Western Alliance Bancorporation Q1 FY2020 Earnings Call

Good day, everyone. Welcome to the earnings call for Western Alliance Bancorporation for the first quarter of 2020. Our speakers today are Ken Vecchione, President and Chief Executive Officer; and Dale Gibbons, Chief Financial Officer. You may also view the presentation today via the webcast through the company's website at www.westernalliancebancorporation.com. The call will be recorded and made available for replay after 2:00 p.m. Eastern, April 17, 2020, through May 17, 2020, at 9 a.m. Eastern by dialing 1-877-344-7529 using the passcode 10142009. The discussion during this call may contain forward-looking statements that relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. The forward-looking statements contained herein reflect our current views about future events and financial performance and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from historical results and those expressed in any forward-looking statements. Factors that could cause actual results to differ materially from historical or expected results are included in this presentation, the related earnings release and our filings with the Securities and Exchange Commission. Except as required by law, the company does not undertake any obligation to update any forward-looking statements. Now for the opening remarks, I would like to now turn the call over to Ken Vecchione. Please go ahead.

Good afternoon, and welcome to Western Alliance's first quarter earnings call. Joining me on the call today are Dale Gibbons, our Chief Financial Officer, and our Chief Credit Officer, Tim Bruckner. I will first provide an overview of Western Alliance's response to the coronavirus pandemic. And then Dale will walk you through the bank's financial performance. Afterwards, we will open the line to take your questions. I'll begin by laying out Western Alliance's approach to the COVID and economic crisis. First and most importantly, I hope that everyone on the line is doing well and that your families and loved ones are safe and healthy. These wishes are especially extended to all the care and safety workers actively putting themselves in harm's way to protect our communities. At Western Alliance Bank, our people remain healthy and engaged and despite the vast majority working from home for the last month, continue to go above and beyond the call of duty to serve our customers and the communities we operate to navigate this challenging time. Our business continuity plans have been working as anticipated, and I am proud of the entrepreneurial spirit our people continue to demonstrate to get the job done and develop unique solutions for our clients. First, I'd like to lay out the business actions Western Alliance has taken in light of the evolving environment. Although we did not anticipate the widespread severity and likely duration of the virus, we did start assessing potential risks and mitigants as early as mid-January. And as the breadth of the pandemic became apparent, we accelerated implementing plans in mid-February to prioritize asset quality, capital and liquidity management. We have since divided the business into appropriate risk segments, led by senior managers with deep credit and workout experience to monitor and force the early engagement with our borrowers and begin the necessary credit triage process. For example, Robert Sarver is leading the hotel franchise group, while I am leading the warehouse lending and gaming groups. Dale has corporate finance, and Tim Bruckner coordinates overseas and directs all credit activities. Our overall risk management approach is focused on establishing individual borrower-level strategies in which we are proactively engaging in customer conversations to evaluate and agree upon financial plans focused on liquidity management to conserve resources in anticipation of an elongated economic downturn. To date, we have had direct dialogue with all borrowers with over $3 million in exposure or 86% of our portfolio and substantial dialogue below this level. We assume that all borrowers will have some level of COVID-19 impact and are focused on evaluating our borrowers' remediation efforts, access to capital and contingency plans. We're also very pleased that Congress and the entire federal government came together to expeditiously pass the CARES Act and stimulus measures a few weeks ago. Additionally, we applaud the transactions to reduce interest rates, support liquidity in the financial markets through quantitative easing for a wide variety of asset classes that provide support for small- and medium-sized businesses through its innovative new lending programs. We recognize that the SBA has a large task in front of them, and I'm extremely proud to say that our people work tirelessly with them so that we could successfully process the PPP program loans on the first day. We have dedicated over a quarter of our workforce to avail our clients of this important program and have successfully approved over 2,600 applications, totaling $1.5 billion to date. We anticipate funding approximately $150 million per day. As part of our broader risk management strategy, we have prioritized implementing the PPP program as the most expedient method to quickly get incremental liquidity to our clients. Furthermore, we believe that the newly initiated Main Street Lending Program, when implemented, provides incremental liquidity for our large clients as well as PPP participants. Our approach to loan modifications and deferment requests is to look for resourceful ways to partner with our clients along with assessing their willingness and capacity to support their business interests. We are asking our clients to work hand in hand with us for long-term solutions to hopefully short-term challenging environment, whereby our clients contribute liquidity, capital or equity as an integral component to loan modifications. Our longer-term, solutions-based approach distinguishes us from industry-standardized 90-day deferral programs. Our approach collectively uses the resources of the borrower, government and the bank's balance sheet to develop solutions that extend beyond the six-month window provided for in the CARES Act. This negotiation process has likely slowed our modification pipeline as approximately $400 million has been processed to date. We learned during the last downturn when both the borrower and the bank use their resources to bridge the gap, it generates a mutually favorable outcome. With all this as a backdrop, I'd like to walk through our financial performance for the quarter. Despite a uniquely challenging operating rate environment, I am proud to report that in the first quarter, Western Alliance generated $163.4 million of operating pre-provision net revenue, up 10% year-over-year and 3% quarter-to-quarter. We continued with the adoption of CECL accounting changes this quarter, which resulted in a provision for credit losses of $51.2 million for the quarter, 47% of which was driven by our robust balance sheet growth. Dale will go into more detail in a bit on how the unique features of CECL drove our provisions, but our ACL-to-funded-loan ratio now stands at 1.14%. WAL generated net income of $84 million or $0.83 per share, and tangible book value per share was $26.73. This quarter, we produced a NIM of 4.22% and had net recoveries of $3.2 million and continued to improve our operating leverage. Even with our increased vigilance, organic balance sheet continued to be healthy in Q1 for both loans and deposits. Deposits grew $2 billion to $24.8 billion as we gained market share in several of our key business lines as well as traction in one of our recently launched deposit initiatives, which added over $400 million. This highlights the continued strength of our diversified funding channels and overall deposit franchise to generate stable low-cost liquidity, irrespective of the macroeconomic environment. Continuing our strong momentum from 2019, total loans increased $2 billion to $23.1 billion. Approximately $1.5 billion of this was through organic loan growth from new client projects and another $500 million was credit line drawdowns, of which approximately half was redeposited into the bank. Let me take a moment now to make a few high-level comments on Western Alliance loan portfolio. We believe that our well-diversified business model and purposeful decisions made over the past decade regarding conservative underwriting criteria and sector allocations position the portfolio to withstand the current economic environment. At quarter end, asset quality was stable with a decline in totally adverse-graded loans and OREO to assets of 1.2% from 1.27% in Q4. Western Alliance has no direct energy or large retail mall exposure. We stopped making loans to the quick-service restaurant sector several years ago with current exposure of only $150 million. Our construction and land and development portfolio is now under 9% of our loan book. And our institutional lot banking business, which makes up 30% of the CLD portfolio, we have not received any deferral requests at this time. Single-family residential construction, which composes another 27%, was still experiencing positive absorption trends through March. However, April's traffic has fallen off. Our portfolio is extremely well positioned coming into the pandemic and right now, it is performing as expected. We are especially focused on monitoring and engaging with our clients in our Hotel Franchise Finance and Technology & Innovation segments, which will be reviewed in more detail later in the call. During the quarter, we repurchased 1.8 million shares at an average price of $35.30. Additionally, consistent with our 10b5 plan, we repurchased 270,000 shares thus far in Q2. However, given the rapidly changing environment, we have now paused our share repurchase activity. Finally, Western Alliance arises at this crisis in a position of strength uniquely prepared to address what's ahead. We remain well capitalized and highly liquid with a CET1 ratio of 9.7% and ample liquidity -- total liquidity resources of over $10 billion. Dale will now take you through our financial performance.

