Western Alliance Bancorp
NYSE:WAL
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Western Alliance Bancorp
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Good day, everyone. Welcome to the Western Alliance Bancorporation’s Second Quarter 2023 Earnings Call. You may also view the presentation today via webcast or the company’s website at www.westernalliancebancorporation.com.
I would now like to turn the call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Please go ahead.
Thank you. And welcome to Western Alliance Bank’s second quarter 2023 conference call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; and Dale Gibbons, Chief Financial Officer; and Tim Bruckner, Chief Credit Officer.
Before I hand the call over to Ken, please note that today’s presentation contains forward-looking statements, which are subject to risks, uncertainties and assumptions. Except as required by law, the company does not undertake any obligation to update any forward-looking statements.
For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, please refer to the company’s SEC filings, including the Form 8-K filed yesterday, which are available on the company’s website.
Now for opening remarks, I’d like to turn the call over to Ken Vecchione.
Thanks, Miles, and good morning, everyone. As usual, I will make some brief comments about our financial results and action items, and then I will turn the call over to Dale who will review the quarterly results in more detail before opening the call for Q&A. Our Chief Credit Officer, Tim Bruckner, as Mile said, is here with us as well.
In many ways, this quarter represented a transitional period for Western Alliance following the events of mid-launch as our firm and our clients increasingly return to a sense of normalcy. We continue to successfully execute on the balance sheet repositioning strategy we laid out last quarter, we exceeded our liquidity guidance by growing deposits by $3.5 billion and repaying over $6 billion in short-term borrowings.
For the second quarter, WAL generated total net revenues of $669 million, net income of $216 million and EPS of $1.96. We maintained strong profitability with return on average assets and return on average tangible common equity of 1.23% and 18.2%, respectively, which grew tangible book value per share by $1.53 to $43.09 or 18% year-over-year and we will continue to support building capital levels in the quarters to come.
We achieved significant progress on the immediate- and short-term objectives identified last quarter to establish a sound foundation for WAL to sustain ongoing client and financial success. Notably, deposits grew $3.5 billion and exceeded our $2 billion quarterly guidance.
Growth was diversified across business lines and included risk core deposit growth from new and returning customers. Net liquidity growth of $2 billion allowed us to significantly reduce higher cost wholesale borrowings.
WAL continues to expeditiously execute our balance sheet repositioning strategy and completed $4 billion in total asset dispositions in Q2, which included $3.5 billion of loan dispositions ahead of the $3 billion outlined in Q1.
Meaningful deposit growth and asset disposition drove WAL’s loan-to-deposit ratio to 94% and allowed us to rapidly reduce reliance on higher cost FHLB borrowings by $6.1 billion over the quarter. I am proud to report core deposits have rebounded another $3.2 billion quarter-to-date, meaning WAL’s deposit levels are now $600 million above our year-end 2022 balance.
CET1 capital of 10.1% increased from 9.4% on March 31st and 8.7% or 140 basis points since Q3 2022. When we initially announced the Bank’s capital building initiatives through organic capital generation without equity issuance.
Finally, we continue to focus on meeting our core client banking needs in order to cultivate strong long-term relationships, leveraging third-party products to significantly grow reciprocal deposits has lifted our insured and collateralized deposit levels to 81%, one of the highest among large U.S. banks.
As we move through the back half of the year, we believe Bank investors will place more emphasis on balance sheet strength, stressing the fundamentals of growing capital, improved liquidity, deposit cost composition and granularity, stable asset quality, moderate and thoughtful loan growth and producing predictable and sustainable PPNR.
Bank diversified funding strategy continue to focus on growing attractive funds from a diverse set of clients and channels in order to prioritize repayment of the more expensive wholesale funding sources and then to optimize deposit balances of lower cost sources to deploy into superior risk-adjusted lending opportunities as we have done historically.
Driving the $3.5 billion of deposit growth with significant new and return of customer activity throughout Western Alliance. In Q2, we attracted $1 billion from approximately 1,000 new and returning commercial relationships as an attractive average total deposit cost of 1.98% with notable contributions from mortgage warehouse, regional banking and settlement services.
Over $400 million of net new deposit money was in non-interest-bearing DDA. Our commitment to foster multiproduct customer relationships has been the key to onboarding new deposits in a very competitive environment. Additionally, we will utilize other diversified sources of projects to accelerate repayment of wholesale borrowings and returned to prudent DDA.
