Western Alliance Bancorporation Q4 FY2023 Earnings Call

Good day, everyone. Welcome to Western Alliance Bancorporation's Fourth Quarter 2023 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.

Thank you, and welcome to Western Alliance Bank's fourth quarter 2023 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; Dale Gibbons, Chief Financial Officer; and Tim Bruckner, Chief Banking Officer 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 more complete discussion of the risks and uncertainties that cause the 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.

Thank you, Miles, and good morning, everyone. I'll make some brief comments about our fourth quarter and full year 2023 earnings before turning the call over to Dale, who will review our financial results in more detail. After I discuss our 2024 outlook, Tim Bruckner will join us as usual for Q&A. Western Alliance's diversified national commercial business strategy continued to drive strong momentum in the fourth quarter, as we generated earnings per share of $1.33 or $1.91 excluding $0.58 of one-time notable items. The quarter featured both healthy balance sheet growth and additional balance sheet repositioning actions to further optimize our funding base. Looking past these notable items which Dale will explain shortly, highlights for the quarter included solid loan and deposit growth, ongoing capital and liquidity accumulation, and continued stable asset quality. Deposit growth of $1 billion allowed us to continue to selectively reduce debt and borrowings. In Q4, we fully repaid $1.3 billion of advances from the Bank Term Funding Program, as well as a $300 million 6.5% AmeriHome Senior Notes, which were not replaced with new borrowings. Regarding the AmeriHome Notes, we seized an opportunity to repay this higher-cost debt at a discount. Additionally, our portion of the industry-wide FDIC special assessment to replenish the Deposit Insurance Fund totaled $66.3 million. Loans rose $850 million in the quarter, bolstered by C&I growth within our regional footprint. Western Alliance begins 2024 supported by a strong capital base and liquidity position. CET1 expanded approximately 150 basis points during the year to 10.8%, which equates to 9.8% when including AOCI. 80% of our deposits are either insured or collateralized, which ranks among the highest levels of the 50 largest U.S. banks. Despite the industry's challenges, our total deposits increased 3% year-over-year. Asset quality also remains in very good shape. We've limited net charge-offs of only 6 basis points of average loans in 2023. Limited realized losses amidst a normalized credit backdrop is indicative, in our view, of the merits of lending with low advance rates adhering to conservative underwriting standards, and approaching credit mitigation proactively. Continuing to shift our funding base from borrowings to core deposits better positions us to grow loans in a rate environment in flux likely to decline later this year. We have made investments and leadership additions in order to drive increased C&I growth in our regional footprint, expand fee income opportunities across client relationships, and complement the growth of our national business lines, particularly our leading national deposit focus verticals. Overall in 2024, we look forward to consistent balance sheet and PPNR growth, with higher liquidity and improving capital. This will empower Western Alliance to continue partnering with our clients on their most important projects. Dale will now take you through the financial performance. Afterwards, I will provide you with our 2024 outlook.

