Western Alliance Bancorp
NYSE:WAL
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Western Alliance Bancorp
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Good day, everyone. Welcome to Western Alliance Bancorporation's Second 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 today's call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Please go ahead, sir.
Thank you and welcome to Western Alliance Bank's second quarter 2022 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; Dale Gibbons, Chief Financial Officer; and Tim Bruckner, our Chief Credit Officer.
Before I hand the call over to Ken, please note that today's presentation contains forward-looking statements which are subject to risks, uncertainties and assumptions. Except as preprimary 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 through 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. We had solid performance this quarter as the company passed the $66 billion asset milestone and the strong earnings power of our diversified asset sensitive business model was on display even as we are keenly focused on the economic uncertainty around us.
For the second quarter, WAL generated total net revenues of $620 million, net income of $260 million and EPS of $2.39. Record earnings were propelled by accelerating net interest income quarterly growth of $75 million or 17% from prior quarter to $525 million as the rising rate environment expanded our net interest margin 22 basis points to 3.54%. Interest income rose 3x faster than interest expenses, inclusive of deposit costs and ECRs. We maintain industry-leading performance with return on average assets and return on average tangible common equity of 1.62% and 25.6%, respectively which will continue to support capital accumulation and strong capital levels in the quarters to come.
Balance sheet expansion continued with quarterly organic growth of $5.3 billion or 52% year-over-year, excluding the $1.9 billion of loans transferred from held for sale to held for investment which was done to avoid income volatility from rising rate bonds. Dale will speak to this later. Deposits rose by $1.6 billion or 28% from the prior year as we continue to effectively attract and deploy liquidity. Loan growth was broadly diversified this quarter with regional banking divisions contributing 16% of organic growth or $863 million, our specialized national business lines, adding 55% or almost $3 billion and residential loans composing 28% or $1.5 billion, excluding the held-for-sale transits. Deposit growth trailed loan growth in our $2 billion guide as a few large customers were pushed to July.
Mortgage banking-related income modestly declined by $5.4 million as the mortgage origination market continues to face headwinds from higher rates, affordability issues and inventory constraints. We believe the rationalization of the mortgage sector will take time but we have already positioned the AmeriHome to profitably operate in a lower origination market and to unlock value as a bank-owned mortgage business by attracting custodial deposits and deploying liquidity into low credit risk loans.
Finally, asset quality continues to remain stable as total nonperforming assets declined $6 million to 15 basis points of total assets and net charge-offs were only $1.4 million. We are cognizant of the macro uncertainties and possibly more difficult credit environment in the future but we have deliberately positioned the portfolio to expand these pressures through credit linked notes issuance, government guarantees and cash collateral that now cover 27% of our portfolio. In addition, another 33% of our loans are in low to no loss loan categories.
At this time, Dale will take you through our financial performance.
Thanks, Ken. For the quarter, Western Alliance generated net income of $260 million, EPS $2.39 and PPNR of $351 million. Total net revenue was $620 million, an increase of $64 million during the quarter and $114 million or 22% year-over-year.
Net interest income increased $75 million to $525 million during the quarter driven by robust loan growth and the impact of higher rates on the margin. Overall, noninterest income declined $11 million to $95 million from the prior quarter, driven primarily by a $10 million loss on mark-to-market adjustments for preferred securities as credit spreads widened and lower mortgage banking related income which fell $5.4 million during the quarter to $72.6 million. This decline was partially offset by a $9 million gain on credit recoveries related to credit linked notes sold during the quarter which is reported in noninterest income as really a contra expense to the provision for credit losses using the same CECL methodology.
Finally, noninterest expense increased $20 million in the quarter, resulting in an efficiency ratio of 42.8% primarily due to higher deposit costs from earnings credit rates as rates rose and processing expenses from a larger balance sheet. All in, net revenues grew 3x out of the increase in expenses.
Total -- turning on to our net interest drivers. Our growing asset-sensitive balance sheet benefited from rising rate environment. Investment yields increased 17 basis points from the prior quarter to 2.94%. On a linked-quarter basis, loan yields increased 21 basis points to 4.19%. Loans held for sale also benefited from rising mortgage rates and increased 85 basis points to 3.99%. Funding costs were higher with interest-bearing deposit costs increasing 17 basis points to 0.37%, while balances grew $1.4 billion.
Total costs of funds increased 11 basis points to 0.38% as the rate and utilization of short-term borrowings increased as loan growth exceeded deposit growth. Net interest income increased $75 million during the quarter or 17% annualized to $525 million as average interest-earning assets grew $4.5 billion and NIM expanded 22 basis points to 3.54%.
