Good day, everyone, and welcome to the earnings call for Western Alliance Bancorporation for the Q3 2020. Our speakers today are Ken Vecchione, President and Chief Executive Officer and Dale Gibbons, Chief Financial Officer. You may also view the presentation today via webcast through the company's website at www.westernalliancebancorporation.com. The call will be recorded and made available for replay after 2 pm Eastern Time, October 23, 2020 through November 23, 2020 at 9 a. M.
Eastern Time by dialing 1-eight seventy seven-three 3447529 and entering passcode 101 48,137. The discussion during this call may contain forward looking statements that relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. The forward looking statements contained herein reflect our current views about future events and financial performance and are subject to risks, Uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from historical results and those expressed in any forward looking statements. Some factors that could cause actual results to differ materially from historical or Expected results include those listed in the filings with the Securities and Exchange Commission. Except as required by law, The company does not undertake any obligation to update any forward looking statements.
Now for the opening remarks, I would now like to turn the call over to Ken Vecchione. Please go
ahead. Thanks, operator. Good afternoon and welcome to Western Alliance's 3rd quarter earnings call. Joining me on the call today are Dale Gibbons and Tim Bruckner, our Chief Financial Officer and Chief Credit Officer. I will provide an overview of our quarterly results and how we are managing the business in this current economic environment and then Dale will walk you through the bank's financial Afterwards, we will open the line to take your questions.
I'd like to focus on 3 trends that define our 3rd quarter results and will continue into the future. Robust balance sheet growth, provision reflecting asset quality and consensus outlook and strong net interest income and PPNR that continue to build capital. The combination of these variables generated record Net income of $135,800,000 and EPS of $1.36 each up more than 45% versus prior quarter and exceeding our pre pandemic performance in 2019. The flexibility of Western Alliance's diversified business model was again demonstrated this quarter as our deep segment and product expertise enable us to actively adapt our business in response to the changing environment and continued to achieve industry leading profitability and growth while maintaining prudent credit risk management. Total loans grew $985,000,000 for the quarter to $26,000,000,000 and deposits increased $1,300,000,000 to $29,000,000,000 reducing our loan to deposit ratio to 90.2%.
Our loan growth continues to be concentrated in low loss asset classes Such as warehouse lending which accounted for over 100% of the loan growth and 56% of the deposit growth and $267,000,000 in capital call lines where the risk reward equation is heavily skewed in our favor. The impact of this strategy will be seen near term in our reduced provisioning expense and longer term in lower net charge offs. We are encouraged by our expanding pipeline as clients have applied lessons learned from prior recessions to right size cost structures and to begin to plan for future opportunities. In the quarter, high average interest earning assets to reflect modification and extension of the CARES Act forgiveness timeframe which pushed our net interest margin downward to 3.71% as net interest income declined $13,700,000 from the 2nd quarter to $285,000,000 but improved $18,300,000 from a year ago period. Excluding the impact of Triple P loans, Net interest income would have only fallen by $4,000,000 which is largely the impact of interest expense on our new subordinated debt issued in middle of the Q2.
We believe approximately 21 basis points of this compression is transitory in nature And NIM is expected to rise as excess liquidity is put to work through balance sheet growth, deposit seasonality and warehouse lending Driving balances lower and PPP loan forgiveness assumptions normalize. Given these margin trends And balance given these margin trends and balance sheet growth, we believe Q4's net interest income performance returns to Q2 levels and PPNR rises above Q3. Provision for credit losses was $14,700,000 in 3rd quarter considerably less than the $92,000,000 in the second quarter which was primarily attributable to stable to modest improvements macroeconomic forecast assumptions, loan growth in low risk asset classes and limited net charge offs of $8,200,000 or 13 basis points of average assets. Dale will go into more detail on the specific drivers of our provision, On our total loan ACL to funded loans ratio now stands at 1.37% or $355,000,000 1.46 percent excluding PPP loans which are guaranteed by the CARES Act. If macroeconomic trends remain stable or begin to improve, future provision expense will likely mirror net charge offs and reserve levels could decline.
Loan deferrals trended lower for the quarter as many of our clients have returned to paying as agreed following their deferral period. As of Q3, dollars 1,300,000,000 of loans are on deferral or 5% of the total portfolio, which represents a 55% decline from Q2. We expect $1,100,000,000 of loan deferrals will expire Next quarter which will continue to drive down our outstanding modifications. Our quarterly efficiency improved to 39.7% compared to 43.2% from the year ago period becoming more efficient during the economic uncertainty provides the incremental flexibility to maintain PPNR. Finally, Western Alliance continues to generate significant excess capital which grew tangible book value per share to $29.03 or 4.3% over the previous quarter and 13.4% year over year.
Supported by our robust PPNR generation, Capital rose $121,600,000 with a CET1 ratio of 10% supporting 15.6 percent annualized loan growth. Dale will now take you through our financial performance.
Thanks, Ken. Over the
last 3 months, Western Alliance generated record net income of $135,800,000 or $1.36 per share, which is up 46% on a linked quarter basis. As Ken mentioned, net income benefit reduction in provision expense for credit losses to 14,700,000 primarily driven by stability in economic outlook during the quarter and a release of specific reserves associated with the fully resolved credit. Net interest income grew $18,300,000 year over year to $284,700,000 but declined $13,700,000 during the quarter, primarily a result of changes in prepayment assumptions on PPP loans that impacted fee accretion recognition. The SBA's interim final rule published in August more than doubled the amount of time that people have to receive forgiveness on their loans And coupled with the systems delay in the forgiveness request processing, we now expect that forgiveness processes to be elongated and the average The loans will be outstanding is projected to double as well. As a result, using the effective interest method, we reversed out 6 $400,000 of the fees recognized in Q2 and overall PPP fee recognition has been extended.