For the first quarter, Western Alliance generated net income of $84 million or $0.83 earnings per share. Net income was reduced by a $51.2 million provision for credit losses driven by the adoption of CECL, balance sheet growth as well as the change in the economic outlook due to the pandemic. Strong ongoing balance sheet momentum coupled with diligent expense management drove operating pre-provision net revenue to $163.4 million, up 10% from a year ago, which we believe is the most relevant metric to evaluate the ongoing earnings power of the company. Net interest income and fee income remained relatively stable, producing net operating revenue of $285.3 million, primarily a result of lower yields on loans which was partially offset by lower rates on deposits and borrowings. Noninterest income declined $10.9 million to $5.1 million from the prior quarter due to mark-to-market of preferred stock holdings of primarily large money center banks of $11.3 million, partially offset by $3.8 million equity investment gain. To date, of the $11.3 million mark, $3.5 million has been recovered. As credit spreads widened during the last quarter, the yield on preferred stocks followed, impacting valuations. We do not believe this represents a permanently reduced valuation and that preferred stock values will continue to recover over time. Finally, noninterest expense declined $9.3 million as compensation and other operating expenses declined by $7 million. Regarding implementing CECL in our allowance for credit losses. In our 10-K, we disclosed the adoption impact of $37 million. $19 million of which was attributable to funded loans, $15 million for unfunded commitments and $2.6 million for held-to-maturity securities. This resulted in a combined January 1 allowance of $214 million. During Q1, loan growth drove an additional $24 million of required reserves and about $30 million was driven by changes in the economic outlook as a result of the pandemic. In total, reserve build during the first quarter was $91 million, an increase of 50% from the year-end reserve. The quarter end ACL of $268 million was 1.14% of funded loans, up 30 basis points. Provision expense for the quarter was $51.2 million, which is over 10 times the average quarterly provision during 2019. As of March 31, the reserve build reflects our best estimate of the future economic environment, including the impact of government stimulus programs. We utilized an assimilation of various Moody's macroeconomic outlook scenarios to capture the most likely economic outcomes and a more severe scenario for potential tail risks. As the economy continues to change, we will adjust our ACL modeling accordingly. Turning now to net interest drivers. Net interest income for the quarter declined a modest $3 million from the prior quarter to $269 million as there was one less day during the quarter compared to Q4, and margin compression was offset by loan and deposit growth. Investment yields showed a modest improvement of 2 basis points from the prior quarter to 2.98%. However, on a linked-quarter basis, loan yields increased 31 basis points due to the lower-rate environment. The average yield of our portfolio at quarter end or the spot rate was 5.02%. Interest-bearing deposit costs increased 18 basis points in Q1 to 90 basis points as a result of immediate steps taken to reduce our deposit costs after the FOMC cut rates twice in March. The spot rate of total deposits at quarter end was 29 basis points. Total funding costs decreased 11 when all of the company's funding sources are considered, including noninterest-bearing and borrowings. Through the transition to a substantially lower-rate environment during the quarter, net interest income was $269 million, a decline of 1.1% from Q4. Continued strong balance sheet growth and immediate steps taken to reduce the cost of interest-bearing deposits counteracted the decline in prime and LIBOR. Net interest margin declined 17 basis points to 4.22% during the quarter as our earning asset yield fell 28, partially offset by 19 basis point funding cost decrease. With regards to our asset sensitivity, our rate risk profile has declined notably as the majority of our variable rate loan portfolio has flipped to fixed rate as floors have been triggered in the declining rate environment. Presently, 82% or $8.1 billion of variable rate loans with floors are at the floors. With the addition of our mix to shift primarily to fixed-rate residential loans, $16.2 million or 70% of loans are now behaving as a fixed-rate portfolio. This has reduced our interest rate risk in a 100 basis point parallel shock lower scenario to 3% at March 31 from 6.5% one year ago and assumes that rates are held flat at 0 across the term structure. Turning now to operating efficiency. On a linked-quarter basis, our efficiency ratio decreased 200 basis points to 41.8%. As mentioned earlier, the improvement was attributed to decreases in compensation and other operating expenses, while our revenues increased modestly. As a core component of our strategy, we continue disciplined expense management to sustain industry-leading operating leverage and profitability. Our core underlying earnings power remained strong as pre-provision net revenue ROA was 2.38%, flat from the prior quarter, while return on assets was down 70 basis points to 1.22%, directly related to our provision expense in excess of charge-offs of $54.4 million. As Ken mentioned earlier, our strong