Thank you, Ken. For the year, Western Alliance generated net revenue of $2.6 billion, net income of $722 million, and earnings per share of $6.54. Net revenue grew by 3% compared to the previous year, showcasing the resilience and adaptability of our business model. Net interest income increased by $123 million, or about 6%, to over $2.3 billion, despite our reduced loan growth and the completion of several asset sales earlier in the year. Non-interest income fell by $44 million to $281 million due to repositioning actions, fair value marks, and a slowing mortgage purchase market. Non-interest expense rose to $1.6 billion, an increase of $466 million year-over-year, mainly driven by higher earnings credit rates and deposit costs in a rising rate environment. In terms of fourth quarter trends and business drivers, we reported pre-provision net revenue of $220 million, net income of $148 million, and earnings per share of $1.33. As part of our balance sheet optimization efforts earlier in the year, we repaid $300 million of AmeriHome Senior Notes at a discount, using this gain to enhance our balance sheet through the sale of securities and adjustments in mortgage servicing rights, which combined resulted in a pre-tax loss of $4.5 million, along with a $66 million FDIC special assessment. Excluding these one-time notable items, our adjusted net income was $211 million with earnings per share of $1.91. Net interest income rose by $4.7 million in the quarter to $592 million, attributed to higher average earning asset balances and reduced high-cost borrowings. GAAP non-interest income was $91 million, or $126 million when excluding notable items, which represented a decrease of around $3 million from the third quarter. During the quarter, we sold approximately $200 million of Mortgage Servicing Rights, improving our capital ratios despite an $11 million loss on the sale. With prepayment speeds beginning to recover from historically low levels, the valuation of Mortgage Servicing Rights decreased at an accelerated pace, leading to a $14 million fair-value adjustment net of hedging. We believe that this combined $25 million charge does not reflect the earnings potential of our Mortgage Banking business. Lock volumes saw a 29% year-over-year rebound, suggesting sustained momentum into 2024. Following December’s rate rally and the subsequent drop in mortgage rates, we experienced an uptick in refinance volume and strengthening margins. If mortgage rates decrease in upcoming quarters, we anticipate that our business will benefit, a factor not yet included in our future guidance. Additionally, income from equity investments rose by approximately $8 million, driven by substantial gains from solar tax credit investments that exceeded expectations during the quarter. GAAP non-interest expense was recorded at $462 million, or $435 million excluding notable items, reflecting a quarterly rise of $9 million. The growth in deposit costs slowed considerably, increasing by $3 million in the fourth quarter as our Settlement Services and Homeowners Association businesses experienced strong customer growth that outweighed the typical seasonal drop in Mortgage Warehouse. Provision expense stood at $9.3 million, indicating stable asset quality. Lastly, our effective tax rate was approximately 30% in Q4, elevated primarily due to timing issues involving low-income housing units that were not put into service in 2023. We expect the 2024 tax rate to adjust to between 22% and 23%. Loans Held For Investment grew by $850 million to $50.3 billion, while deposits rose by $1 billion to $55.3 billion at the end of the quarter. Mortgage Servicing Rights decreased to $1.1 billion due to MSR sales and lowered valuations impacted by the lower rate environment. As a whole, we continue to enhance our levels of high-quality liquid assets and maintain on-balance sheet liquidity through strong deposit growth. The previously discussed debt repayments reduced cash investments by $351 million since September 30. Our robust deposit growth over the past three quarters has enabled us to halve total borrowings and debt since the end of Q1. Ultimately, tangible book value per share rose by $3.06, or 7%, over the prior quarter and 16% year-over-year to $46.72, driven by retained earnings and diminished negative impacts from all other comprehensive income. Growth in Loans Held For Investment was largely from commercial and industrial categories, with some areas showing increased utilization of higher-end lines. Construction and land loans increased by $220 million, with nearly half stemming from lot banking. Considering the nationwide undersupply of homes and the likelihood of upcoming rate cuts, we remain optimistic about the macroeconomic outlook for this sector. The $1 billion deposit growth occurred despite the usual seasonal declines in Mortgage Warehouse deposits due to tax and insurance payments. We continue to see widespread growth from our specialized value-added deposit channels. The HOA sector had its best fourth quarter to date, and we believe it will maintain and possibly expand its leading market share, similarly to what we achieved in the third quarter of last year. Settlement Services, Tech and Innovation, Corporate Trust, and our Digital Consumer Channel all experienced significant growth and contribute to our well-diversified expansion. Non-interest-bearing demand deposits accounted for 26% of total deposits, with 45% yielding no cash earnings credits. The reduction in non-interest-bearing balances was primarily due to the anticipated $3 billion decline from the seasonal nature of property tax and insurance escrow funds within the Mortgage Warehouse. We have not seen any client attrition related to these outflows, and this decline is expected to recover as predicted this quarter. Regarding net interest drivers, the Held For Investment loan yield decreased by 8 basis points because of the full quarter impact from the $1.3 billion reclassification of loans from Held For Sale to Held For Investment at the end of Q3. Coincidentally, this resulted in an increase of 31 basis points in Held For Sale yields. Looking ahead, we expect Held For Investment yields to remain supported by an average of $2.9 billion in loans repricing or maturing in the third quarter of 2024. Yields on total investments rose by 8 basis points in Q4 to 4.99%. The Securities portfolio increased by $1.9 billion to $13 billion as we continue to meet our High-Quality Liquid Assets goal, which elevated our treasury holdings from $900 million at the end of Q1 last year to about $4.9 billion by year-end. The cost of interest-bearing deposits rose by 7 basis points, which was significantly slower than in the previous quarter, and the total cost of funds increased by 2 basis points to 2.82% due to an uptick in demand deposits and reduction in short-term borrowings. Deposit growth allowed for a $768 million increase, a reduction in average short-term borrowings, and a 6 basis point improvement in the cost of interest-bearing liabilities. Overall, net interest income rose by approximately $5 million, while the net interest margin of 3.65% aligned with the midpoint of our Q4 guidance. The growth in our net interest income was surpassed by the growth rate of average earning assets. Non-interest expenses saw a $27 million impact from notable items during this quarter. After adjusting for these one-time items and the costs associated with deposits, our adjusted efficiency ratio increased by 100 basis points to 51%. We expect that deposit costs will benefit from the end of rate hikes and will decrease as rates fall. For historical context, average earnings credit rate balances were $19.9 billion in the fourth quarter, compared to $17 billion in Q3 and $15.4 billion in Q4 of 2022. We foresee ECR-related deposits maintaining a consistent proportion of our deposit base as total deposits increase. Based on our rate expectations and an overall high beta repricing for ECR-related deposits, we anticipate such pricing will largely decline in line with rate cuts, counterbalancing any potential declines in net interest margin. Our asset quality metrics remain stable, consistent with what we reported last quarter. The total net increase in Special Mention loans and classified assets was only $7 million from the level in Q3. Non-performing assets rose to $281 million, equating to 40 basis points of total assets, marking a 5 basis points rise above the third quarter. Quarterly net loan charge-offs were $8.5 million, or 7 basis points of average loans, aligning with Q3's charge-offs. Provision expense of $9.3 million was driven by loan growth and has slightly improved Moody's consensus forecast, although our consensus and early risk ratings for our Allowance for Credit Losses continues to incorporate an 80% recessionary outlook. Our allowance for credit losses increased by $10 million from the previous quarter to $337 million, leading to an ACL ratio of 73 basis points, covering 135% of non-performing loans. When examining the reserve block, you'll see a revised perspective on our allowance; when factoring in insured loans and those in no-loss categories, the allowance adjusts to 1.31% of loans. Our Common Equity Tier 1 ratio rose by 20 basis points to 10.8%, or 9.8% adjusted for the AOCI debit. Our tangible common equity to total assets increased by approximately 50 basis points from Q3 to 7.3%, due to earnings and enhancements in our AOCI position. Tangible book value per share grew by $3.06 from Q3 to $46.72, driven by earnings and the recovery of AOCI marks. The $220 million improvement in AOCI resulted from significant reductions in intermediate-term treasury rates during the quarter. Our consistent increase in tangible book value per share has far surpassed peers by nearly five times since 2013, including strong growth reported in 2023. Throughout various time periods, Western Alliance continues to deliver top-quartile total shareholder returns compared to both asset-light peers and the Regional Banking index. Thank you, Ken.

