Good day, everyone. Welcome to the Western Alliance Bancorporation's third quarter 2022 earnings call. You may also view the presentation today via webcast through the company's website at www.westernalliancebancorporation.com. I would now like to turn the call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Please go ahead.
Thank you, and welcome to Western Alliance Bank's third quarter 2022 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer and Dale Gibbons, Chief Financial 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 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.
Thanks, Miles. This quarter, the company continued its strong financial performance as our diversified national commercial bank again delivered record net interest income, PPNR, and earnings, complemented by strong deposit and loan growth, supporting higher net interest margin with stable asset quality. For the third quarter Western Alliance generated record total net revenues of $664 million, net income of $264 million and EPS of $2.42. Earnings were propelled by accelerating net interest income quarterly growth of $77 million or 15% from the prior quarter to $602 million as the rising rate environment expanded our net interest margin 24 basis points to 3.78%.
We maintain industry-leading performance with return on average assets and return on average tangible common equity of 1.53% and 24.9% respectively, which will continue to support building capital levels in the quarters to come. Sound balance sheet expansion continued with quarterly loan growth of $3.6 billion or 7.5% quarter-over-quarter, and deposits rose by $1.9 billion or 3.5% quarterly, mostly from non-interest-bearing DDA accounts. Loan demand remained healthy with 27% of growth coming from our regional banking divisions and 50% from national business lines. Deposit growth of $1.9 billion trailed strong loan growth this quarter. In Q3, our regional banking divisions contributed 32% of deposit growth and our specialized deposit franchises added 63%.
We are proud that one of our new deposit business lines, Business Escrow Services, is gaining meaningful traction and contributed $424 million this quarter. We expect Business Escrow Services, Settlement Services, and other deposit initiatives to meaningfully contribute to growth and continue to enhance our funding profile in 2023. Mortgage banking-related income declined $35 million as the origination market continues to face major market disruption. The speed and level to which rates have climbed have greatly reduced refinance activity and strained affordability in the purchase market. Servicing revenue was negatively impacted by a $22 million MSR hedge loss driven by volatility that spiked towards the back end of the quarter. We have positioned AmeriHome to profitably operate in a lower origination market focused on becoming the industry's leading low-cost operator and have implemented a strategy to prioritize profitability against volume market share.
Finally, asset quality continues to remain in great shape, and we do not see issues on the horizon. For the quarter, WAL recorded net loan recoveries of $1.9 million or negative 2 basis points. Year to date, we are in a net recovery position. At this point, Dale will take you through our financial performance.
For the quarter Western Alliance generated net income of $264 million, EPS $2.42, and PPNR of $358 million. Excluding a $2.8 million mark-to-market loss on preferred securities and a $4 million charge related to severance and other compensation charges primarily on AmeriHome, our EPS was $2.47 at 13% higher on a linked quarter annualized basis. Additionally, loan growth of $1.3 billion in excess of consensus added approximately $10 million in incremental provisions, which is front-loaded due to CECL. Total provision expense of $28.5 million also captures our somewhat softer outlook on the economy. Total net revenue of $664 million was an increase of $44 million during the quarter and $115 million or 21% year-over-year.
Net interest income increased by 15% from Q2 to $602 million, was driven by loan growth and further NIM expansion. Overall, non-interest income declined $33 million to $62 million from the prior quarter due to lower mortgage banking-related income which fell $35 million to $37.5 million. Gain on sale revenue was $14.5 million due to lower purchase volumes, while servicing fell to $23 million as volatility rose, which led to an MSR hedge loss late in the quarter. While the mortgage industry has made strides in rightsizing overcapacity to adjust to lower volumes in a higher rate environment this process is ongoing and normalized margins have not yet returned. Non-interest expense increased 13.7% or $37 million resulting in an efficiency ratio of 45.5, primarily due to higher deposit costs related to earnings credits.
If the efficiency ratio was adjusted to reclassify deposit costs as interest expense, it would be 40.5%, as remaining operating expenses were flat. Turning now to net interest drivers, our growing asset-sensitive balance sheet benefited from the rising rate environment. Investment yields increased 72 basis points from the prior quarter to 3.66% as variable rate securities repriced. On a linked quarter basis, loan yields increased 65 basis points with an end of quarter spot rate of 5.43%. Loans held for sale benefited from rising mortgage rates and increased 88 basis points to 4.87%. Total funding costs, including borrowings and deposits, increased 50 basis points to 88 basis points with a spot rate of 1.12% as the average rates and balances for deposits rose. Short-term borrowings and credit-linked notes also climbed.
Long-term debt expense increased $13.5 million this quarter due to $940 million in total CLNs we have issued program to date, which has preserved nearly $400 million in equity capital and minimized stock issuance. The higher interest expense in lieu of capital issuance also provides credit protection on 24% of our loan book. As mentioned earlier, net interest income growth of $77 million or 15% linked quarter benefited from average interest earning asset growth of $3.8 billion and NIM expansion of 24 basis points to 3.78%. Interest income grew 32% more quarter-over-quarter than our total funding costs inclusive of ECR expenses as we remain asset sensitive.
Our rate shock analysis shows that with a 100 basis point rise over 12 months and on a static balance sheet, net interest income is expected to lift 6%. Using the same scenario on a growth balance sheet, we expect net interest income to grow over 15%. Reviewing the effect of a 200 basis point shock on a growth balance sheet, net interest income is expected to rise over 25% over the 12 months from the current run rate. Our efficiency ratio increased 270 basis points to 45.5%. After reclassifying deposit costs as interest expense, it improved from 41.1% in the second quarter to 40.5% in the third, demonstrating the high operating leverage of the company.
