Valley National Bancorp
NASDAQ:VLY
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Valley National Bancorp
Earnings Call Analysis
Q4-2023 Analysis
Valley National Bancorp
The company witnessed a healthy increase in traditional branch deposits by approximately $600 million and specialty niche contributions, particularly from the online delivery channel and technology deposit team, by about $1 billion during the quarter. With a well-diversified deposit base and no single commercial industry dominating their deposits portfolio, the company achieved the lower end of the previously set 7% to 9% loan growth target for the year. Despite a proactive slowdown in growth to respond to changing market conditions, the company's loan portfolio remained robust, with both their multifamily portfolio and commercial real estate portfolio showcasing attractive loan-to-value and debt service coverage ratio metrics.
The company faced a decrease in net interest income, attributed to a decline in average noninterest-bearing deposits, but countered this by replacing maturing CDs with high-yielding accounts. Strategic moves to manage funding costs include reducing high-yield savings rates and CD rates while ensuring holistic customer profitability. The noninterest income remained stable, and even with adjustments for FDIC special assessments and other nonrecurring expenses, the noninterest expenses were kept well-controlled. The company anticipates mid-single-digit expense growth moving forward.
A nearly 2% increase in tangible book value exemplifies the company's capital strength. With mid-single-digit loan growth expected in 2024, mainly centered on C&I and noninvestor commercial real estate, the organization projects a net interest income growth of 3% to 5%. Furthermore, they forecast a 5% to 7% growth in noninterest income, counterbalancing any setbacks in their swap business with advancements in wealth, insurance, and tax advisory sectors, as well as treasury management capabilities. They predict the 2024 EPS to be marginally lower than the current consensus estimate of $1.08.
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Thank you for standing by, and welcome to the Q4 2023 Valley National Bancorp Earnings Conference Call. [Operator Instructions]. Pease be advised that today's call is being recorded. I would now like to turn the call over to your host, Mr. Travis Lan, please begin.
Good morning, and welcome to Valley's Fourth Quarter 2023 Earnings Conference Call. Presenting on behalf of Valley today are CEO, Ira Robbins; President, Tom Iadanza; and Chief Financial Officer, Mike Hagedorn. Before we begin, I would like to make everyone aware that our quarterly earnings release and supporting documents can be found on our company website at valley.com. When discussing our results, we refer to non-GAAP measures, which exclude certain items from reported results. Please refer to today's earnings release for reconciliations of these non-GAAP measures. Additionally, I would like to highlight Slide 2 of our earnings presentation and remind you that comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry. Valley encourages all participants to refer to our SEC filings, including those found on Forms 8-K, 10-Q, and 10-K for a complete discussion of forward-looking statements and the factors that could cause actual results to differ from those statements. With that, I'll turn the call over to Ira Robbins.
Thank you, Travis. In the fourth quarter of 2023, Valley reported net income of $72 million and earnings per share of $0.13. Exclusive of noncore items, including the one-time special FDIC assessment tied to the year's bank failures, adjusted net income and EPS were $116 million and $0.22, respectively. While I'm pleased with the quarter's balance sheet trends, I'm disappointed with the earnings and profitability metrics, which I will discuss shortly. On the positive side, we made progress enhancing C&I growth while curtailing commercial real estate originations. This enabled us to both accrete organic capital and reduce funding needs. On the deposit side, we added a remarkable 14,000 net new consumer households and 8,000 net new commercial deposit relationships during the year. This represents 4.5% growth in consumer households and 10.5% growth in commercial relationships from the same period a year ago. The ongoing addition of new deposit clients is critical as it directly relates to Valley's franchise value and our future earnings potential. Our new customer growth was broad-based across all of our geographies, and I might add, was undertaken against the backdrop of a difficult external environment with midsized banks like Valley were too often front page news. During the quarter, our new relationships helped to generate strong customer deposit inflows, which enabled us to significantly reduce our reliance on broker deposits. While customer deposit inflows were exceptional, the organization like focus on ensuring a successful core conversion in October likely led us to take our eyes off the ball relative to deposit pricing. There is no doubt that this negatively impacted net interest income during the quarter. And in a few minutes, Mike will illustrate some of the subsequent efforts that we have undertaken to manage these deposit costs going forward. From a strategic perspective, we are refocusing on holistic customer profitability and will return to pricing deposits in consideration of balance and return as opposed to just balance. The quarter was also impacted by a few additional factors worth calling out. First, waste service charges and proactive efforts taken to supplement customer support, both associated with our core conversion weighed on quarterly earnings by an estimated amount equaling approximately $0.01 per share. These efforts were enacted out of an abundance of cost to ensure that our customer experience smoothly transitions to our new system. I'm pleased with the customer response to our core conversion but acknowledge that some of the amounts of the excess support costs will persist in the first quarter as well. Secondly, our provision was partially elevated as a result of a loan charge-off in our commercial premium finance business. The after-tax impact of the associated provision was approximately $0.01 per share as well. This business line has approximately $275 million in outstanding balances, and we have an agreement in place to sell this business and a portion of the outstanding loans is expected to be a modest premium during the first quarter of 2024. While this quarter's earnings are not satisfactory, I continue to believe that our strategic progress over the last few years positions us well in the evolving banking landscape. The financial consistency that we have achieved in support of this strategic evolution is evident in our tangible book value growth results. Our stated tangible book value has increased 52% since 2018, which is more than double our proxy peers at 25%. Our value creation as measured by tangible book value plus the dividends we have paid out totaled 90% since 2018 or more than 1.7x our proxy peer median of 53%. From a balance sheet perspective, we have successfully transformed and diversified our funding base. At the end of 2017, approximately 92% of our deposits were held in our branch network. By utilizing technology to expand our delivery channels and establishing new growth-oriented deposit verticals, we have reduced our reliance