This is purely a change in timing impacting NIM, but with no change to cumulative fee revenue ultimately recognized from this program. The $43,000,000 we already received will simply be booked to income more slowly than our original expectations. Net interest income was impacted in Q3 as a result of this timing change by 10,600,000 Non interest income fell $700,000 to $20,600,000 from the prior quarter. We benefited from a recovery of an additional $5,000,000 in mark to market Loss on preferred stocks that we recognized in the Q1. Over the last two quarters, we've recovered 80% of that $11,000,001 original loss.
Finally, non interest expense increased $9,300,000 as the deferral of loan origination costs fell as PPP loan originations dropped as well as an increase in incentive accruals as our 3rd quarter exceeded our original 3rd quarter budget, which was established before the pandemic. Strong ongoing balance sheet momentum coupled with diligent expense management drove preprovision net revenue to $181,300,000 up 13.5 percent year over year And consistent with our overall growth trend from the Q1 as the 2nd quarter benefited from one time PPP recognition of BOLI restructuring and FAS 91 loan cost deferrals. Turning now to net interest drivers, investment yields decreased 23 basis points the prior quarter to 2.79 percent and fell 29 basis points from the prior year due to the lower rate environment. Loan yields decreased 35 basis points following declines across most loan types, mainly driven by changing loan mix and in the reduction of PPP loan fees, resulting in lower PPP loan yield during the quarter. Notably for both investments and loans, spot rates as of September 30 are higher than the Q3 average yields.
Cost of interest bearing deposits was reduced by 9 basis points in Q3 to 31 basis points With an end of quarter spot rate of 27 as we continue to lower posted deposit rates and push out higher cost exception price funds. The spot rate for total deposits, which includes non interest bearing deposits, was 15 basis points. When all of the company's funding sources are considered, Total funding costs declined by 2 basis points with an end of quarter spot rate of 25. Unlike last quarter, where spot rates indicated a likely margin In the Q3, these rates appear to demonstrate that the margin will improve as both earning asset yields will rise and funding costs will fall in the 4th quarter. Additionally, in October, we called $75,000,000 of subordinated debt that has diminishing capital treatment with a current rate of 3.4%.
Despite the transition to a substantially lower rate environment during 2020, Net interest income increased 6.9% year over year to $284,700,000 As mentioned earlier, during Q3, our Extraordinary build in liquidity and adjustments to PPP loan fee recognition compressed our net interest margin to 3.71 percent as net interest income declined to $13,700,000 However, the majority of these reduction drivers are transitory. PPP loans reduced our NIM during the quarter by 13 basis points. This changes to prepayment assumptions Reduced SBA fees recognized, resulting in PPP loan yields of 1.76%. Excluding this timing difference, net interest income declined only $4,000,000 quarter over quarter, primarily due to interest on the new subordinated debt that we issued last May, resulting in an net interest margin of 3.84. Referring to the bar chart on the lower left section of the page, of the $43,000,000 in total PPP loan fees net origination costs that we received, Only $3,300,000 was recognized in the 3rd quarter.
We recognized reversal of PPP of $6,400,000 in Q3 And expect fee recognition to be approximately $6,900,000 in the 4th quarter and taper off as prepayments and forgiveness are realized. In reality, these assumptions are dependent on actual forgiveness from the SBA. Additionally, average excess liquidity Relative to loans increased $1,300,000 in the quarter, the majority of which are held at the Federal Reserve Bank earning minimal returns, which impacted NIM by approximately 21 basis points in aggregate. Given our healthy loan pipeline and ability to deploy these funds to higher yielding earning assets, we expect this margin drag to dissipate in the coming quarters. Regarding efficiency, on a linked quarter basis, our efficiency ratio increased to 39.7% as we continue to invest in our business support future growth opportunities.
As described earlier, the non interest expense increase is largely related to a net increase in compensation costs As we now have greater confidence in our ability to execute on our pre pandemic budget and are no longer benefiting from deferred costs for PPP loan originations. Excluding PPP, net loan fees and interest, the efficiency ratio for the quarter would have been 40.7%, which as we indicated last quarter should be moving closer to our historical levels in the low 40s. Return on assets increased 44 basis points from the prior quarter to 1.66% while provisions fell. PP and R ROA decreased 47 basis points to 2.22 as it tracks the decline in margin from the prior quarter. This continued strong performance in capital generation provides us significant flexibility to fund ongoing balance sheet growth, Capital management actions or meet our credit demands.
Our strong balance sheet momentum continued during the quarter as loans increased $985,000,000 to $26,000,000,000 and deposit growth of $1,300,000,000 brought our total deposit balance to $22,800,000,000 at quarter end. Inclusive of PPP, both loans and deposits grew approximately 29% year over year with our focus on loan loss segments in DDA. The loan to deposit ratio decreased to 90.2% from 90.9% in Q2 as our strong liquidity position continues to provide us with balance sheet capacity to meet funding needs. Our cash position remains elevated at $1,400,000,000 atquarterend compared to $2,100,000,000 quarterly average as deposit growth continues to outpace loan originations. While this does impair margin near term, we believe it provides us inventory for selected credit growth as demand resumes.