Deposit costs increased $38 million from the prior quarter due to higher earnings credit rates on deposits of $15.9 billion of which $11.3 billion is in non-interest bearing DDA. Pre-provision net revenue rose to a record $358 million during the quarter, a 14% increase from the same period last year and an increase of $7 million or 2% from the prior quarter. This resulted in PPNR ROA of 2.08, a decline of 11 basis points compared to 2.19 last quarter. WAL's leading organic capital generation produces approximately 45 basis points in CET1 capital on a static balance sheet per quarter and provides significant financial flexibility to fund balance sheet growth or build capital ratios.
Balance sheet momentum continued during the quarter as loans held for investment increased $3.6 billion to $52.2 billion, and deposit growth of $1.9 billion brought balances to $55.6 billion at quarter end. Mortgage servicing rights balances increased $218 million during the quarter to $1 billion, in part from declining prepayment speeds. Total borrowings increased $1.1 billion over the prior quarter to $7.2 billion, primarily due to an increase in short-term borrowings to fund loan growth in excess of deposit expansion. Tangible book value per share increased $0.49 or 1.3% over the prior quarter to $37.16, primarily due to strong organic earnings that offset unrealized marks on available-for-sale securities recorded in AOCI. Tangible book value increased 7.2% over the prior year.
This quarter, we generated sound organic growth for our national business lines and regional banking divisions. Loans held for investment grew $3.6 billion, driven by $1.6 billion in C&I loans, $893 million in sponsor-backed commercial real estate, and $766 million in residential real estate. C&I growth was driven by $534 million in tech and innovation, $392 million in warehouse lending, and $350 million in capital call lending. 43% of our loan growth this quarter came from our core very low to no loss national business lines. Turning to deposits, we continue to experience growth across our diversified funding channels. This quarter, our regional banking divisions generated approximately 32% of our net deposit growth while specialty deposit NBLs drove the remainder.
In total, deposits grew $1.9 billion or 13.9% annualized in the third quarter, with non-interest bearing DDA up $1.2 billion, CDs $533 million, and savings and money market $176 million. Non-interest bearing DDAs now comprise 45% of our total deposit mix, of which 55% or $13.6 billion have no associated earnings credit rate. Our diversified deposit franchise continued to provide ample opportunities to generate attractive funding to support loan growth with warehouse lending up $1.2 billion, regional banking divisions up $604 million, and Business Escrow Services up $424 million. Business Escrow Services has continued to establish new relationships with large corporate acquirers, attorneys, and private investment firms that support the growth ramp this quarter.
Going forward, we expect our scalable national deposit businesses such as HOA, Settlement Services and Business Escrow to continue to generate attractive deposits to fund ongoing balance sheet growth and temper the impact of elevated rates on our overall funding costs. Our asset quality remains stable and strong as classified and non-performing assets as a percentage of total assets are still lower than pre-pandemic levels. Total classified assets increased $39 million in Q3 to $385 million or 56 basis points of total assets. Subsequent to quarter end, approximately half of this increase in classified has been resolved, and we see nothing to demonstrate a trend. Total non-performing assets to total assets remained stable at 15 basis points and the realized net recoveries of $1.9 million.
Special mention loans decreased $5 million during the quarter to 60 basis points of funded loans, which represents a further decline from already historical lows last quarter. As the prospects for additional economic volatility continue to evolve, we believe our underwriting discipline borne out through our national business line strategies has prepared us for any credit stress that may accompany additional macro headwinds. However, we have not observed any preliminary signs of credit migration or client pressure. We believe our safe and sound asset quality decisions will dictate our thoughtful, diversified loan growth trajectory and enable us to navigate through heightened economic uncertainty. Approximately 55% of our loans are now in low to no loss categories, and 24% of the portfolio is credit protected through government guarantees, CLN first loss or is cash secured.
Quarterly net recoveries were $1.9 million, 2 basis points of average loan, which brought us to a net recovery position on a year-to-date basis. Our total loan ACL increased $29 million from the prior quarter to $356 million and is now greater than our pandemic high watermark that was set in 2020. Year to date, our ACL has increased by $66 million. Total loan ACL to funded loans remained flat quarter over quarter at 68 basis points, while our ACL to non-performing loans rose from 385% in the prior quarter to 396% this quarter. Adjusting for the $10.8 billion of loans covered by credit link notes, where ample first loss coverage is assumed by a third party, the ACL coverage ratio rises to 86 basis points.
We believe these superior asset quality trends are sustainable throughout economic cycles due to Western Alliance's deliberate post-GFC business transformation strategy to become a national commercial bank focused on deep underwriting specialization and greater business diversification. While its national reach and deep segment expertise enable selective relationships with the strongest counterparties on their most attractive projects with superior company risk management. During the global financial crisis, 67% of Western Alliance's losses came from loan categories comprising 44% of the 2009 loan portfolio, which today makes up less than 6% of total loans. Western Alliance has spent the last decade working to minimize these risks and diversify the business. We view a primary impediment to a higher stock valuation as misplaced concern about the credit risk heading into a likely recession.
Cumulative net charge-offs for the past decade have totaled only $27 million against $356 million in current reserves. 55% of our loan book is in two low- to no-loss categories. Lastly, the intended consequence of the credit-linked notes issuance has 24% of the whole portfolio credit-protected. We know of no other bank that can make this claim. Excellent asset quality has been a hallmark of the new WAL. Rapid improvement drove ratios to the top quartile where they have essentially held even through the height of the pandemic. Classified and non-accrual loans continue to hold below peers while charge-offs have been minimal with the net recovery recognized year to date. Non-accruals and net charge-offs have consistently ranked as one among the best in the industry and with classified loans in the top quartile even during the pandemic.
