Earnings Call Transcript - WAL Q2 2023

Operator, Operator

Good day, everyone. Welcome to the Western Alliance Bancorporation’s Second Quarter 2023 Earnings Call. You may also view the presentation today via webcast or the company’s website at www.westernalliancebancorporation.com. I would now like to turn the call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Please go ahead.

Miles Pondelik, Director of Investor Relations and Corporate Development

Thank you. And welcome to Western Alliance Bank’s second quarter 2023 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; and Dale Gibbons, Chief Financial Officer; and Tim Bruckner, Chief Credit Officer. Before I hand the call over to Ken, please note that today’s presentation contains forward-looking statements, which are subject to risks, uncertainties and assumptions. Except as required by law, the company does not undertake any obligation to update any forward-looking statements. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, please refer to the company’s SEC filings, including the Form 8-K filed yesterday, which are available on the company’s website. Now for opening remarks, I’d like to turn the call over to Ken Vecchione.

Ken Vecchione, President and Chief Executive Officer

Thanks, Miles, and good morning, everyone. As usual, I will make some brief comments about our financial results and action items, and then I will turn the call over to Dale who will review the quarterly results in more detail before opening the call for Q&A. Our Chief Credit Officer, Tim Bruckner, as Miles said, is here with us as well. In many ways, this quarter represented a transitional period for Western Alliance following the events of mid-March as our firm and our clients increasingly return to a sense of normalcy. We continue to successfully execute on the balance sheet repositioning strategy we laid out last quarter, we exceeded our liquidity guidance by growing deposits by $3.5 billion and repaying over $6 billion in short-term borrowings. For the second quarter, WAL generated total net revenues of $669 million, net income of $216 million and EPS of $1.96. We maintained strong profitability with return on average assets and return on average tangible common equity of 1.23% and 18.2%, respectively, which grew tangible book value per share by $1.53 to $43.09 or 18% year-over-year and we will continue to support building capital levels in the quarters to come. We achieved significant progress on the immediate- and short-term objectives identified last quarter to establish a sound foundation for WAL to sustain ongoing client and financial success. Notably, deposits grew $3.5 billion and exceeded our $2 billion quarterly guidance. Growth was diversified across business lines and included core deposit growth from new and returning customers. Net liquidity growth of $2 billion allowed us to significantly reduce higher cost wholesale borrowings. WAL continues to expeditiously execute our balance sheet repositioning strategy and completed $4 billion in total asset dispositions in Q2, which included $3.5 billion of loan dispositions ahead of the $3 billion outlined in Q1. Meaningful deposit growth and asset disposition drove WAL’s loan-to-deposit ratio to 94% and allowed us to rapidly reduce reliance on higher cost FHLB borrowings by $6.1 billion over the quarter. I am proud to report core deposits have rebounded another $3.2 billion quarter-to-date, meaning WAL’s deposit levels are now $600 million above our year-end 2022 balance. CET1 capital of 10.1% increased from 9.4% on March 31st and 8.7% or 140 basis points since Q3 2022, when we initially announced the Bank’s capital building initiatives through organic capital generation without equity issuance. Finally, we continue to focus on meeting our core client banking needs in order to cultivate strong long-term relationships, leveraging third-party products to significantly grow reciprocal deposits has lifted our insured and collateralized deposit levels to 81%, one of the highest among large U.S. banks. As we move through the back half of the year, we believe Bank investors will place more emphasis on balance sheet strength, stressing the fundamentals of growing capital, improved liquidity, deposit cost composition and granularity, stable asset quality, moderate and thoughtful loan growth and producing predictable and sustainable PPNR. Bank diversified funding strategy continue to focus on growing attractive funds from a diverse set of clients and channels in order to prioritize repayment of the more expensive wholesale funding sources and then to optimize deposit balances of lower cost sources to deploy into superior risk-adjusted lending opportunities as we have done historically. Driving the $3.5 billion of deposit growth with significant new and return of customer activity throughout Western Alliance. In Q2, we attracted $1 billion from approximately 1,000 new and returning commercial relationships as an attractive average total deposit cost of 1.98% with notable contributions from mortgage warehouse, regional banking and settlement services. Over $400 million of net new deposit money was in non-interest-bearing DDA. Our commitment to foster multiproduct customer relationships has been the key to onboarding new deposits in a very competitive environment. Additionally, we will utilize other diversified sources of deposits to accelerate repayment of wholesale borrowings and return to prudent DDA. Our recently launched online consumer channel is demonstrating steady progress, providing another source of uncorrelated liquidity and generated approximately $700 million this quarter at attractive rates compared to the marginal cost of repaying borrowings. Going forward, continued deposit channel optimization and growth, new and returning core client commercial relationships will lower the proportion of funds generated in brokered CD volume. Now Dale will take you through our financials.