To put our asset sensitivity into perspective, our total funding costs, inclusively ECR expenses only grew 30% of the $95 million increase in interest income for the quarter. After recent Fed actions to rapidly increase interest rates, we continue to remain materially asset-sensitive since our variable rate loans moved above their floors.
Given that the Fed has increased rates by 125 basis points since last quarter, a proportion of variable rate loans after floors is now only 16%, down from 80% in Q1. Based on expectations of an additional 75 basis point rate increase by the Fed next week, nearly all of our loans will be at variable rate at that point in time.
In a rate shock scenario of 100 basis points over 12 months in our static balance sheet, net interest income is expected to rise 5.3%. Using the same scenario on a growth balance sheet, we expect NII to grow over 25%. Under a plus 200 basis point rate shock scenario on a static balance sheet, net interest income is expected to decline by 10.8% in the coming year and over 40% at this rate environment were to materialize when balance sheet growth expectations are also incorporated.
Our efficiency ratio fell to 42.8% from 44.1% in Q1 due to rapidly increasing net interest income. Non-interest expenses rose $20.3 million or 8% during the quarter, primarily due to an $8.8 million increase in ECR-related deposit costs on noninterest-bearing deposits and higher loan servicing and data processing expense from a larger balance sheet.
Total deposits subject to ECRs were $14.5 billion at quarter end. We expect our efficiency ratio to remain in the lower 40s for 2022. Pre-provision net revenue was a record $351 million during the quarter, a 34% increase from the same period last year, an increase of $44 million or 14% quarter-over-quarter. This resulted in a PPNR ROA of 2.19% for the quarter, an increase of 9 basis points compared to 2.10% in Q1. Despite our strong balance sheet growth and volatile rate environment, our PPNR ROA has remained quite stable over time.
Strong balance sheet momentum continued during the quarter as loans held for sale -- loan held for investment increased $5.3 billion, net of the HFS HFI loan transfer or 13% to $48.4 billion and deposit growth of $1.6 billion from balances back to $53.7 billion at quarter end.
As Ken mentioned, during Q2, we transferred $1.9 billion of government guaranteed early buyout residential loans from held for sale to the held for investment portfolio to eliminate the mark-to-market volatility of HFS loans. Since these loans are targeted to re-perform or roll off the balance sheet in various forms of liquidation, they have significantly lower duration than other mortgages. Mortgage servicing rights balances declined $124 million in the quarter to $826 million as we optimize capital through certain MSR portfolio sales.
Total borrowings increased $4.4 billion over the prior quarter to $6.1 billion, primarily due to an increase in short-term borrowings of $3.9 billion and issuance of $494 million in credit linked notes, providing first loss credit protection on a pool of $2.2 billion in capital call loans and $3.9 billion in residential loans.
Finally, tangible book value per share increased $0.46 -- decreased $0.46 or 1.2% over the prior quarter to $36.67 primarily due to unrealized fair value losses on available-for-sale securities recorded in all other comprehensive income. Tangible book value per share increased by 11.6% year-over-year.
We continue to generate attractive organic loan growth from our flexible commercial business strategy and see broad-based loan demand between our regional banking divisions and national business lines. Loans held for investment grew $5.3 billion, driven by an increase in C&I loans of $2.9 billion as demand for capital call lines and regional banking remains strong contributing $1.1 billion and $863 million to growth, respectively. Commercial real estate loans grew $969 million and residential grew $1.5 billion representing 28% of loan growth, excluding the EBO transfer during the quarter. We expect residential loans to remain at this lower proportion of loan growth going forward than it has been historically.
Turning to deposits. We continue to see growth across our diversified channels that will generate stable, low-cost funding in different rate environments through deep rooted banking relationships with our clients. This quarter, our specialty deposit nonnational business lines drove most of the deposit growth, while regional banking divisions were flat. In total, deposits grew $1.6 billion or 11.9% annualized in the second quarter driven by increases in term CDs of $760 million, interest-bearing deposits of $592 million and noninterest-bearing DDA of $201 million. Noninterest-bearing accounts comprised 44% of our total deposit mix. Our specialty deposit franchises continue to provide ample opportunities to generate attractive funding to support loan growth with deposits from warehouse lending higher by $520 million, HOA up $219 million and settlement services up $135 million.
Going forward, we expect deposit growth to more closely match our loan growth as 2Q was impacted by a few deferrals of new deposit relationships to the current quarter. Our asset quality continues to remain strong and total classified assets and special mention loans as a percentage of total assets and funded loans are lower than 2019 levels.