Finally, tangible book value per share increased $1.19 over the prior quarter to $29.03 an increase of $3.43 or 13.4 percent over the past 12 months. The vast majority of the $985,000,000 in loan growth was driven by increases in C and I loans of 892,000,000 Supplemented by construction loan increases of 103. Residential and consumer loans now comprise 9.3% of our portfolio, while Construction loan concentration remains flat at 8.8 percent of total loans. Within the C and I growth for the quarter Highlighting our focus on low risk assets that Ken mentioned, capital call lines grew $267,000,000 mortgage warehouse loans grew over $1,000,000,000 Corporate finance loans decreased $141,000,000 this quarter. Residential loan originations were offset by higher prepayment activity leaving the balance fairly flat.
We continue to believe our ability to profitably grow deposits is both a key differentiator A core value driver to our firm's long term value creation. Notably, year over year deposit growth of $6,400,000 is higher than the annual deposit growth in any previous calendar year. Deposits grew $1,300,000,000 or 4.7 percent in the 3rd quarter, driven by increase non interest bearing DDA of $777,000,000 which now comprise over 45% of our deposit base, Plus growth in savings and money market accounts of $752,000,000 Market share gains in mortgage warehouse Robust activity in tech and innovation continue to be significant drivers of deposit growth. As we initially described on our Q1 earnings call, WAL's unique credit risk management strategy is focused on establishing individual borrower level and direct customer dialogue to develop long term financial plans. Our approach to payment deferral requests is to look for resourceful ways to partner with our clients along with assessing their willingness and capacity to support their business interests.
We ask our clients to work with us hand in hand, whereby our clients contribute liquidity, capital or equity as an integral component to modified prepayment plans. Our approach collectively uses the resources of the borrower, government and the bank's balance sheet to develop solutions that extend beyond the 6 month window provided for By quarter end, deferrals had declined by $1,600,000,000 or 55 percent, reducing total loan deferrals from 11.5 percent in Q2 to 5%. Excluding the Hotel Franchise Finance segment, In which we executed a unique sector specific deferral strategy, the bank wide deferral rate is approximately 1.6%. We have received minimal additional requests for further deferrals and 98% of clients with expired deferrals are now current in payments. We expect $1,100,000,000 of loan deferrals will expire in the current quarter, which will substantially drive down outstanding modifications.
Consistent with this trend as of yesterday, deferrals are down $420,000,000 in October, bringing the current total to 880,000,000 Regarding asset quality, our non performing assets at OREO to loan ratio remained flat at 47 basis points to total assets, While total classified assets increased $28,000,000 or 4 basis points to 98 basis points of total assets, Classified accruing loans rose by $21,000,000 explainable by a few loans 90 days past due as of September 30.
All of
these loans are now current. Special mention loans increased $81,000,000 during the quarter to 1.83% of funded loans, which is a result of our credit mitigation strategy to early identify, elevate and apply heightened monitoring to loans and segments impacted by the current COVID environment. Over 60% of the increase in special mention loans are from previously identified segments uniquely impacted by the pandemic, Such as the hotel portfolio and a component of our Corporate Finance division credits determined to have some level of repayment dependency on travel, leisure or entertainment. As we have discussed in the past, special mention loans are not predictive of future migration to classified or loss Since over the past 5 years, less than 1% has moved through charge offs. If borrowers do not have through cycle liquidity and cash and capital plans, We downgrade to some standard immediately to remediate.
Our total allowance for credit losses rose a modest $7,000,000 from the prior quarter due to improvement in macroeconomic forecasts and loan growth in portfolio segments with low expected loss rates. Additionally, we covered $8,200,000 of net charge offs. The ending allowance related to loan losses was 355,000,000 For CECL, we are using a consensus economic forecast outlook of blue chip forecasters as it tracks management's view of the recession and recovery. The economic forecast improved during the quarter, which would have implied a reserve release. However, given the still unknown time horizon of COVID impacts, Political uncertainty and the unknown status of further stimulus, we adjusted our scenario weightings to a less optimistic outlook.
In all, total loan allowance for credit losses to funded loans declined a modest two basis points to 1.37% or 1.46% when excluding PPP loans. On a more granular level, our loan loss segments account for approximately 1 third of our portfolio includes mortgage warehouse, residential and HOA lending, capital call lines and resort lending. When we exclude these segments, The ACLs of funded loans on the remainder of the portfolio is 2%. Provision expense decreased to $14,700,000 for Q3, driven by loan growth in lower loss segments and improved macroeconomic factors, while fully covering charge offs. Net credit losses of $8,200,000 or 13 basis points of average loans were recognized during the quarter compared to $5,500,000 in Q2.
Relative to other banking companies, our lower consumer exposure continues to result in much lower total loan losses. We continue to generate significant capital and maintain strong regulatory capital ratios with Tangible common equity total assets of 8.9 percent and a common equity Tier 1 ratio of 10, a decrease of 20 basis points during the quarter Due to our strong loan growth. Excluding PPP loans, TCE to tangible assets is 9.3%, a modest Inclusive of our quarterly cash dividend payments of $0.25 per share, Our tangible book value per share rose $1.19 in the quarter to $29.03 up 13.4% in the past year. We continue to grow our tangible book value per share rapidly as it has increased 3 times that of the peers over the last 5.5 years. And I'll turn the call back to Ken to conclude with comments on a few of our specific portfolios.