Our credit risk mitigation expertise shined during 2020 and 2021 and will be critical if the economy weakens further. A hallmark of WAL's business model is that greater diversification leads to sustained superior earnings growth with reduced volatility. Similar to a traditional Sharpe ratio for stock returns, our risk-adjusted net income growth has been excellent relative to other large peers. Among the 33 domestic publicly held, publicly traded banks in the U.S. with assets between $25 billion and $150 billion, WAL has produced the highest risk-adjusted average net income growth. While we weren't the leader in earnings growth or the lowest in earnings volatility separately, our combined strong and steady growth has produced the top risk-adjusted return. Given our industry-leading return on equity and assets, we continue to generate significant capital to fund organic growth and maintain well-capitalized regulatory ratios.
Our tangible common equity to total assets of 5.9% and common equity tier 1 ratio of 8.7 were both slightly lower than quarter-over-quarter. With AOCI dynamics impacting tangible book value ratios across the industry, we utilized our ATM to strengthen capital in addition to our solid earnings. We do not anticipate any share issuance will be needed as CET1 builds throughout next year. Finally, inclusive of our quarterly cash dividend payment of $0.36 per share, our tangible book value per share increased $0.49 or 1.3% quarter-over-quarter to $37.16, which is slightly above our Q1 level. Notably, our tangible book value has grown 19.4% annually since 2013, 3.5 times the rate of the peer group. I'll hand the call back to Ken for closing comments.
Thanks, Dale. I was pleased with the management team's ability to adapt to the changing interest rate and economic environment to produce record operating results.
Thoughtful balance sheet growth in conjunction with operating and executional focus position the bank to capitalize on net interest income sensitivity while simultaneously growing both sides of the balance sheet with industry-leading performance. Our superior operating leverage offsets the decline in mortgage banking income. Asset quality remains stable and solid with no signs of elevated stress. Organic earnings should grow capital as we reposition the company for slower growth ahead of a potential slowdown. Let me tell you what you can expect going forward here. Given the uncertain future economic and operating environment, we believe it's prudent to prioritize more measured but still double-digit loan growth targeting up to $1.5 billion per quarter. We plan to surgically reduce loan growth through increased pricing and tighter credit criteria while de-emphasizing loan growth not accompanied by high-quality deposits.
Deposits are expected to grow at approximately $2 billion a quarter. This will lower our loan-to-deposit ratio over time, which currently stands at 94%. Our goal over the next year is to bolster key capital ratios back to pre-AmeriHome levels, including 10% CET1. Our bank industry-leading return on average tangible common equity produces significant organic capital of approximately 45 basis points of CET1 net of dividends per quarter, which provides us with significant flexibility to grow capital ratios and fund the balance sheet growth. We expect to achieve our 10% CET1 target by mid-2023, aided by restrained balance sheet growth and risk-weighted asset optimization programs. Net interest margin is expected to continue to expand in Q4 at a similar pace to Q3, given the anticipated rising rate environment. Excuse me.
We expect continued quarterly expansion of NIM and growth in net interest income throughout 2023, even after the Fed pauses rate increases as fixed rate securities and loans reprice and balance sheet growth continues. Total revenue should continue to climb due to strong net interest income, with the drag from mortgage banking likely to moderate, assuming muted volatility. Our expense ratio, excluding the impact of deposit costs, should remain in the low forties, given inherent operating leverage of our business. Asset quality remains well-positioned and ranks among the industry's best. The technical recession we believe we have entered may move some key ratios slightly higher, but we do not anticipate any material deterioration that would change our above-peer standing. In conclusion, we continue to see an EPS of $9.80 for 2022 as a launching pad from which 2023 EPS can ascend.
At this time we're happy to take your questions, and I should have also said that Tim Bruckner, our Chief Banking Officer, is with us here today as well.
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press the star key followed by the number one on your touchtone phone. You will hear a three-tone prompt acknowledging your request and your question will be pulled in the order that they were received. Should you wish to decline from the polling process, please press the star key followed by the number two. If you're using a speakerphone, please lift the handset before pressing any keys. One moment for your first question. Your first question is from Casey Haire from Jefferies. Please go ahead.
Yeah, thanks. Good morning, guys. Was hoping to get some color on the comments about NIM expanding through next year. Obviously, it sounds like you're gonna be a little bit more selective on the loan growth front, which could help on the yield side. It does obviously seem a little bit tougher on the deposit betas and the funding pressure there. I know you guys don't manage to deposit betas, but what kind of deposit beta is in your forecast that is still allowing you to drive NIM expansion through next year?
Okay. We'll tag-team this. Let me start off, then I'll throw it over to Dale. I just wanna make sure we're clear that, for Q4 and through 2023, we are projecting a growing and vibrant net interest income using the consensus FOMC forecast. Net interest income and NIM will continue to grow into 2023 even after the FOMC concludes raising rates. We feel comfortable with this forecast for several reasons. Number one, the increase or excess liquidity that we're gonna get from having deposits grow faster than loan growth will drive Federal Home Loan Bank borrowings downward, lowering funding costs. Second, current and future loan growth is being priced to higher levels as we've seen liquidity withdrawn from the banking system.
Third item is, $1.5 billion of loans reprice every quarter, with about 50% rolling over at higher spreads. Our fixed rate securities and loans totaling $800 million also reprice quarterly, which we see, we think we can get some benefit from. The other thing I would say is, since my return to the company, taking over as CEO, we focused on net interest income, rather than net interest margin rate. Then focusing on net interest income allows us to also produce the EPS results that we have. In our mind, what we have done is, going forward, we have priced 100% deposit beta with 100% loan beta.
We kind of see the spreads which have been materially increasing for us certainly since the beginning of Q3, but even before that, to carry us for the rest of the year. Dale you wanna add anything to that?