Total classified assets declined $19 million during the quarter to $346 million or 52 basis points of total assets as the temporary impact of the overtime bearings on hotel loans continues to wane. Special mentioned loans decreased $33 million during the quarter to 66 basis points of funded loans and are at historical lows as a percentage of assets.
As the economic environment continues to evolve, we believe that our portfolio is structurally well positioned to sustain superior asset quality through cycles based on our deliberate decade-long business transformation and diversification strategy that emphasizes underwriting discipline. Our national reach and deep segment expertise enables selective relationships with the strongest counterparties, leading profitability and superior company risk management. Approximately 56% of our loans are in low to no-loss categories and 27% of the portfolio is credit protected from government guarantees, credit-linked notes, first loss protection or in cash security. We do not currently see signs of a notable recession or credit stress but we're prepared for these events if -- should they arise.
Quarterly net credit losses were $1.4 billion or one basis point of average loans. Our total loan allowance for credit losses increased $26 million from the prior quarter to $327 million as the provision exceeded losses due to strong loan growth and the adjusted economic assumptions for unexpected tail risks. In all, our total loan ACLs and funded loans declined 5 basis points to 68 basis points. Adjusting for the $11.2 billion of the loans covered by credit linked notes, where ample first loss coverage is assumed by a third party, the ACL coverage ratio rises to 0.88%.
Finally, given our industry-leading return on equity and assets, we continue to generate capital to fund organic growth and maintain well-capitalized regulatory capital ratios. Our CET1 ratio was stable at 9% as our net income and risk-weighted asset reduction from credit-linked notes offset the capital necessary to support our exceptional loan growth. However, our tangible common equity to total assets fell to 6.1% this quarter, reflecting negative fair value marks on available-for-sale securities. It's notable that the TCE ratio does not consider the increased value of low-cost deposits in this higher rate environment.
Inclusive of our quarterly cash dividend payment of $0.35 per share, our tangible book value per share declined $0.46 during the quarter to $36.67 primarily reflecting the adverse available-for-sale mark at quarter end. While rates have continued to rise, the rate of increase we witnessed in the first quarter and the second should subside later this year. Given our robust capital generation, we still expect that 2022 will look into be a year of tangible book value growth.
I'll now hand the call back to Ken.
Thanks, Dale. I was very pleased with Q2's results and the management team's ability to adapt to the changing interest rate and economic environments. Loan and deposit growth was strong. Net interest growth accelerated with expanding NIM. Credit remains solid and clean and expenses were balanced for both near-term efficiency and long-term investments.
Looking forward, we expect loans held for investment and deposits to grow in excess of $2 billion per quarter. Our loan and deposit pipelines also by client confidence gives us reassurance that our balance sheet will continue to grow in a safe, sound and balanced manner.
Net interest margin is expected to grow throughout the year, accelerating net interest income growth and driving higher PPNR. Net interest income expansion in the third quarter is expected to exceed the increase in the second quarter. Strong net interest income growth will continue to drive total revenue higher, inclusive of mortgage banking slowdown. Mortgage banking-related income is likely to more closely track changes in overall mortgage sector volumes going forward. The bank's asset quality remains solid. We are not seeing emerging delinquencies or defaults within any segment. However, we believe we are in a technical recession and are planning for a further slowdown and are prepared for a more dollar economy if that occurs.
Regarding capital, we believe our internal capital generation can support up to $3 billion to $4 billion of loan growth depending on mix. We expect capital ratios to remain fairly stable at current levels throughout the remainder of the year.
In conclusion, we continue to see EPS of $9.80 for full year 2022 as a floor from which 2023 can ascent. At this time, Dale, Tim and I would be happy to take your questions.
[Operator Instructions] Your first question comes from Casey Haire of Jefferies.
Question on the funding strategy. The borrowings up to $5.2 billion at quarter end. I know that everyone sees short term and they think it's overnight. I'm just wondering, are those one year borrowings, what is the spot rate at 630 versus 119 [ph]? And then what is the appetite? How aggressively are you going to use this going forward?
Yes. So it's two items in there. One of them is we have some other -- the credit linked notes are in there too. But some 90% of it really is predominantly Federal Home Loan Bank borrowings on short-term duration. I expect that is basically kind of 100% beta response to what we're seeing. We are -- that our loan growth is also overwhelmingly 100% beta. I do believe that we're going to see deposit growth and loan growth really kind of merge within the third quarter unlike the disparity we had in Q2. So we're comfortable continuing our growth strategy. And over time, I think that our funding from wholesale sources would probably weigh.