Dale Gibbons, Chief Financial Officer

Thanks, Ken. For the quarter, Western Alliance generated net income of $216 million, EPS of $1.96 and pre-provision net revenue of $282 million. Net interest income decreased $60 million during the quarter to $550 million, mostly from elevated higher cost to term borrowings that were materially reduced near quarter end. Q2’s net interest income should be considered a trough in which Q3 and Q4 levels should ascend. Non-interest income increased to $119 million from an adjusted level of $102 million in the second quarter. As a reminder, loan marks in Q1 resulted in a net loss of $141 million as part of our balance sheet repositioning efforts, responsible for negative fee income last quarter on a reported basis. On an operating basis, non-interest income was $18 million higher from Q1. The green shoots we signaled with mortgage last quarter were evident again in the second quarter as AmeriHome revenue increased to $86 million. We remain cautiously optimistic continued stabilization, improving margins and profitability momentum is sustainable as AmeriHome capitalizes on the exit of a major competitor from the correspondent lending channel earlier this year. Production margins widened closer to normalized levels of 43 basis points as the industry has rationalized and win rates continue to improve. Other non-interest expense growth was driven by higher insurance costs related to elevated insured and broker deposit levels, which also include core reciprocal deposits above a certain threshold. Recent expense of $22 million is indicated by return to a normalized credit environment; we remain conservative on macro assumptions as a commercial bank and the outlook for commercial real estate is a key driver that informs our provisioning. Our allowance for credit losses modeling assumes an 80% likelihood of a recession using Moody’s Analytics scenarios. A lower tax rate was beneficial to earnings this quarter and we expect going forward a normalized rate as an average of the last two years. We made substantial progress in our balance sheet repositioning and surgical asset disposition efforts in the second quarter to accelerate higher capital and liquidity building. These dispositions complemented our organic earnings and contributed approximately 43 basis points of incremental CET1 capital. $4 billion of asset dispositions were completed, including loan sales and runoffs, primarily in equity fund resources, syndicated loans and mortgage warehouse businesses. The equity credit resource facility was fully unwound. Loans held for investment increased $1.4 billion to $47.9 billion and deposits increased $3.5 billion, which brought balances to $51.0 billion at quarter end. Mortgage servicing rights balances of $1 billion rose 11% during the quarter. Total borrowings were reduced by $6.3 billion to $11.5 billion due mostly to paydowns of Federal Home Loan Bank borrowings. At March 31st, the remaining EFR credit-linked note was also fully redeemed, which completed the unwind of $542 million of CLNs year-to-date. Deposit momentum has continued into the third quarter as deposits are $3.2 billion higher for July 17th. Total held-for-investment loan growth of $1.4 billion consisted of $700 million of organic loan growth, primarily from mortgage warehouse, regional banking divisions and resort finance. Improved liquidity from deposit growth well in excess of loan growth allowed us to reclassify $100 million of held-for-sale loans back to held-for-investment, which will improve the company’s return profile. Deposit growth of $3.5 billion resulted from remixing the deposit base into interest-bearing DDA from savings and money market, as well as CD growth from client promotions and brokered CDs. Non-interest-bearing DDAs comprised a third of our total deposit mix with approximately half having no cash payments of earnings credits. Turning now to our net interest drivers. The securities portfolio grew $1 billion to $10.1 billion as we look to bolster our high quality liquid asset balances. The yield expanded 8 basis points to 4.76%, largely from floating rate product benefiting from higher rates and should continue to benefit from higher reinvestment rates. Approximately $1.3 billion of securities are expected to mature in the second half of this year, with an additional $1.1 billion in 2024. The spot rate for the entire portfolio was 4.85% at quarter end. Held-for-investment loans increased $1.4 billion and the portfolio yield increased 20 basis points to 6.48% at quarter end; the spot loan yield was 6.74%. Interest-bearing deposit costs rose 33 basis points to 3.08% on a $3 billion increase to $34 billion. The elevated costs resulted from a higher interest rate environment, which offset more tempered non-interest-bearing demand deposit growth. Total cost of funding rose 58 basis points to 2.5% from higher utilization of wholesale borrowings at an average cost of 5.6%. $6 billion of these borrowings were repaid, which gives a $3.4 billion difference between average and end of period balances. Optimizing the funding mix with more core and reciprocal deposits in conjunction with the $6 billion of Federal Home Loan Bank paydowns, which occurred later in the quarter, should contribute to improving our net interest margin. Moving down further into our funding base we have actively utilized reciprocal deposit channels to drive growth and provide greater insurance coverage to larger depositors. 62% of broker deposits consist of sticky reciprocal deposits. We believe these core client relationships have been fortified through this product enhancement, making them exceptionally stable. Overall, net interest income decreased approximately $60 million or 9.8% over the prior quarter due to compressed net interest margin and average earning assets declining $562 million, mostly stemming from balance sheet repositioning actions. Net interest margin compressed 37 basis points to 3.42% with higher interest expense from outsized higher cost borrowings. This excess liquidity is generated with deposit growth greater than loan growth in non-AmeriHome held-for-sale or liquidations. We expect to pay down additional repo lines costing SOFR plus 200 basis points that should contribute to funding cost tailwinds. The effect of these dynamics can start to be seen in the expansion of the June NIM to 3.5%. Our efficiency ratio of 57% improved by about 500 basis points from the prior quarter though our adjusted efficiency ratio increased to 50% from 43% in the prior quarter. Higher insurance costs and elevated brokered and insured deposits, as well as lower net interest income from increased interest expense were the main reasons for this change. We still view mid- to upper-40s adjusted efficiency at the right level and expect expenses to align with our core run rate of revenue as we look to optimize additional work streams throughout the bank. Pre-provision net revenue was $282 million during the quarter. Solid profitability was sustained with the Q2 return on average assets of 1.23% and return on average tangible common equity of 18.2%. Strong PPNR provides capital flexibility to absorb provision expense and credit losses support, while still growing the balance sheet and attaining higher CET1 capital levels. Given the increased attention on the commercial real estate sector, we are providing additional details on our CRE investor and office portfolios, as well as our overall early identification and elevation credit mitigation strategy. This proactive migration approach has historically produced lower loss convergence. Our CRE investor underwriting strategy rests on a foundation of low loan-to-cost underwriting in submarkets where we have deep experience with strong financial sponsors. As a reminder, our financing structures carry no junior liens or mezzanine debt, which enables maximum flexibility in working with clients and sponsors. We have low uncovered tail risk since 92% of the portfolio has LTVs below 70% and these LTVs are based upon the most recent appraisals and assuming commitments are fully funded. Within commercial real estate, office accounts for just 5% of total loans. We have previously discussed our focus on shorter term bridge loans repositioning office projects in the suburban areas. Our exposure in two central business district areas that we believe are most vulnerable to overall risks are minimal at just 3% of office loans. We have re-designated some midterm exposure away from the CBD classifications as in our view the dynamics in these markets make them less susceptible to work-from-home risk present in larger cities. For example, we do not have CBD office loans in New York, Boston, Chicago, Atlanta, Houston or Dallas. Looking at LTVs, only 3% of office loans are 80% or greater loans-to-value in line with our central business district exposure, primarily focused on in-demand Class A to B+ office properties and 94% of Class A properties have LTVs below 70%. The entire office book carries an LTV of 55%. Finally, we are not facing a large maturity wall; approximately three quarters of the loans come due in 2025 or later. Turning to asset quality trends in light of the present environment and due to the sharp increase in interest rates over the past 12 months, we have completed a proactive comprehensive review of our commercial real estate portfolio which is reflected in loan migrations this quarter. As part of our early identification and early mitigation strategy, it has served us well. We proactively move loans into special mention when cash flow may be curtailed in the present environment despite having well-supported collateral values and borrower sponsorship remaining strong and the loan still performing. We do this to ensure attention and monitoring at the highest levels within our credit organization as we require the sponsors to re-margin the loan that was established or provide satisfactory cash reserves to support our cash rating. This is an important element of our credit control process and an established process for more than 10 years. As a result of these efforts, the special mention loans increased to $694 million, or 1.45% of funded loans with $250 million or two-thirds of the migration coming from office and hotels. Classified assets increased to $145 million or 89 basis points of total assets. Half of the increase in classified assets was driven by one $75 million office loan in Downtown San Diego, which makes up the preponderance of the central business district office exposure I mentioned. We don’t anticipate meaningful losses as this property is 82% leased, current appraisal exceeds the outstanding loan amount and all cash flow will go to pay down this credit. Our proactive identification and resolution process results in lower realized losses; over the last 10 years, less than 1% of special mention loans have become losses and within commercial real estate investor properties less than 10 basis points of those special mention loans have migrated to loss. And looking at the next two slides, you will see the results of our early identification, elevation, negotiation and resolution process has resulted in best-of-class loss rates over the last 10 years. For us, at Western Alliance, it’s about the process, which sometimes produces earlier criticized and classified designations, but at the end of the day, leads to low net charge-offs. On average, we have ranked in the top third among asset peers on adversely graded loans as a percentage of total loans and are the best ranking on historical credit losses. The difference between our ranking on adversely graded loans compared to our number one position on historical credit losses highlights the success of our proactive credit mitigation strategy. Quarterly net loan charge-offs were $7.4 million or 6 basis points of average loans compared to net loan charge-offs of $6 million or 5 basis points in the first quarter. Our total loan ACL rose almost $13 million in the prior quarter to $362 million due to higher provisioning and lower loan loss rates. Total loan allowance for credit losses on funded loans increased 1 basis point to 76 basis points in Q2, but is 94 basis points when loans covered by credit linked notes are excluded. The allowance was 141% of non-performing loans at the end of the quarter. We feel well positioned in an uncertain economic environment based on the business transformation since the global financial crisis. Our loan portfolio is diversified across risk segments with almost a quarter either credit protected, government guaranteed or cash secured and over half of the portfolio is either insured or resistant to economic volatility. These percentages aligned with ratings reported before we embarked on our balance sheet repositioning initiative late in the first quarter. Of note, our lower average loss rates in the resilient and more sensitive categories are indicative of conservative underwriting and highly responsive remediation actions. We discussed reprioritizing capital and building capital back to premerger levels on our Q3 2022 earnings call. Since then, CET1 capital has grown from 8.7% to 10.1% and is up over 70 basis points since the first quarter. Our tangible common equity to total assets rose 50 basis points from the first quarter to 7%. We remain committed to achieving a medium-term CET1 target of 11%, which we view as prudent considering the heightened regulatory attention regarding appropriate capital levels. We also expect increased excess capital will provide more financial and strategic optionality in the future. Looking at the strong combination of insured deposits and high capital to make depositors comfortable with the stability of their financial institution, Western Alliance has materially moved its insured deposit levels to among the highest in the nation compared to the largest banks. Capital has also listed in the top third even adjusting for fair value marks in both the available-for-sale and held-to-maturity securities portfolios. Inclusive of our quarterly cash dividend payment of $0.36 per share, our tangible book value per share increased by $1.53 in the quarter to $43.09. Western Alliance has compelling long-term tangible book value per share divergence from peers remains intact. This increased over 6 times out of the peer group since the end of 2013, which leads to a compound annual growth rate of nearly 20% through economic cycles and market disruptions. This outperformance is still 4 times that of peers when adding common dividends back. I will now hand the call back to Ken to conclude with closing comments.