on branch deposits to just 65% today. From a geographic perspective, 78% of our total deposits were in the Northeast branches in 2017. Today, that number is down to just 45% of total deposits. Our focus on geographic diversity and holistic relationship banking has benefited the asset side of our business as well. In 2017, 78% of our total loan portfolio was in New Jersey and New York. That composition has declined to just 55% today. In 2014, we entered Florida with the acquisition of First United Bank, which had just over $1 billion in loans. Through additional strategic acquisitions and targeted organic efforts in this dynamic growth-oriented market, our Florida loan portfolio has expanded beyond $12 billion. There continues to be significant diverse commercial growth opportunities available to us in Florida and across our entire footprint. The proactive evolution of our technology infrastructure is a less tangible but equally significant achievement for our organization. We have recruited and developed a strong pool of technology talent, which has helped us to modernize our infrastructure and positions us to be on the leading edge of further advancements in the banking space. Our technology adoption has allowed us to scale this franchise with limited net headcount growth. Since 2018, we have nearly doubled our asset base from $32 billion to $61 billion with a near 17% increase in headcount. Our recent core conversion aligned technology across our company and provides additional capabilities, which we look forward to leveraging for our clients. As we move past the conversion, we anticipate that further efficiencies will also emerge. We have also focused on enhancing a more uniform data infrastructure, which allows us to react quickly and purposefully to changing market dynamics. An internal AI working group has been established to help us determine appropriate potential use cases and to begin to execute on related opportunities. I now want to pivot to our strategic imperatives for the coming year. While none of these are new initiatives for Valley, we continue to believe that they would drive shareholder value over a long time. First, we need to continue to drive core deposits to the bank. We have an incredible service-oriented branch network across our dynamic geographic footprint. We will generate more consumer and commercial activity out of these locations in 2024. As the curve increasingly normalizes, we will further leverage the existing specialty niches that we have established and will build on our momentum for the second half of 2023. Secondly, we will continue to deemphasize investor commercial real estate lending in favor of C&I and owner-occupied CRE. We have restructured our commercial banking organization to better align expertise and experience with opportunities in our markets and business lines. Our enhanced treasury management capabilities and product offerings will support expanded wallet share among our customer base and help us to acquire new customers on the commercial side. We have also adjusted our incentive programs in support of our deposit gathering and lending goals, which will drive further strategic alignment across the entire organization. Finally, we will continue to grow our differentiated noninterest income businesses to diversify our revenue base. Through organic and acquisitive efforts, we have developed a robust suite of fee-income products and service offerings for our growing customer base. The recent enhancements of our treasury management offering will help to offset certain capital market headwinds associated with lower swap-related revenues in 2024. The industry challenges of the past year confirmed to me that we have undertaken the right long-term strategy, and I'm pleased with our ability to navigate this difficult year. 2024 will be about accelerating our progress towards achieving our strategic initiatives and improving our performance as we continue to mature. As we execute on these initiatives, I want to reiterate that we continue to prioritize tangible book value growth. We believe that consistent growth in tangible book value would drive shareholder value over time, and we continue to expect to outperform our peers on this metric. With that, I will turn the call over to Tom and Mike to discuss the quarter's growth and financial results.
Thank you, Ira. On Slide 6, you can see the quarter's deposit trends. Direct customer deposits increased approximately $1.6 billion to largely offset the significant $2.3 billion reduction in indirect deposits. The meaningful reduction in our reliance on wholesale deposits was a key highlight of the quarter. We generated strong growth in our interest-bearing transaction accounts, and we're pleased by the slowdown in noninterest deposit runoff. That said, we acknowledge that a competitive interest rate is one of the tools used to support our generation efforts during the quarter. Still, the pace of deposit cost increases slowed and in a moment, Michael outlined efforts, which we have undertaken to control interest expense on a go-forward basis. The next slide provides more detail on the composition of our deposit portfolio by delivery channel and business line. Traditional branch deposits increased approximately $600 million during the quarter. This growth was spread across our geographic footprint. Our specialty niches increased approximately $1 billion as well with key contributions from our online delivery channel and technology deposit team. Turning to the next slide. You can see the continued diversity and granularity of our deposit base. No single commercial industry accounts for more than 7% of our deposits. Our government portfolio remains diversified across our footprint and is fully collateralized relative to state collateral requirements. Slide 9 provides an overview of our loan growth and portfolio composition. At the top left, you can see the proactive growth slowdown, which occurred throughout 2023. Ultimately, we achieved the low end of the 7% to 9% growth target that we had laid out at the start of the year. Annualized loan growth slowed consistently as the year progressed, illustrating our ability to be responsive to changing market dynamics. The following slide breaks down our commercial real estate portfolio by collateral type and geography. As a reminder, we have an extremely granular loan portfolio, which is well diversified by collateral type and geography. Our debt service coverage and loan-to-value metrics remain very attractive. We continue to closely monitor pools of maturing and resetting loans and believe that our borrowers are well-positioned to absorb the pass-through of higher rates. This reflects consistent underwriting discipline at conservative cap rates and significant stress testing efforts at origination. The next 2 slides provide additional details around our multifamily and office portfolios. From a multifamily perspective, our $8.8 billion portfolio includes $2 billion of co-op loans with an extremely low loan-to-value. Exclusive of our co-op portfolio, our Manhattan multifamily exposure is a near $600 million, which you can see in the last column of the table. The remainder of the portfolio is well diversified across our footprint with low average loan sizes and attractive loan-to-value and debt service coverage ratio metrics. With that, I will turn the call over to Mike Hagedorn to provide additional insight into the quarter's financials.