Okay. So it sounds like borrowings hold this level or not and potentially decline. If you could give some of the path growth side?
Yes. I think they're going to be trending lower. We have -- we have initiatives that are underway and under development on deposits that I think are going to -- are going to take hold. I'm not sure we're going to see much of a drop in the third quarter. I think you're going to see more balance and loan and deposit increases.
Casey, it's Ken. We're trying to balance loan growth and deposit growth. But that's very hard to do. And sometimes loan growth gets a little bit ahead of deposit growth, in which case, we're going to use short-term borrowings if we think the loans we're putting on the balance sheet are good loans, good asset quality. So while we try to have a balanced approach, any particular quarter, we could be slightly out of balance.
Got you. Okay. And I got your comments on the NII growth exceeding the 2Q level in 3Q. But can you just give us a flavor for where asset yields are exiting the quarter, specifically spot loan yields versus 4.19% and then the HFS loan yields at 6.30% versus the 3.99% in the quarter?
Yes, sure. So we're looking for rates to be up kind of where we're ending something in about 30 basis points. Again, that's going to get overwhelmed by what we expect to happen next week and we have dialed in another 50 basis points in our estimates for the September meeting. Just remember, we're -- after July, I think we'll almost be nearly 100% above all the floors of the loans and that's going to have a little bit of an extra kick to the third quarter as well.
Got you. Okay. Last one for me. Just a big picture question for you, Ken. You guys -- you mentioned that you're planning for a slowdown. Just wondering I know you guys are a growth story and you've made some promises on the EPS front and building on that $9.80 in the next year. But just wondering, is there a thought to maybe get a little more aggressive on the ACL build just given the overhang on credit normalization for Western Alliance?
So I'd say a few things on the ACL build. I'll give you a smaller answer and then maybe a larger macro answer. But on the ACL build, one, remember that 27% of our total loans happened to be credit protected. So what you see in the ACL is also offset in the fee income on the gain there. That's number one. Number two, a number of our loans, certainly on the C&I side have an average life of 26 months. So you're not going to see a big build there just because of the average life is so short. And on the real estate side, it's an average life of a little more than 3.5 years or so. So we don't have long duration loans that will build up an ACL or credit loss reserve. And additionally, what we've been doing for the last several years is focused on these low loss or no loss loan segments. And when you go back and you look at history for the last 10 years and use that to calculate our CECL provision, the numbers are very low.
So we moved the provision up from $9 million to $27.5 million this quarter. You saw we only had $1.4 million of losses. Our special mention loans dropped and our classified assets dropped. So I think we're appropriately positioned at this time. And I think the provision will stay around this number as we go forward depending on loan growth. I think our response to what happened during -- kind of during the pandemic and what you saw in terms of our -- in terms of losses that we incurred which were almost nil. I think really is borne out in terms of our underwriting strategy with really low LTV. So I mean the hotel group is just such a good example here in terms of it was a direct hit from the pandemic, occupancy rates fell into the low teens and yet, we didn't lose the time in that portfolio because we came in low in terms of advance rates. We had strong sponsorship with entities with liquidity. And that pervades the underwriting we do on our balance sheet.
So I mean, as you know, for the past 10 years, losses have been almost nil. The ratio that we have today, if you look at the duration of our loan book, as Ken mentioned, under four years and the basis points we're incurring on losses and then multiply that by four, that would tell you that the reserve ratio would really only need to be a single-digit number. And here we are at 88 basis points, excluding what we already have [indiscernible] from the insurance of these credit linked notes.
Your next question comes from Ebrahim Poonawala of Bank of America.
I just wanted to follow up. One, I think a few things that you mentioned. We want to make sure we interpret this correctly. One, you expect loan-to-deposit ratio went from 80% to 90%. You don't see that going higher given what you said about funding loans with deposits. And secondly, can you give us a sense of just the pace of loan growth when you think about the third and the fourth quarter, the resi book is now all the way up to 30% of the total loan portfolio. So I would love to hear just in terms of the pace of the loan growth and the makeup of that we are hearing from others around the slowdown in capital call line lending as well. So any color would be helpful.
Yes. First, on the loan-to-deposit ratio. If we're -- if we execute our plans to have loans and deposits balance each other every quarter, the 90% is about the right level. But I will say that there will be some quarters that could be out of balance and that number could go up a little bit or come down. So in Q1, for example, we had $4 billion of deposit growth and that exceeded the loan growth. So I think you'll see it float around 90% but don't be surprised if it should rise a little bit above that. That's the first thing. Ebrahim, second question was what again?