I would now like to briefly update you on our credit risk mitigation efforts And the current status of a few exposures to industries generally considered to be the most impacted by COVID-nineteen pandemic. Throughout the quarter, Tim Bruckner and the credit administration team led ongoing focused portfolio reviews by risk segment To monitor credit exposures and performance against cash budgets, operating plans through the liquidity trough. We are not waiting for deferrals to run out to make rate changes or affect remediation strategies. If borrowers are not performing against defined plans are determined to not have a sufficient through cycle liquidity. We downgrade them now to substandard and enact remediation strategies To ensure the best outcomes, we do not hold loans in SFs, a special mention for a time to eventually downgrade and as a result, Special mention graded loans slowly migrate to classified or substandard.
These facts With our people and our clients help me feel confident that our credit mitigation strategy and early approach to proactively manage our risk Segment is bearing fruit and puts Western Alliance in a strong position to come out on the other side of the pandemic in better shape than our peers. In our $500,000,000 gaming book focused on off strip middle market gaming linked companies, Total deferrals were reduced from 37% of the portfolio to only 4% and as of today it's 0. As our clients are now open for business and are performing at or above their reopening plans, The $1,300,000,000 investor dependent portion of our Technology and Innovation segment has continued to benefit From significant sponsor support for technology firms best positioned to succeed in this COVID environment and an active fundraising environment as well. Since March 2020, 65 of our clients have raised over $1,700,000,000 in capital resulting in 87% of borrowers with greater than 6 months remaining liquidity up from 77% in Q1. Our CRE retail book of $674,000,000 focused on local personal services Based retail centers with no destination mall exposure continues to modestly exceed national trends That shows rent collections rising from 50% in May to 80% in August.
Similarly, this Portfolio's deferrals have fallen from $176,000,000 to $31,000,000 Lastly, Our $2,100,000,000 hotel franchise finance business focused on select service hotels With greater financial flexibility and LTVs at origination of approximately 60% continues to trend towards stabilization. Occupancy rates are tracking national averages currently around 50% which have tripled from April lows. At approximately 55% occupancy, select service hotels are estimated to cover amortizing debt service. So a typical hotel is operating at breakeven. Furthermore, we have seen deferrals decline from 83% of the portfolio to 44% of the portfolio and currently we do not anticipate granting any additional deferrals in the hotel portfolio.
We are proactively engaging with hotel sponsors to validate ongoing support and hotel performance against operating plans. As mentioned earlier, We are not waiting for deferrals to end before migrating to ensure remediation options. With strong sponsor support, the worst A great hotel typically receives is SF or special mention. Let me just finish up with our management outlook. We believe that our Q3 performance is the baseline for future balance sheet and earnings growth.
With this record quarter, we beat our quarterly budget that was established pre pandemic. Our pipelines are strong and we loan growth to return to previously anticipated levels of $600,000,000 to $800,000,000 for the next several quarters in low risk asset classes. However, there will be some offsets as PPP loans pay off or are forgiven. Depending on timing of the realized PPP forgiveness, Organic loan growth should more than offset PPP run off. In Q4, we expect to see the seasonal declines associated with our mortgage warehouse clients.
Therefore, deposit growth will be at the lower end of the target range, reducing our excess liquidity. To supplement our residential lending initiative, we acquired Galton Funding, a residential mortgage platform that specializes In the acquisition of prime non agency residential home loans. The acquisition is a low risk, low cost entry point To build a meaningful residential mortgage business line at an accelerated timeframe with over 100 additional mortgage originator relationships. We anticipate that the Gautam team will be fully integrated by the end of October and be contributing to loan growth by the end of the year. As Dale mentioned, our current spot rates indicate that the net interest margin pressure experienced this quarter will subside and net interest margin will trend upwards was 3.9% in Q4.
We expect net interest income to rise in Q4 aided by both an increased NIM and higher end of Quarter loan balances compared to the quarterly average. Additionally, it is expected that PPP fee income will pick up next quarter as forgiveness is granted. This will however abate during 2021. Key KNR is expected to increase as net interest income growth More than offset any increase in non interest expense. Looking ahead, we will continue to invest in new product offerings and infrastructure To maintain operational efficiency, but Q2 and Q3 efficiency ratios are temporary and will eventually return to a sustainable level In the low 40s.
Our long term asset quality and loan loss reserves are informed by economic consensus forecast, which is consistent going forward could imply reserve releases in the coming quarters. We believe that the provisions in excess of charge offs Year to date are more than sufficient to cover charge offs through the cycle as we do not see any indicators that imply material losses Are on the horizon. Finally, Western Alliance is one of the most prolific capital generators in the industry. Our strong capital base and access to ample liquidity will allow us to take advantage of any market dislocations to maintain leading risk adjusted returns to address any future credit demands, all while maintaining flexibility to improve shareholder returns. At this time, Dale, I and Tim We'll take your questions.
Operator, if you want to open up the line.
We will now begin the question and session. Our first question comes from Brad Milsaps of Piper Sandler. Please go ahead.
Hey, good morning, guys.
Good morning, Brad.
