to retain the full relationship which moved back to a national bank along with the accompanying deposits of roughly $120 million in the quarter. More generally, though, we have been successful in growing relationship-based balances, originating over $1 billion of deposits from new relationships during the year, with average balances for these new accounts, materially exceeding those in closed accounts. Lastly, I'd like to point to the growth of our specialty deposit verticals, which are detailed on Slide number 14, and which continue to enhance our flexibility to optimize our funding strategy. During Q4, balances grew within each of our specialties, community associations, property management and third-party escrow. Specialized deposits in aggregate grew $102 million in the quarter and $302 million or 13.6% for the year. Now, I'd like to turn the call over to Keene Turner for further financial highlights.

Thanks, Scott and good morning, everyone. My comments begin on Slide 15, where we reported earnings per share of $1.58 in the fourth quarter on net income of $60 million. Organic growth in earning assets and continued margin expansion drove a meaningful increase in operating revenue in the fourth quarter. This led to record earnings per share that expanded 20% from the third quarter. Non-interest expense and the provision for credit losses both increased in the quarter, but these increases were more than offset by the 16% sequential increase in operating revenue. For full year 2022, we reported net income of $203 million and earnings per share of $5.31 compared to $3.86 in the prior year. Turning to Slide 16. Net interest income for the quarter was $139 million compared to $124 million in the linked quarter, an increase of $15 million. The increase came as a result of higher average loan balances, along with the benefit of increasing interest rates, driving our asset yields higher. The increase in net interest income was primarily driven by a $21 million increase in loan income and was partially offset by a $6 million increase in deposit expense. With the current composition of our balance sheet as of December 31, we expect the full impact of the existing interest rate increases will result in a quarterly net interest income in the range of $143 million to $146 million. As noted in the earnings release, approximately 17% of the variable rate loan portfolio reprices on the first day of each quarter and did not benefit from the fourth-quarter interest rate increases. We expect that with the Fed reducing the magnitude of interest rate increases, that first and second-quarter actions will be largely offset by lagged deposit costs. We're experiencing better-than-expected pricing on interest-bearing deposits. However, we do expect that we will continue to address deposit costs and competition in 2023. That is to say that net interest income growth will be correlated with loan growth and any additional actions by the Fed. Moving on to Slide 17, net interest margin on a tax equivalent basis was 4.66%, an increase of 56 basis points from the linked quarter. With an asset-sensitive balance sheet, we continue to benefit from rising rates and asset yield rose more than liability costs in the period. Earning asset yields improved 78 basis points which included 77 basis points of loan yield improvement, including a 6.64% origination rate on new loans and the investment yield improved 26 basis points as reinvestment rates continued to increase to a 5.2% fourth quarter tax equivalent rate. Asset yields were also aided by an enhanced asset mix as we continue to grow loans and investments while reducing cash balances. The cost of interest-bearing liabilities increased 40 basis points from the prior period, driven mainly by higher deposit rates and variable rate borrowings. Our deposit portfolio remains more than 40% non-interest-bearing balances which allows us to be more deliberate with deposit pricing compared to prior rate cycles. The loan portfolio is our largest driver of asset sensitivity as 63% of loans are variable rate. More than 60% of those have interest rate floors. Essentially, all of those with floors are currently priced above the floor. While our variable rate loans have enhanced earnings during this cycle, we executed several interest rate swaps in the fourth quarter to protect future earnings if rates should begin to move in the opposite direction. Our interest-bearing deposit beta was approximately 30% in the fourth quarter. While it was higher than the previous periods in 2022, it remains below our expected and historical level. While we expect this lag in the deposit pricing to abate, we believe our ability to control deposit costs through this rising rate environment has been greatly enhanced compared to prior interest rate cycles. We remain committed to funding asset growth through relationship-based deposits and our specialty verticals. On Slide 18, we demonstrate our credit trends. Annualized net charge-offs remained low at 9 basis points in the fourth quarter compared to 2 basis points in the linked quarter. For the full year, net charge-offs were $3.9 million or 4 basis points compared with $11.6 million or 14 basis points in the prior year. Overall, asset quality improved in the quarter with non-performing assets and non-performing loans declining in dollar and percentage terms, from both the linked quarter and the prior year-end. Non-performing assets were 8 basis points of total assets and non-performing loans were 10 basis points of total loans. In addition to the improvement in the non-performing category, we also experienced a decline in past due loans