Just the pace of loan growth and the makeup of loan growth now that mortgage has hit 30% target that you had?
Good. Okay. Our loan pipeline is very, very strong. And we're talking about credit commitments that we're going to be making that are straight down the middle of the fairway. They're not different than anything we've been doing for the last couple of years. We're not looking to steal someone else's market share on loan growth and do something that we're not comfortable with. And so the -- straight down the middle of the fairway loan growth is in front of us. It's going to come from capital call lines. It's going to come from our entertainment and media business line that we started up. It's going to come -- actually, the national business lines are all showing good pipeline growth and for all the regions, quite frankly.
And so what we get a chance to do here is pick the best of the best credit quality that we want to put on our balance sheet. And so I think the loan growth will continue to grow, $2 billion as a floor and I see the amount of residential loans that comprise the $2 billion to continue to drop. And right now, I would assume it wouldn't be any more than maybe 25%.
Got it. So let's say, about 25% of that growth. And just on a separate note, when we think about core expense outlook. You talked about the low 40s efficiency ratio is still good. But just talk to -- I mean, your NII guidance implies a pretty decent revenue lift. Give us a perspective of investment spend where expenses are going, be it hiring, technology, etcetera?
Okay. So our -- we haven't stopped investing in the company. We haven't stopped investing both for the short term and the long term. Short of things, continued improvement in technology, continued improvement in risk management. We are keenly focused on crossing over the $100 billion asset level and we need to be prepared for that well in advance. And a lot of our spending is going into tech and risk management. Additionally, we're spending a lot of money on the deposit side of our national business lines, putting in place new products and services that we think will be hopefully up and running either at the end of this year or maybe into the early part of 2023.
So that has a little even more of an intermediate outlook to it but we're spending on that stuff today. Nearer term, you will see expenses rise a little bit and that's because the deposit costs are going to rise. But when you look at that, deposit cost rise in connection with very strong net interest income rising. I think you'll see efficiency ratio drift up somewhat in Q3 and then come back down in Q4.
Got it. And just one quick follow-up. The held-for-sale portfolio, is that done declining after the transfer you made? Or could we see held-for-sale balances continue to drift lower?
Yes, it will track the mortgage industry and it should stay roughly at the number it is today.
Your next question comes from Brad Milsaps of Piper Sandler.
Dale, I was curious on deposits. Can you remind us what percentage of the DDA are subject to the earnings credit rating? And maybe kind of what spot deposit rates were as you exited the quarter?
Yes, it's approximately half. Deposit -- spot deposit rates were up about a little less than what we saw on the spot loan rates. Again, what we're focused on is we're not managing betas. We're managing net interest income growth, PPNR and earnings per share. And so we're less concerned about that. I do think that there's two different kinds of betas. There's a beta to maintain a balance and then there's a beta to acquire new business. And since we are acquiring more business than other institutions, we're going to have a greater proportion of our growth come in and probably higher beta numbers in terms of the delta. So again, yes, the spot rates were up about 23 basis points. And going forward, we expect to kind of continue to drive net interest income, as Ken indicated.
Great. And it looks like you added some more bonds in the quarter. Are you still adding variable bonds? Or I think it was about 1/3 of the mix in the second quarter or the first quarter. Just curious if that was maintained?
Those were in the early part in Q2, all 100% beta bonds basically [indiscernible] loan obligation subject to only 20% risk-weighted asset categorization and that is basically soft.
Got it. And then the CONs that you did, I presume those were at the end of the quarter and didn't really have a huge impact in the quarter. What were the rates there similar to the other credit linked notes that you did?
Yes. So the rates are basically SOFR plus $600 million [ph]. There's a little difference between them but -- on each of them. That isn't picked up in the total funding cost beta I mentioned earlier. But you're right, they were booked out in June.
Got it. And then maybe a final question for me. On the loan transfer, understand more in the mark-to-market. But as those loans fuel themselves, are they -- do they come off your books any differently than they would have otherwise? Is there something else you have to trigger or is it just -- it just goes back the same way it would have if it were in held for sale?
Yes. The reason why they're so much shorter is because they had some type of a credit distress. Again, these are 100% guaranteed by Ginnie Mae. So there's no risk to us. And as a result, you're going to get faster liquidation. Most of these are going to be sold probably by the current borrower. I mean they've got a good opportunity to do that if they -- their personal situation has changed. You're also going to see a good portion of them refinanced at now current rates to put them in to probably a lower fee per month or something like that. And then, also some of them are just going to go through kind of a foreclosure process. We expect that to be about half of that total. So those are either going to get remarked to current rates or move off completely. The balance will probably be adjusted and reperform at the current note rate and those will have a longer life to them but half of them are going to have a shorter life.