Dale or Ken, I just wanted
to make sure I understood kind of all the moving parts around the balance sheet. It sounds like A lot of the growth that you saw at the end of the quarter was mortgage warehouse related, which can obviously be very volatile and End of the quarter can be very different than the average. As you go into the 4th quarter, is your expectation that you're going to be able to Replace that, if it does wane a little bit with other types of loan growth. You also mentioned that you also just expect deposits From that, from the warehouse business to go down, so you'll get some liquidity bleed there as well. Just want to understand kind
of
what the moving parts would be within average earning assets As you go into 4Q with kind of everything you talked about.
Yes. So Mortgage warehouse had a great quarter as you can see by the results. They are Increasing market share simultaneously as our warehouse lending clients Increase their activity or see increased activity. So we're getting a 2 for 1 and that's why you saw the increase, the large increase in loan balances this Q4 is traditionally a little lighter and so we're just sticking to our Q4 Analysis or historical viewpoint that loan growth there will be less. And yes, our model is designed Such that we can replace loan growth there with other loan growth around the company.
And that's why we're giving you the $600,000,000 to $800,000,000 range For Q4 loan growth and also the same for deposits. They lose some of their deposits in Q4 as taxes are paid.
Fred, I would also say that we have a senior loan committee that meets weekly that approves the largest credits in the company. And the activity level of loans coming in from the line to that committee, which is loans about $15,000,000 Has really stepped up significantly over the past couple of months compared to where we were, say, in the second quarter. And so we're seeing we think we're seeing broader strength in other classes of loan credit. And at the same time on the deposit side, despite what we think may happen on in terms of the warehouse lending piece, We're seeing some increase in some of these other channels as well that I think are going to bear fruition in the fairly near term.
Yes, just to add to Dale, I mean we're seeing strength in capital call business. We're seeing strength in the CRE business certainly around the industrial side where there We're building we're doing a lot of deals for distribution centers. And then tech and innovation is seeing a lot of new opportunities as well.
And maybe just a follow-up on the loan growth. Where are kind of new loan yields coming on the books. I know you mentioned the spot rate of $450,000,000 but kind of curious where new production is coming on? And then can you talk a little bit more about the impact Of the acquisition that you made, how much you paid, kind of what's the incremental benefit you kind of see over the next 6 to 12 months?
Sure. So in terms of the yes, that spot rate is really spot on In terms of kind of where the numbers are. So the actual loans that have come on have been about 5 basis points higher yielding than what the average was. And I think that's kind of reflected there. Again, we have a lot of discipline with our team in terms of putting in floors.
So let's suppose somebody makes a At L plus 3 or L plus 3.5, what we'll define in the low docs that L can't go below 1% in that That's a really common structure for us. So the floor is active on the 1st day and that's how we're able Sustain new originations really right on top of the current yield.
So I'll take the second half. Galton, first, we didn't pay much money Forward at all, all right. And it's a mortgage business that specializes on buying non QM loans from warehouse lenders. And so non QM mortgages have a slightly different feature than standard agency paper. They sometimes offer interest only features Or they have more self employed borrowers, but they underwrite to very low LTVs in the 67% to 60 And the paper carries higher yields than the standard agency paper.
So standard agency paper could be 2.25% and these yields will be 3.25% to 3.5%. The acquisition came with 12 people, 4 sales people and 8 operations people and it provides us with a dedicated sales force and servicing operations. So this will allow us to ramp up our residential purchase volume while improving customer service with knowledgeable experts. It provides cross selling opportunities to the Galtan customer base. Galtan has 100 warehouse lenders that They work with 30% of which is an overlap with us, but the other 70% will allow us to offer warehouse lending lines And then to remove mortgages off of the warehouse lending line onto our balance sheet if they fit our credit box.
We've seen Galton in operation for a couple of years. We've probably seen over 1,000 mortgages that they've underwritten. So we have a real sense that their approach to credit mirrors ours. And we think the big Impact here will be seen middle of next year as this thing continues to ramp up and we bring them into the fold here. So where we were doing residential mortgages either bulk purchases or forward flow agreements Off the side of our desk, meaning other people had other responsibilities, we now have a dedicated team to do this and that's knowledgeable people And that's what excites us about this opportunity.
Our next question comes from Chris McGratty of KBW. Please go ahead.
Great. Thanks for the question. Dale, I just wanted to make sure I got the 4th quarter guide accurately. I was writing pretty quickly. The $390,000,000 I believe Ken you said $390,000,000 margin, is that a fully loaded margin with the impact of the fees from the PPP?
Correct. Yes, the $6,900,000 level that we show on that one page. So rebounding from the 2nd quarter, but much lower than what we had We're bringing from the Q3, but lower than we had in the second.
Okay. And based on the balance sheet, the comment was 4th quarter reported all in net interest income higher than 2nd quarter reported, right?
Yes.
Okay, great. In terms of the growth strategy, can you just size up how big the warehouse is and the capital call book.
Yes. So the warehouse book is Yes, dollars 3,900,000,000 and capital call is $737,000,000 Getting to your question, Chris, yes, no, We see that we have kind of stability here. We have an opportunity to continue to sustain earning asset growth. So we believe we can even if there We're margin pressure in 2021 that we have we've got the growth trajectory that we can sustain increases in net interest income.
Got it, understood. And if we look maybe one more on just the mix of the earning assets, if we look at the mix between cash And securities, it's call it roughly 20% of earning assets. Is that the same is that the proportional mix you'd expect of the balance sheet going forward, maybe toggling between cash Securities, 20 percent?