Thanks, Dale. Our guidance for 2024 is to build on the second-half momentum of 2023 and progress towards returning to above-industry returns. In the first half of 2024, the Company will emphasize liquidity growth over loan growth, drive capital above 11%, and further build our HQLA portfolio, which will temper earnings growth for the first half of the year. As these goals are achieved, earnings momentum will accelerate in the second half of 2024 and into 2025. So, for the full year of 2024, we expect continued thoughtful balance sheet growth driven by our diversified business model, with an origination mix designed to drive net interest income above 2023 levels. Loan and core deposits are expected to grow $2 billion and $8 billion respectively for the year. Core deposits-driven growth should continue to push our loan-to-deposit ratio towards the mid-80% level by the middle of this year. Regarding capital, we are targeting a CET1 ratio above 11%, reflecting steady organic capital accumulation in concert with balance sheet growth. Net interest income should grow 5% to 10% from a Q4 2023 annualized jumping-off point. This forecast assumes four 25 basis point cuts back-loaded in the year. We expect any future NIM compression resulting from the rate cuts to be matched by comparable deposit cost declines in non-interest expense, which will be accretive to earnings. Non-interest income should increase 10% to 20% from an adjusted 2023 baseline level of $397 million, which excludes 2023's mark-to-market adjustments and the impact of asset sales, as we prioritize growing commercial banking-related fee income from holistic customer relationships. Mortgage banking-related income will be somewhat dependent on the rate environment and mortgage buying, but we're encouraged that with the recent low rate environment, application volume is picking up with firmer margins thus far in early 2024. Non-interest expense, inclusive of the ECR-related deposit costs, should rise only 0% to 2% from an annualized adjusted Q4 baseline of $1.740 billion and allow for continued operating leverage. In aggregate, these factors will enable WAL to consistently grow PPNR throughout the year. Asset quality remains manageable and projects continue, and we project continued support from our sponsors. Based on our conservative underwriting and low advance rates, net charge-offs are expected to be 10 basis points to 15 basis points for the year as the economic cycle normalizes. Lastly, we expect the effective tax rate to revert between 22% and 23% starting in Q1. At this time, Tim, Dale, and I are happy to take your questions.

Thank you. Our first question for today comes from Casey Haire of Jefferies. Your line is now open. Please go ahead.

Thank you and good morning, everyone. I wanted to begin by discussing the four cuts and their impact on the PPNR guidance. This certainly affects you in several ways. Dale, I believe you mentioned that your fees don't factor in any potential upside from mortgage banking. It seems that the deposit costs within your expenses are fully tied to beta. Can you confirm that? Additionally, regarding the four cuts, what kind of deposit beta do you anticipate for the non-ECR component, and how will that affect NII?

Yes. Overall, the net impact on PPNR is relatively minimal. As we've mentioned previously, our net interest income is moderately asset-sensitive, which may lead to a slight decrease. However, as you pointed out, we anticipate a decline in ECR price deposits, and we believe that will align accordingly. Combining these factors, we expect to become somewhat liability-sensitive, resulting in a net benefit to PPNR, excluding the AmeriHome aspect, which serves as a potential upside if conditions improve significantly, and that's a positive development.

So, AmeriHome would be gravy if it did, but obviously, if it's back-half-loaded, it might be modest.

Yes. So, the mix will look a little different. I mean, if you had a more accelerated rate decline, maybe you're going to see a faster decline perhaps in net interest income, reflecting the net interest income profile that we have. But again, when you layer in the deposit costs, I think it's going to eliminate that.

Okay. And then, so the loan-to-deposit growth guide for '24, you've got $613 million of liquidity to play with. What is the plan for that? Build the bond book? Build cash? Pay down borrowings? Just wondering what your plans are there.