Ken Vecchione, President and Chief Executive Officer

Thanks, Dale. Our guidance for the rest of 2023 continues to be driven by the strategies and priorities laid out in our prior earnings calls. So let me tell you what you can expect from here. Regarding capital, having exceeded our immediate CET1 target of 10% in Q2, we expect continued, although more gradual growth in our capital ratios towards a medium-term CET1 ratio target of 11% in 2024. This will be driven by our continued strong return on average tangible common equity and capital generation. Core deposits are expected to grow at approximately $2 billion per quarter and exceed more muted loan growth by approximately $1.5 billion. This will lower our loan-to-deposit ratio over time towards a mid-80% target. Net interest margin is expected to rise modestly from our Q2 trough of 3.42% and land in the range of 3.5% to 3.6% for the second half of 2023 based on our successful repayment of borrowings this past quarter and the cost of new deposit funding. Our efficiency ratio, excluding the impact of deposit costs should decline slightly to the high 40s given the reduced borrowing costs and higher asset yields. Asset quality remains manageable as it returns to more normalized levels. We expect credit losses to be 5 basis points to 15 basis points through the economic cycle. Overall, for the second half of 2023, we expect quarterly operating PPNR to remain consistent to Q3 results and begin to climb as we exit the year. As we continue to reposition the balance sheet and continue to reestablish our core deposit and loan growth trajectory, we see Western Alliance as an even better institution and well positioned for the future. We view our earnings performance being driven by balance sheet growth, improving margins and efficiency, along with continued strengthening in our mortgage operations that should result in quarterly operating PPNR consistent to Q2 2023 results and then grow thereafter. At this time, Dale, Tim and I are happy to take your questions.

Operator, Operator

Thank you. The first question will be from the line of Ben Gerlinger with Hovde Group. Your line is now open.

Ben Gerlinger, Analyst (Hovde Group)

Hey. Good morning, everyone.

Ken Vecchione, President and Chief Executive Officer

Good morning, Ben.

Ben Gerlinger, Analyst (Hovde Group)

I was curious if we could — I mean, I am sure we are going to get a lot of questions on credit, because deposits seem to have cleared themselves up. But if we could just take a moment to walk through the guidance a little further: what are you assuming for average earning assets in the back half of the year under that margin guidance? It seems like you already have a spread difference of plus $2 billion per quarter, which gives you $4 billion in deposits, and then on loans it’s plus $1 billion. So you essentially already have that $3 billion now. Can we expect debt paydown to occur fairly immediately in the third quarter, or will it be more gradual throughout the second half of the year?

Dale Gibbons, Chief Financial Officer

Well, we still have a couple of billion dollars that fund our $2 billion that we have in our held-for-sale loans with repo relationships with another commercial bank, and those loans and those funds that we have borrowed from them cost us SOFR plus 200 basis points. So paying that down with some of the liquidity we bring in is going to help improve our net interest income, but doesn’t really change earning assets. But in addition to that, we do expect that a portion of these dollars we bring in are going to be used to provide new credit opportunities to our clients and so it’s going to be a combination of the two. So I am looking for earning assets to continue to climb, but not as fast as the deposit growth.

Ben Gerlinger, Analyst (Hovde Group)

Got you. Okay. That’s helpful. And if we could just take a moment, I think, just kind of holistically about credit here, it seems like you have got a decent amount of NPL increases and the reserve was essentially the same, a modest uptick. So with credit like not being a little bit less of importance, now that we have kind of had a strategic repositioning, how do we think about the allowance going forward in terms of like a GAAP percentage relative to loans?

Dale Gibbons, Chief Financial Officer

Well, a couple of things. In terms of the ratio, I think it’s really important to note how much our charge-offs have been and why that number may appear lower relative to other institutions. We don’t have consumer loans, which have a constant burn rate of losses. I mentioned the Moody’s scenarios: we used 60% of their consensus forecast, which includes a recession in the third and fourth quarters of this year. We also applied a 20% weight to S4, the severe recession scenario, which shows commercial real estate values contracting by more than 30%. Importantly, because we are a low advance rate lender, even with significant valuation reductions we still don’t incur losses. Our borrowers still have skin in the game, retain equity they want to protect, and are willing to negotiate with us to reach solutions. If our advance rates were much higher, we wouldn’t be in this position, but our low advance rates have been key to our strong asset quality.