Thank you, Tom. Slide 13 illustrates Valley's recent quarterly net interest income and margin trends. While end-of-period noninterest-bearing deposits stabilized, the decline in noninterest deposits on an average basis weighed on quarterly net interest income by approximately $4 million. Throughout the quarter, we replaced maturing direct and indirect CDs with relatively high-yielding interest-bearing transaction accounts and promotional retail CDs, which was the cost of our significant customer deposit growth during the quarter. The right side of this page outlines efforts that have been undertaken to more precisely manage our funding costs on a go-forward basis. We have cut back the high-yield savings rate in our online channel but remain competitive. We have also significantly reduced our 1-year CD rate, which will help to mitigate the repricing issue that we faced during the recent quarter. Finally, we are working with our relationship bankers to ensure that deposit rates are reasonable in the context of holistic customer profitability. In a few quarters, following the industry's challenges of March, we price deposit products to ensure that direct customer balance has rebounded. As we continue to move past these challenges, we will price products with a more even consideration of balances and profitability. Turning to the next slide, you can see that noninterest income on an adjusted basis was generally stable from the third quarter of 2023. The Deposit service charges declined sequentially as we waived certain transactional fees around the time of our core conversion. Other than this, growth trends were relatively strong for the quarter despite the headwind of swap revenues. On the following slide, you can see that our noninterest expenses were approximately $340 million for the quarter. Adjusting for our $50 million FDIC special assessment and certain other nonrecurring litigation and merger charges, noninterest expenses were approximately $273 million on an adjusted basis. Compensation costs continue to be very well controlled. The sequential expense increase was primarily due to higher traditional FDIC assessment costs, consulting costs, occupancy and advertising expenses, and the seasonal uptick in other business development expenses. A portion of the quarter's expense increase was associated with certain consulting and customer support initiatives associated with our core system conversion in October. While the customer experience associated with our conversion has been extremely positive, some of these costs will have a tail into the first quarter. As you know, the first quarter also has traditional seasonal headwinds associated with payroll taxes. We are very pleased with our ability to proactively control headcount and associated compensation expenses throughout 2023. We expect that 2024 will be a more normal year in terms of expense trajectory. And as you will see shortly, we anticipate mid-single-digit expense growth in the coming year. Slide 16 illustrates our asset quality trends for the last 5 quarters. While nonaccrual loans ticked up somewhat during the quarter, they remained relatively flat on a year-over-year basis. Net charge-offs were $17 million during the quarter and included approximately $5 million associated with our commercial premium finance business, which is under an agreement to sell during the first quarter of the year. As a result of our higher provision, our allowance for credit losses for loans increased 1 basis point during the quarter to 0.93% of total loans. The next slide illustrates the sequential increase in our tangible book value and capital ratios. Tangible book value increased nearly 2% from the third quarter of 2023 and benefited from a reduction in the OCI impact associated with our available-for-sale securities portfolio. We are pleased that during the year, we were able to support our strong loan growth and organically accrete regulatory capital. Based on our expected loan growth in 2024, we would anticipate this trend to continue. We lay out our expectations for the coming year on Slide 18. We anticipate generating mid-single-digit loan growth with a focus on C&I and noninvestor commercial real estate in 2024. Based on consensus interest rate expectations for 2024, we would anticipate net interest income growth between 3% and 5%. Noninterest income should grow between 5% and 7% on an annual basis as headwinds in our swap business are more than offset by continued scale in our wealth, insurance, and tax advisory businesses as well as our recently enhanced treasury management capabilities. Noninterest expenses should grow approximately in line with revenue, higher FDIC costs and inflationary pressures are offset by savings from our core conversion and the continued benefits of our previously announced expense initiatives. Factoring this guidance together, we expect 2024 EPS to come in just slightly lower than the existing 2024 consensus estimate of $1.08. With that, I'll turn the call back over to the operator to begin Q&A. Thank you.
Thank you. [Operator Instructions]. Our first question comes from the line of Frank Schiraldi of Piper Sandler.
Just on the NII guide. I recognize you guys follow the market or the forward curve here and most of those at -- assumed rate cuts are backloaded in the year. What sort of annualized basis or annualized pickup do you get in terms of either NII or NIM from a given 25 basis point cut? What's the assumption?
So I want to make sure I understand the question. You want to know what just the impact would be of a single 25 basis point increase, I'm sorry?
Yes. Basically, as you get -- if we get 3 or 4 cuts, I mean, I'm just trying to assume or get a sense of what 25 basis points does on average for the NIM or NII in your modeling.
So I'm going to direct you back to our guidance around 3% to 5%. So what we're expecting right now in 2024 is roughly 175 basis points that will affect most short end of the curve as you get less inversion in the curve. And that first increase does start in the end of March. You don't get much in the first quarter. But you are correct, they are more backloaded on the cuts into the fourth quarter of 2024. So I'm not prepared to answer a question on what is exactly a 25 basis point cut because it's going to depend upon the mix of the funding sources at that time. For the full year, we're expecting a 3% to 5% increase in NII. And that should drive a slightly higher NIM year-over-year.
And Frank, conceptually, we're relatively neutrally positioned to the short end of the curve. So there's not a significant move based on if those cuts don't materialize, we're much more exposed to the longer end as it impacts the benefit that we'll get as our fixed rate loans mature and reprice.
Okay. So I guess over the full curve, you're still liability sensitive, but more neutral to the front end.
Yes. That's correct.
Okay. And just kind of -- I don't know, more a theoretical question in terms of the business mix has changed a bit here over the years with a specialized deposit opportunity, the opportunity on the C&I side, which you guys continue to see in 2024. In a more normally sloped yield curve. What do you think sort of a normal sort of margin is in a normalized sort of NIMs for Valley in the way you've built the balance sheet here?