Well, I think we can take our cash down to something in kind of the low to mid 100 of 1,000,000. We think that's really kind of the floor for us. And so we're up at $1,900,000,000 that gives us a fair amount of room. And the Federal Reserve, I mean, it's Not a criticism, but they pay 10 basis points. So we think that the we know liquidity is abundant these days at banking companies, But we think that actually garnering more relationships and even if they're flat or even slightly negative In terms of price, and obviously, they crushed the margin because you get a big balance that's a 0 spread or something like that.
But we think that's going to bode well In the future, as we come out of this situation, and as Ken mentioned, with Gulf and Funding among other channels, Where we've got opportunities to really grow safely on the credit side. Okay.
And then the investment portfolio, Dale, just that just kind of you solve for that based on the deposit? I mean, how are you thinking about the size of the bond book?
Yes. I think the bond book had actually I don't know that it's got a lot of room. I think we're comfortable with our loan to deposit ratio in the 90s. So that's going to drive some of the Investment securities portfolio. But we've got a couple of $1,000,000,000 $2,500,000,000 of mortgage Securities in there that are yielding $100,000,000 $150,000,000 less than if we buy, we think, similar risk credit with low LTV First mortgages.
So there's a possibility that after we sop up our current liquidity through residential and other channels That maybe we don't need to grow the MSR book anymore and that could become a smaller proportion of the balance sheet in aggregate.
Got it. And then last one if I could, just everyone's topic on taxes. Anything meaningfully different In your tax structure and strategy today, if we got a tax increase that the same math opposite direction wouldn't work Next year.
Yes. So I mean, I think you could the proportion holds pretty well. So even though our tax rate may be lower than some others, Basically looking if you're going to 28% and you're at 21%, that's a 33% increase in the tax rate. If you take our tax expense, say for the Q3, which was $30,000,000 and say, gosh, if that were to go into effect, our tax recognition expense would be up for this A similar quarter would be about $10,000,000 higher, about a third higher.
Got it. Okay. Thanks a lot.
Our next question comes from Michael Young of Truist. Please go ahead.
Hey, thanks for taking the question. Was kind of curious, it sounds like there's an effort to grow the balance sheet maybe with some more residential, but or warehouse. But I was kind of curious just about the trade off between growing the balance sheet and some of those more non relationship oriented areas versus maybe just looking at a share buyback program and a larger proportion. So just kind of growing balance sheet versus Returning capital and how you guys are thinking about the trade off between the 2?
Yes. I would argue that we do have relationships. What we're doing is with each warehouse lending customer, we have a warehouse lending relationship, We could have an MSR relationship. We can have note financing relationships. They provide deposits to us and they also provide us With a go forward flow on residential mortgages.
So don't think about the relationship as the end customer in their Home, think of it as the mortgage servicer, which controls a lot of business. And we see an opportunity now. There is dislocation in the market with a number of mergers and also I just say poor performance That we're coming in with higher high touch customer service that we're getting business that's coming to us and we're not having to Struggle to bring that business in. So that to us is very important and that's what's driving the balance sheet growth. We're not Trying to buy mortgages for mortgages' sake.
It's really the warehouse lenders and those relationships that we have with them.
In terms of the repurchases, I mean, where we are with this is we can sustain a balance sheet growth. And while We don't have an eye to being opportunistic in terms of share price. We think the long term value creation It's from expanding the franchise.
Okay. That's fair. I appreciate it. And then Maybe just on credit. Have you all actually foreclosed on or liquidated any of the hotel assets or any other CRE assets that have given you any more confidence or anything, any color you could provide on those books?
There's been no liquidation, no foreclosures. The hotel book Is given its circumstances performing okay. 45% of the book Has a debt service coverage ratio above 1%, 45% is below it. And then we've got a few construction loans. We don't have a debt service coverage ratio on that.
You can see hotel occupancy coming back to 50%. That's about where our Our hotels are tracking to the national averages. Again, when we underwrote these hotels, We underwrote good liquid sponsors that had the ability to call on capital from their LPs And they did that to enter into many of the 3 +3 or 6+6 deferral relationships. Tim, do you want to say anything else? Yes.
I think it's important to remember we started this dialogue Particularly with hotel in February. We brought together the segment, we put dynamic leadership, Some of our senior most executives in place and we've maintained that dialogue around liquidity, operating And forward looking capital plans. That has allowed us to be way out ahead of problems that arise here. So we've got strong sponsorship, we've got an active dialogue and we're seeing Good progress towards stabilization.
Okay. Thanks.
Our next question comes from Gary Tenner of D. A. Davidson. Please go ahead.
Thanks. Good morning. Just wanted
to ask on the mortgage acquisition that we talked about earlier. Day 1, are there any other is the revenue coming off that purely the mortgages that you put on balance sheet or are there any is there any other associated revenue or fees, anything That would be related to that. No.
No, it comes off of the revenue comes off of the mortgages put on balance sheet And we've been just integrating the team over the last 3 weeks or so. So we're not looking for any mortgages Begin to hit the balance sheet on maybe for another 2 or 3 weeks.
Okay. And Dale, you may have alluded to this when you talked Kind of balancing the investment portfolio against the resi book. You've been hanging around in the kind of 9.5% Yes, or plus or minus in terms of residential loans. Where would you take that bogey to now that you've got this other Kind of stream of product coming in.