Yes. When I consider the year ahead, I see the first half as a time to enhance our liquidity profile. This will enable us to strengthen our high-quality liquid assets portfolio. We aim to achieve a loan-to-deposit ratio in the mid-80s. Following that, we anticipate significant growth leading into 2025. It’s essential for us to continue repositioning ourselves, and we expect to complete this by the end of the second quarter. After that, we will experience more traditional earnings, similar to what you've seen from us historically. I want to emphasize that the influx of deposits and loans will occur gradually throughout the year, with an expected increase of about $500 million per quarter for loans and roughly $2 billion per quarter for deposits.

Got you. Thank you. And then just last one. Dale, you mentioned the DDA. It sounds like it's recovering seasonally within Mortgage Warehouse, just any update you can share on how much of that $3 billion has come back in?

Well, so, it's really based upon the semi-annual property tax payments, largely in California. And so, we would expect that we're going to get half of that or two-thirds of that this quarter. And then the rest of it would start coming in. The payments due in May are less dramatic in terms of kind of the dip that we see. Meanwhile, other Warehouse funds look to be growing consistently, and we're also off to a good start in our HOA business for Q1.

Casey, let me just add, right now we're on track to beat the $2 billion for our Q1. And that's inclusive of the HOA deposits coming back in.

Great. Thanks, guys.

Thanks.

Thank you. Our next question comes from Steven Alexopoulos from J.P. Morgan. Your line is now open. Please go ahead.

Hi, everybody. I wanted to start on the margin. So, you were 3.65% in the quarter, right in the middle of what you had guided to. Dale, for you, how should we think about the NIM trending the backdrop of four cuts? And then it's funny, when I look at where the NIM was when we had a more normal curve, I mean, you guys were like 4.50%, but this is a completely different balance sheet today. So, assuming we eventually get a normal curve, normal level rates, like what's a reasonable NIM for this balance sheet?

Hello, Steve, it's Ken. Thinking about the year, I expect that in the first two quarters, the net interest margin should align with our Q4 net interest margin of 3.65%. In Q3 and Q4, the net interest margin will gradually decrease as rate cuts take effect. However, this decline in net interest margin will be balanced by the reduction in ECR expenses.

So, what's transpired is, we have and we expect to continue to have considerably more liquidity on the balance sheet, and that is going to kind of depress NIM at basically a permanent basis. Where can we be kind of going forward, I think we can be close to kind of where we are. So, maybe the 3.5% range is kind of sustainable kind of over kind of a broader economic cycle than what we have seen. We'll probably have a little bit better return on the Residential portfolio that we presently have. But for the most part, I think our numbers rather than being in the 4%s, I think we're destined for the 3%-level here going forward.

Got it.

Preamble.

Okay. And then on the expense guide, so you guys were $437 million on the ECR deposit cost in '23, what's assumed within this expense guidance for 2024 for the cost of ECR deposits, like where is that roughly?

Yes. It's quite stable, and as we mentioned previously, we expect our forecast to be back-end loaded starting in June regarding the rate, which could impact how things develop.

That's something that we don't do.

Go ahead.

Steve, your line is a bit unclear, but I want to emphasize that your question pertains to total dollars. While the rate will decrease, total dollars might still increase as we continue to focus on deposit growth. So, please consider the impact of the rate volume in that context.

Yes. Got it. Okay. Ken, can I just finally ask you a big-picture question? So, when I look at the Company, right, years back, we had the financial crisis and you guys made quite a few changes after that, right, built-out national businesses, you had top-decile growth for a long time. Then we had March Madness, you again pivoted, right, you made adjustments, pushing up insured deposits, chained-in liquidity, et cetera. When I look at the 2024 guide, it looks like more of the same in the first half, but then when we get to the second half of the year and then 2025, what does this company then look like? Do you throttle up loan growth from where we are? Do you throttle that deposit growth? Are you back to a growth Bank? Like how you see the world right now and a longer-term for the Company? Thanks.

Yes. Good question. We started to pivot by the way in the third quarter of 2022 with higher liquidity and higher capital. And we certainly were very happy that we did. As we entered March Madness, it really served us well. And that's informed our decision-making as to why we want to keep that moving forward. And as you said, we'll have that basically completed by the first half of 2024. Then, I think what you're going to see is a little bit of the same Bank, but I don't think we're going to put our foot on the accelerator as hard as we used to push down on the throttle there. And one reason is, we never got really paid for that. So, up until the end of 2022, we were probably growing deposits and loans about 24% to 25% per year and we didn't see that in our evaluation. And in fact, people always got nervous with that and said, geez, there must be a credit problem that was lurking behind, but really over that period of time, we only had $29 million of net losses. So, what we're going to do is, we're going to be targeting for above-industry trend growth going forward in the back-half of '24 and into '25, and we think we'll get rewarded for that, and takeaway concerns that they'll always linger about going way back even to 2006 and '07 and '08, that people bring up and I think we'll run from there. But we should be higher in our return on equity, higher on return on assets, but not to the old levels of coming back to 2010 to 2013, 2014, 2015. Okay?

Got it. Yes. That's great color. Thanks for taking my questions.

You're welcome.

Thank you. Our next question comes from Ebrahim Poonawala from Bank of America. Your line is now open. Please go ahead.

Hey, good morning.

Good morning.