So again, it does, as we said, it kind of avoid the mark-to-market effects on them and there's no risk of credit.
Your next question comes from Timur Braziler of Wells Fargo.
Just following up on credit linked notes. Dale, if you can give us just some color as to how you choose the credits that these are applied to? I know you gave us the balance of the capital call and the residential loan. But what's the process in deciding which credits you choose to go, the credit linked route versus traditional?
Sure. So I mean -- so I mean, the key feature of this basically strategy is to reduce the risk-weighted assets of these. So we want to take something that we can get good leverage on risk-weighted asset reduction. And we also want something that the expectation of losses is probably low to begin with such that the rate that we pay on the note is SOFR plus $600 million [ph] is lower. And if you had something that was maybe more uncertain in terms of what the credit risk was, maybe that note rate is going to have to be higher to cover that. So that's how we kind of guide into these. We've seen where the trail has been blazed already. Residential real estate and we did one last year in warehouse lending, we've seen those before. We're not aware of anyone. It's actually done one domestically for capital call lines but we thought that would work well too in terms of kind of queuing that up. And we've been active in that space and it's -- I think it's working well.
Let me just add one follow-on to the -- excuse me because I need to have one follow-on to the credit linked note. We went down that path mostly to bolster our capital position. But I want to make sure it's not lost on folks that because of the three deals that we've done, several deals we've done -- sorry, four deals that we've done since last year, 27% of our book of business is now insured. I don't think there's a bank that could say we've done that. We know what we were looking. Over 25% of their book has credit insurance on and so a very important aspect of what we've done really gives us a lot of confidence around our asset quality. By getting the relief on risk-weighted assets has saved us $500 million in capital.
Great. Maybe switching over to bridge just to see that the lending activity is still pretty strong. What do deposits do out of that business?
So tech and innovation loans just had a very small outflow this quarter of just over $100 million. And year-to-date, the deposits over at bridge have remained rather steady. So they're really flat to the beginning of the year.
And do you have the warehouse balances at quarter end?
Yes, we do -- when we talk about warehouse lending, we group it with two other categories because it's run by the same manager. So we have warehouse lending in there. We have MSR lending and we have loan finance lending. I don't think we've ever provided information on each one of those things broken out and so I would, for competitive reasons, rather not do that but say to you that on a cubic basis, those three groups, those three things, MSR, loan finance and warehouse lending were up for the quarter.
Okay, great. And then just lastly for me, I'm glad to see that it made it to this part of the call before you get your first AmeriHome question. But with production kind of being more or less flat sequentially and a pretty marked reduction in the gain on sale margin, are we nearing the bottom kind of on -- gain on sale revenue? And then for the MSR revenue, if you can provide a breakout of kind of what's core versus what was the fair value adjustment for the quarter?
So as we've said, I think almost from day one, we look at everything together and it's mortgage banking revenue. And I would say that based upon the industry data that we are seeing and what we are seeing in day-to-day activity, there will be a natural drifting downward from the numbers that we posted in Q2. All that was taken into account when we provided the floor of the $9.80 EPS guide.
Your next question comes from Chris McGratty of KBW.
Ken, I want to come back to the $9.80 for a minute and just to make sure I understand all the pieces. You talked about the investments that you're making. You talked about the conservatism you're making on the provision. But then you say that the NII increase in Q3 is going to be larger than Q2. To me, it feels like that number should be decently higher than $9.80. And so I'm interested in some color there. And I think on prior calls, you've talked about, like, I think, $2.75 [ph] fourth quarter run rate? Just maybe an update would be great.
Yes. I think, by the way, we started putting out the $9.80 floor number and keyword there is floor. In the back half of 2021, we haven't moved off of that. And we'll keep directing you to the word floor. So at this point, we feel very comfortable at saying that $9.80 is a floor number. There are some upward biases that you could see in our P&L that could raise that number. And our Q4 number exiting Q4, I think, is $2.75 [ph] if not higher than that.
Okay. Is there anything you're doing in the back half of the year just because NII momentum is so significant to set up for maybe some expense -- the easing of expenses next year since the year is kind of -- you're going to hit that number? Are you doing things in the back half, I guess, to make the comps easier for next year?