Sure. Yeah, Casey. We have lower levels of interest-bearing deposits and other funding sources, borrowings, and CLNs than we do in terms of interest-earning loans and securities. That's primarily because of our DDA that has no ECR. I mentioned that is $13.6 billion. We're okay bringing on high beta, you know, funding, so long as it's going into 100% beta assets, and we're gonna continue to see that. I think some of the other institutions have been challenged because they've actually held back on raising their deposit costs. They have consumer or something else and they believe that it's gonna withstand that and then they've been surprised. Now they have betas in excess of 100, at least for some accounts. We haven't been there.
We know what our funding looks like. We haven't relied that we can kind of sneak things by. Our pricing is right there in terms of where it needs to be. What we're seeing in terms of our spot rates, you know, kind of confirms this. For example, on our loan yield, our spot rate at the end of the second quarter was 451. At the end of the third quarter, it was 543, up 92 basis points. Meanwhile, for our funding costs, our deposit liabilities and costs was up from 63 to 112, so up 51 basis points. What we had during the second and third quarter is we had loan yields tempered because floors were still active. That's not the case anymore.
We see that picking up, and then we're gonna have more dollars rolling over in terms of, you know, maturities. Right now, those fixed rate loans are about 300 basis points below the current offer rate that we would do today. That is going to reprice more than what we're gonna see on liabilities because liability repricing for us hasn't lagged.
Hey, Case I'm gonna give you a quick story I think everyone on the phone will like, and then, I'm gonna ask you for a pop quiz here, okay? We turned down 31 loans in our senior loan committee. Those are loans $25 million or greater, not because of credit. We like the credit a great deal, but we turned them down because of pricing. Either the initial price wasn't high enough, or the step downs were coming down too quickly, or we didn't like the floors, and we decided to move the floors up. Here's your pop quiz. How did we do against 31 loans? We went back to the borrowers and asked them if they would accept the higher pricing level.
Not very well?
Wrong. We went 100 for 100, 31 to 31, right? Which told us.
They all took the higher price?
Well, 31 people came back and said yes to the higher price. You're right. That told us a few things.
All right.
One, it makes us almost feel like you put your house on the market on day one, and you sell it. First thing you say is, "Oh my God, I sold it too cheaply." What we really determined from that and that was over a couple week period when we went back and looked at the 31 loans. What we really determined was liquidity is leaving the system, right? And one of the things that's natural for us and what's different for our bank versus others is that we try to be a bank for all seasons, and we try to remain open for all seasons. Now that may mean that we tighten credit criteria, which we have. It may mean that we ask for more equity in the deals, which we have.
It may mean that we're asking for higher pricing, but we remain open. One of the reasons you see the volume of loan volume continue to come in above what our previous guide has been is because we've developed this loyalty, and people come to us because they know they can get a deal done and the incremental short-term costs or higher cost of funding doesn't compare to the longer term value that they're getting. I just wanted to - y ou asked a simple question, and we decided to give you a long answer.
Yeah. No, no, appreciate it. Okay, just on the 10% CET1 target by midyear. You're gonna do that organically, right? Just moderating the loan growth. Or is there-
Yeah.
With and without the ATM, is there any, like, bond book runoff? Is that part of it or anything else that help you get there in short order?
Well, there are a few things that we're doing. Certainly just repositioning our loan growth to up to $1.5 billion is gonna help us probably grow net 12-14 basis points per quarter. We generally do 45 basis points of organic growth, subtract out for the $1.5 billion, and that's how you get to 12 or so basis points quarter by quarter. The other thing is Tim Bruckner is sitting here with us, but he's led this re-optimization or optimization of our risk-weighted assets, specifically around unfunded commitments, and we expect that to grow as well. There may be a CLN note that you'll see a deal happen maybe this quarter or maybe in quarters one or two.
It's the combination of those things and a bunch of other smaller activities that I just don't think are worthwhile going through at this time that drive us to a 10% level, Q2 we think at least Q3. You asked a very specific question. It's all without hitting the ATM.
Okay. Very good. Thanks. I'll step back. Thanks, guys.
Your next question comes from Ebrahim Poonawala from Bank of America. Please go ahead.
Hey, Ebrahim here. I guess just maybe going back to comments around $2 billion plus in deposit growth, some perspective around your comfort around there. Obviously, there's a lot of concern around the industry, around deposit pricing, deposit growth. Like, your conviction level in meeting those deposit growth numbers, and then what should we think about its impact on deposit costs and mix shift as we think through 2023?
All right, we're going to split this one up and tag-team it as well. I'll take the volume side. Dale will take the cost side. If I heard you clearly enough and correct me if I'm wrong here, you really want to know what gives us the confidence around the $2 billion right? Well, you know we've been running that and then some on that if you go back looking at our history. But we've got several deposit franchises that are very strong. We have our HOA business, okay? That's strong. Settlement Services is something we started to build in 2018. We rolled out in 2019. It now has $3 billion of deposits.
Going back a couple of years when everyone, when I say everyone, I mean other banks said, "Gee, we don't want any more deposits." We always said, "No deposit franchises will really determine what our market capitalization will be in the future and how well we perform." We rolled out Settlement Services. We rolled out Business Escrow Services. We also have a tech business that produces $3 of deposits for every $1 in loans. Warehouse lending has also been a very strong provider of deposit growth. I want to bring you back to AmeriHome for a moment. This is very important.
When we bought AmeriHome, we said we bought it because we saw an emerging regional bank. In the seven quarters that we've owned AmeriHome, we've taken AmeriHome's deposits from a standing start of 0 to $7 billion, $7 billion in seven quarters. All right? Now, I would tell you not to extrapolate that going forward, but it goes to show you that that $7 billion really sits on the bank side of the company and has been generating that incremental interest income from us. So those are the growth channels. You want to take the cost side, Dale?