I guess maybe just one bigger-picture question around earnings. If I have the math right, in terms of your earnings outlook, you probably shake-out on $8 in EPS for '24, should we expect EPS to dip in the first half before re-accelerating in the back half of the year? How do you think about earnings growth relative to the $1.91 you printed in the fourth quarter? Just given the moving pieces around what you're doing with HQLA, the benefit of rate cuts in the back half, I would love to hear just the earnings trajectory that you are looking at.

That's a really good question, Ebrahim. The first quarter typically experiences a dip, as seen in previous years. By the fourth quarter, we might notice some factors like diesel and higher fiber costs affecting us, along with fewer days in Q1. This means the start of the year will likely be softer. As we progress into Q2 and Q1, we'll be focusing on building and finalizing our HQLA position by the end of the second quarter or early in the third. This could lead to slightly lower earnings growth during these first two periods because our anticipated strong deposit growth will be allocated to an asset class with lower yields. However, as the situation evolves and the loan-to-deposit ratio approaches the 80% range, we expect to see a more balanced growth rate in loans and deposits by summer. Consequently, growth rates are expected to improve toward the end of 2024 and carry into 2025.

That's helpful. I have another question regarding your approach to acquiring deposits today. Ken, has your strategy changed? You've highlighted the focus on certain regions and their deposit growth, but I'm curious if your perspective on large deposits has shifted, especially considering the emphasis on liquidity. Should we anticipate a different strategy for deposit growth and client acquisition as a result?

Yes, Ebrahim, thank you for the question. Your inquiry is insightful as it aligns with how we are evolving our business. We have been developing several new deposit verticals that are gaining traction. The first is Settlement Services, where we saw a growth of $2.1 billion this quarter. These deposits tend to be larger, and the growth rate has been steady and consistent. As we reach certain levels, larger deposits will cycle out and we will need to attract new large deposits. Additionally, our business in escrow and Corporate Trust is also gaining momentum, with growth of $350 million this quarter. This sector will continue to expand, especially once we restore our investment-grade ratings, as this will allow Corporate Trust to contribute more significantly to our deposits. With our current 11% CET1 ratio and a loan-to-deposit ratio in the mid-80s, combined with stable asset quality, we believe we will be positioned for an upgrade. Moreover, our HOA segment, which has been a primary national business line for us, continues to perform exceptionally well. Typically a slow quarter, the fourth quarter saw an increase of $300 million, contributing to an annual growth of about $1.2 billion from more consistent, smaller deposits. These come from both new acquisitions and existing clients expanding their business. Additionally, we are excited about our Consumer Digital Platform, launched on January 4th, 2023, which brought in nearly $800 million this quarter. This has proven to be a major success, with client deposits generally averaging between $53,000 and $57,000. Looking ahead to 2024 and 2025, we plan to transition this platform from an external vendor to an internal solution, which may involve running both for a period until we are fully operational with our own system. This shift should ultimately lower our maintenance costs in the years following 2024. Lastly, we are also re-evaluating our regions, which is why we have transitioned Tim from his Chief Credit Officer position to Chief Banking Officer for the regions. Lynne Herndon has taken over as Chief Credit Officer, with Tim tasked to rethink the regions to make them more focused on Commercial and Industrial (C&I) activities. This approach should not only increase deposits—$600 million came in from the regions this quarter—but also enhance our fee income. We expect this focus to contribute positively as we continue to engage in our Treasury Management Services, gaining momentum into late 2024 and into 2025. I hope that provides a comprehensive view of our initiatives, and we are also exploring additional deposit verticals that are in very early stages, which we aim to advance in 2024 or early 2025.

So, that is helpful. Thanks for the rundown, Ken. And what I didn't hear was, does this change at all your view around doing any Bank M&A where you pick up a retail franchise, bring in another deposit sort of generating engine or is that not kind of part of the equation today?

Today, M&A is not part of the discussion. We are focusing on achieving an 11% CET1 ratio and moving it upward. Eventually, the topic of M&A will come up as we continue to grow. Once we reach a certain level with deposits, this might become relevant as we aim for $100 billion in assets. However, this is a conversation for later, as we believe it will be a couple of years before reaching that milestone.

Perfect. Thank you.

Thank you. Our next question comes from Matthew Clark of Piper Sandler. Your line is now open. Please go ahead.

Good morning, everyone. Regarding the loan growth guidance of $2 billion, or $500 million per quarter, we had previously mentioned a potential acceleration in loan growth in the second half. Is this a conservative estimate on your part, or should we not expect an increase in loan growth during that period?

So, you know, the further we take, Q4, we thought loan growth was going to be doing zero on the $300 million, and so, we were a little surprised that it came in at $850 million. I'd rather be surprised on the upside as a general trend, but we're still going to be a little cautious about economic activity going forward. And so, we're going to be mindful of this recession or slowdown that only at least advertised to come but has not shown up yet. And then, we have sort of deemphasized certain asset classes for now, those being obviously CRE office and residential just to name the two, some construction areas as well. And so, we're just going to stay with the guide of $500 million a quarter. We think that's reasonable. And if the liquidity comes in faster than we think, then we'll look to deploy it in loan growth. As a general rule, we've never had a problem deploying our liquidity and getting good, safe, sound, and thoughtful loan growth.