Yes. This is Ira. I think it's a lot higher. I mean, obviously, being an inverted curve for 3 years, running the balance sheet in which we do, where we try to take as much of a neutral stance as we can. It's a really challenging environment for us. That said, as the curve does get to a more normalized focus, we do anticipate significant margin expansion as we get back to an appropriate environment. We've done a really good job shifting the commercial growth within the organization. We've been running a 10% CAGR on C&I growth for an extended period of time. And as you mentioned, the diversification of the funding base really will help us as that curve gets a little bit more normal, and we can get back to an appropriate deposit pricing approach across the organization.
Okay. Great. And then if I could just sneak in one last one on that kind of front. In terms of the specialized deposits coming on board in the quarter, the growth there. And just thinking through the betas on your deposit book, the specialized versus the deposits in the branch. Are the betas expanding here, given the national businesses, and would that help you obviously help you maybe to a great degree in a down rate environment?
I mean those datings have a bit of a higher beta in some of those national businesses. And I think that refers back to what Travis said that it's going to be a bit more neutral when we have some of that curve impacted right off the bat. I think the mix shift from out of noninterest-bearing really impacted us during the course of the year. So that's changed a little bit of the asset-liability, right? So we do have more sensitivity on the downside on the deposit cost when we were running 28% to 29% noninterest-bearing deposits as those are now sitting in interest-bearing deposits. So that is going to be a benefit to us. But I think as you really mentioned, it's the diversity in the granular that sits within that deposit book that we're really excited about and what the opportunity is. As we mentioned earlier on the call, I think deposit pricing definitely got a little bit away from us as we were focused more on the core conversion. That said, I do believe it's an easy fix. We will focus on it and make sure that 2024 gets back to the results that you would expect from us.
Our next question comes from the line of Steve Moss of Raymond James.
Just following up here on the liability side of the business. Just curious with regard to how much of your fixed rate loans and securities reprice in 2024.
Yes. Steve, so we've talked in the past, we have $20 billion of fixed-rate loans. It's not necessarily linear. So we have more -- more of our contain loans repriced in the second half of the year than do in the first half. But in total, it's between $3 billion and $4 billion that would reprice this year. But again, that's relatively backloaded.
Okay. And then on the security side, I assume there's probably just minimal cash flows for the upcoming year?
Yes. Duration on securities portfolio has extended to 7 years, give or take. We get -- yes, it's really de minimis. It's a $5 billion portfolio. It's a couple of hundred million dollars in the year.
Okay. And then on credit here, just curious to get a little more color on the uptick in C&I and CRE NKs. It sounds like some of it's from the premium finance that you charged off this quarter. But just kind of curious as to what the loan types are and any incremental color you can give.
Yes. Steve, it's Tom. There was an uptick in that nonaccrual primarily in the CRE business, $20 million, $10 million has since been repaid. When you look at our performing past dues, you will see a decline on the commercial side and very little, if any, in that 90-day bucket. The increase in the accruing past due is on that residential side. And the color on that, it's our jumbo on-balance sheet portfolio, average loan-to-value of 58%. We don't expect any loss. Historically, looking over a 15-year period, our real estate portfolio ran at about 35% of charge-offs against our peer banks. We expect that trend to continue. We are seeing really improvement across the board. Our metrics remain solid, especially on the commercial side.
Okay. And just curious, I know in the text that you guys did refer to an uptick in classified assets. Just kind of curious, where did criticized and classified assets in the quarter here?
That, you'll have the number. But the uptick, we do that forward review of all of our loans or the total portfolio, especially looking early on in the year at the ones that are repricing or resetting. There was a migration of those loans in the third quarter, primarily into that special mention category where they might have fallen below or right at a 1x step service coverage. I just want to remind everyone, the loan that we repriced during 2023 and our review of 2024 reprice resulted in no modifications of any of the contractual terms to the repayment. But Travis, is there is a different number that I'm not referring to?
Yes, I don't have the number in front of me, but I would say in the third quarter, that stress test process that Tom referenced resulted in a more significant increase in criticized and classified loans. Again, not an impression that we would see additional losses, but just the way that debt service coverages shake out. In the fourth quarter, it was a much more normal increase, so it was not significant.
And this is Mike. That increase would have been mostly in special mention credits, not the more extreme ratings.
Okay. Got it. And maybe just following up to that point. As you're seeing some borrowers get close on debt service coverage ratios, just curious what color you can give around the -- whether it's a workout process, borrower's ability to maybe pay down the loan? Just kind of what you're seeing and what potential NPA formations you could see here in 2024.
And again, we haven't had to modify any terms to those borrowers where we were repricing in the past year, 1.5 years. Typically, our underwriting standards, which start -- we use a higher cap level than probably our peers use. We underwrite the current cash flow. We don't underwrite to future cash flow. Our leverage tends to be lower going in, our average loan-to-value in that real estate portfolio is about 60%. Of course, all of our asset classes. So there is flexibility. We do a lot of business with existing customers. They have the wherewithal. If it's tight, we'll either get additional collateral or pay down or reserve to support any funding below at an appropriate level. Yes. And the other piece I want to add, the refinance activity, especially in multifamily picked up in the fourth quarter. So it did allow us to exit those nonrelationship noncore loans.
Our next question comes from the line of Michael Perito of KBW.
I understand this isn't something you guys guide to, but I'm trying to understand some of the cadence of kind of profitability around NIM and some of the expense targets and the rationalization, I think, which will start to have a bigger benefit in the middle part of the year. Just are you guys willing or able to just kind of qualitatively talk about how you're thinking in the current budget about what the kind of return ROE profile will look like as you exit '24? I mean it feels like the first half of the year might continue to be a little bit depressed. But just wondering if you can kind of give any indications around that cadence relative to the guide that you provided?