Our recently launched online consumer channel is demonstrating steady progress, providing another source of uncorrelated liquidity and generated approximately $700 million this quarter at attractive rates compared to the marginal cost of repay borrowings. Going forward, continued deposit channel optimization and growth, new and returning core client commercial relationships will lower the proportion of funds generated in brokered CD volume.
Now Dale will take you through our financials.
Thanks, Ken. For the quarter, Western Alliance generated net income of $216 million, EPS of $1.96 and pre-provision net revenue of $282 million. Net interest income decreased $60 million during the quarter to $550 million, mostly from elevated higher cost to return borrowings that were materially reduced near quarter end. Q2’s net interest income should be considered a trough in which Q3 and Q4 levels should ascend.
Non-interest income increased to $119 million from an adjusted level of $102 million in the second quarter. As a reminder, loans marked in Q1 and a net loss of $141 million as part of our balance sheet repositioning efforts, responsible for negative fee income last quarter on a reported basis.
On an operating basis, non-interest income was $18 million higher from Q1. The green shoots we signed with mortgage last quarter were evident again in the second quarter as AmeriHome revenue increased to $13 million to $86 million.
We remain cautiously optimistic, continued stabilization, improving margins and profitability momentum is sustainable as AmeriHome capitalizes on the exit of a major competitor from the correspondent lending channel earlier this year. Production margins widened closer to normalized levels of 43 basis points as the industry has rationalized and win rates continue to improve.
Other non-interest expense growth was driven by higher insurance costs related to elevated insured and broker deposit levels, which also include core reciprocal deposits above a certain threshold.
Recent expense of $22 million is indicated by return to a normalized credit environment, we remain conservative on macro assumptions and as a commercial bank and the outlook for commercial real estate is a key driver that informs our opportunity.
Our allowance for credit losses modeling assumes an 80% likelihood of a recession using Moody’s analytics scenarios. A lower tax rate was beneficial to earnings this quarter and we expect to go forward a normalized rate as an average of the last two.
We made substantial progress in our balance sheet repositioning and surgical asset disposition efforts in the second quarter to accelerate higher capital and liquidity building. These dispositions complemented our organic earnings and contributed approximately 43 basis points of incremental CET1 capital. $4 billion of asset dispositions were completed, including loan sales and runoffs, primarily in equity fund resources, syndicated loans and mortgage warehouse businesses. The equity credit resource [Technical Difficulty] fully unwound.
Loans held for investment increased $1.4 billion to $47.9 million and deposits increased $3.5 billion, which brought balances to $51 million at quarter end. Mortgage servicing rights balances of $1 billion rose 11% during the quarter.
Total borrowings were reduced by $6.3 billion to $11.5 billion due mostly to paydowns of federal loan bank borrowings. At March 31st, the remaining EFR credit-linked note was also fully redeemed, which completed the unwind of $542 million of CLNs year-to-date. Deposit momentum has continued into the third quarter as deposits are $3.2 billion higher for June 30th.
Total held for investment loan growth of $1.4 billion consisted of $700 million of organic loan growth, primarily from mortgage warehouse, regional banking divisions and resort finance. Improved liquidity from deposit growth well in excess of loan growth allowed us to reclassify $100 million [ph] of held for sale loans back to held for investment, which will improve the company’s return profile.
Deposit growth of $3.5 billion resulted from remixing the deposit base into interest-bearing DDA from savings and money market, as well as CD growth from client promotions and brokered CDs. Non-interest-bearing DDAs comprised a third of our total deposit mix with approximately half having no cash payments of earnings credits.
Turning now to our net interest drivers. The securities portfolio grew $1 billion to $10.1 billion as we look to bolster our high quality liquid asset balances. The yield expanded 8 basis points to 4.76%, largely from floating rate produce benefiting from higher rates and should continue to benefit from higher reinvestment rates is approximately $1.3 billion securities are expected to mature in the second half of this year, $1.1 million additionally in 2024. The spot rate for the entire portfolio was 4.85% at quarter end.
Held for investment loans increased $1.4 million and the portfolio yield increased 20 basis points to 6.48% at quarter end, the spot rate was 6.74%. Interest-bearing deposit costs rose 33 basis points to 3.08% on a $3 billion or a $3 billion increase to $34 billion. The elevated costs resulted from a higher interest rate environment, which offset more tempered non-interest-bearing demand deposit growth.