Okay. Regarding the fee income guidance, if you examine the fourth quarter run rate and account for the fair-value adjustments while excluding the Securities losses, I estimate a run rate closer to $124 million, please correct me if I'm mistaken. If that's accurate, it indicates a 7% decrease this year, and as you mentioned, we're not anticipating any increase in Mortgage, but I’d like to understand the factors we may not have considered.

We have several initiatives underway on the non-interest income front, some of which we are currently implementing. We are planning to revise our service charges, as we believe that as interest rates decrease and earnings credit rates decline, many clients may find that their earnings credit rate no longer adequately covers their use of internal services. This situation could lead to an increase in service charges. Therefore, we anticipate growth in this area moving forward and expect to see positive results.

Okay. And then just last one for me, on the interest-bearing deposits. Can you update us on the spot rate at the end of the year? And it seems like the pressure there is subsiding and kind of how you think about the beta on the way down on interest-bearing specifically?

Yes. Interest-bearing deposit spot rate was 3.63% at year-end. In terms of the beta coming down, we think it's going to be very strong. We expect betas to be certainly no slower on the way down than they were on the way up. You may recall that our betas have been faster than industry norms, kind of, this entire time, and our clients are expecting that, that is that we're watching that closely, and so are they. So, I expect that we're going to be able to pull down the interest-bearing costs. And for those that are ECR-related, pull those down as well on the imputed yields that some of them have, which might be tied to effective Fed funds.

Got it. Okay, great. Thank you.

Thanks.

Thank you. Our next question comes from Chris McGratty of KBW. Your line is now open. Please go ahead.

Great, good afternoon. Ken, maybe a question on the balance sheet and capital. You talked about not wanting to be in the 98th percentile or so in terms of growth perspective because you weren't getting paid for it. But you're going to be at 11% pretty soon. Can you open the door a little bit on comments about appetite for buyback maybe in the back half of the year?

Yes. Right now, we have no plans to do a buyback. And 11% is a little more of a floor for us. I know we call it a target, but it's more of a floor. So we want to build above that. And then we'll have growth capital. And as we enter '25, well, we're going to have a lot of decisions to make. If we see a lot of internal growth in front of us, that's where I like to deploy the money. First, you got to tell me what the economic environment is, and I'll tell you if we're going to do a buyback. But really, the buyback conversation has not been on the table in this company. And again, the 11% is a floor for us.

Okay. So nothing for ‘24, but perhaps you'll weigh the alternatives between accelerating the growth and using the capital. Is that a fair for 2025 conversation?

We spend a lot of time talking about ‘25 year. I want to get through ‘24 and make everything we just told you. But for '24, I could definitely tell you, there's no buyback on the table.

Thank you. Regarding the balance sheet, you mentioned the HQLA. What percentage of your balance sheet are you targeting for securities? How do we view the prospects this quarter? Specifically, how do we approach bridging the $8 billion and the $2 billion, and how much will be allocated towards purchasing additional bonds?

Yes. You can infer this from our guidance, which indicates $1.5 billion in growth for deposits exceeding loans. A significant portion of that will be allocated to High-Quality Liquid Assets (HQLA). As we mentioned earlier, we expect to overcome that hurdle in the first half of the year, likely in the summer, which should contribute to this growth. If you look at it that way, we could see an increase of $3 billion in HQLA, bringing us to that target. After that, there may be a more balanced growth rate between loans and deposits. This gives you an idea of the range of numbers we are discussing.

Okay, great. Thank you.

Thank you. Our next question comes from Bernard von-Gizycki of Deutsche Bank. Your line is now open. Please go ahead.

Hi, guys. Just a question on ECR pricing dynamics. I know you noted the ECR-related deposit costs are expected to decline with rates and volume. Just on rates, I believe you have some deposits that pay in Fed funds and others that are in the lower 2% range. So, you get a 25 basis point cut with 100% beta, does that flow through all customers or just the higher cost ECR deposits? And then you need additional rate cuts to get to the lower 3s before cutting them? Or will ECR rates decline for all ECR deposits for balance relationship?

The preponderance of our ECR price deposits are of the type that you initially talked about, i.e., those that are really tied to effective Fed funds. And we think the beta with those is going to be very near 100%. The second piece where rates are significantly lower, we probably have maybe a stutter step with the first rate increase. We're not necessarily going to be able to kind of fully kind of pass through. But after that, I think we can put them on a trajectory as well. But those betas will be significantly lower, maybe we can get to 50% on that piece of it. But the larger piece, I think it's going to be at or near 100%.

And if we think about the volumes between those two or the balances, are they much higher for the 3%, like the lower ones? So once we start getting the cuts, even though you have the 100% beta for the ones paying Fed funds, is it just a smaller balance? I'm not sure if you could size it or give a magnitude between the two.

Yes. So between what you're going to see in terms of warehouse lending, some of the things that are settlement services, some of our HOA deposits, you're probably approximately two-thirds of the number is going to have an elevated beta.