Ken Vecchione, President and Chief Executive Officer

But if you are asking a question about the provisioning going forward, I would say, it’s about in the same vicinity going forward as Q2 provisioning for Q3 and Q4.

Ben Gerlinger, Analyst (Hovde Group)

Got you. That’s very helpful color. Great to see you guys go from defense to offense so quickly. Appreciate the color, guys.

Ken Vecchione, President and Chief Executive Officer

Thank you.

Operator, Operator

Thank you. The next question will be from the line of Casey Haire with Jefferies. Your line is now open.

Casey Haire, Analyst (Jefferies)

Yeah. Great. Thanks. Good morning, guys. Just want to follow up on the borrowing paydown. So you guys have a PPNR guide of around $280 million, what you have here in the second quarter. Just wondering the pace of what the guide assumes for borrowing paydown and timing as well, like, how low does that $11.5 billion go?

Dale Gibbons, Chief Financial Officer

Well, I don’t have a number for you, Casey, exactly. What I would say is we are trying to do two things here. One is to pay down further, particularly the more expensive lines as I mentioned, and secondly to provide more liquidity for our clients. So it’s the combination of those two. I don’t have a number in terms of what exactly that looks like. That’s the trajectory we are on. That’s the trajectory we started to be on in the second quarter, and I think we will be more focused on that as we complete 2023.

Casey Haire, Analyst (Jefferies)

Okay. Given the progress you have made on deposits quarter-to-date, which is pretty strong, has there been any paydown quarter-to-date? Are you making use of that deposit growth, and do you have a borrowing balance as of July 17?

Ken Vecchione, President and Chief Executive Officer

Yeah. This is Ken. Yeah. We do. Let me just take you through the deposits. Yeah. We are seeing great deposit growth so far early into the quarter. To remind everyone that the natural flow of our deposits, they grow early, and just about in the next couple of days, we are going to see some paydowns coming from our warehouse lending group for P&I and T&I accounts and so those deposits will shrink, okay? So for us, we have the borrowings scheduled to be paid down, probably, closer to the back end of the quarter as a safer way of thinking about it. As we grow our deposits to $2 billion, we actually hope we can do better, but as we grow our deposit growth to $2 billion.

Casey Haire, Analyst (Jefferies)

Okay. Very good. And just, I guess, switching to the dispositions about $1.8 billion left, apologies if I missed this, but can you get that done this quarter and stay within the original fair value mark of 2% that you took?

Dale Gibbons, Chief Financial Officer

We have updated our marks. We think that they are good. What we did initially, I think, proved to be pretty accurate. I don’t think it’s all going to get done this quarter, but we expect to make significant progress on that, and as I mentioned, that will be coincident with paying down higher cost borrowings, I think.

Casey Haire, Analyst (Jefferies)

Okay. Dale, any color on what’s causing the delay, because I mean, what’s left does not look like a lot of high risk stuff for you guys?

Tim Bruckner, Chief Credit Officer

Let me take it. Hi. Tim Bruckner. Yeah. We are actually receiving much stronger values on some of these discrete single note sales related to some of the assets, and just in the normal course, that takes a little bit longer than doing a large pool sale.

Ken Vecchione, President and Chief Executive Officer

I just want to make a brief comment. We were pretty early in moving assets to held-for-sale and I think our aggressive fostering of that helped us keep the dispositions inside of our marks and that’s sort of the hallmark and the culture here at the company and which connects to the asset quality approach that we take as well. So we tend to be early on everything and try to execute early on. We have found whether it’s disposition of assets, whether it’s asset quality and talking to clients being there early, being there first, produces better results. So I just wanted to add that little color commentary.

Casey Haire, Analyst (Jefferies)

Great. Thanks, guys.

Operator, Operator

Thank you. The next question will be from the line of Bernard von-Gizycki with Deutsche Bank. Your line is now open.

Bernard von-Gizycki, Analyst (Deutsche Bank)

Yeah. Hi. Good morning. So on slide five of your presentation, you showed some nice detail on the growth drivers of that $3.4 billion of deposits during the quarter. It looks like, as you mentioned in your prepared remarks, about $1 billion in core deposit growth with the new and returned client deposits and existing client net growth. So that’s about one-third returning funds and two-thirds new money. So that mix is right, is this the type of mix between new money and returning when you would expect, say, over the next few quarters, potentially improve over time and maybe if you could give us a sense what that mix was for the $3.2 billion you noted quarter-to-date?

Dale Gibbons, Chief Financial Officer

Regarding where the funds still come from. I think that there’s some clients that were really waiting for our second quarter results, wanted to make sure that the noise related to Q1 is cleared, there weren’t other kinds of financial institution failures during this interim period. And so I think we have a strong ability to pull in funds in the near-term from some of the returning clients. That, of course, will diminish over time when there’s less returning. But at the same time, we can generate again some of our deposit business lines, which were a little hamstrung after what happened with Silicon Valley Bank. So some of the initiatives particularly in settlement services and our corporate trust operation, clients gave pause after seeing what had happened to that institution and so that’s not old money returning, but that is an acceleration of new opportunities.

Ken Vecchione, President and Chief Executive Officer

I would add a little different perspective which is the March disruption really disrupted our pipeline going forward and we had a very, very strong pipeline in business escrow services and in settlement services; corporate trust was a developing pipeline, but really in settlement services. The disruption in March actually disrupted our pipeline. We are seeing that pipeline reappear, it’s stronger. As Dale said, a lot of people wanted to wait until we were announcing our quarterly earnings. I think that will make people feel comfortable and we have some great deal of comfort on that pipeline returning, which gives us comfort to the $2 billion guide that we have put out there for deposit growth. So I think what you will see is besides the regions which are seeing healthy deposit growth and also led by Bridge Bank in our tech and innovation space, we will see growth come for the rest of the year in business escrow services, in settlement services, in HOA. By the way, those are three standalone deposit channels, which we have been developing over the past couple of years and also in our online consumer platform as well.

Bernard von-Gizycki, Analyst (Deutsche Bank)

Okay. Got it. Thanks for that color. Just as a follow-up. I am just wondering, I believe a big chunk of the deposit growth was also in CDs. Just curious, how far are you going on, say, some of the promotional pricing, given you and the industry are leading with rates paid, just given the current environment. Just trying to get a sense of how much of these balances can be sticky or how can you deepen the relationship so these deposits to become sticky?