Yes. I think your perspective, Mike, is pretty accurate. So I think in the first quarter of the year, I mean, whether it's on the expense side, the headwind of payroll tax or on the NII side, day count and other things and the lack of kind of change that's projected in the industry environment. We anticipate a generally stable margin, I'd say, in the first quarter, improving somewhat in the second quarter and then getting more expansion in the third and fourth quarter. It's kind of the way the budget is built now based on the implied forward curve. In terms of expenses, I mean, we have -- if you look back to last year, there was a $7 million pickup in the first quarter related to payroll taxes. So you're looking at something similar there. As we stand here in December, we, on an annualized basis, got $20 million of expense saves out related to the headcount reduction that was enacted in June. We think there is another $8 million or so, give or take, from an annualized perspective from further actions here in the first quarter on the personnel side. And then as we get into the second quarter and beyond, there should be some saves related to the core conversion, some of these elevated costs that we've talked about with customer support efforts and other things. So I think the first quarter, there will be some seasonal expense headwind, but then you're looking at general stability over the 3 quarters following. So we do think the profitability improves throughout the year. When you blend it all together, again, at the midpoint of our range, you get to $1.04, $1.05 that puts you at an ROA level that I'd say is similar to what we've achieved this year, but it does improve as the year goes on.
Yes. I mean it should kind of put you maybe in the 90s on the ROA on the exit. I guess the question is if revenue to expense grows dollar for dollar, right, that's not going to really improve much. And that's kind of what the outlook is for '24. But I guess what gives you confidence that in '25 and beyond, you guys can get back into a more positive operating leverage territory and continue to see those improvements kind of carry forward in '25. I mean is it just margin? Is there other kind of unit economics in some of the specialty businesses that you're growing that will benefit from scale? I would love some additional color there.
I think there's a lot of opportunity for us. I think if you look at the net interest income side, right, sitting in an inverted curve hopefully is not one that we sit in for that much longer, but it definitely has an impact on us. I think the core conversion is really understated as we think about what the ability to scale looks like for us. We changed every single one of our clients into a new core platform across the entire organization. That said, we put in 261 different APIs sitting on top of that core conversion to think about what that client experience looks like. You go into Valley, you open up a checking account in one of our branches. It's the exact same platform that you do when you're opening up a digital account sitting at Valley. So we were very smart, I think, in the approach that we took as to how we were going to leverage the infrastructure and technology base. So from a scalability perspective, for us, we're not paying per individual unit we open up an individual account to a core provider somewhere. We really have a technology infrastructure that's scalable here that's focused on what that client experience is going to look like and will definitely drive outsized growth. When I talked about some of the commercial growth numbers and the consumer growth numbers, those are household growth numbers, not even individual accounts. That was done during our core conversion when everyone hated midsized banks. So I think there's a lot of positive tailwinds that we have when we think about what we're doing from a franchise value perspective. So I'm really excited about what I think the opportunity is on the expense side of the book, but the revenue side is definitely going to begin to accelerate as well.
Helpful. And then just lastly, kind of on the same line of questioning, you guys had the 5% to 7% loan growth target for '24, obviously, still trying to...
Look at our fourth quarter originations, they were $2.2 billion One moment... [Technical difficulty]. Sorry, Mike. We were hearing your question on loan growth, but it dropped out when you said that...
No problem. And it was more just asking, it's kind of the same line of questioning. Just the loan growth, as you guys focus more kind of on pricing of customers and holistic kind of customer profitability, et cetera, is it fair to assume that the incremental loan growth and the customer loans that you're bringing on, you guys would think with some of the deposit pricing changes, et cetera, will be coming on at better kind of profit margins than they were in '23? Or is there a lag to some of those impacts? Or how should we think about that dynamic?
You should expect that our spreads on those will continue to widen and increase and give you a little context around it. We have seen an uptick in that C&I pipeline in that business is probably 70% of what its high point was, and it represents 65% of our total portfolio. And it's across all business lines, especially in our health care and fund banking line. So we are starting to see the improvement and spreads are holding.
But really just adding to that, when you think about the compression we've seen in the margin is largely a function, as we talked about some of the mix shift and some of the other repricing as rates either stabilize, which they seem to have or go down, there really is going to be a significant benefit to us. The new value margin that we put on is from $3.50 to $3.60, which reflects the ability that we have from a pricing perspective and how we're going about it from a profitability perspective. The new loans that we've put on, we've been able to bring on an equal amount of funding associated with that from a client perspective. So it's not as even if we're out of the broker market. So once we do get some stabilization, which we anticipate having on that mix shift, there really is upside for what that margin looks like based on the fact that the new originations, as Tom mentioned, $2 billion came on at a spread of positive 3.50 for us.
Helpful. And then just I wanted to just clarify some quick and I'll step back. But just, Mike, can you repeat -- I just want to make sure I heard it correctly. Just the rate assumptions baked into the NII guide around Fed funds. And then just to be clear, Travis, you're basically saying that on the short end, whether it's 2 cuts, cuts, focus, it doesn't actually have a huge impact to 2024. It's more the long end and then some of the back book and other dynamics that we've been discussing. I just want to make sure I heard that all right.
That's correct. And while we haven't laid out specifically and we expect the Fed to cut this amount on this day, I can tell you the first-rate cut that we anticipate is 25 basis points, but they accelerate as the year goes on. So we get larger rate cuts in the third and fourth quarters. And again, the biggest benefit to us would be a lessening of the inversion in the curve and a reduction in short-term interest rates. Hence, why we took the cost this quarter to shorten our duration on our liabilities or just funding generally, as Tom talked about, around the mix of our deposits moving away from FHLB and some of our maturing whether they were indirect or direct CDs that we had in the fourth quarter to money market and transaction accounts. And that was all done purposely to prepare the balance sheet for the Fed to come.
Our next question comes from the line of John Arfstrom of RBC Capital Markets.
Just a follow-up on that, Mike, is the liability shortening? Is that largely complete for you guys at this point?