Yeah. On the cost side, I'll note, we talked about that we brought in $420 million in deposits from Business Escrow Services. Well, $300 million of that is in non-ECR DDA. That should help us, you know, on the cost side, and we're getting traction there. I got to tell you we've got an application pending with the OCC to commence a corporate trust operation. We think that is likely to kick off this particular time. We hired a team from Wells Fargo after they sold their operation, and we think that's going to be a source of funding for us also kind of going forward. In terms of deposits.
Again, you know, we're aware that we're not trying to necessarily wrestle, you know, that everything has to come in, you know, at super cheap standard rates or market rates. We have the ability, and we've demonstrated this to bring in funds consistently. I would say our pipelines going forward are at least as good as what they've been the past couple of quarters. You know, it has been a little harder than we thought. You know, we did exceed loan growth versus deposit growth. We're right-sizing that from Q4 forward.
You know, let me just tie it back to a question that Casey asked as well, and tie it back to net interest income. If you don't have loan growth, it's harder to bring in deposit growth because that deposit growth is coming in at a very high incremental cost to it. We have the ability to grow loans in excess of $1.5 billion, and you've seen that, right? The fact that we can match off deposit growth at a marginal rate compared with a 100% beta to it compared to a 100% beta on the loan side allows us to make the spread. As we've said, we've increased those spreads. That's what kind of gives us the benefits.
Again, I'll point you right back to, and I don't think we get enough credit for this, and I'm going to start harping on it, that our business model is different than almost every other bank's business model, and this is what our model allows us to do.
Got it. As long as there are no pop quizzes, I'm fine with that. I guess just another follow-up question, Dale. You talked about credit costs. When you look at the ACL 86 basis points, what is that embedding in terms of the macro? Understanding your portfolio is very different. If the economy is headed into a recession, like where do you see that reserve ratio building? Because that's the other piece of downside EPS risk as we think about the next few quarters.
Yeah. We use the Moody's model like I think most do. We take weights. The preponderance is on the kind of consensus, and then we have a much heavier weight on S-4 versus S-1. And so, you know, as those numbers have become kind of, you know, more impaired as they did in three or third quarter over second, you know, it did pull up a little bit more in terms of what an appropriate ACL would be. I would say, you know, we're not expecting charge-offs to occur and, you know, so long as we are right side up on LTVs.
We're a low LTV lender across the board. Our residential book is, you know, was underwritten at 65% and is now probably under 60% in terms of LTV. Our commercial real estate is done anywhere from 45% to about 65%. We feel strongly that, and the Moody's model showed this, that, you know, unless there's something really severe happening, we're gonna be able to do well on that. I'd like to point back to the pandemic. You know, so, you know, the hotel book and hotels clearly took a direct hit from travel during 2020 and 2021. People were throwing numbers back at me in terms of what we're looking at in terms of losses.
We didn't lose a dime in hotels the entire time because we had good sponsorship, low loan-to-value, and the type of loans we were doing. We weren't doing central business big boxes, you know, where people weren't coming anymore, and that have very brittle cost structures in terms of not a lot of flexibility. These are like select service deals like a Residence Inn. They, you know, the hotels, they close every other floor to hold their costs down. That worked and it worked for us.
Got it. Just making sure Ken, I heard you correctly. I think you mentioned full-year EPS $9.80 improves about $2.77-$2.78 exit EPS run rate for fourth quarter. Do you believe you can grow earnings off of that in any way?
I'm sorry. I didn't hear it clearly. If I heard you correctly, Ebrahim, I mean, yes. We think that the $9.80 is a period from, you know, that we can. That's a fourth quarter number implicitly, obviously. From there, you know, given what we expect to happen in terms of, you know, continued loan growth, a little bit more tempered than maybe what the street has had us at, but margin expansion, which is the opposite of what the street has had us at. That we can continue to sustain that throughout 2023. Again, this is the backdrop of, you know, what the FOMC actions are going to be as predicted in the futures curve.
Understood. Thanks for taking my questions.
Thanks. Welcome.
Your next question is from Steven Alexopoulos from JPMorgan. Please go ahead.
Hi, everybody. I wanted to start on the deposit cost side. If I include the cost of -
Steve, you got to talk up. Steve, we can't really hear you. Can you pick up the receiver or get closer to the phone? We're just not hearing you clearly.
Is that any better?
Much better.
Okay. On the deposit cost side, if I include the cost of the earnings of credit-related deposits and the cost of total, we calculate these change by about 61 basis points quarter-over-quarter. Earning assets are up 71 basis points. From a spread view, it's up about 10. Looking at it through that lens, how do you see that spread trending over the next few quarters?
Probably most likely parallel. I mean I think we have a little bit more momentum in the loan side because kind of they were held back, but because of floors. Yes, you know, we're comfortable with the parallel shift there. Also, we're getting better pricing on the loan side. I don't think that there's much more to go on funding cost increases.
Okay. On the ECR deposits, how much of the $2 billion per quarter growth do you assume will come from that? How should we think about that cost moving forward?
We're not expecting that our deposit structure on the liability side is going to be improving at all. What we've dialed in is growth predominantly in either interest-bearing or in ECR-related. I do think that we've got opportunities to bring some other stuff in, as I mentioned, with escrow, Business Escrow Services and some of these others but that is not a major factor in terms of moving that needle. I think we're going to be paying for deposits.
Got it. Okay. Finally, in terms of pulling back the lending a bit, which categories are you planning to de-emphasize here? Thanks.