balance sheet momentum from 2019 continued into Q1. During the quarter, loans increased $2 billion to $23.2 billion, and deposits also grew $2 billion to $24.8 billion. Loan-to-deposit ratio increased to 93.2% from 92.7% in the fourth quarter. Our strong liquidity position continues to provide us with balance sheet capacity to meet funding needs. Shareholders' equity declined by $17 million as dividends and share repurchases were matched by net income. Tangible book value per share increased $0.19 over the prior quarter to $26.73 per share as our share count declined. We continue to believe our ability to profitably grow deposits is both a key differentiator and a core value driver to our platform's long-term value creation. Q1 is a seasonally strong deposit quarter. And coupled with the rollout of our deposit initiatives, deposits grew $2 billion. The increase was driven by growth of $1.3 billion in noninterest-bearing DDA primarily from market share gains in our mortgage warehouse operations. Additionally, HOA continues to perform well and contributed $330 million of low-cost deposits. During the quarter, the relative proportion of noninterest-bearing DDA grew to nearly 40% of deposits from 37.5% on a linked-quarter basis. Turning to loan growth. In line with the industry, the vast majority of growth was driven by increases in C&I loans totaling $1.8 billion, followed by $107 million in construction and land development and $92 million in residential. Residential loans now comprise 9.7% of our portfolio, while construction loans decreased as a relative proportion of the portfolio to 8.9% from 9.2% in the fourth. At the segment level, Tech & Innovation loans grew $626 million with $124 million from capital call and subscription lines and $176 million from existing technology loan draws, in turn, bolstering technology-related deposits by $383 million. Corporate finance loans grew $408 million, which is primarily due to line draws, two-thirds of which were from investment-grade borrowers, bringing utilization rates to 38% from 13% during the prior quarter. Mortgage warehouse also contributed loan growth of $550 million, approximately 50% of which was due to line draws. Across the bank, one-fourth or about $500 million of our net new loan growth was driven by drawdowns on existing loan commitments from the beginning of the quarter. In all, total loan growth of $2.2 million for the quarter was fully funded by deposit growth for the same amount. Overall, asset quality was stable during the quarter with total adversely graded assets increasing $10 million during the quarter to $351 million. While nonperforming assets comprised of loans on nonaccrual and repossessed real estate increased $27 million to $97 million or 0.33% of total assets and is now held for sale. Within these categories, we had migration from special mention to substandard and some of the normal investor funding was delayed in Tech & Innovation. As a precaution, when remaining liquidity declines below 6 months, we bring those loans into either special mention or sub for enhanced monitoring and engagement. This quarter, we saw the cumulative impact of our efforts on managing certain special mention and substandard loans as several resolved in our favor with no losses. $100 million of adversely graded loans resolved during the past quarter. 37 loans are $50 million paid off in full, while the other $50 million were upgraded to pass. As Ken mentioned in his introduction, we are well positioned entering this economic cycle. We only incurred $100,000 of gross credit losses during the quarter, which was more than offset by $3.3 million in recoveries, resulting in net recoveries of $3.2 million. We typically have one or two one-off credit charges every quarter. However, highlighting the strength of our loan book, we didn't experience any of these in Q1. We believe early identification and conservative management helps mitigate losses on these assets. In all, the ACL to funded loans increased 30 basis points to 1.14% in Q1 as a result of CECL adoption and the result in provision expense related to Q1 loan growth and changes in the economic outlook. We continue to generate capital and maintain strong regulatory capital ratios with tangible common equity to total assets of 9.4% and a CET1 ratio of 9.7%. In Q1, our reduction of TCE to total assets was mainly driven by a $2.3 billion increase in tangible assets due to our significant loan growth, while the tangible common equity was affected by $54 million of provisions in excess of charge-offs due to CECL adoption. In spite of reduced quarterly earnings and the payment of quarterly cash dividends of $0.25 per share, our tangible book value per share rose $0.19 in the quarter to $26.73 and is up 15.2% in the past year. Our diversified deposit-generation platform and access to significant liquidity resources is critical in times of economic stress. Overall, we have access to over $10 billion of liquidity primarily through our $4.7 billion investment portfolio, of which $2.7 billion are investment-grade, readily marketable and not pledged on any borrowing base. Additionally, we have $7 billion in unused borrowing capacity with the Fed, Federal Home Loan Bank and correspondents. Our strong capital base, access to liquidity and diversified business model will allow us to address any credit demands in the future. I'll now hand back the call to Ken to conclude with comments on a few of our specific portfolios.