Dale Gibbons, Chief Financial Officer

I mean, on the brokered element, I wouldn’t call those sticky. However, I would call them cheaper. So what we borrow from some of these credit lines, as well as from the Federal Home Loan Bank are at rates higher than the brokered CD channel. In addition to that, brokered CDs do not consume liquidity availability. So if we borrow, we have a credit line that over $10 billion from the Federal Home Loan Bank. But as you borrow against it, you have less availability. To bring in broker deposits that cost less leaves that availability open. So this is something we are going to wean ourselves down from over time, but you are not going to see it chop off during the third quarter. But all the guides that Ken mentioned that we have in terms of our deposit growth, respectively, does not assume any broker deposit increases from where you were at June 30th.

Bernard von-Gizycki, Analyst (Deutsche Bank)

Okay. Great. Thanks for taking my questions.

Operator, Operator

Thank you. The next question will be from the line of Steven Alexopoulos with JPMorgan. Your line is now open.

Steven Alexopoulos, Analyst (JPMorgan)

Hi, everybody. I wanted to start and drill down a little bit into the $3.2 billion you are calling out through July 17th. What’s the rough composition of that, are those more new and returning client funds or using any brokered there, and very roughly, what’s the cost so far?

Ken Vecchione, President and Chief Executive Officer

As it relates to the composition, it’s very little coming from the broker CD channel, actually zero. Where you are seeing it come from is our warehouse lending and mortgage financing group, which generally builds up in the early parts of the month and then pays down towards the third week and then restarts its build process in the fourth week. So you are seeing those funds come in. Generally, they are non-interest-bearing deposits. They do carry earnings credit rate credits, which we will see in the operating expense. We also are showing very early signs of a very strong HOA deposit build as well. So primarily that’s where the funds are coming from.

Dale Gibbons, Chief Financial Officer

I think there’s also been some repatriation from our tech group. We did have outflows from that in March and those dollars are up month-to-date as well.

Ken Vecchione, President and Chief Executive Officer

I think, Dale, brings an important point on the tech group. There’s been a lot of disruption with the demise of SVB there. Our brand Bridge is a steady consistent player in that market and what you are seeing is a lot of disruption with clients, with former people that had worked at SVB and their new companies establishing their operating processes and credit policies. Now that has all been established for us and people know our players and they know the type of bank we are and I think that’s going to lead to more deposit growth out of Bridge, which is going to support the overall regional deposit growth as we move forward.

Steven Alexopoulos, Analyst (JPMorgan)

Got it. That’s helpful. I am curious, in terms of the deposits that left in the aftermath of SVB, what rough percentage have returned? Is it like 5%—is it a material percentage at this point? And what are you hearing from, one, the customers who are returning — I think you mentioned they were waiting to see your 2Q numbers — and for the customers that haven’t returned, what are you hearing from them about why they haven’t returned yet?

Dale Gibbons, Chief Financial Officer

I would say roughly 30%, maybe a third have come back. Why haven’t they returned more? I think a lot of them — some of these are related to particular types of actions. For example, in settlement services, you might have a settlement on and then that’s moved to another institution and what we get back is the promise that future settlements will come to us. I think there was some question about what the new landscape was going to look like. It’s well publicized that SVB had policies that restricted clients from moving deposits, which proved damaging to some franchises and so some clients have established relationships at two or three banks now.

Ken Vecchione, President and Chief Executive Officer

We recaptured one large client that left us out of warehouse lending. In bringing that client back, they have a lot of funds in what we call P&I, principal and interest accounts and those build up rather quickly and come down, pay build up come down every month and it just oscillates. When we went back to them and established the relationship, we now took in T&I, tax and insurance accounts, which have a more steady stream to them. So what we have also done here is traded off volatility of balances for more consistency. As we bring clients back, we are trying to get better quality, stickier deposits, and so this has allowed us to have a lot of great conversations with our client base. I spend more time with depositors in meetings that feel like an earnings presentation. That’s what we did coming out of Q1 and in Q2. Now that has all changed and it’s about really the growth of the relationships, the growth of the business and how we work together. So that’s some color there.

Steven Alexopoulos, Analyst (JPMorgan)

This quarter should help those conversations. Final question — even with the increase in more expensive type funding, if I just look at the sequential roll in both interest-bearing deposit costs and total funding, these are decelerating pretty nicely over the past few quarters. Do you guys expect that trend to continue through the back half of this year? Thanks.

Dale Gibbons, Chief Financial Officer

That’s what gives us a little bit of comfort to provide the net interest margin guide going up. As you saw June was 3.50% and we think it rises from there and it also gives us comfort as to why we think net interest income is going to be higher in Q3 than in Q2. Only a modest part of that net interest income rise is coming actually from loan growth, because we are going to grow $500 million to $1 billion, probably closer to $500 million is a good number to use. That’s going to come in ratably across the quarter. So you won’t see that benefit until Q4. So most of the growth in net interest income for Q3 is really coming from minimizing the rise in cost of funds which we are very focused on.

Steven Alexopoulos, Analyst (JPMorgan)

Got it. Okay. Thanks for taking my questions.

Ken Vecchione, President and Chief Executive Officer

Thanks, Steve.

Operator, Operator

Thank you. The next question will come from the line of Chris McGratty with KBW. Your line is now open.

Ken Vecchione, President and Chief Executive Officer

Hey, Chris.

Chris McGratty, Analyst (KBW)

Oh! Great. Thanks. In terms of the PPNR guide, you addressed the net interest income component. I wonder if you could spend a minute on both the expenses and the AmeriHome aspect to get a full circle on PPNR. Obviously, the deposit and the insurance lines are biased both comment there and then also kind of comments on the gain on sale margins approaching normalized, is there room to go there on AmeriHome? Thanks.

Ken Vecchione, President and Chief Executive Officer

AmeriHome generated about $86 million of total mortgage banking revenue. We modeled that at roughly the same amount for Q3 and Q4. It’s only mid-July, but they are having a very strong July. Production margins have stabilized and returned to more historic levels, running closer to 43 to 45 basis points. What we saw was the retreat of one very large money center bank from the correspondent lending market, combined with industry capacity rationalization, which has paved the path to higher margins and higher win rates, and that’s giving us a good deal of comfort. We are also building an MSR that is being valued and is producing double-digit returns, and as we grow our capital we can bring in more servicing income. So that’s the AmeriHome story: steady total mortgage banking revenue going forward with potential upside given current market conditions. Related to expense efficiency, we expect that over time it will come back into the high 40s. WAL has always made investments with a viewpoint toward longer-term returns for its business and product development. We focus on generating consistent earnings with appropriate returns. Over the last several years, the investments that created escrow services, settlement services, corporate trust, the online consumer platform and the growth in HOA were all funded by consistent expense investments in our P&L. We will balance the efficiency ratio for future growth while also looking into our PPNR guides, and our PPNR guides assume the adjusted efficiency ratio remains in the high 40s to achieve the PPNR targets we have given.