Well, I think it's got a lot of runway in front of it. I don't have a number for you for where it might stop, but As you know, a typical bank, that number is going to be about triple that concentration level, which is Even with the growth rates that we're talking about, augmented with Galton and what we've been doing before, jeez, I mean, if we could take 20% on a growing balance sheet, that's going to be a substantial increase in the balances outstanding. So I think we've got years for this thing to run. We think it's It's a strong asset class to be in. We think the rates work now.
We've been, as you know, asset sensitive. We're really now kind of asymmetric, And this balances that out as well. So we think it's a good place to be. It's a lower risk weighted asset category And we're one of the smallest out there in terms of relative exposure. Thanks.
Our next question comes from Brock Vandervliet of UBS. Please go ahead.
Great. Thanks for the questions. Adeel, I guess if you could Talk about you touched on this in your prepared remarks, I guess, in terms of the deposits. How much of those do you think you can Kind of hold on to going forward. What's the volatility of the deposit mix at this point?
Well, I think there's I think it's good, but there's 2 areas that I want to keep my eye on. One of them is, I'll call it PPP deposits. So we took $1,800,000,000 of loans that we made and we deposited into these accounts And we track how much money is still there. And that number is still over $1,000,000,000 And it's like, well, that's going to get burned Somehow at some point in time, maybe that's a little bit lazy because we're in this kind of no rate environment. So we want to keep our eye On that piece of the thing.
And then the second piece is kind of the mortgage warehouse area. Obviously, it's been a torrid pace of refinancing. That's going to increase volumes generally. And so I think is there a space for kind of take a breather In that scenario now, my read of what's transpiring is, well, maybe the refi business It's going to temper to some degree. There's still a lot of people that are eligible for refi in terms of putting themselves in a lower So is there some area that could come out of that?
I think there is. What do we have? Well, we've talked about our 2 business lines that are deposit generating. Those both You know, did run into a little bit of a sidetrack regard because of the pandemic. They each of them benefits from kind of In person contact for development of personal relationships with these enterprises that they service.
We think that's coming out of it now. We think those pipelines look strong also. Ken mentioned the tech and innovation space and one of our competitors It's fairly bullish in terms of what that outlook is like and we would second that assessment. So while we may see softness In a couple of these categories that have been really powerful in 2020, we think we've got handoffs that we can make to kind of Sustain the Relay performance in 2021 to some of these new areas.
Got it. And separately, just on the Galton acquisition and the non QM, and that encompasses many different Flavors of mortgage origination. Is this generally paper that just doesn't quite check the agency The box or is it more of a heavier credit component to it? And I guess separately, what's the step up from vanilla Agency origination, what's the step up in rate with this paper?
Yes. It just doesn't check the box For the agencies and the step up in paper is about 1%.
Our next question from Timur Braziler of Wells Fargo. Please go ahead.
Hi, good morning.
Good morning.
Starting with efficiency, it seems like NII has seemingly reached a bottom here in the 3rd quarter and should start Moving in the Q4. As we look ahead, should we expect a similar level of operating leverage, whether it's 2 to 1 or 3 to 2 as we've Seen in recent years or does the current rate environment present enough challenges where it's likely Lower than that for the foreseeable future.
I think we can sustain where we are in terms of the operating So, yes, we think the margin is fairly stable even if rates kind of stay at this level for maybe in perpetuity for certainly Extended period of time. And then our expenses running at around $0.40 relative to the revenue we bring in, We think that's pretty sustainable as well. So we had some volatility in the Q2 for a variety of reasons. We talked about Really, it underscores that we're looking at the Q3 of 2020 as really being a pretty good baseline. I know Some of you have commented or looked at that we had these we had this gain from securities gains, kind of a recovery of about $5,000,000 In the Q3, which of course we did.
But in my view, I don't back that out in terms of what a run rate is because I'm offsetting that with the reversal we had in PPP kind of going forward. So we think the revenue is a good base to come from. We think the expense base is a good base from which to grow. But again, holding in at kind of the low-40s on efficiency.
Okay, thanks. And then I just want to make sure I'm thinking about deferrals correctly. So the 1,100,000,000 deferrals that are rolling off in the 4th quarter, how much of that was part of the 6 +6 program? And for those loans, is it now the liquidity that was collected as part of the initial deferral process, is that now kicking in for another 6 months? Or is that entire balance going to be moving into performing status essentially?
Yes, so I mean they prepaid. I mean so before they got 6 months of deferral, they prepaid another 6 months. And this is what we recommended that they do because it takes them out until the Q2 of next year, Which again, I you can different assumptions in terms of when we get out of this, but with therapeutics and I think vaccines are just frankly pretty close to around the corner. Yes, I think by that point in time, what we're these entities, these hotels are going to be able to benefit from kind of relaxed Social distancing. And so they prepaid it also, yes, they are paying as agreed because they're dipping into basically a control account That is making the principal and interest debt service as they've come off of deferral.
Okay. And Is that around 50% that's 6% plus 6% of that or is it going to be a smaller amount That's about $1,100,000,000
Well, of those that are coming off in the Q4, it's predominantly the 6 +6 Because they were done. I mean, we did some that were 3 plus 3. Those typically came off mostly In the Q3, right. So the Q4, those are the 6 plus 6s that were done in the Q2 of this year. Okay.
And then one last one for me. Just looking at the technology sector, another strong quarter of growth, but I noticed that the allowance For that sector decline on a linked quarter basis, was that the specific reserve release that you spoke of or was there something else going That portfolio that drove a linked quarter reduction in allowance?