It's largely complete. There's another big piece in the first quarter still to come. Just it was loaded, front-end loaded because we were preparing for this when we were putting on these liabilities with duration going back to the first quarter of last year. So there's another piece in the first quarter. And then after that, it tails off quite a bit.
Okay. Good. And then on the same topic, Slide 13, you talked about the CD rate reductions in December, and then you have some more coming in say, maturing liabilities in the first quarter. What was the reaction on the CD repricing? And is this maturing liability pieces that deposits as well? Or what is that? And where can that reprice?
So the customer impact on it is yet to be seen, but I don't expect it to be extreme. So to be really clear about that 1-year CD rate. The majority of the impact of that will be [indiscernible] roll. So if you remember from our previous comments back in '23, we put on several CD specials, most notably around a 13-month duration. And now those things are rolling at 12. And so we're reducing the role. We generally average between 70% to 80% retention of the CDs when we're in the market. So I think there should be a pretty big tailwind there.
Okay. Good. And then Ira, it's kind of a margin question, but maybe not, but it feels like maybe the deposit pricing pressure was a little bit more than you expected. But to me, I look at it and I think about the numbers and maybe we're at the bottom of the margin -- so curious on that. And then also curious about the trade-off decision you talked about earlier about deposit growth against maybe some of the promotional pricing or things you did to gather new accounts and bring in deposits. Can you talk a little bit about that trade-off decision that you guys made?
I think from a big-picture perspective, there were a couple of variables. One, we made a conscious decision to go shorter, right, on our liability side. So we sort of extended or kept the same duration as we were having before. But when we started to see some of the movement in November and sort of where the expectations were maybe even a little bit earlier where the forward curve was on that short end, we definitely moved a little bit shorter. So that definitely negatively impacted the interest expense for the quarter. We do think that there'll be a positive impact to that though, as we think about where 2024 comes out, sort of for the full-year period. And that said, from a macro perspective, look, it was a very challenging year for an organization like ours, looking at the beginning of the year, what happened with Signature, what happened with SCB, and the others. And we were really focused on the retention of deposits. And as a result of that, I think we were probably maybe 2 lenient on some of our clients and acquiescing to some of their rate requests. We had a lot of money that moved to treasuries right off the bat. That said, we're really competing with that. Today in the conversations we have with clients, I'm not so sure that we need to necessarily do that. And we're going back reengaging with our clients. Again, we were a bit distracted, I think, in the fourth quarter based just with the core conversion and probably even in the third quarter, even leading up to that core conversion. For us, getting the core conversion done was important. We did an unbelievable. I have 3 e-mail complaints. So that's it from clients out of an entire client base. There's really nothing. So there's a lot of focus on retention and clients through that core conversion. Once again, now I just think we get back to having appropriate conversations with our clients, appropriate conversations when it comes to what the pricing should look like, and we'll get the deposits back to an appropriate beta as to what it should look like. But I think most importantly, we did an unbelievable core conversion. We retained all of our clients. We actually grew clients through a core conversion, which doesn't even necessarily happen. We put on, as I said, 10.5% household growth in commercial during this year. I mean those are unbelievable numbers. So while once again, I said I'm not so happy with where the fourth quarter ended up, big picture, I'm not that concerned.
You shouldn't be yourself up too much. It's not terrible. But just one more thing on net interest income. I kind of asked this earlier, but it implies a decent step up your guide, like about $140 million incremental from the run rate that you had in the fourth quarter. Do you guys think we're near the bottom or at the bottom on net interest income at this point?
So we're certainly getting close. So let me do this. I'm going to direct everybody to Slide 6 because I know that this is a really important topic. And when you look at the quarter-over-quarter cost increase in deposits, you'll see that we started off at 60 basis points, and we had 2 consecutive quarters at 49%. And in the third quarter or the fourth quarter, it's only 19 basis points. So why do we feel better about the direction of NIM, it's mainly that, combined with the fact that we're starting to see some stabilization and maybe in our noninterest-bearing accounts. The noninterest-bearing rotation, going back to when we closed on Leumi, we had 36% of our total funding sources in noninterest-bearing. That's come down to 23% now and summer starting to see some stabilization. I mean you combine that with the deceleration in the overall cost of deposits, that's why we feel like there's some additional increase in our NIM as 2024 plays out. Obviously, we need the Fed rate cuts to capture all of that opportunity.
Our next question comes from the line of Steven Alexopoulos of JPMorgan.
I want to start. So when you took over as CEO, one of your top priorities was improving the efficiency ratio, right? And I know it was a rough year for everybody because of what happened with rates and NIM pressure, et cetera. But when I look at the strategic imperatives for 2024, I'm very surprised, I felt like you moved the goalpost a bit that improving where we are is not on there. Is this still a top priority for you? And should we expect to see improvement this year?
Yes. Look, I think the contraction of what we saw in the efficiency ratio is largely just a function of the NIM, Stephen, right? And as we get back to better core funding as we get back to some better diversification that sits within that asset class, the NIM will definitely expand as a result of that. We were down -- I think we were at 3,325 plus or minus employees when I took over. We're sitting around 3,700 today, and we're $20 billion, $21 billion back then in $60 billion today. And I think we've definitely focused on what the efficiency looks like. We've definitely embedded technology in here. For me, it's not something that's even called out as the strategic imperative is just sort of in the core of who we are today. I think we're very focused, obviously, on what that efficiency is. As I mentioned earlier, the technology infrastructure that we put into place allows for scalability, which is something that's important to us. So the technology, the drag, and what the cost is for that isn't going to be nearly what it was before. So definitely not focusing on it as calling it out isn't something that I want to want to take away and say, hey, it's not a priority for us. I think it's just day in, day out what we do. And I think as the NIM gets to an appropriate level back to where we think it should be, you'll see that number dip back down to a number that you'll be happy with.