in the quarter. On Slide 19, we demonstrate the allowance for credit losses. The allowance for credit losses declined $3.6 million in the quarter to $137 million, primarily due to net charge-offs and the overall improvement in asset quality. While the economic forecast factors used in our CECL model generally worsened in the fourth quarter, the loan portfolio mix shifted to areas that carry a lower reserve. A provision expense of $2.1 million was recognized in the quarter which primarily reflects an increase in the reserve for unfunded commitments. The allowance for credit losses represents 1.41% of total loans compared to 1.5% at the end of the third quarter. When adjusting for government guaranteed loans, the allowance to total loans was at 1.56% at the end of December. Turning to Slide 20. Our fourth quarter fee income was $17 million, an increase of $7 million in the quarter. The increase was led primarily by a $6 million increase in tax credit income. As you recall, this line item was negatively impacted in the third quarter by rising interest rates on tax credit projects carried at fair value while fourth-quarter results did not see the same negative impact as rates were steady in the quarter and benefited from seasonally strong sales of tax credits. Tax credit income will continue to be seasonal and subject to further interest rate movements. However, fair value adjustments that reduced tax credit income are more than offset by higher net interest income in a rising interest rate environment. The fourth quarter also saw fees earned on community development investments compared to the linked quarter increase, and they were partially offset by a decrease in deposit service charges driven primarily by an increase in earnings credits to clients based on recent interest rate trends. Turning to Slide 20. Fourth quarter non-interest expense was $77 million, an increase of $8 million compared to $69 million in the third quarter. Deposit service expenses were the main driver and increased $6 million from the linked quarter due to rising interest rates and growth in certain specialized deposit businesses. Compensation and benefits increased $1.2 million from the linked quarter, principally from higher performance-based incentive and bonus accruals due to the company's strong financial results. The fourth quarter's core efficiency ratio was 48.1%, an improvement of 170 basis points compared to the third quarter. This reflects the continued momentum in operating revenue, outpacing the rise in non-interest expense during the quarter. Looking to 2023, we're expecting the core efficiency ratio to be in the 50% to 51% range as we expect to see margin expand further from our fourth-quarter levels. First quarter trends typically include an expected seasonal decline in fee income as well as higher compensation expense. Overall, for 2023, we expect salaries and benefits to increase around 6% from the fourth-quarter annualized run rate. The next big driver of expense is from increased deposit service expense from both rate and growth in certain specialized deposit businesses. We view this space as competitive and evolving and there may be some opportunity for us to manage throughout the year but not necessarily in the next couple of quarters. Our efficiency ratio guide reflects our posture on how we expect this line item to trend in 2023. Our capital metrics are shown on Slide 22 and the record earnings we generated in the fourth quarter of $60 million combined with an improvement in accumulated other comprehensive income resulted in tangible book value per share of $28.67, an increase of 8% from the third quarter. During 2022, we still increased tangible book value per share by roughly $0.40 with our strong earnings level while returning $67 million to common shareholders through dividends and share repurchases. We announced another increase to our dividend for the first quarter of 2023, marking the seventh consecutive quarter of the dividend being increased. In 2022, we paid common dividends of $0.90 per share, a $0.15 increase or 20% compared to the prior year. While our dividend has increased, our dividend payout ratio of 17% in 2022 remains at a level that provides flexibility in our capital structure moving forward. The tangible common equity to tangible asset ratio improved to 8.4% at the end of the year. After the initial decline in the first quarter, when market interest rates increased and negatively impacted accumulated other comprehensive income, the tangible common equity ratio has improved in each of the last three quarters. While the tangible common equity ratio is now within our target range of 8% to 9%, we do not plan to execute any meaningful share repurchases in the near term. With the uncertainty on the path of interest rates and the potential economic impact of further short-term rate increases, we intend to let our organic earnings further strengthen our capital base. When market conditions and our capital position align, we still have 2 million shares available under our Board-approved purchase program. We had great momentum throughout the year and finished 2022 with a strong quarter. We delivered a 23% return on tangible common equity and a 1.8% return on average assets in the fourth quarter with a 19% return on average tangible common equity and a 1.5% return on average assets for the full year 2022. We believe that we are well positioned and look forward to carrying this momentum into 2023. Thank you for joining the call today and we'll now open the line for analyst questions.

Your first question comes from Jeff Rulis from D.A. Davidson. Your line is open.