Thanks, Dale. Regarding our hotel franchise finance business, we believe our focus on the select service subsegment, conservative loan-to-cost underwriting discipline and strong operating partners set us up for maximum financial flexibility to weather the duration of the crisis. Like most hotels in the country, our clients have seen a dramatic reduction in occupancy rates over the last month, and senior management is involved in active dialogue with each borrower to evaluate remediation efforts and contingency plans. Going into the pandemic, 75% of the portfolio had an LTV under 65%, and more than 73% had a debt service coverage ratio of 1.3x. Additionally, we only partner with experienced hotel operators with significant invested equity and resources to support ongoing operations. Fully 66% of the portfolio is with large sponsors who operate more than 25 hotels, and 90% operate 10 or more properties with top franchise or flags. Based on our ongoing constructive dialogue, we believe that sponsors view this as a temporary event and want to continue to maintain and support these properties over the long term given their significant equity investments. We are actively working with them to appropriately utilize the PPP program and the Main Street Lending Programs along with their own liquidity as a helpful financial bridge to arrive at a longer-term solution. Based on the mutually developed financial action plans, we will selectively implement loan modifications along the lines we previously discussed. This is a prime example where both parties contribute to a comprehensive solution. Now regarding our Tech & Innovation business, we primarily finance established growth technology firms with a strong risk profile mainly companies classified as Stage 2 with an established business model, validated product, multiple rounds of investment and a path to profitability. This provides greater operating and financial flexibility in times of stress. 99% of the borrowers have revenues greater than $5 million and a strong institutional backing, with 86% backed by one or more VC or PE firms. During the quarter, the portfolio grew $495 million to $2 billion or 8.8% of the total portfolio, which was attributed to $175 million of existing line drawdowns in the technology division and an additional $124 million from capital call lines, a product that historically has had 0 losses. Tech & Innovation commitments grew $284 million in Q1, and utilization rates increased to 60% from 49% in Q4 2019. The portfolio was fairly granular with an average loan size of $6 million, and these borrowers are generally liquid with more than 2:1 deposit coverage ratio. Additionally, since 2007, warrant income has covered cumulative net charge-offs 2 times over. Currently, 14% of technology loans or $164 million have less than 6 months remaining liquidity, which is in line with historical trends. Although some fundraising has been delayed, we were pleased to see several investment rounds close over the last several weeks and days with strong continued sponsored support. In conclusion, we see increased cash generation driven by our balance sheet momentum going into the quarter end as well as continued loan growth from the PPP distributions. We expect pre-provision net revenue to continue to grow through Q2 with the ability to absorb any necessary future provisions. Given uncertainty surrounding the likely duration of the virus and evolving economic environment, we will continue to reassess our outlook as health and economic facts warrant. Regarding asset quality, our proactive risk management approach is institutionalized throughout the company. We are actively working with our borrowers to develop mutually agreed-upon financial plans, assuming an elongated economic downturn that leads to long-term solutions. Our strong collateral positions and little unsecured or consumer lending should serve us well in mitigating potential risk of loss as we navigate these uncertain times. We stand ready to implement the likely next phase of PPP and the Main Street Lending Program to assist our clients and communities. Finally, Western Alliance has assembled a seasoned management team that has weathered several economic downturns and is applying the lessons learned from the Great Recession to face these uncertain economic times. And with that, we'll open up the line, operator, and we'll take everyone's questions.