Okay. And then if I could just ask one more. Just on your outlook guidance. Just as we think about net interest income, you have the up 5% and up 10%. Could you just give us the underlying assumptions just the difference between the two? Like what gets you to the 10%?

The 10% on management income is a combination of really the loan growth as we move forward, that's what's going to move us in that direction. And the additional liquidity we're bringing in, and placing that into investments.

Yes, what does the yield curve look like? I mean if the yield curve tends to be flat or it remains inverted, that's going to probably look a little bit better on some of these commercial loans. What does that mix look like? And how is competitive pricing changing for all those items? We don't have a lot of insight into what that might be, hence, the parameters around a number that might be more median.

Okay, got it. Thanks for taking my questions.

Thank you. Our next question comes from Ben Gerlinger of Citi. Your line is now open. Please go ahead.

Hey, good morning, everyone.

Good morning.

Just had a question. It seems obviously a bit more technical in nature, but it seems like loan yields were down linked-quarter on almost every lending category. I was curious if you can just kind of touch base on maybe the nuance of why? Might be just a technicality, like I said.

I mentioned earlier the situation regarding the loans we have held for sale versus those classified as investments, which led to a transfer from held for sale to investments. This transfer occurred right before the end of the third quarter and will have some impact on the decline in loan yields. Additionally, there have been some mix revisions moving forward. We continue to see pricing opportunities related to repricing. We discussed the $2.9 billion we are rolling this year on average. Of that amount, around 20% is fixed rate, which allows for a more gradual increase. However, even on the variable side, we are observing higher spreads compared to when those loans were originated two or three years ago.

Got you. No, that's good. So the next question I had was about the spreads you're seeing in the market today. It seems like many of the large banks, with assets over $100 billion, are pulling back in certain areas. Are you experiencing better spreads due to a reduction in available lenders or lending from the larger banks? Or is it more about your strategic decisions and not witnessing too many changes? Considering you work with solid clients, they would typically secure the best rates because of the competitive nature of the market. I'm just thinking about the future yields, especially with some expected rate cuts in the latter part of the year.

Yes. It's almost market-by-market dependent. There are just things going on in different markets for us. If you're talking tech and innovation, spreads there really haven't moved, but a little more competitive because there's less deal flow because they're raising less cash there. If you're talking some very specific lot banking deals, spreads are strong and we were getting our pricing. And some of these banks are moving in and moving out. It's really hard to give one generic answer as to, well, are they all pulling back or not.

Got it. Okay. If I could just sneak one more in. It seems like you said 11% is a bit of the floor going forward in capital. You also referenced the credit rating. The moment we get a public announcement from a credit rating agency, is that a catalyst event for you guys? Or is it more just you get to the 11% is kind of what you guys agreed upon? And once you hit 11%, you kind of operate a bit more autonomously?

Well, the 11% is, as I said, a floor for us. We have to engage or continue to engage with the rating agencies. That's usually a two-step process. They usually put you on outlook positive and then come back and make the change. As far as I know so far, we got a change in our outlook from Fitch, but I don't know if there's any other bank that had a change in their outlook. So my friends at the rating agencies may be a little slow to pull the trigger. But when we go in there, we want to go in there with great capital levels, a firm, steady, stable asset quality and very strong liquidity. And that's how we're positioning the company. In the meantime, our corporate trust group is still operating and bringing in good business. They could just bring in more business with the upgrade to an investment rating. So they're doing just fine. This would just accelerate their opportunities to bring in more business.

Got you. Okay. I appreciate it. You'd probably be at 12 by the time you get that announcement. But I appreciate the time, guys. Thanks.

Thank you. Our next question comes from Brody Preston of UBS. Your line is now open. Please go ahead.

Yes, thanks. I just wanted to follow up on the loan yields. I understand the move from the HFS to HFI. I was hoping, Dale, if you could provide what the spot rate was for the loan portfolio at the end of the quarter?

Yes, 703.

Okay. Thank you very much. I also wanted to get a better sense for the BTFP. What was the rationale behind paying off the BTFP but not more borrowings. I think the last time in your 3Q 10-Q, I think the rate on the BTFP was 4.76 versus the average short-term borrowing rate of 5.74 this quarter. I just wanted to better understand the thought process there.

We didn't feel it was necessary to borrow from the Federal Reserve, so we decided against it. While it's true that it came at a modest cost, the borrowing was set to mature anyway. We acquired this in March of last year as part of a 12-month deal, so it was a couple of months early compared to its original timeline. We just thought it was part of the 2023 situation and preferred to move on from it in 2023.

Got it. Thank you. I wanted to clarify just on the ECR-related deposits. I think the slide says you have $17.8 billion of ECR deposits at quarter end. But you got about $14.5 billion of NIB. So is there another component of the ECR-related deposits that's technically still interest-bearing but also gets compensated through ECR?

Yes, correct. So what will happen is, depending on what type of client it is, we could have a situation whereby the manager gets the ECR and the owner gets the interest income. So you don't really see that in mortgage warehouse because those are really non-interest-bearing deposits. But on an HOA, for example, it's a dual situation most commonly, whereby the aggregator gets an earnings credit rate on the dollars that are owned by the HOA itself. That is not interest expense because they simply have no claim on that liability to us and the deposits of that enterprise. So that's why that doubled up.