Yeah. Good question there, Steve. As I said, we've tried to do this in a very surgical way. We're going to pull back our resi loan growth. This quarter was $750 million. I would expect that to drop to under $250 million in Q4 and then drop to under $100 million going forward. But just to refresh the memory for those on the phone, it wasn't too long ago that we had $6 billion sitting in liquidity at 10 basis points. Building up a residential book seemed to be the appropriate thing to do back then. We're not going to be emphasizing it now going forward. The other places you'll see us be more circumspect on is in the capital call and subscription line space.
We really haven't seen the cross-lending portfolio company opportunities that we hoped to have materialized. They did not. We're going to pull back there. That business eats up a lot of our unfunded lines or unfunded commitments. That's why Tim Bruckner is working on that in terms of the optimization. The other thing is, you know, we continue to stay close to all our clients. No loan gets approved, certainly at the most senior level in this company without a significant deposit relationship coming over. We've made that a big focus as well. If you're not bringing over deposits, then some of our loan growth will slow naturally.
Quite frankly, as an entrepreneurial bank that has always performed on the loan growth side, this is a challenge for us and to a certain extent, to be more surgical on where we're going to grow. Now we think we can do that and we think we could keep the loan growth to under $1.5 billion. That kind of connects back to the CET1 ratio on why we're trying to also move it up to 10%. We're not getting credit for the loan growth, Steve. People are saying, "Well, you're probably lending into a recession." We just will pull back, and we'll look for higher yields on all that.
Got it. Okay. Thanks for taking my questions.
Your next question comes from Bradley Milsaps from Piper Sandler. Please go ahead.
Hey, good afternoon.
Good afternoon, Brad.
Ken, I think I heard you mention that you thought the efficiency ratio would stay in the low 40s, sort of ex the impact of ECR deposit costs. I wanted to make sure I heard that correctly. Saw there were some small severance costs in the quarter and, you know, wondering what the benefit from those might be going forward. Finally, because you're pulling back on growth, does that mean we should, you know, maybe think about, you know, pulling back on the expense growth as well? Just trying to get a sense of kind of the expenses ex the ECR.
Yeah. So you did hear me correctly that ex deposit cost the efficiency ratio should stay in the low 40s. Brad, if we don't keep it there. I mean, look, we could take it down, but we're not gonna do that for several reasons. I think I've been clear about this on previous calls. Number one, we're preparing for the day that we grow over the $100 billion threshold. We always need to continue to invest in risk management and technology, which we're doing. We also are continuing to invest in new products and new services and new rollouts. Dale mentioned one. He actually got a little ahead of what I was gonna say about that on the corporate trust. I was gonna wait until we brought in some deposits.
We've built that into our expense base next year as well, which is a new product or a new business line. It's important for us to continue to build up these new business lines, and that's why we're going to keep it in the low forties. That will help us, or that will not deter our growth in total EPS as we roll into 2023. There were a couple components to your question. Did I answer all of them?
Yes. Yeah, I think so. And then maybe as my follow-up question to Dale, just to on the ECR deposits again, do you see a change in the pace of that beta or the, you know, rate in which those costs are going up? Do you see that accelerating? I'm sure it's not decelerating, but just kind of curious your thought around, you know just kind of the pace of that change going forward.
You know, I don't. I mean, you know, out of the gate, you know, we had some that were a little more sluggish than others. This has been the most widely telegraphed rate rise scenario, I think in history. No one is not aware of it, not at Western Alliance anyway. Yeah, so they're fully participating. They're basically moving in lockstep with FOMC or, you know, effective Fed funds.
Okay, great. Thank you.
Thank you, Brad.
Your next question comes from Timur Braziler from Wells Fargo. Please go ahead.
Hi, good morning.
Morning.
Maybe looking at the MSR hedge loss this quarter, can you just help us kind of frame our thoughts around that? You know, is that kinda gonna continue in the fourth quarter, just given the pace of rates? Or is that a little bit more idiosyncratic with just the shift in volume? Any color on kind of broader direction for AmeriHome kind of gain on sale revenue would be greatly appreciated.
Yeah. Let me give you the broader direction and tell you what we are planning for in 2023. We are using the Q3 total mortgage servicing revenues of $37 million as our base, going forward throughout 2023. We hope to do much better than that, but for our planning purposes, $37 million is the base as we go forward. That's I think the first thing. Regarding the $22 million vol hit that we had. You know, our models when we model things, we model out the life of the loan for 30 years, all the cash flows, and then we - you know, we discount it back. We hedge that in our model, but we hedge it out to 18 months.
After that, there's not enough liquidity in some of the hedging instruments. We took a little bit of a hit in the volatility going out above 18 months. Now, what I should say, we should have said in the opening statements here, we pulled back half of that in the MSR valuations. We have outside firms look at the MSR valuations. While we took a $22 million hit, we pulled back about $10 million of that. The net impact was $12 million. We're also doing something different in the business. We continue to right-size that business. We're probably down about 29% in total people count there. We're trying to make sure we are the low-cost operator in that space.
We're not trying to win share for share purposes only. We're trying to win profitable share. The volume of the correspondent loans that we purchase will be less. We are pushing and hopefully, the market will see this and also follow that the margins will increase. So far, early results. Early Q4 is that strategy beginning to work.
Okay. That's great color. I appreciate that, th ank you. Then maybe just going back to one of Dale's comments when talking about asset quality. You mentioned that provisions kind of capture a softer view of the economy. I know you're pulling back on some lending verticals, but that doesn't seem credit related. I guess, as you look out across your landscape, what are those softer areas that you're kind of focusing on here?
You mean softer or the more opportunistic areas? Actually, I'll let Tim answer.
Yeah, I can take that. I think even we signaled that we saw some headwinds in the economy where.
Oh.
Where have we pulled back or where will we respond? Is that correct?
Yes, that's correct.