Total cost of funding rose 58 basis points to 2.5% from higher utilization of wholesale borrowings at an average cost of 5.6%, $6 billion of these borrowings were repaid, which gives a $3.4 billion difference between average and end of period of balances.
Optimizing the funding mix with more core and reciprocal deposits in conjunction with the $6 billion of Federal Home Loan Bank of paydowns, which occurred later in the quarter. Adjusting just for improving funding cost to support our net interest margin line.
Moving down further into our funding base we have actively utilized reciprocal deposit channels to drive growth and provide greater insurance coverage to larger depositors. 62% of broker deposits consist of sticky reciprocal deposits. We believe these core client relationships have been fortified through this product enhancement, making them exceptionally stable.
Overall, net interest income decreased approximately $60 million or 9.8% over the prior quarter due to compressed net interest margin and average earning assets declining $562 million, mostly stemming from balance sheet repositioning actions.
Net interest margin compressed 37 basis points to 3.42% with a higher interest expense from outsized higher cost borrowings. This excess liquidity is generated with deposit growth greater than loan growth in non-AmeriHome held for sales are liquidation. We expect to paydown additional repo lines costing SOFR plus 2% that should contribute to funding cost tailwinds. The effect of these dynamics can start to be seen in the expansion of the June NIM to 3.5%.
Our efficiency ratio of 57% improved by about 500 basis points from the second quarter though our adjusted efficiency ratio increased from 50% -- to 50% from 43% in the prior quarter. Higher insurance costs and elevated brokered and insured deposits, as well as lower net interest income from increased interest expense were the main reasons for this change. We still view mid- to upper 40s adjusted efficiency at the right level and expect expenses to align with our core run rate of revenue as we look to optimize additional work streams throughout the bank.
Pre-provision net revenue was $282 million during the quarter. Solid profitability was sustained with the Q2 return on average assets of 1.23% and return on average tangible common equity of 18.2%. Strong PPNR provides capital flexibility to absorb provision expense and credit losses support, while still growing the balance sheet and attaining higher CET1 capital levels.
Given the increased attention on the commercial real estate sector, we are providing additional details on our CRE investor and office portfolios, as well as our overall early identification and elevation credit mitigation strategy. This proactive migration approach has historically produced lower loss convergence.
Our CRE investor underwriting strategy rests on a foundation of low loan-to-cost underwriting in submarkets where we have deep experience with strong financial sponsors. As a reminder, our financing structures carry no junior liens or mezzanine debt, which enables maximum flexibility in working with clients and sponsors. We have low uncovered tail risk since 92% of the portfolio has LTVs below 70% and these LTVs are based upon the most recent appraisals and assuming commitments are fully funded.
Within commercial real estate office [Technical Difficulty] Within commercial real estate office accounts for just 5% of total loans. We have previously discussed our focus on shorter term bridge loans repositioning office projects in suburban areas. Our exposure to the two central business district areas that we believe are most vulnerable to overall risks are minimal to just 3% of office loans.
We have re-designated some midterm exposure away from the CBD classifications is in our view [inaudible] in these markets make them less acceptable to work from home risk present in larger cities. For example, we do not have CBD office loans in New York, Boston, Chicago, Atlanta, Houston or Dallas.
Looking at LTVs, you will know there’s only 3% of office and then 80% or greater loans of value in the line with our central business district exposure, primarily focused on in-demand Class A to B+ office properties and 94% of Class A properties have LTVs below 17%. The entire office book carries LTV of 55%. Finally, we are not facing a large maturity and while is approximately three quarters of the loans that come due in 2025 or later.
Turning to asset quality trends in light of the present environment and due to the sharp increase in interest rates over the past 12 months, we have completed a proactive comprehensive review of our commercial real estate portfolio which is reflected in loan migration this quarter.
As part of our early identification and early application trend and mitigation strategy has served us well, we proactively move loans into special mention when cash flow may be curtailed in the present environment despite having well-supported collateral values and access interest rates sponsorship remaining strong and the loan still turn.
We do this to ensure attention in monitoring the highest levels within our credit organization as we require the sponsors to re-margin the loan of established or satisfactory cash reserves to support our cash rating. This is an important element of our credit control process and established process for more than 10 years. As a result of these efforts, the special mention loans increased to $694 million or 145% of funded loans with $250 million or two-thirds of the migration coming from office and hotels.