[Operator Instructions]. Your first question today comes from Casey Haire of Jefferies.

Just a question on the reserve build. Obviously, a tricky proposition here. But trying to get a -- you guys mentioned you used a bunch of Moody's scenarios. Can you just give us some color as to how much weighting was given to the Moody's adverse scenario? What kind of recovery you guys are assuming? How much government help -- the stimulus stuff that the government is doing is -- offset it and then obviously, the duration? I know that's a lot, but just trying to get some color as to the magnitude of reserve build here.

Yes. So we primarily use the baseline case as of March 31. And then we looked at S1, and we looked at S3. S3 is the kind of the adverse scenario, which is obviously more critical and a longer recovery period. We do struggle with what is the timeline of this type of thing and how much these things come back. We do think that the institutions and the plans done by the federal government and both on the congressional side as well as the FOMC have an effect in terms of being able to mitigate this and draw -- make a bridge to when we're at a time when we can start to turn the economy back on. I don't have a timeline for you in terms of kind of when that is going to be. But we will look at this. We fully reserved as of March 31, and we'll look at this again at the end of the second quarter.

Yes. I would just add and say, we did factor in some impact of the PPP program. But as we were processing, we didn't know what that size level is going to be. So having 2,600 participants over $1.5 billion looking to go out is going to be very helpful. I don't think it's been fully factored into our reserve calculations. But that $1.5 billion will help cover $6.7 billion of commitments in our company or $4.6 billion of current outstanding loans, which means that's about 20% of our current portfolio.

Okay. Great. And just following up on the loan modifications. If I heard you right, I think you said $400 million to date. So just specifically, what exactly are you guys doing there? And then like any color as to how much you've improved upon that $400 million as of April 17 here.