Hi, good morning.

Good morning, Jeff.

I wanted to get a better understanding of the variable deposit costs. Keene, we have your guidelines on efficiency and margin expectations, but I'm specifically interested in the variable deposit costs. Is this a one-time occurrence, or is it seasonal? I know you mentioned it being influenced by rates, but is there anything related to year-end? I'm trying to anticipate that line more accurately from a run rate perspective.

Sure, Jeff. I'm happy to give you some color there. So there was a little bit of catch-up that was in there from year-end and it really related to a competitive decision we made in the fourth quarter. Obviously, everybody is fighting for liquidity now. And I think the specialized deposit space is one where we're seeing some of the key players there. They've had some major deposit outflows and really trying to get aggressive. So we're just holding our ground there. I think we had a good quarter in terms of balances and we were responsive to some competitive pressures that had a little bit of an effect on some of what was earned throughout the year and there was some catch-up. I would say going forward, when you look at 4Q to 1Q sequentially, we're thinking that, that line item is up maybe $2 million to $3 million just depending on what happens with balances and rates and sort of everything that we know at the end of the year. So maybe based on December run rate itself, it's probably $2 million. And then based on growth and maybe some more leakage from a competition perspective, that increases to up to $3 million sequentially. And then I think if you layer that in with our efficiency ratio guide, I think you can kind of see how we think that plays out for 2023.

Okay. If I catch that right, you're referencing the variable deposit cost line item specifically and that's in addition to the...

Yes, yes.

And then we got your salaries and comp in Q1 commentary as well. So it looks like an up in Q1 but again, kind of use that efficiency ratio to back in for the full year?

Yes. I think the first quarter will not match the 48% efficiency due to the seasonal fee income and a slightly shorter number of days affecting net interest income, along with some seasonal expenses. However, I believe that the $2 million to $3 million in the first quarter for the ECR line item will provide a solid basis for estimating the expenses for the first quarter.

I wanted to ask about the margin. Did you mention putting on some swaps this quarter? I can't recall if this is the first time we've heard of it. I'm trying to understand if you've been implementing these in previous quarters and what your strategy is. Are you aiming to be more proactive in managing or securing margins to protect against potential rate increases? I'm curious if we might see more activity in this area and how far you're willing to go. You're clearly benefiting from asset sensitivity, but I'm interested in your plans for 2023.

Yes. We have been focused in 2023 on various strategies to reduce some asset sensitivity off the balance sheet. Initially, this involved moving cash into securities and increasing the loan-to-deposit ratio, which absorbed some excess liquidity. As interest rates rose, particularly by late second quarter to early third quarter, we began implementing a hedging strategy to decrease asset sensitivity by about 50 to 100 basis points. We are currently about halfway through this process, having executed a couple of hundred million so far and potentially having another $200 million to $300 million remaining. We are exercising caution and won't be overly aggressive. While we would have preferred to act more assertively with the hedges earlier, the way loan hedges move in relation to the fair value of securities led us to be more careful. Now that our tangible common equity is in a better position, we are starting to layer in some of these hedges. Given the current interest rate curve, these will likely be short-term hedges, and we are not looking to reduce sensitivity by 3%. Instead, we intend to settle around 100 basis points. This approach is reflected in our net interest income and margin guidance provided earlier.

That's helpful. Thank you.

Your next question comes from the line of Damon DelMonte from KBW. Your line is open.

Hi, good morning guys. Hope everybody is doing well today. So first, I want to kind of continue on the margin commentary there. So Keene, do you think you guys kind of peak here in the first quarter for your margin? And then kind of are able to defend it and hold it as you progress through '23? Or do you think you still see a rise as far as the second quarter of this year?

Yes. Based on my comments, it seems more defensive with the first-quarter peak. When we look at our forecasts, I believe that the margin on a monthly basis peaks sometime in the third quarter, but I’m not suggesting that the third-quarter margin will be higher than the second quarter. This depends on when we receive the expected 75 basis points of Fed funds increases. If they occur in the first quarter, then the second quarter will likely reflect the peak. However, if the increases are spread out over time, the peak might be lower but come later. We’re considering a timeframe around June or July for the peak, and we anticipate that the first and second quarters will showcase the peak margin you will observe.