Dale Gibbons, Chief Financial Officer

Chris, we have had a reputation that we are pretty efficient. We have been in the low 40s for a number of years and now we find ourselves elevated from that level. But we have also grown very quickly during that period of time and it’s natural as one is in strong growth mode that some things are done that aren’t as efficient as they could have been structured or organized at that time. We are going through a process now to streamline and look through elements in terms of vendor relationships and consultants and things like this that we think also can push down some of these extra costs in our operating expense line.

Chris McGratty, Analyst (KBW)

That’s great color. If I could ask a follow-up. You talked about net interest income growing exiting the year. If I take a step back and think about PPNR, the stable number for the back half of the year. As the balance sheet normalizes and everything gets back to normal, is the expectation that the PPNR dollar should grow off that low $282 million as we enter 2024?

Ken Vecchione, President and Chief Executive Officer

So the way I would think about it, it’s a little more stable in Q3 as we look to pay down our borrowings and maintain that Q3 to Q2 and then see that begin to rise in Q4 as we exit the year into 2024.

Chris McGratty, Analyst (KBW)

But as you get into the fourth quarter and then during next year, if everything else is considered with the balance sheet, PPNR should grow again in 2024?

Ken Vecchione, President and Chief Executive Officer

Yes.

Chris McGratty, Analyst (KBW)

Okay. Thanks, Ken.

Operator, Operator

Thank you. The next question will be from the line of David Chiaverini with Wedbush. Your line is now open.

Ken Vecchione, President and Chief Executive Officer

Hello, David.

David Chiaverini, Analyst (Wedbush)

Hi. Thanks. I wanted to follow-up on the expense question. You mentioned optimizing work streams through the bank. Could you elaborate on that, are we talking kind of trimming on the edges or are you contemplating exiting any businesses?

Ken Vecchione, President and Chief Executive Officer

We are talking about trimming on the edges predominantly. Some of the expense savings that we are going to find throughout the company will be repositioned into risk control and risk management infrastructure. Regulators have clearly signaled higher supervisory expectations for banks as they grow above certain thresholds. As we continue to grow, we need to be prepared and we have been preparing all along, but some of that expense savings we are going to take and reinvest in the risk control infrastructure that we will need to cross $100 billion in assets. We would rather do it early on and have a steady growth of expenses related to that rather than wait and try to put it in just before you cross $100 billion. So David, we will see work stream repositioning in terms of lower cost of vendor relationships, eliminating FTE growth that we don’t need. That will help a little bit. And then looking at vendor management and using technology, a lot of those cost savings will be repositioned into the risk management side, so we can continue to grow as rules change for the $100 billion and above banks.

David Chiaverini, Analyst (Wedbush)

Thanks for that. And then a follow-up on credit quality related to the increase in special mention loans. What does it take or what do you have to see for you to designate a loan as special mention? Does the borrower have to trip covenants for that to happen and what actions do you take with a borrower after it goes on special mention?

Tim Bruckner, Chief Credit Officer

Let me take this. I’m pretty proud of the process. A few things are foundational to our credit process. First, in all areas, we assess covered and uncovered risk. Covered means you are mitigated by collateral. Early identification and elevation are key and then timing of resolution is critical. We manage tail risk by managing our uncovered exposure by getting to that early. To do that, we have to be pretty mechanical in our process. So to answer your question directly, in all cases, special mention loans are current and paying as agreed. Special mention at the regulatory definition means potential weakness, not default or late payment. So we are not looking for a monetary default. We are looking for situations where there might be potential weakness so that we can elevate those within our credit architecture and make the appropriate changes before those become problems. We use special mention to elevate the situation and drive to a satisfactory resolution before we are dealing with a default or a late payment. Everything that’s in special mention, we believe that we are going to reach a resolution, which would be a satisfactory re-margining or additional support from sponsorship that would return that to pass or we have that credit as substandard. So that’s how we use the category; it’s mechanical in our process.

David Chiaverini, Analyst (Wedbush)

Thanks very much.

Operator, Operator

Thank you. The next question will be from the line of Timur Braziler with Wells Fargo. Your line is now open.

Timur Braziler, Analyst (Wells Fargo)

Hi. Good morning. Thanks for the question. Most have been asked and answered, but just looking at the loan growth this quarter, I guess, a surprise to the upside. Just curious as to what drove that? How much of that was kind of contractual funding, and as you look forward, what gives you confidence in getting to that $500 million number versus the growth that we saw maybe in 2Q?

Ken Vecchione, President and Chief Executive Officer

The $1.4 billion of loan growth can be broken in half: 50%, $700 million was really a reclassification from held for sale going back into held for investment, which means our deposit drive and increase in liquidity did not necessitate us having to sell those loans and so we were pleased with that. Then we had $700 million of organic growth this quarter and most of that came from the warehouse lending, mortgage financing and MSR lines of business. Those businesses carry deposits that often come along with the credit decisions; they almost self-fund themselves. As we go forward and what gives us confidence on the $500 million guide, we see a few areas to focus on more: C&I at this point, MSR lending providing opportunity, non-mortgage financing providing opportunity. We do resort lending, which we think will provide opportunity and we are doing tech and innovation loans which are small-sized loans, often under $15 million, where we see opportunity to bring with it deposits. Those areas give us comfort on the $500 million guide.

Timur Braziler, Analyst (Wells Fargo)

Okay. Great. And then, I asked this last quarter, but with some of the return of technology related customers. Where do you see Western Alliance fitting into the tech ecosystem going forward? Are you going to be playing a larger role in taking up some of the market share vacated by Silicon Valley Bank or should we think about the technology offering of Western Alliance similar to what it had been prior?

Ken Vecchione, President and Chief Executive Officer

We will continue to play in the space where we have been active—primarily Stage 2, and some late stage. We are not focused on early-stage lending. That’s not our strategy. We prefer to be in the middle stage and some late stage. What we are seeing is current and prior SVB customers and bankers evaluating the changing landscape; they want to see how new players' credit policies and operating practices are administered. Bridge Bank is uniquely positioned as a known brand and a consistent player in that market and that approach is getting traction. We have great expectations from our tech and innovation group, Bridge Bank, in terms of deposit growth in Q3 and into Q4 as we continue to be a steady player in that market. When clients come to us, they know our policies, who they are talking to, our credit decision process and how to reach senior management. We have a track record with these folks, so we think it’s an opportunity and we are excited by it.

Timur Braziler, Analyst (Wells Fargo)

Okay. Great. And then lastly for me, maybe following up on Bernard’s question for some of the promotional products, given how strong the deposit growth has been and the momentum you are gaining and bringing back prior customers, why not pull back from some of the promotional rates? Is it a near-term dynamic where the more the better regardless of the cost?

Ken Vecchione, President and Chief Executive Officer

There’s a bit of the more is better, but more significantly, many of these rates are still less than what we are paying for other wholesale sources. So we can bring in more stable deposits at lower cost than alternatives, and we will continue to do that. Over time we expect to convert these relationships to more sticky, lower-cost funds. More liquidity is a good thing and to the degree we can add it less expensively, we will do that.