Okay, great. A year ago, we started adding a real heavy stress to everything development construction related in commercial real estate. That's one. We had tempered our underwriting. We've become more conservative in advance and underwritten with a significantly heavier interest rate stress. I think that's positioned us well in that segment. On the investor-dependent side, starting in October and November of last year, we significantly stressed our enterprise valuation methodology. Those two areas are areas that, given our portfolio weighting, would receive more stress, and we adjusted early.
We've also broken our portfolio down. We did this coming out of last year into four major categories. The insurable portfolio which Dale referenced, which is about 24% of our portfolio is credit protected insured or have a government guarantee to it. We have economically resilient, economically resistant, and then we have economically sensitive. We've been de-emphasizing the economically sensitive loan categories and staying with the other three. Actually, basically, the insurable category and the economically resistant categories are where we've been spending more of our time in terms of our lending pursuits.
Got it. Just as a follow-up, you know, you guys have certainly outpaced the market when it comes to warehouse lending. I know a good component of that is just kind of tapping into the AmeriHome network. I guess, how big of an opportunity is left there, and maybe just broader thoughts around warehouse would be appreciated.
Yeah. When we say warehouse lending, we've got a couple of components to that. One is the traditional warehouse lending but also embedded in warehouse lending is our note financing opportunity. That's note-on-note financing, where we'll see LTVs of about maybe 40% or lower, and we'll be in a first position. The note financing business is really very strong at this point. It's helping lift the warehouse lending side a little bit. To be honest with you, we're still seeing a lot of good growth coming in warehouse lending. There I would say is that we're taking some market share as other people are pulling back and as other people are struggling to deliver the type of service we deliver.
We're also seeing MSR lending is embedded in that group too, and that has a lot of interest from borrowers. We have some comfort level that we can grow that throughout 2023.
Great. Thank you for the color. I appreciate it.
Your next question comes from Chris McGratty from KBW. Please go ahead.
Hey, great. Thanks. Dale, I wanna go back to the loan and deposit repricing, if I could. I'm moving a little slow today. Can you just repeat kind of the comments about incremental betas on both sides of the balance sheet? I'm just trying to make sure I get what the messaging is on repricing of assets and liabilities.
If I look at our spot rates, we have a greater momentum coming from Q2 to Q3 that isn't captured in the average rates on the loan side more significantly than it is on the funding side. I think that's because in part, the loans were held back because of floors, and nothing is close to a floor today. I think that carries us in terms of what that looks like going forward. So long as we have a loan beta from here that is, you know, no lower than the deposit beta, and we're anticipating deposit betas to be very high, we're going to continue to do well.
Especially if we can reprice things higher as Ken mentioned, you know, with these 31 returns that we had from our senior loan committee, all of which came back with, "Yeah, we'll take the underwriting even at a higher cost." We think we're well situated to carry that. Now through the fourth quarter, you know, I mean, I think, you know, we're dialing in 75 and then 50, and then we don't have anything in 2023. I think maybe there's going to be a little bit of a tail. With that kind of a profile and with, you know, really the repricing we're doing on our loan book, I don't see that in our funding book because our funding book is already really fully moving in lockstep.
Now, we do have some benefit opportunities like we had in 3Q where, you know, $300 million of our DDA was not ECR related. You know, I think some of those things are going to kick in. We don't have to do that so long as all we have to do is have our loan betas be no lower than our deposit betas. The loan book and with the securities book which is demonstrating variable rate as well largely, we're going to be able to continue to have a expansion of net interest margin and then couple that with, you know, a more modest expansion of the balance sheet.
Yeah. You said a very high deposit. Did you put a number on that for kind of future betas?
No. I mean look, really as Ken mentioned, but that's not our management thing. We're not trying to optimize betas. We're trying to optimize net interest income and PPNR.
Okay. Last one just to make sure I understand the $980 that you reiterated. Is that just remind me, is that full year net income, you know, earnings per share, or is that fourth quarter annualized? Just trying to get the right starting off point.
Yeah. That's the full year of, you know, kind of, what a, you know, an operating income would be. Correct.
Okay. Thanks.
Thanks.
Your next question comes from Andrew Terrell from Stephens Inc. Please go ahead.
Hey, good morning. Most of mine have been asked and addressed already. Dale, can you remind us just expectation for the size of the average loans held for sale portfolio? And then do you have the spot rate on that book at the end of the quarter?
Yeah. The spot rate on that book was 5.29%. We think that balance is going to be modestly lower than where we ended at 9/30.
Okay. Perfect. Thank you.
Your next question comes from Brandon King from Truist Securities. Please go ahead.
Hey. Just one question from me. I understand NI sees benefits when rates are rising. I'm curious what are the actions you've taken in the event that, you know, we have a recession and theoretically rates will fall. Just curious if there have been any actions that you've taken in place to kind of protect against that in the future.
Yeah. You know, one thing that really helped us during the pandemic is we are active and basically mandate anything that isn't a syndicated situation led by somebody else that we get loan floor. We did that, and that held up our loan yields much better than some others and it kind of improved our net interest income. You know, we're still doing that today. They're really I would say largely ineffective at this point in time because you know, you put a floor in. Maybe that floor is 100 basis points lower than the current rate of you know, based upon the variable rate instrument there.
If it's going up another 150 in the next 90 days, it's going to be way out of the money. If we hold at higher rates for say like a year, we'll be able to reprice a lot of those floors much closer to the current rate, which will give us a lot of insulation in terms of what that would be like. The other thing I would say is, you know, my gosh, I mean, in a lower rate environment, you know, I think the mortgage market is going to get jump-started and we're certainly ready for that also.
Okay. No other, I guess, hedges or interest rate collars being put on the balance sheet. Has that been contemplated as well?