Yes. By the way, that $400 million is April 17 number, just to be all clear. Okay? Number two, I would say in terms of color, I think we caught a lot of our clients by surprise, our borrowers by surprise when we said early on, this is going to be a longer-term problem. And let's have a longer-term solution rather than the standardized cookie cutter, 90-day P&I deferral. And by the way, that took a lot of getting used to from our client base, and we had to go back to them several times. As we've had that conversation, you can see that our viewpoint is more likely than not going to be correct. We don't know how long it's going to go. But we said, 'Let's start with figuring it out through the end of the year.' And because of that, we need you, the borrower, to contribute something with more equity, more collateral, more liquidity to the project, and then we will help you along with the deferral as well. And we took each loan on a case-by-case basis. So we didn't make broad proclamations that said, 'We'll just do 90 days here.' So every loan is being different. And I assume as we get into questions about different books of business, I'll give you some stories behind each one of those books of business. But we think getting out there and dealing with our clients on a one-to-one basis is going to be helpful. And by the way, the same lessons that we learned in the Great Recession that getting there early, having conversations for the longer term helps our clients survive. But more importantly, they know that we'll be there when they start to see growth opportunities. And the combination of their growth opportunities and the ability to get through this gives them the ability to prosper long term. And that's our approach when we sit down and we talk to our clients, Case.

Okay. Great. Just last one for me. You guys are clearly prioritizing the PPP program for loan growth. Just a question, so how are you guys funding this? Just trying to get a sense for what the margin -- the incremental NIM might be. And how willing -- how regarding capital and liquidity, are you willing to go much higher on the loan-to-deposit ratio and -- as well as on the TCE ratio?

So you may have noticed, our ending balances for loans and deposits were significantly above the average balance for the first quarter. So we had $1.7 billion more in loans and $1.5 billion more in deposits. Two-thirds of the deposit number was in DDA. That gives us, we think, momentum in terms of expanding PPNR into Q2. You layer this $1.5 billion then on top of that, we have a myriad of ways to be able to fund this. One is we think we have additional deposit opportunities; two is the Federal Reserve has said they'll advance 100% on these loans; and three, we have another $10 billion of liquidity that we could get elsewhere. So we're not really concerned about funding that cost. I think it's going to be something around 25 basis points. If we put it to the Fed, it's 35 basis points to do that. And then we'll take these in. So that, again, I think, shows that we expect continued balance sheet growth into the second quarter primarily driven by these PPP notes.

Okay. And if I'm understanding the PPP, it comes on at around 2% with the fees associated. So it looks like about 1.75% incremental margin. Is that right?

Yes. So our weighted fee on the $1.5 billion we've done is 2.4%. And then these loans -- I mean the preponderance of this is fairly short term. We're going to call it 6 months. But then for the part that isn't forgivable, that has a tail that goes out 2 years. So on those actual loan rates on the entire program was 1%. So you get 2.4% on the entire bucket, and some of that is going to be accelerated in terms of recognition based upon the short-term nature of the forgivable element.

The next question today comes from Arren Cyganovich of Citi.

I was wondering if you could just talk a little bit about the working with the customers. I appreciate all the commentary. I guess I just want to have a better understanding of what proportion of your customers are actually getting deferrals now and how that -- how those are categories relative to the modifications that you're discussing.

All right. Thank you. And this is, I think, a nice follow-on to the discussion we've just had. In the prioritization of this, the customer conversation, that dialogue is of top priority. So that started for us back in February. We've got two parts to this that have come into our common language. There's the trough, and then there's the recovery and stabilization and a new normal. As a bank and as a business, we know that the better that we do and the better that we help our borrowers through that trough in terms of proper planning, the better that asset stabilizes in the new normal. So the conversations are actually going very, very well. But there's obvious differences between borrowers and industries and businesses. And necessarily, there's different conversations and discussions. But what that lets us do as a business is then monitor that cash and liquidity through the trough and be best positioned in the recovery and then stabilization and in normal, whatever it is for their business. And so it's really a dialogue that started in February, and it will continue throughout this entire process. PPP is just part of it.