Okay. All right. Let me ask -- so if we look at the expenses, which were elevated, you called out related to the system conversion, how much was that in the fourth quarter? What's expected in 1Q and what comes out in 2Q?
Yes. In the operating expense number, there was $5 million associated with the core conversion. In the first quarter, we anticipate that will be around $3 million, so you maybe declined $2 million. And then from there on, it should be out.
I think those are really the one-time items or infrequent whatever you want to refer to them as. But keep in mind, there was dual operating expenses and running those multiple platforms as well as their quarter. Once we get to a better place, which we're pretty much right on the verge of, you're going to have those being eliminated as well. And I do just want to go back to your efficiency comment, Steve. I mean if you look back a year ago, our efficiency ratio was 50% in the fourth quarter of '22, 60% this year. But relative to average assets, noninterest expenses declined in that same period. So I mean, I think it is directly -- obviously, it's directly tied to the revenue environment that you described. But I mean we've talked about the headcount reductions that we've seen, the limited headcount growth over the 5 years relative to the asset growth that we put on. So the efficiency ratio does tend to be more tied to just market dynamics and things, but structurally what we can control, I think we've done a very good job.
Okay. Let me ask you guys called out that the deposit pricing got a bit away from you because of the system conversion. What's the connection between the 2?
Look, we have a lot of relationship clients, which an organization our size should have. I think we have internal models as to how we look at pricing deposits. I think the focus largely on our frontline staff was on reaching out to clients, retaining clients, and some of the profitability metrics as to how we think about engaging with our clients, how we want to direct certain conversations. We're probably distracted based on client retention and based on just conveying to clients what was going to be new with regard to how they approach the different systems. That said, I think certain deposit rates from the exception pricing perspective, got a little bit out of hand. And there was necessarily the focus that should have been on making sure that we were within our targeted guidelines as to what that pricing should be. That said, I'm very confident that we'll get there very soon.
So I'm trying to where that the NIM drives, you said it's neutral in the short run, but Ira said multiple times, your NIM should expand. I think you said very nicely, what's the curve looks more normal. How long are we talking? Like what's the lag? I would think it would be sooner than later, but if we get a positively sloped curve towards the back end of this year, is it a 2026 story before your NIM starts to look more normal? I'm just confused why the Fed cutting rates given how much you're paying on deposits. You guys are one of the higher pairs. Isn't more beneficial in the short run?
I think there's the front-end curve, I think, coming down. Jeff is going to be impactful to us, but it's the long end where we have a lot more that's tied to. It's definitely going to be a pretty significant tailwind for us as to how we're thinking about where the net interest income is going to go. I think the commentary was more along, there's some day count issues really that goes into that first quarter as well as we're not expecting much change within the first quarter as well. So once the curve does begin to normalize, we do believe that there's going to be some positive impact to that net interest income and the margin as well. That said, they're really not asking or forecasting anything to really change until the tail end of the first quarter, and there is that pressure from the day count right in that -- right off the bat as well.
Our next question comes from the line of Nick Cucharale, Hovde Group.
Just a question on the noninterest income outlook. What are the primary drivers of the 5% to 7% year-over-year growth? And are you expecting a reversion of swap activity closer to the first half of '23 as opposed to the back half?
So the biggest driver would be, as I said earlier, stabilization in our noninterest-bearing deposit balances. But that was the biggest driver of net interest income... Adjusted noninterest income. You said interest income? I missed that. Sorry about that. So you can see that in our IP deck as well as it lays out the portions of that. Keep in mind that in 2023, we also had some one-time events related to some revenue recognition that aren't going to repeat in the prior year. But I think when you look at the totality of our fee income, we feel very good about where we're at because it only generates about 10% of our total revenue, sometimes the increases in any one category get lost. But I do think given the lower loan growth that we have, swap income will be somewhat challenged and will be replaced with things like FX, wealth management. And we have a very strong treasury management project going on in our company. And as we put on more C&I business, we would expect that to contribute as well. Okay.
And then just looking at the expense base, you mentioned some investments and some reduction opportunities throughout 2023. Now that the core conversion is complete, what investments are you most focused on to drive the next leg of growth for the company?
I think a lot in line with some of the strategic imperatives that we talked about, right? I mean I think when we think about the growth in the C&I and some of the specialty entities that we have, there's definitely some technology investments that we put forth. That said, a lot of it from a foundation perspective is already there, and it's just enhancements at this point for things that were already put in place, but really largely aligned with what we've talked about on the strategic side, mostly focused on some of the C&I stuff.
Our next question comes from the line of Manan Gosalia of Morgan Stanley.
Can you talk about how you're thinking about deposit betas and deposit mix as rates come down? Is there still a lag in how deposit yields come down as rates come down and do NIB deposits start to rebound once we get to a certain level in rates? So yes, if you can expand on that and just talk about how you're thinking about deposit costs through maybe the first-rate cuts versus the next few rate cuts?
Yes, Manan, this is Travis. So I do think there is some lag on the beta side on the way down. Our model assumes around 35% beta on the way down. As you can see the cycle to date was 57% on the way up. Relative to noninterest-bearing, our budget and our forecast assumes that it remains relatively stable as a percentage of total deposits is around 23%. But I do think there is a terminal point at rates with rates that you do continue to build that backup. And obviously, as we expand C&I and treasury management, I mean, those are strategic initiatives that are in place to continue to grow noninterest deposits faster than what we actually include in our budget. So that's some thoughts around that.
Very helpful. On the loan growth guide of 5% to 7%, I know that includes the mix shift away from investor CRE. So can you talk about some of the drivers? And also, what does the cadence of that look like? Is that more back-end loaded? And do you need some help from the environment there? Or is that based on customer conversations you're having today and there's a high degree of confidence that loan growth will accelerate as we get through this year?