No, that was part of it that drove the decline in balances It was a reserve release on an asset that we were able to get off our books and we were happy to get off our books.
Okay, great. Thank you very much.
Our next question comes from David Seyafirne of Wedbush
A couple of questions for you. And the first one is a Strategic question on mortgage warehouse with it now $4,000,000,000 of loans and you addressed a little bit about this with the deposit discussion. But I was curious because some investors have expressed concern generally about seasonality and volatility around the mortgage warehouse business. Can you talk about how you're viewing that business in addressing that volatility over time as we look ahead?
Yes. So we thought this was again, if you look at the kind of the business lines with which we can select from and which This was a great time to go into mortgage warehouse. The balance the demand was strong. The quality is excellent. And because of the cycle where we are in interest rates after the FOMC actions, it's a robust growing area.
So, yes, I mean, I don't think that what's going on there is sustainable long term. If rates start to rise, I think It's going to come down significantly, although the purchase market is pretty active still and that maybe has more legs to it and less cyclicality. But in any event, I mean, it's just I think it's just a good example of, hey, we can go here because this is safe, this has activity, this is something where we can move to In the immediate timeframe that we did that basically earlier this year. If that pulls back in 2021, which I think is a reasonable probability, Like I mentioned, we're looking at our the things that are coming to our credit committee and they're strong and they're diversified. And we think that that's where we can kind of pivot to as this one may wane a bit.
Let me just add. First, remember While we have $3,900,000,000 sitting out there in loans, we have almost an equal amount 3.6 sitting out there in deposits. So it's a great strength of deposit for growth for us. And so I think that's important to remember. The other thing is when we say warehouse lending, you got to remember that includes MSR lending, that includes note financing and warehouse lending, Right.
So it's a combination of all those things. So we do have some other levers to pull when we're dealing with some of our clients.
Great. That's really helpful color. And then shifting gears, you mentioned about the potential for reserve releases looking out over the next Few quarters or towards the maybe middle or end of 2021. But nonetheless, I was curious, do you have a target Reserved loan ratio in mind?
We don't because it's so dependent on each particular asset type. So that number has as we've grown in these categories that are about a third of our balance sheet now That's our little to 0 loss mortgage warehouse, public finance, capital call lines, Residential mortgages, resort finance, as those have become a larger proportion, that number is going to fall. And so I think you need to look at it more on a category by category basis. I mean, if you look back to kind of what a standard normal situation might be, If you take where numbers were as of Twelvethirty Onetwenty 19 before this pandemic Started and then add in the overlay that was done at the beginning of this year for the adoption of CECL, which front loads provisioning as everyone is well aware. That number was about a 1% number for us in terms of reserve level.
I think in a more benign environment and less uncertainty, I think you Go back to that level. With that mix, if the mix is lower, I think that number could even fall further.
Great. Thanks very much.
Our next question comes from Andrew Terrell of Stephens.
Most of my questions have been asked and I did just want to touch on the increase in compensation this quarter. Was there included in that number any type of from prior quarters that we would see fall out of the 4Q run rate?
Yes. That's exactly it. As we Moved closer to our performance targets, we caught up for the 1st two quarters as well.
Okay. That's helpful. And then maybe just a bigger picture question. These 2, I guess, overall revenue Are consistently just around the mid single digit range. If we're in a lower for longer interest rate environment, are there any thoughts to potentially growing out Any specific offerings in the fee income base?
So we're always looking at that. As you know, we're very We lead the industry in many different categories. We do not lead the industry in fee income. And so we are working on a few things. I would say they're going to be marginal at this point.
There's nothing that's going to move the needle As we look towards 2021. So we're a spread business and for us it's important for that balance sheet growth to occur. Good ask the quality of costs that will negate some of the lower funding lower interest rate environment. But remember, we're able to get floors on our loans and 78% of our loans have floors. And so The impact to us on a NIM basis will not be as great.
That's helpful. Thanks for taking my question.
Our next question will come from Jon Arfstrom of RBC. Please go ahead.
Hey, thanks. Good morning, everyone.
Good morning.
This is maybe I think everything's pretty much been covered, but Touchy feely philosophical question for Kim or Kim. I can look at this and you're making more than you were pre pandemic. Your returns are Tangible, return intangibles almost 20%, but stock buy 30%. So the gap is probably Do you feel like we're all overreacting to that? Or should we expect some kind of a surge in losses over the next few quarters That doesn't seem like you're indicating, but are we missing something here?
The short answer is yes. I mean if you piece through everything we said today, we said that the baseline Of earnings for Q3, dollars 136,000,000 this quarter is going to be the baseline Going forward, for the upcoming quarters into 2021, assuming at this point The same provisioning of about $15,000,000 Now, we don't see large losses on the horizon. We don't see charge offs rising dramatically. It's hard to find them in our book of business at this point. So even our provision may be a little high and certainly would be a little high if the consensus economic forecast Is changed to be more favorable for the vaccines and what have you and more states opening up After the election.
So I think that the A lot of investors, I'll say it that way, overreacted to what they thought our losses could be, all right. Almost $10,000,000,000 of our book Is in really, really low loss categories. And as I said, we don't see the losses coming our way And we're feeling good about where our net interest income is going to be in Q4, and we're feeling good that the baseline for earnings Is what you see this quarter.
Okay. That's all I had. Thank you.
Okay. Well, thank you all for attending the call. We look forward to speaking to you In the Q4 and everyone enjoy their weekend.
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