So Arren, this is Ken. Let me just -- it's an interesting question that you asked because there's not one singular answer for the entire portfolio. It depends on which portfolio you're talking about. But maybe some color behind the portfolios would be helpful here. So for example, we're talking to everyone in the hotel book, right? That's HFF. That's $2 billion. Well, 50% of those -- 50% of our clients have already made their P&I for April. And then 80% of the remaining 50% are in deep conversations with us, where we hope that we'll have something tied down in the next couple of weeks in terms of a modification program. And then they'll make their payments at that time or maybe they'll extend first, and then we'll get some payments after that. So that's the hotel book, and that's how the conversation is going there. The conversations, say, in lot banking is quite different. We're actually getting inbound calls. And we're -- and people are asking us, 'Are you going to be there when we find opportunities?' And then our question is, 'Well, are you looking for deferments?' And we've had a couple of deferrals. We've got a couple of clients call in and say, 'I'm not going to ask for anything. I'm looking at the future. I need you to stand with us.' So those are just two different ways. The book is different. Our gaming book, okay, is completely different than what's happening. We think our gaming book, other than 5 or 6 small deferrals that we made on principal, we think our overall gaming book has enough liquidity to survive into the summer, right? Which is -- so that makes our conversation there a little bit different. We can take a little bit more time. We can see how the Main Street lending facility can be accessed because the gaming companies could not access the PPP program. So every different segment of our book has a different conversation. And that's why, if I can reiterate again, and Tim was very early on this in our -- we do a weekly senior operating committee meeting, but in the second or third week of January, he just stood up and said, 'Okay. We're going to have senior leaders be in charge of books of business across the entire company that have workout experience, heavy credit experience, has been through something like this. And therefore, we can tell each discussion differently.' That's -- for example, Robert running the hotel business -- Robert was born with hotel business in his veins. Why wouldn't he take that on and run with that, all right? And so we look for different strengths to match up against the portfolio here. I'm sorry, it was a longer answer, but I hope I gave you some color as to how we're managing our conversations with our clients.

The next question today comes from Brock Vandervliet of UBS.

Just big picture to start. Do you think this is going to be a mild or severe recession in the scale of recessions that you've experienced in the past?

Well, my answer keeps evolving as information evolves. And I try not to be tick by tick, but certainly more pessimistic than I was in early March than mid-March, given the 22.5 million people have recently filed for unemployment claims. So I think it's going to be deeper than I've ever experienced, all right? But I think our answers or our approach was one that we anticipated that it was going to be longer than what people thought. We just didn't think the severity of what we're seeing was going to be as deep.

Okay. And more specifically around investors' real concerns here, for the hotel book, like what percentage of properties would you say go bankrupt in an average recession? What...

Okay. So we went back and we looked at the GE -- this was originally the GE business, and we bought it in GE -- from GE in 2016. So when we went back and we looked at their performance level from 2007 to 2015. And during that time, during those 8 years, total losses amounted to $52 million. Average charge-offs of 60 basis points, with peak losses coming in 2010 at 3.3%. They had a portfolio of about $1 billion in size. Now what's important to note is their portfolio was completely different than the model that we constructed. Their portfolio was more of a shotgun approach. They had weak flags. We do not. They have small operators. We do not. They had weak sponsors. We do not. And they had LTVs of 75% and our LTVs, as I said earlier, are about 60%. So we have a different model than what they have, but that's our best look back to get a gauge on what may happen going forward, adjusting for the difference of our model. Tim, you want to comment?

I just want to add one thing to that is I think if you really look at it to our sponsorship and sophistication of investor competition, is a lot different than that legacy portfolio as well. We really have the larger operators, the higher level of sophisticated investor. When we have these dialogues and say, 'Come on, we're solving for something here that isn't 90 days.' We have folks that understand why and how we can work together and do that. And that's going to keep the leverage down on this portfolio. How we do on that puts us in the position and the rebound that we want to be at.

And lastly, the debt service coverage ratios that you show on Page 20, are those as of Q1? Or are those through April? Because clearly, the hotel performance has gotten -- deteriorated.

Yes. Now they're through Q1, Brock. We wouldn't have that information that quickly for April.

The next question today comes from Brad Milsaps of Piper Sandler.

Ken, I think you gave the stat on the tech book that 14% of the companies had cash on hand six months or less, which was pretty consistent with history. I was curious if you could give that same kind of stat for the hotel book. Obviously, I know that the PPP program is having an impact there as well. But just kind of wanted to get any kind of sense on kind of the forward look on debt service coverage for that book, if you could look at it in a similar way to -- as you look at the tech book.

Well, I don't have the stat on what the collective liquidity is for the hotel book. We are -- that is one of the single most important questions we have, our clients. And it's -- we're gathering that information as we speak. They generally don't run with a lot of liquidity. And now here's my however: my however is if you are a recently opened hotel, which we have a couple, they have liquidity. Because they had that liquidity on their balance sheet, getting ready for the opening. So they're okay. If you're a hotel that was building up your reserve to do a pit, you have some of that liquidity. If you're a hotel that's been operating for a while and distributions have gone back to your investors, you have less. And therefore, we have to talk to you to go to the investors to get a capital call to come in for you to get a defer -- to get some deferral. So a little bit different, and that's why one of the things that I can keep repeating here, case by case, individual hotel by individual hotel and our individual property throughout the whole book of business.