Occupied assets increased to $145 million to 89 basis points of total assets. Also the increase in classified assets was driven by one $75 million office loan in Downtown San Diego, which makes up the preponderance of the central business district office exposure I mentioned. We don’t anticipate meaningful losses since this property is 82% leased, current appraisal exceeds the outstanding loan amount and all cash flow will go to paydown this credit.
Our proactive identification and resolution process results in lower realized losses over the last 10 years, less than 1% of special mention loans have become losses and within commercial real estate investor properties less than 10 basis points to special mention loans have migrated to loss.
And looking at the next two slides, you will see the results of our early identification and elevation, negotiation resolution process has resulted in best-in-class loss rates over the last 10 years. For us, the Western Alliance, it’s about the process, which sometimes produces earlier criticized and classified designations, but at the end of the day, leads to low net charge-offs.
On average, we have ranked in the top third among asset peers of adversely graded loans as a percentage of total loans and will be best ranking on losses. The difference between our ranking and adversely graded loans compared to our number one position of historical credit losses highlighting the success of our proactive credit mitigation strategy. Quarterly net loan charge-offs were $7.4 million versus 6 basis points of average loans compared to net loan charge-offs of $6 million or 5 basis points in the first quarter.
Our total loan ACL rose almost $13 million in the prior quarter to $362 million due to higher provisioning and low loan loss rates. Total loan allowance for credit losses of funded loans increased 1 basis points to 76 basis points in Q1, but is 94 basis points when loans covered by credit linked notes are excluded. The allowance for -- was 141% in non-performing loans at the end of the quarter.
We feel well positioned in an uncertain economic environment based on the business transformation since the global financial prices. Our loan portfolio is diversified across risk segments with almost a quarter of either credit protected, government guarantee or cash security and over half of the portfolio is either insured or resistant to economic volatility. These percentages aligned with ratings reported before we embarked on our balance sheet repositioning initiative late in the first quarter. Of note, our lower average loss rates in the resilient and more sensitive categories are indicative of conservative underwriting and highly responsive remediation actions.
We discussed reprioritizing cap -- and building capital back to premerger levels on our Q3 2022 earnings call. Since then, CET1 capital has grown from 8.7% to 10.1% and is up over 70 basis points since the first quarter. Our tangible common equity to total assets rose 50 basis points from the first quarter to 7%.
We remain committed to achieving a medium-term CET1 target of 11%, which we view as prudent considering the heightened regulatory attention regarding appropriate capital levels. We also expect increased excess capital will provide more financial and strategic optionality in the future.
Looking at the strong combination of insured deposits and high capital to make depositors comfortable with the stability of their financial institution, Western Alliance has materially moved it sure deposit levels to among the highest in the nation compared to the largest banks. Capital has also listed as a top third even adjusting for fair value marks in both the available for sale and held to maturity securities portfolios.
Inclusive of our quarterly cash dividend payment of $0.36 per share, our tangible book value per share increased to $1.53 in the quarter to $43.09. Western Alliance has compelling long-term intangible book value per share divergence from peers remains intact. This increased over 6 times out of the peer group since the end of 2013, which compound -- which leads to a compound annual growth rate of nearly 20% from economic cycles and market disruptions. This outperformance is still 4 times that of peers when adding common dividends back.
I will now hand the call back to Ken to conclude with closing comments.
Thanks, Dale. Our guidance for the rest of 2023 continues to be driven by the strategies and priorities laid out in our prior earnings calls. So let me tell you what you can expect from here. Regarding capital, having exceeded our immediate CET1 target of 10% in Q2, we expect continued, although, more gradual growth in our capital ratios towards a medium-term CET1 ratio target of 11% in 2024. This will be driven by our continued strong return on average tangible common equity and capital generation.
Core deposits are expected to grow at approximately $2 billion per quarter and exceed more muted loan growth by approximately 1.5 -- $1.5 billion. This will lower our loan-to-deposit ratio over time towards a mid-80% target.
Net interest margin is expected to rise modestly from our Q2 trough of 3.42% and land in the range of 3.5% to 3.6% for the second half of 2023 based on our successful repayment of borrowings this past quarter and the cost of new deposit funding.
Our efficiency ratio, excluding the impact of deposit costs should decline slightly to the high 40s given the reduced borrowing costs and higher asset yields. Asset quality remains manageable as it returns to more normalized levels. We expect credit losses to be 5 basis points to 15 basis points through the economic cycle. Overall, for the second half of 2023, we expect quarterly operating PPNR to remain consistent to Q3 results and begin to climb as we exit the year.