Timur Braziler, Analyst (Wells Fargo)

Thanks, guys. Appreciate it.

Operator, Operator

Thank you. The next question will be from the line of Gary Tenner with D.A. Davidson. Your line is now open.

Gary Tenner, Analyst (D.A. Davidson)

Thanks. Good morning. A couple of questions. First, as it relates to the PPNR guide, you talked about fees in terms of what and how you are thinking about mortgage, but the service charge line this quarter increased from $9.5 million to almost $21 million. I don’t recall you mentioning that at all, so I’m just curious what the driver was. Ultimately, how is that level baked into the PPNR guide for the back half of the year?

Ken Vecchione, President and Chief Executive Officer

Our total fee income, which is primarily driven by AmeriHome, we are looking at remaining consistent with Q2, possibly with upside if the early signs in July continue throughout the quarter. So when you think about the PPNR guide, fee income is modeled roughly consistent with Q2, with potential upside from mortgage.

Gary Tenner, Analyst (D.A. Davidson)

Okay. And then on AOCI, Dale, I think you mentioned about $2.5 billion of securities to mature back half of this year and through 2024. What amount of the AFS-related AOCI just based on maturities, would you expect to recover over that 18-month period?

Dale Gibbons, Chief Financial Officer

Well, obviously that depends on the yields on maturity. If securities are close to maturity and yields are as they are now, you’ll see more immediate recovery. We have a portfolio duration of about four years. Over 18 months you reduce duration by roughly one-third. So you would get partial recovery of the mark. Maybe a couple hundred million in AOCI improvement over that period from duration roll-down and higher reinvestment yields, but the larger improvements come from lower rates, which is beyond our control.

Gary Tenner, Analyst (D.A. Davidson)

Okay. And last question, if I could. In terms of the office or the investor office portfolio, can you tell us what your allowance is specific to that portfolio?

Tim Bruckner, Chief Credit Officer

Not counting certain credit-linked coverages, the allowance against office investor exposures is about $100 million.

Gary Tenner, Analyst (D.A. Davidson)

Okay. Thank you.

Operator, Operator

Thank you. The next question will be from the line of Ebrahim Poonawala with Bank of America. Your line is now open.

Ebrahim Poonawala, Analyst (Bank of America)

Hey. Good morning. Just a quick follow-up. One, in terms of the margin outlook, as you talked about the third quarter NIM higher versus 2Q, does that trend continue into fourth quarter as we think about on a go-forward basis or could we see some volatility in the margin where 4Q could be lower and same with NII?

Dale Gibbons, Chief Financial Officer

We expect some continued improvement. We think the Fed may raise near-term, and we are modestly asset sensitive, so that should augment NIM. More importantly, repaying higher-cost funding will improve funding costs. We expect significant paydowns of SOFR plus 200 basis point repo lines this quarter, timing within Q3 could be August or September, and you will see follow-through into Q4. So yes, I would expect continued improvement on margin, leading to a better NII as we exit the year.

Ebrahim Poonawala, Analyst (Bank of America)

Got that. And remind us, Dale, in terms of the actual loan book, how much of the loan book is yet to reprice in terms of reflecting the current backdrop, like, how should we think about loan betas going forward and repricing of the fixed-rate book maybe?

Dale Gibbons, Chief Financial Officer

The fixed-rate portion is predominantly residential-related loans and prepayment rates on those loans are quite low. So at some point, rates have to come down for prepayments to accelerate. Aside from that, there’s not a huge repricing opportunity in the loan book. The securities portfolio and maturing securities are more immediate drivers of yield expansion as we reinvest. Within the loan book we have about another $1 billion of loans that will roll and reprice over time. So much of the margin improvement is driven by funding cost reduction and securities reinvestment rather than immediate loan repricing.

Ebrahim Poonawala, Analyst (Bank of America)

Understood. Thank you.

Operator, Operator

Thank you. The next question will be from the line of Jon Arfstrom with RBC. Your line is now open.

Jon Arfstrom, Analyst (RBC)

Hey. Thanks. Tim, on slide 17, the asset quality slide. You guys talked about being proactive. What do you think those lines look like in Q3 and Q4? Should we be prepared for those to go higher or do you think that this proactiveness is going to keep those relatively flat?

Tim Bruckner, Chief Credit Officer

That’s a good question. I think relatively flat. That’s been our experience with this approach in past cycles. We are already contemplating a tougher economy going forward; we have elevated the situations and know them by name. We aren’t dealing with a large broken-out portfolio in the absolute. We discuss these credits monthly and don't wait until quarter-end, so I feel comfortable saying relatively flat absent a severe change in macro conditions.

Ken Vecchione, President and Chief Executive Officer

We also completed a very exhaustive and comprehensive review of CRE office in Q2, so we have taken a deep dive into that portfolio.

Jon Arfstrom, Analyst (RBC)

That ties into my next question. You guys are seeing stable PPNR and then relatively stable provision based on Moody’s and the S4 weighting. You usually give EPS guidance, is this the trough on EPS? I am looking at the $8.15 consensus for 2024. It feels like a layup, given what you just put up, but am I missing something on that?

Dale Gibbons, Chief Financial Officer

We are not ready to project 2024, but the direction we laid out for Q3 and Q4 we have good confidence in. We hope to continue to execute bringing back lower cost funding and expanding underwriting. If the economy does not deteriorate materially and we continue to manage expenses, we are optimistic about the trajectory.

Jon Arfstrom, Analyst (RBC)

Okay. So said another way, Dale, it feels like there’s at least stability going into Q3, assuming nothing changes materially from a credit point of view?

Dale Gibbons, Chief Financial Officer

Yeah. That’s a good assumption.

Jon Arfstrom, Analyst (RBC)

Okay. And then one more for you, Ken, a strategic question: it’s been a hell of a four months and you guys have managed through it well, given the hand you had. Do you feel like there’s been any permanent damage done to your franchise, or do you think it’s a transient disruption and you are back to normal?

Ken Vecchione, President and Chief Executive Officer

I don’t think there’s permanent damage. There was disruption that took us off our growth trajectory. We had to rely more on wholesale funding for a period, hence higher costs. We anticipated some rebalancing in Q3 2022 toward higher liquidity and capital and lower loan growth, and we accelerated actions in March 2023. If any damage occurred, it was to pipelines in some newer businesses that gave people pause, but we are rebuilding those deposit pipelines and that gives me optimism for our guidance on deposit growth.