Yes. It is based on the confidence we have in the conversation with customers and seeing the uptick in their requests from us and to build on the pipeline that we've experienced in the fourth quarter and so far into January. And again, pointing out to the originations in that fourth quarter, $2.2 billion, up from that $1.8 billion in the third quarter, and the uptick in our pipelines and C&I's contribution to that pipeline, it is now the lion's share of 65% of our pipeline. So we are seeing that activity. Typically, the first quarter is a slow quarter as people get your financial statements in place and you start seeing progressively more business as the quarters roll on.
Got it. And the loan-to-deposit ratio should stay at about these levels of between 95% to 105%?
Yes.
Our next question comes from the line of Matthew Breese of Stephens.
First, I was hoping on the NII guide. Could you provide just for context, I would love a sense of how dynamic it is, what the guide would be or estimate what the guide would be under a no or minimum rate cut scenario for the year.
It's effectively captured in 3% to 5% range that we provided. If rates stayed flat, then we think that there would still be upside in NII and margin from our current levels. Again, the most exposure we would have is to significantly lower rates on the long end. So absent that, most other interest rate scenarios would end up in the kind of guide that we provided.
Got it. Okay. And I think you also alluded that the NIM has already started to show some stabilization, hopefully, stabilization in the first quarter. Could you provide some detail as to how the NIM provides on a monthly basis throughout the fourth quarter and if we started to see that stabilization already?
We did. November was the low point, I would say, on a monthly basis. When we were on the call last time, we looked back at 6 consecutive months of generally stable NII and margin. Some of the factors that we've already talked about in terms of shortening up the liabilities and other things provided a little bit of pressure in the fourth quarter. But I would say that the margin, again, was at its low point in November. If you look at what we originated loan yields -- loan origination yields also bottomed in November and bounced back in December, but deposit -- new deposit origination costs actually declined throughout the quarter. So October was the high point that November was lower in December it was even lower than that. One thing I would throw out there, too, we do provide, obviously, in the deck what our loan origination yields are and they declined 8 basis points in the quarter, but new deposit origination costs declined 11 basis points in the quarter, which kind of feeds into the commentary we've provided on spreads. So November again was a low point on the margin. December was somewhat better if that's helpful.
Yes, any frame of reference for what the difference was low to high?
It wasn't that significant, to be honest with you. I think November was 4, 5 basis points lower than December.
Got it. Okay. A couple of other quick ones. I noticed that service charges on deposit accounts were quite a bit lower quarter-to-quarter like 15%. Was that driven by the conversion? And should we expect that line edge to come back to its normal kind of $10.5 million level?
Yes. So for about a month around the conversion, we would have certain transactional fees. So if you look at the decline, it was about $1.5 million, $2 million, that's exactly what that was. So otherwise, it would have been flat. Obviously, we put on a lot of deposits throughout the fourth quarter, customer deposits. So that should continue to drive deposit service charges going forward. That will also be supplemented by the treasury management stuff that we talked about. That generates deposit revenue as well in the noninterest income area.
Okay. And then on the average balance sheet, it struck me as odd, cash balances or interest with bank deposits was down like 90 basis points quarter-to-quarter to 4.6%. I usually look at that as kind of a Fed funds proxy. What happened there? What drove yields down so substantially in cash categories?
I think you're generally right. So we go through an accrual process to estimate what the cash payments received from the SEDAR. The actual payments do tend to move around a little bit. So there are certain credits that go in and out there so you can have a yield that may not directly align with the interest on overnight reserves.
Okay. But generally speaking, we should see a model that back to setons.
Yes, I think that's generally right.
Okay. On Page 11 of the presentation, you showed the multifamily portfolio, in pretty good detail. What struck me was that a number of these geographies have weighted average set service coverage ratio, sub 1.4x. Should we feel a little bit risky given the repricing dynamics? So one, I'm curious, those debt service coverage ratios, are those at origination? Or are they updated? And then two, do you happen to know what the existing loan yield is on this book versus updated?
Yes. The weighted average user coverage are current. They're based on recent rent rolls. We update that and the loan to values on a regular basis. I don't have the loan yield in front of me. But I will tell you, again, when we look at that repricing, we've not had to modify any of the terms on our repricing, and our forward look where we assess each loan that reprices over the next 12 months, we expect the same results. But we'll have to look that up. I don't know if you have it, Travis.
Yes. I don't have the full portfolio in front of me, but I'll try and give you some color that may be helpful. So as we show on that page, Matt, we had $420 million of fully rent-controlled loans. Those would be the lowest-yielding segment, and that's 4.6% yield. We have another, call it, $1.5 billion, I'd say, of exposure to properties that have some amount of rent control in them, and that portfolio yields 5.45%. So I think when you look broadly at multifamily, you're going to be closer in total to that $545 deal, give or take.
And those buckets, the 420 of pure rent-regulated and the $1.8 billion of some rent, those pass the stress testing we went through as well.?
Yes. Yes. And the $420 million is pure rent-regulated, and it's 1.4 which is partial, 20% are less rent-regulated.
Okay. And I know I'm being long-winded, but this is my last one. Ira, you had mentioned some frustration with overall profitability levels. Can you better define for us at which level you'd be satisfied profitability-wise, maybe is measured by ROA or ROTC? And as we think about the forward model here, when do you think we can get back to, let's call it, a 1% ROA for the bank?
I don't want to go against the guidance that Chad has provided, right? But I'm pretty optimistic about where I think we're going to be in 2024. We were generating 60% of return on tangible common at the end of last year. And I think that's an appropriate level that we should begin to target, and we should get back there.
I'm showing no further questions at this time. I will turn the call back over to Ira Robbins for any closing remarks.
I just want to say thank you for dialing in today, and we look forward to talking to you next quarter.
Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.