As we continue to reposition the balance sheet and continue to reestablish our core deposit and loan growth trajectory, we see Western Alliance as an even better institution and well positioned future.
We view our earnings performance being driven by balance sheet growth, improving margins and efficiency, along with continued strengthening in our mortgage operations that should result in quarterly operating PPNR consistent to Q2 2023 results and then grow thereafter.
At this time, Dale, and Tim and I are happy to take your calls -- your questions.
Thank you. [Operator Instructions] The first question will be from the line of Ben Gerlinger with Hovde Group. Your line is now open.
Hey. Good morning, everyone.
Good morning, Ben.
I was curious if we could -- I mean, I am sure we are going to get a lot of questions on credit, because deposits seem to have cleared themselves up. But if we can just take a moment to kind of just walk through the guidance a little bit further. I was curious on, what are you guys assuming for this average earnings assets for the back half of the year with that margin guide and it seems like you already have that spread difference of plus $2 billion per quarter, which gives you $4 billion in deposits, and then on loans, it’s plus $1 billion. So you already have that $3 billion essentially now. Can we see paydown of debt pretty immediate in the third quarter or do you think it’s a bit more granular throughout the second half of the year?
Well, we still have a couple of billion dollars that fund our $2 billion that we have in our held for sale loans with repo relationships with another commercial bank, and those loans and those funds that we have borrowed from them cost us SOFR plus 200 basis points. So paying that down with some of the liquidity we bring in is going to help improve our net interest income, but doesn’t really change earning assets.
But in addition to that, we do expect that a portion of these dollars we are going to -- we bring in are going to be used to provide new credit opportunities to our clients and so it’s going to be a combination of two. So I am looking for earning assets to continue to climb, but not as fast as the deposit growth.
Got you. Okay. That’s helpful. And if we could just take a moment, I think, just kind of holistically about credit here, it seems like you have got a decent amount of NPL increases and the reserve was essentially the same, a modest uptick. So with credit like not being a little bit less of importance, now that we have kind of had a strategic repositioning, how do we think about the allowance going forward in terms of like a GAAP percentage relative to loans?
Well, a couple of things. I mean, in terms of what the ratio is. I think it’s really important to note how much -- what our charge-offs have been and why that number maybe screens lower relative to other institutions. We don’t have consumer loans, which have a constant burn rate of losses, and in addition, we -- I mentioned the Moody’s scenarios.
Well, so we took 60% of their consensus forecast. That is -- that has two consecutive quarters, third quarter and fourth quarter of this year of a recession in it. And then we took 20% weighted on S4, which is the severe recession, whereby you are seeing contraction in commercial real estate values in excess of 30%.
What’s important about that is because we are a low advance rate lender, even with significant reductions in terms of valuation we still don’t incur losses because our borrowers still has skin in the game, they still have equity that they want to protect and they are still willing to negotiate with us in terms of how we can come to a solution set together. So it’s really, if we ended at a much higher rate, we wouldn’t be in that position, but because our low advance rates has been really key to our strong asset quality.
But if you are asking a question about the provisioning going forward, I would say, it’s about in the same vicinity going forward as Q2 is provisioning for Q3 and Q4.
Got you. That’s very helpful color. Great to see you guys go from defense to offence so quickly. Appreciate the color, guys.
Thank you.
Thank you. The next question will be from the line of Casey Haire with Jefferies. Your line is now open.
Yeah. Great. Thanks. Good morning, guys. Just want to follow up on the borrowing paydown. So just you guys have a PPNR guide of around $280 million, what you have here in the second quarter. Just wondering the pace of what the guide assumes for borrowing paydown and timing as well, like, how low does that $10 million go?
Well, I don’t have a number for you, Casey, exactly. What I would say is, we are trying to do two things here. One is paydown further, particularly in the more expensive line as I mentioned, but secondly as well, to provide more liquidity for our clients.
So the combination of those two. So it’s going to -- I don’t have a number in terms of what exactly that looks like. That’s the trajectory we are on. That’s the trajectory we started to be on in the second quarter and I think we are going to be more focused on that as we complete to 2023.
Okay. And given your -- given the progress you guys have made on the deposits quarter-to-date, which is pretty strong. Have you -- has there been any paydown quarter-to-date? You are making use of that deposit growth, like do you have a borrowing balance as of July 17th?