You know, we always debate that. We put some term kind of hedges on. Some fixed swaps, you know, back when rates were in the, you know, low double-digit basis points. You know, we'll evaluate that at that time. Again, that's just to mitigate kind of the downturn.
Okay. Thanks for taking my question.
Thank you.
Your next question is from Jon Arfstrom from RBC Capital Markets. Please go ahead.
Hey. Thanks. How you guys doing?
Good, Jon.
Good. Just a few cleanup questions. One on Chris McGratty's question on the run rate deal. I know it's kind of nitpicky, but if you take the annualized $980, you get to a $245 for the fourth quarter. I think you're saying that's too low. But we kind of have to stretch to get to $980. Just clarify that for us on the $980 number. What do you mean by that?
Yeah. The $9.80 is the full year operating EPS, so you have to be above that. Maybe I misunderstood Chris's question a little bit. You have to be above that. That's going to take you to, you know, kind of the $2.70 range or somewhere in there to be able to do that.
Yeah, for the fourth quarter. You're saying that's the jumping off point for 2023?
Yes.
Yeah. Okay. I've had a couple questions. I think people know I'm the last guy on the call maybe. Can you talk about the ECR expenses and talk about the efficiency ratio with ECR and how you want us to think about that expense in the model?
Well, we're showing it both ways. You know, I mean, to me, you know, if it looks, acts and smells like something, maybe that's what you should call it. I think it really acts like interest expense. That's not really how the GAAP maps it geographically. Here we are.
Mm-hmm.
We, you know, we look at it both ways. I do think that taking it out and considering it as interest expense gives one a much better view in terms of, one, is the bank, you know, asset sensitive or not? How is revenue Rising in interest income relative to expense. You know, and we're still higher, not as much higher as if we keep it in expense. Then you look at your operating kind of architecture, and we're in the low 40s% if you just eliminate it completely. I think those are kind of both appropriate. As Ken said, I think our efficiency ratio going forward, you know, in a roughly the same position of the low 40s% is appropriate. We're looking for, you know, continued improvement on net interest income, you know, gross relative to interest expense, including deposit costs.
Please go on.
I mean, I'd add probably only one-
Yes.
Jon, I'd add only one thing to that is, you know, you'll see deposit costs rise in Q4 again, near maybe the same level as Q3. As we begin to enter into 2023, that rise will be tempered, and it won't be as noticeable as we go through 2023 based on the FOMC projected rate increases.
Yeah. Okay, okay. I just have two more if I can. Just, kind of on that topic, when do you think the margin starts to top out, kind of when or where? Because I look back in my models, and I know your business is a little different, but you were, you know, approaching the high fours in the last hiking cycle, and I'm just curious if that's just out of the question and just the timing on when you think this all might peak.
Again, everything is predicated, at least right now for us, on what the FOMC is going to do, which for us is-
Yep
75 basis points in a couple weeks, followed by 50. That's what's in our forecast. We actually don't have anything in there at all, any upward actions in 2023. We see in terms of the NIM, the rate, we see that continuing to rise quarter to quarter. It may flatten a little bit out towards the very end of the year. Right now, we even still have that kind of rising as a nice slope throughout the year, in excess of what we see in consensus. Yeah, but certainly lower than the historical highs that you alluded to.
Yeah, yeah. Okay.
Yes.
The last one I have, you know, I like what you guys are doing, but I have to ask this. When you go 31 for 31 on higher pricing, I mean, I understand that's a positive, but you could take it the other way as well. It could cause you to question, you know, pricing and the competitive environment as well. What do you really learn from that 31 for 31? What does that say about the competitive environment and maybe what did you learn from that? Thanks.
Yeah. Thanks, Jon. On the competitive side, it's telling us that other banks, other competitors have pulled back probably for several reasons. First and foremost, we think it's because they don't have that deposit base that we have or that fresh liquidity coming into their bank, number one. Number two, they may be more regionalized in their lending, or they may be just more product niche-focused. You know, we have the ability to deploy liquidity and capital to at least 17 different national business lines that we have inside the bank. So it gives us an opportunity to really flex our business models and capability. The third may be different perception on the economy.
Now, we are expecting a recession, and we are modeling that and we are doing our underwriting as if a recession is going to occur. Of course, we stress-test everything for much higher rates and lower vacancies and lower rents and all the other things you would expect us to do. We feel comfortable with our underwriting and the quality of borrower that we're getting in. The reason why I think we feel comfortable, one of the reasons is back to being a bank for all seasons. We remain open. As I've said this to every client, we'll always remain open to try to help you, but given the economic either uncertainty or environment, we're gonna just change around credit criteria, equity that we're gonna require in the deal, and pricing.
You should be able to get a loan from us, assuming that the deal pencils out and then we're dealing with a good borrower. While borrowers always, you know, grouse a little bit about higher interest rates, they come back and pay them because they realize the short-term cost of that interest rate is nothing compared to the longer-term benefits they're gonna get. This comes back to the service side. Dependability, the ability to close. When we say we're gonna close, we close. Once we shake hands, we don't re-trade. That has a lot of positive force to having our clients continue to return to us. We don't provide a commodity service.
I mean, so even, you know, even in normal times, our pricing is almost always higher than others. Because of what Ken said in terms of our ability kind of to deliver on time and in this consistent structure and as promised, that's worth something to our clients and, you know, and they're willing to pay for it.
Okay. All right. Thank you very much.
Yeah. Thanks, Jon.
There are no further questions at this time. Please proceed.
Okay. Thank you all for attending the call. Good questions. We like the quarter that we had. We're positive about what we can do going forward, and we look forward to speaking to you on our next call in January. For those that I don't talk to, I know it's early but have a good holiday. Thanks, everyone.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.