Dale Gibbons, Chief Financial Officer

There is a silver lining: this has focused our attention on our business model and we have honed it. We have shifted away from syndicated and certain structures that didn’t provide strong deposit funding, and we have moved more toward bilateral, reciprocal relationships that provide deposits. We have increased insured deposit levels and capital, and materially moved our insured deposit levels to among the highest in the nation. When someone looks at the next potential stress scenario, Western Alliance is not near the top of that list due to our capital strength, liquidity and performance.

Jon Arfstrom, Analyst (RBC)

Okay. Very helpful. Thank you.

Ken Vecchione, President and Chief Executive Officer

Thanks, Jon.

Operator, Operator

Thank you. Next question will be from the line of Brody Preston with UBS. Your line is now open.

Brody Preston, Analyst (UBS)

Hi, everyone. Thanks for taking my questions. Dale, I was just hoping to dig a little deeper on the moving parts on the margin. The $3.2 billion of new deposits, I know it’s weighted towards mortgage warehouse. But I was interested and if you have an idea as to what the cost is, because when I look at the new and return deposit growth in the existing client growth, it looks like it had about a 2% cost on it for this quarter, is that $3.2 billion close to that cost?

Ken Vecchione, President and Chief Executive Officer

A lot of that deposit growth is coming from our warehouse lending group, which means it’s growing our non-interest-bearing deposits. From an interest expense perspective, those are zero cost, although the earnings credit rate is accounted for in operating expense. So that skews toward lower interest expense. Some growth is also coming early on from HOA deposits, which are a lower-cost channel.

Brody Preston, Analyst (UBS)

Got it. So if you are getting a lot of growth in the non-interest-bearing side, I am looking at interest-bearing deposit cost and the spot rate of 3.05% is lower than the 3.08% you did on average for the quarter. Why wouldn’t interest-bearing deposit costs continue to move lower from here in the third quarter?

Dale Gibbons, Chief Financial Officer

Warehouse deposits have an earnings credit rate which is much higher than 3%—it’s often close to effective Fed Funds. So those funds are not free of cost in an economic sense; they just do not show up as interest expense the same way. But you are correct that these are not brokered or wholesale and they are generally lower cost than other alternatives, so we are effectively trading down our funding costs. Some of these ECRs show in operating expense rather than interest expense, but overall we should see funding cost improvement over time.

Brody Preston, Analyst (UBS)

Okay. And then just on loan yields, the average loan yield for the quarter, the difference between the spot and the average for the quarter is relatively large. The spot rate is 6.74%. If we get another rate hike, how does loan yield move off that 6.74% for the third quarter?

Ken Vecchione, President and Chief Executive Officer

You will see a partial move; not all loans reprice immediately. We expect incremental loan yield improvement as variable-rate loans reprice and as new originations occur at higher spreads. But the full effect unfolds over time; we estimate a meaningful portion will reprice through the remainder of the year as variable and new loans come on.

Brody Preston, Analyst (UBS)

Given those two pieces, if deposit costs stall and loan yields move higher, should we be thinking NIM well above 3.5% to 3.6% by Q4?

Dale Gibbons, Chief Financial Officer

We are being conservatively modeled. Also consider that some deposit-linked costs will track the Fed moves as rates near-term move higher, which pushes some funding costs up. We are asset-sensitive, so the net effect of a Fed hike should be positive, but we are being measured in our guidance. If funding costs come down faster than assumed and loan yields reprice faster, there is upside to our guidance, but we are guiding conservatively.

Brody Preston, Analyst (UBS)

And on credit, you mentioned the office CRE deep dive. Was that what drove the reappraisals on those CBD office loans?

Ken Vecchione, President and Chief Executive Officer

Yes. That deep dive was the driver. We have one credit in CBD we reclassified to substandard; appraisal exceeded the loan amount and it is well leased. That was a focused outcome of our review.

Brody Preston, Analyst (UBS)

Okay. And with special mention loans, have you had borrowers agree to bring more equity to the table as part of re-margining?

Ken Vecchione, President and Chief Executive Officer

Not broadly. Special mention reflects potential weakness but generally the borrowers and sponsors still have substantial equity positions and motivation to work with us. Our average LTV is about 55% across the CRE book, so sponsors often have significant equity in front of us which provides leverage for negotiation toward resolutions rather than loss.

Brody Preston, Analyst (UBS)

Thanks for the answers, guys.

Operator, Operator

Thank you. The next question will be from the line of David Smith with Autonomous Research. Your line is now open.

David Smith, Analyst (Autonomous Research)

Good morning. So the strong liquidity growth this quarter led you to bring about $700 million from held-for-sale back to held-for-investment. Of the remaining $1.8 billion in held-for-sale, are you viewing any of that as potentially coming back as well if you have another strong quarter of deposit growth?

Ken Vecchione, President and Chief Executive Officer

A good portion of the held-for-sale relates to our operational portfolio. We continuously evaluate whether to sell or retain based on liquidity and strategic fit. The $1.8 billion is queued up, marked, and we expect to exit most of it, but we will evaluate based on market conditions and our liquidity needs.

David Smith, Analyst (Autonomous Research)

Would you expect the CET1 benefit from that to be proportional to the benefit you saw from the $4 billion of sales you already executed?

Dale Gibbons, Chief Financial Officer

Most of the assets we are discussing are 100% risk-weighted, so when those loans come off the books, it is beneficial to CET1. There may be other offsetting items—for example there may be an industry assessment or insurance fund recapitalization charge being discussed which could be roughly 10 basis points against capital in Q3 if implemented. So the net CET1 improvement from dispositions will be somewhat offset by such industry or regulatory charges, but the loan sales themselves are capital positive.

David Smith, Analyst (Autonomous Research)

Lastly, you talked about laying the groundwork for eventually crossing the $100 billion asset mark. With core deposit growth at roughly $2 billion per quarter, that’s a multi-year path to $100 billion. What would give you comfort to open the growth back up and accelerate?

Ken Vecchione, President and Chief Executive Officer

Supervisory review and expectations start well before crossing $100 billion in assets, so we are proactively building risk, control and capital infrastructure early. Growth will be deposit-driven. Historically we have been very good at growing loans when deposits are available. We are investing in deposit channels—escrow, settlement services, HOA, online consumer—that will drive deposit growth and allow us to grow loans when the opportunities arise. If deposit growth accelerates sustainably, we will accelerate loan growth accordingly.

David Smith, Analyst (Autonomous Research)

All right. That’s helpful. Thank you.

Ken Vecchione, President and Chief Executive Officer

Thank you.

Operator, Operator

At this time, there are no additional questions registered in the queue. So I would like to pass the call back over to our host, Ken Vecchione, for some concluding remarks.

Ken Vecchione, President and Chief Executive Officer

I just want to thank you all for attending the call. It was a pretty exhaustive earnings call today and we are happy to field all your questions and we look forward to the next quarterly call. Thanks again.

Operator, Operator

That concludes today’s conference call. Thank you for your participation. You may now disconnect your lines.