Okay. And just maybe a follow-up -- two follow-ups. One, how large is the gaming book? And then secondly, I think at the end of last year, you had about $8.5 billion of unfunded commitments in total for the whole loan portfolio. Can you talk about the potential for those to be drawn down, maybe where you've cut those 2 and implications of that would have on capital?

So I'll take the easy question, and then I'll slip it over to Dale for the harder one. The simple answer is $500 million on gaming.

Yes. So the most significant draw we've ever had on unfunded has been 8% of that amount, which, frankly, we got close to kind of where we were with this drawdown. We're not seeing any more additional draws at this time. We're -- in fact, we've had some kind of repayments of some of those draws. So we don't see -- and a lot of these draws there -- I mean they're -- or these commitment lines, we don't think they would really kind of ever be drawn down in terms of the structure behind some of these credits. So while we have these unfunded elements to them and we did have a drawdown in March predominantly, we're not seeing anything else subsequent to that.

The next question today comes from Chris McGratty of KBW.

Quick question on just the balance sheet trajectory. Given the comments about the growth and the draws, any thoughts on adjusting the resi mortgage strategy a bit just in light of the capital and liquidity?

So the resi -- the purchase of resi mortgages may be far more opportunistic right now than we've ever seen as some of our clients are selling their mortgages at significant discounts, which will allow us to go ahead and buy at higher yields than we bought in Q1. So we're going to look at that. The keyword we used to use -- or we used for our share repurchase was opportunistic. Same thing here. If we can get the right risk/reward trade-off, in fact, there are resi mortgages available that have better or lower LTVs, lower DTI and higher FICO scores that are selling for much higher yields than what we've recently purchased, say, at the end of 2019. So we'll look at that and if there's opportunity there, we're going to take advantage of it.

I think an important thing on this program as well as on the hotel book is collateral. I mean we are in strong collateral positions that -- such that it would take considerable sustained valuation declines to ever pierce where we are in terms of risk of loss.

Okay. And just if I could follow up, Dale, in terms of either the CET1 or the tangible. Obviously, this quarter had a big jump down just because of the growth. Where do you comfortably run those ratios in this environment over the next few quarters?

Well, I mean, so we saw a decline in those two. Now with the PPP program, that could pull down our TCE. It really won't have an effect on CET1 because those are all 0% risk weight as they're SBA back. But we could see this number come down into the 8s.

Maybe just a follow-up, Ken, on your comments about net charge-offs and when they'd be realized. I guess maybe in particular, could you just talk about high level where you think those will come from at this point? It sounds like maybe you don't expect as much from hotel given the collateral base there, but would it be more tech and life sciences businesses with less collateral base or some of the C&I categories, in particular, shared national credits or anything like that that maybe we're not seeing or focusing on right now?

So I think I took a little bit of a step out there saying, 'I just think charge-offs will be a little bit later. My crystal ball isn't as clear to say which group is going to have the charge-offs. And I don't feel comfortable really putting that out there at this time. I just don't -- if things are changing so quickly that I would clearly be wrong. And I'd just rather hold back my intuitive feel on that. But I do feel generally that charge-offs will come later in the year and not as early as people think.

Yes. I mean we are probably at about $1.4 billion. I mean most of the draws that have come down have come down in SNCs. And as we've talked about in the past, this is a low investment-grade portfolio. The syndicators are, as I just mentioned, the large banking companies that we participated in. We've -- at times, we've tried to do so, so that we can augment our ability to push for deposits from some of these enterprises that are in our markets. And so we've taken a little piece of them.

Okay. And then maybe just last one for me. Just on the expenses. Obviously, a pretty decent step-down this quarter related to, I assume, lower comp expectations. But is that kind of a new run rate that we should kind of base growth off of from here? Or any other factors that maybe shifted meaningfully with everyone working from home, et cetera?

No. I think we're on a lower trajectory from where we were with the step-down. We're continuing to do the necessary investments that we have in technology to make sure our platform continues to support what we're doing today, which is basically executing on our -- in our business resumption continuity programs. Ken?

Well, it looks like we've exhausted all the questions. So we ran longer. We thank you for spending time with us. We look forward to talking to you again, and we wish you a good weekend, health and safety out there for everyone. And we'll be in touch. Thank you all.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.