No. I mean we're -- we've been running the business for the long term -- for the longest time. So projects that we have in place have been in place probably since going back to somewhere in 2019 and 2020 that continue to be invested in. So we're not accelerating expenses to offset revenue, the acceleration in revenue. I think you'll see a little higher, as I said, expense growth just because of deposit costs and the ECR credits but that will be more than made up in the net interest income growth. The provision is something that we continue to look at. And the provision is also predicated upon loan growth. And again, we're looking at a $2 billion loan growth floor. So the provision could be equal to about where we are for Q2 going forward in Q3, Q4.
Great. And if I could sneak one in for Dale. I know you managed NII but one of the themes in the quarter has been peak margins for the industry when we get there. And maybe just interested in your thoughts about the cadence of the margin given the futures curve. And when you think timing and about where that would occur.
Well, yes, we're clearly -- we're currently in the longest lag of this uptrend right now. And maybe that starts to ebb in the fourth quarter or first. I do think that there may be a little bit of momentum even after that as, say, fixed rate loans kind of reprice at higher levels. We've had this floor strategy that was so successful during the pandemic. But right now, when rates are moving as quickly, the floors fall away from the current variable rate very fast and they're not of much use. So, I would prefer that we kind of flatten out here for maybe the first half of next year and then maybe trail down from then and maybe that's a little optimistic in terms of how fast we get through this. But I think it's probably early in '23.
[Operator Instructions] Your next question comes from Brandon King of Truist Securities.
I wanted to get a sense of the compensation of the deposit growth going forward -- composition of deposit growth going forward. I noticed most of the growth in the quarter came from CDs when the market accounts and savings. So I was curious if that will be kind of a similar composition for the back half of the year?
I think it's going to be a little more balanced to our current mix. I don't think CDs are going to be as large a piece. I think it is probably going to be money market and some interest-bearing checking. I would say that kind of garnering real DDA without an ECR in this environment with a very elevated level of awareness of what's happened with rates, it's probably challenging. So I don't think we're going to hold that mix at 44% DDA but I don't think it's going to be skewed to CDs in what you just saw.
Got it. Got it. And then just broader picture, looking out to next, most comments on the strong pipeline near term and for this year. But is there any sort of possibility of slowing loan growth depending on if you get a more severe downturn next year? Is that a potential? Or do you think you could continue to achieve this growth even if we get some sort of a mild-to-moderate recession next year?
This is Ken. I'm going to let Tim Bruckner, our Chief Credit Officer, that he probably gets a chance to speak, take that one.
Thanks, Ken. It's a good question. We have focused the whole business on appropriate lending in every economic circumstance. So there's -- there's things naturally that we will do less as we head into what might be a recessionary economy. And there are segments that we began adjustments in the second half of last year. So we've already seen muted volume. In some segments, we will achieve appropriate balance really for any economic scenario but we do that in a deliberate way and we do it in advance.
Okay. So I get a sense that you could achieve the same loan growth but just the composition would change. Is that fair to say?
Yes. That's definitely possible. We would generally be less aggressive in stressed economic circumstance. So if that presents, you'd see likely a little bit less, a little more deliberate and a little higher margin. We kind of did -- we've been doing this, what I'm about to say, for the last four or five years. But we break loan commitments into a couple of different categories. The first and the easiest one is insurable risk which is what the CLMs are. That's on one end of the spectrum. On the other end of the spectrum are economic sensitive loans tied more to the economy. And so we've been pulling back on that for a while now. And so less growth will come from that. And then, our middle two categories are what we call economic resilience and economic resistance, sorry. And so we balance what we -- we balance our loan growth into those categories to ensure that we can grow in a very balanced and safe manner.
And as I said, we've been doing this for several years now. So entering into a downturn, there's an intellectual curiosity on our part that I think we prepared the balance sheet the stresses that are going to come forward. Tim?
I'd like to tie back to one thing that you said when we talked about ACL. It's important that's foundational to the way that we underwrite here. We have a short tenured portfolio very deliberately. We underwrite in the current economic circumstance. We underwrite within our line of sight. Underwriting to a short tenor permits that. It also lets us reset those assets that are on our books in an appropriate way based on the current economic circumstance. So it all really ties together.
Your next question comes from Gary Tenner of D.A. Davidson.
I wanted to say kind of the flip of the peak margin question and just thinking how whether it be next year, 2024, if we get lower rates, anything -- any thoughts around doing anything to protect some of the margin gains that you're going to generate over the next several quarters in that scenario?