I want to ask about the MSR loss. Can you clarify the details, Dale? Throughout this past year, did you assign a higher value to the MSR and correspondent production? Did you capitalize it at a higher rate? Did that affect the gain on sale margin, leading to a loss when rates changed and you sold the MSRs this quarter? I'm looking to understand the components involved.

No, I wouldn't say that. The situation was influenced by the volatility we experienced. We observed constant prepayment rates decline to the lowest levels I have seen, around 3% to 4%, which is exceptionally low. When rates increased again, the prepayment rates jumped, likely due to a catch-up from refinances that had been postponed. Consequently, we realized a gain from our hedge, but it was less than the loss in valuation. As a result, the value of our servicing rights decreased by $100 million in the fourth quarter, and we fell $14 million short of the gain we recorded on the hedge. This was due to a rapid shift from an extremely low prepayment rate to something more typical.

Brody, I'd remind you that by the end of Q4, the 10-year treasury decreased by 69 basis points, from 4.57 to 3.88, which supports Dale's point. Regarding the MSR balance, we work with several valuation firms that assess the MSR to ensure that we're within the appropriate range.

Got it. Understood. Thank you very much for taking my questions, guys.

Welcome.

Thank you. Our next question comes from Andrew Terrell of Stephens. Your line is now open. Please go ahead.

Good morning. Dale, I hear your comments regarding the mortgage banking and the potential upside not being reflected in the forward guidance. If the mortgage market improves and we start to see an increase in fee income over time, could you remind us about the added efficiency in that business? Also, could you provide insight on how expenses might change with the increase in fees?

When they operated as an independent entity, their efficiency was around 50%. Upon our acquisition, we were at approximately 40%, but incorporating them brought us to about 45%. I believe that level has remained stable. Currently, their efficiency rates are nearly aligned with the bank's overall efficiency, especially since we've made investments in higher cost areas like technology and risk management, as well as experiencing lower investment yields due to our high-quality liquid assets. Currently, our efficiency ratios stand at around 50%.

Okay. I appreciate it. And then just looking at the deposit cost expense line this quarter, if I compare the disclosed expense on deposit costs versus the average balance of ECR deposits. It looks like on a percentage basis, the cost ticked down a few basis points this quarter. Have you lowered rates anywhere on the product already? Or is that more of a function of mix this quarter?

We haven't reduced rates. Instead, we've approached individual clients and indicated that their spread compared to effective Fed funds has been adjusted. Some adjustments might occur slightly later. However, we've provided options for clients who want an immediate rate cut, which may allow them to skip to their next rate. We're applying these changes on an individual basis as we proceed. I believe this trend will continue into January and February.

And did you see any attrition as a result of those conversations? Or is there any color there?

There hasn't been any attrition. And I think that's an input point for us in terms of what is our pricing like relative to alternatives elsewhere. I think what it means is that the fever is broken on the rate cycle, certainly, and the opportunity to move into either other financial institutions or to move it to some kind of off-balance sheet thing that maybe is invested in treasury, all of those have fallen in terms of what the opportunity is and what they might be able to migrate to. And I think that has helped us in these negotiations. We do these one-off and, to some degree, sequentially, in case we run into a situation like that, where we're starting to see some attrition like, okay, that's an important point. And then we'll ease off in terms of how many we're doing or what we're asking for, for them to give up.

Okay, great. Really appreciate the time this morning.

Thank you. Our next question comes from David Smith of Autonomous. David, your line is now open. Please go ahead.

Thank you. I wanted to circle back to those normalized NIM comments earlier in the call. Are you saying that 3.5% should be a floor or more the middle range for NIM in a typical rate cycle?

That was part of a broader discussion about our potential direction over time. Regarding a specific number, I don't have one to share. This reflects an expectation of where we might end up. I feel we are nearing a balanced level now, and the 3.5% figure is relatively close to that. However, that isn't our official guidance for where we anticipate heading in 2024.

Yes. So if there's nothing else on the NIM, talking about capital, you're going to keep doing a high-teens ROTCE, and with your loan growth guide, I think that only implies something like 4% or 5% RWA growth this year. So that just seems to imply a ton of excess capital being generated and you should reach 11% CET1 pretty soon. I know 11% is a floor, but is there a level where you think that it just starts to get excessive? And even regardless of a change in ratings, just starts to make sense to turn on the buyback? If you're still being measured with loan growth?

As we exceed 11%, it opens up various options. You can accumulate capital, which could then be used for an M&A deal, among other possibilities. However, we are not at that stage yet. We are currently addressing a few final adjustments on our balance sheet. By summertime, I believe we will achieve the liquidity profile we are aiming for.

Thank you. Our next question comes from Tim Braziler of Wells Fargo. Tim has disconnected. At this time, we currently have no further questions. So I'll hand back to Ken Vecchione for any further remarks.

Well, thank you very much for joining us today, and we look forward to talking to you about 2024 in a couple of months from now. Thanks again.

Thank you for joining today's call. You may now disconnect your lines.