Got it. Okay. That's helpful. And with regards to the outlook for loan growth, can you just provide a little color on what the expectation would be for next year? The commentary seemed pretty positive. Do you think you could kind of replicate the level you had in '22? Or do you think we start to see a bit of a pullback?

Yes, Damon, this is Jim. I'll handle that. We're very comfortable in the mid- to high single-digit number with everybody contributing. We talked about the fact that we don't want to jump into transactional lending or do the last project in any market. Just keep to the game plan, then we're going to have quarters like we had in the fourth quarter when it all comes together but we're comfortable with mid- to high single-digit growth going forward.

Great. Do you engage significantly in the office space within your commercial real estate portfolio?

Scott, do you want to talk about that?

Yes. Damon, it's I wouldn't say it's a focus. It's a function of those relationships that I talk about in each of our markets. But it's not a large focus or concentration for us. And I think the portfolio we do have seems to be performing well. Generally, it's like neighborhood type offices. We don't have a large metro Class A type portfolio.

Got it. And are you able to quantify the percentage of overall loans or of the CRE portfolio?

Yes.

Yes. It's roughly $450 million to $500 million kind of sitting here today. So pretty diversified in terms of industry as well. So relatively small in terms of the whole.

Maybe I'll just add too. We had done a targeted review on that portfolio not too long ago. And we're talking about LTVs averaging in the 50% range. Debt service coverage is above 150%, so also performing pretty well.

Okay, great. That's all that I had. Thank you very much.

Your next question comes from the line of Brian Martin from Janney Montgomery. Your line is open.

Hi, good morning guys. I just wanted to find out, just get a little bit more insight on just you talked a little bit, Keene, about the tax credit business and kind of the rebound and the seasonality at one point and maybe there's some seasonality going away and then last quarter, the issue. But just in general, that kind of tax credit or fee income, just kind of some guidelines as far as how to think about how you guys are thinking about that this quarter. Obviously, the CDE this quarter was a little bit of inflator but just any input or thoughts you have on the fee income would be helpful.

Yes, I think year-to-date, we're around $2.5 million in tax credit income for this year. Assuming no significant changes in long-term rates, we expect to see a similar level for the upcoming year. If the 10-year SOFR decreases further, there may be an opportunity for increased fair value, and the opposite is also true. We're at a crucial point. Additionally, we anticipate some cash sales will help cover the start-up and operating costs of our business. Regarding other income from CDE private equity, we generally estimate that to be around $2 million to $3 million annually, with potential upside depending on how certain projects perform and are finalized. Both of these areas are seasonal, and we believe their performance will be more pronounced in the second half of the year, particularly with the tax credit business being weighted towards the fourth quarter. I hope this provides some clarity on our expectations and the variable line items for 2023.

Yes. If you exclude the tax credit line's volatility, this fee income appears to be a mid-single-digit grower when you review all the line items. Is that how you perceive it if you disregard at least one item that had significant noise last year? Or is that on the low end where it seems reasonable?

Yes, if you're looking at third and fourth quarter, call it, recurring fee income, I think we think of those as kind of mid-single-digit businesses together overall. And I think there's maybe a little bit of pressure in competition in their traditional earnings credit space in some of our cash management and treasury management products but we're working to mitigate that. So we sort of think between card wealth deposit service charges that 5% from where we're operating in the second half of the year gets you in the ballpark.

Yes. Okay. That's perfect. That's what I thought. And then just on the capital, kind of getting back here. As far as the buyback and potential M&A, I guess, the organic growth sounds like it's there. I guess when you look at the other options, how are you guys thinking about the buyback today in the M&A? I mean you talked about the dividend already. So just any feedback on how to think about those or how you're thinking about those going into '23?

Can you want to handle the buyback and I'll handle M&A?

Yes, that sounds good, Jim. Brian, we're being mindful of all the volatility we've experienced and that investors have faced. Our goal is to maintain a very strong balance sheet, which we already have. Our earnings capacity and dividend profile enable us to do this. The allowance might be a bit lower than we'd prefer if a recession is on the horizon, but our asset quality is excellent, making it a challenge. Therefore, our immediate focus is on building up our reserves conservatively. If it turns out we're holding too much capital, as the environment and valuations improve, we can consider being a strong acquirer and address any surplus capital through a deal structure or something similar. Jim, if you want to discuss our interest in M&A, now might be the ideal time.