Sure. Sure. I mean sometimes those are more difficult to time without [indiscernible] of hindsight. But we would, we would look for that. We put on a few billion dollars of swaps when we could get term swaps, 3-year deals for 8 basis points. And that seems to have made sense now, obviously, in retrospect. So we have multiple ways to do that, one of which, of course, is just to shift the mix of what we're engaged in. So we maybe go back to a heavier residential component then. We could also put in swaps. I think -- what I think is most attractive about our business model is our ability to pivot that we have these different business lines.
And just like during the pandemic, when things change, rates fell, everyone else is pulling back on credit, we said, okay, let's go to capital call, let's go to residential real estate, really safe assets and we sustained loan growth throughout that period of time. I think we're going to make a situation that you mentioned on the timing. I think it's probably before the presidential election that we'll see -- certainly see a turn. I think we'd like to be in that scenario and we may play that card again.
All right. And then secondly, just in terms of -- I wonder if you could kind of provide any progress update there in terms of integration launch, etcetera and you kind of customer reception at this point?
Well, sure. So we have some clients on it. I would say that it's still under beta testing of some sort. So we're -- it's not a big number. We didn't talk about it for that reason. We have nominal kind of deposit balances from that space presently. But we're -- despite the volatility that's taking place, we think there's probably a big opportunity for stable coins in financial services going forward.
Your next question comes from Jon Arfstrom of RBC Capital Markets.
A couple of quick ones. Can you go back to the message you want us to take away on Q3 expenses, Ken? You kind of alluded to it but I just want to make sure I understand it. It sounds like you're talking about a step-up in Q3. I'm just curious how material you want us to think through that? How material is that?
So expenses are going to rise as deposit costs rise and the impact of the ECR changes that are happening at the end of Q2 take hold into Q3. And as I said, those deposit costs are going to earn their way back to the bottom of the P&L through net interest income. And so I guess, I would tell you, don't get posed and always look at the efficiency ratio here because it will move up in Q3 but it will then come back down to about where we are now in Q4. So for us, it's looking at the net interest income that's being generated from interest expense and incremental deposit costs. As we said in Q2, that was a 3:1 ratio. Probably as we go forward, in Q3 and Q4, that ratio will compress somewhat. It won't be 3:1 but it should be above 2:1, 2:2.5. And so that's what we're focused on. And just to -- you give me a platform here, Jon, so I'm going to take it and that is -- we are just focused very heavily on net interest income growth and pushing that net interest income growth down to the bottom line and preparing us also for 2023.
Okay, got it. I appreciate that. And then last one, I think this is probably a platform for Dale. But in that -- your comments about capital and your TCE ratio and AOCI impact. You talked about not marking the low-cost deposits. Two-part question. Do you feel like the TCE ratio where it sits now, does that limit you at all in terms of how you run the company? And then the second thing is what kind of value would you put on your deposit base?
No, I don't think the TCE ratio limits our capacity. I'm sure you're aware, there's a number of banks, including some of the global SIFIs that are a point below us or nearly a point below us. So we think there's kind of latitude there. Ours hasn't been primarily driven by the AOCI mark. We have had strong hope but I think that can come down. I think the kind of the regulatory view, the one that we're focused on is really [indiscernible] is risk-weighted assets and that's kind of the CET1 level. So yes, we feel strongly about that.
I'd say we target at or around 9% for CET1, Jon and that's what we're more focused on. And that drives us to making decisions about risk-weighted assets which drives us to the CLNs. It all gets combined together which drives us to ensuring 27% of our portfolio. So when you take down the waterfall thought, that's how we think about it when you think about a 9% CET1 ratio.
Okay. And then any bigger picture thoughts on your deposit base?
So yes, I mean, we've had a number of different initiatives that had, I think, strong success with. We've got some more queued up and we think we're going to have kind of continued growth with what we've had already. We acquired digital disbursements in the first quarter. We're still seeing that kind of come into provision in terms of accelerating that performance. And our philosophy has been having a strong stable kind of core deposit franchise, it really gives you the opportunity to underwrite good credit. And that hasn't changed. That's been going on for quite a while, a few years. And we expect that to kind of rebalance with where we've been in loans going forward. So we're looking forward to it. We think this is a good opportunity for us to shine. The volatility is something that we can make our way through, we think, better than most as we have more opportunities to pivot more appropriately.
There are no further questions at this time. I'll turn the conference back over to Ken Vecchione for closing remarks.
Yes. We're very pleased with the quarter. We like the results very much and we look forward to talking to you on our third quarter earnings call. Thank you all and have a great day.
Ladies and gentlemen, this does conclude your conference call for today. We would like to thank everyone for participating and ask you to please disconnect your lines.