Brian, we have great momentum in the business. M&A is a priority, but it's further down the list this year compared to 2019 and 2020. We continue with our usual calls and meetings, but it will be quite dynamic and special to pause our current activities for new opportunities. As we've mentioned before, M&A includes lift-outs, teams, and new businesses, which are always ongoing opportunities for us.

Got you. Okay. That's helpful. And maybe just on the deposit beta, is there any change in your expectations regarding the cumulative beta given the outlook for a couple more rate hikes in February and March? How are you all thinking about the cumulative deposit beta?

Yes. I'm looking at the data, and the cumulative beta has been increasing, but not significantly. Deposit pricing, especially in interest-bearing accounts, has remained stable. In December, the cumulative beta was under 25%. We made some pricing adjustments towards the end of the year, and the monthly beta was 50% and under. For the quarter, it’s around 30% and under. We feel confident about the stability of our deposit base, the current rates, and our response to them. We believe we can secure enough funding to support high single-digit organic loan growth, approximately 8%, in 2023, with contributions from commercial specialty, business, and consumer banking. We are being cautious regarding any potential lag. The guidance we provide includes some caution beyond current performance. If we are seeing high to mid-20s cumulatively, we anticipate marginal beta moving forward to be around 40%. However, we've held this view since the third quarter without any changes. Overall, we have a solid understanding of how account types are used, where we need to be responsive, and where we maintain stable core funding that doesn’t need to change with rates.

Got it. That makes sense. My last question is regarding the funding of loan growth this year, considering that liquidity levels have decreased. Should we think of the balance sheet or the funding for loan growth as coming primarily from deposit growth this year? Is that your perspective, with some liquidity expected to decrease as a result?

Yes, Brian, we're considering funding it through all the various units, teams, and specialties that we have. We feel confident that we can do that.

Yes. Got you. Okay. That's it. Thanks for the taking the questions, and nice quarter, guys.

Your next question comes from the line of Michael Hultquist from Piper Sandler. Your line is open.

Hi guys. Good morning. I am on for Andrew. Just wanted to follow up on the last question. Can you give us some color surrounding kind of the leftover runoff of potential rate-sensitive deposits on the balance sheet right now?

Scott, do you want to talk about that?

Yes. It's kind of what I've said in the comments, James. A majority of the decline is really a handful of larger commercial clients that are redeploying excess funds and into nonbank alternatives, T-bills, maybe what I'll call competitive specials. We see that in certain markets. But I feel really good about how we are having conversations with our clients. We know that handful of clients. We've also developed some products that we can use and we're proactively approaching with clients that we know have those excess funds, and we've been able to really moderate that. We're also having really good conversations with other deposit prospects in the market as well. And I feel good about our pipeline of being able to bring in new deposits. And the results that I talked about in the quarter show that we've been successful there as well. So hopefully, that helps.

Yes, that's super helpful. And then my follow-up question, you kind of just touched on with the outlook growth but do you think it's reasonable to repeat specialty deposit growth this year compared to last year at that same pace?

Yes. We think this. We think that those businesses for us are consistent providers. We've added some new sales people there. So we feel good about its ability to contribute appropriately for the total funding growth for our company.

Great. That's super helpful. Thanks guys.

Next question comes from Jeff Rulis from D.A. Davidson. Your line is open.

Just a follow-up. The nonaccrual decline. Any color on the loans that were either back on nonaccrual or paid off, just looking for some detail there.

Jeff, it's Scott. I can respond to that. The majority involved two credits that were not new. They had been part of our workout process for most of this year, or possibly even the previous year, but we reached successful conclusions for both. One was an agricultural credit for which we completed a charge-off and workout, and the other was a commercial and industrial credit where we actually saw a recovery. This likely accounts for most of the reduction in nonaccruals for the quarter.

Got you. And then Keene, did that reduce the margin at all in that recovery? I mean is that meaningful at all?

It was a relatively modest recovery, sorry...

Yes. No, the recovery, Jeff went through the allowance. So I think that's what Scott is referring to. So that was part of the net but it didn't meaningfully impact margin. I think margin and net interest income were fairly clean in the quarter. So nothing too consequential either way that you need to think about for 1Q or anything like that.

Great. Thanks guys.

There are no further questions at this time. I will now turn the call back over to Jim for closing remarks.

Colby, thank you and thank you all for joining us today and for your interest in our company. We look forward to speaking to all of you again at the end of our first quarter. Take care and have a great day.

This concludes today's conference call. You may now disconnect.