Yeah. This is Ken. Yeah. We do. Let me just take you through the deposits. Yeah. We are seeing great deposit growth so far early into the quarter. To remind everyone that the natural flow of our deposits, they grow early, and just about in the next couple of days, we are going to see some paydowns coming from our warehouse lending group for P&I and T&I accounts and so that those deposits will shrink, okay?
So for us, we have the borrowings scheduled to be paid down, probably, closer to the back end of the quarter as a safer way of thinking about it. As we grow our deposits to $2 billion, we actually hope we can do better, but as we grow our deposit growth to $2 billion.
Okay. Very good. And just, I guess, switching to the dispositions about $1.8 billion left, so apologies if I missed this. But is -- can you get that done this quarter and within the original fair value mark of 2% that you took?
We have updated our marks. We think that they are good. What we did initially, I think, proved to be pretty accurate. I don’t think it’s all going to get done this quarter, but we expect to make kind of significant progress on that, and as I mentioned, that will be coincident with paying down higher cost, I think.
Okay. Dale, any color on what’s causing the delay, because I mean, what’s left does not look like a lot of high risk stuff for you guys?
What?
Let me take it. Hi. Tim Bruckner. Yeah. We are actually receiving much stronger values on some of these discrete single note sales related to some of the assets, and just in the normal course, that takes a little bit longer than doing a large pool of sale.
I just want to…
Got you.
…make…
Thank you.
Thanks for the question, Casey. But we were pretty early in moving assets to HFS and I think our aggressive fostering of that helped us keep the dispositions inside of our marks and that’s sort of the hallmark and the culture here at the company and which connects to the asset quality that we are approach that we take as well.
So we tend to be early on everything and try to execute early on. We have found whether it’s disposition of assets, whether it’s asset quality and talking to clients being there early, being there first, produces better results. So I just wanted to add that little color commentary.
Great. Thanks, guys.
Thank you. The next question will be from the line of Bernard von-Gizycki with Deutsche Bank. Your line is now open.
Yeah. Hi. Good morning. So on slide five of your presentation, you showed some nice detail on the growth drivers of that $3.4 billion of deposits during the quarter. It looks like, as you mentioned in your prepared remarks, about $1 billion in core deposit growth with the new and returned client deposits and existing client net growth. So that’s about one-third returning funds and two-thirds new money. So that mix is right, is this the type of mix between new money and returning when you would expect, say, over the next few quarters, potentially improve over time and maybe if you could give us a sense what that mix was for the $3.2 billion you noted quarter-to-date?
Regarding where the funds still come from. I think that there’s -- there are some clients that were really waiting for our second quarter results, wanted to make sure that the noise related to Q1 is cleared, there weren’t other kind of financial institution failures during this kind of interim period.
And so I think we have a strong ability to pull in funds for -- in the near-term for some of the returning clients. That, of course, will diminish over time when there’s less bunch of return to begin with.
But at the same time, we can gen up again some of our deposit business lines, which were a little hamstrung after what happened in -- with the Silicon Valley Bank. So some of the initiatives particularly in settlement services and our corporate trust operation, clients gave pause after seeing what had happened to that institution and so that’s not new -- that’s not old money returning, but that is an acceleration of new opportunities.
Yeah. I would take that question and just maybe add a little bit different perspective or, I think, observations, which is the March disruption really disrupted our pipeline going forward and we had a very, very strong pipeline in business escrow services, in corporate trust, let’s just say, corporate trust was a developing pipeline, but really in settlement services and so the disruption in March actually disrupted our pipeline.
We are seeing that pipeline reappear, it’s stronger. As Dale said, a lot of people wanted to wait until we were announcing our quarterly earnings. I think that will make people feel comfortable and we have some great deal of comfort on that pipeline returning, which gives us comfort to the $2 billion guide that we have put out there for deposit growth.
So I think what you will see is besides the regions which are seeing healthy deposit growth and also led by Bridge Bank in our tech and innovation space and we will see growth come for the rest of the year in business escrow services, in settlement services, in HOA. By the way, those are three standalone deposit channels, which we have been developing over the past couple of years and also in our online consumer platform as well.
Okay. Got it. Thanks for that color. Just as a follow-up. I am just wondering, I believe a big chunk of the deposit growth was also in CDs. Just curious, how far are you going on, say, some of the promotional pricing, given you and the industry are leading with rates paid, just given the current environment. Just trying to get a sense of how much of these balances can be sticky or how can you deepen the relationship so these deposits to become sticky?
I mean, on the broker element, I wouldn’t call those sticky. However, I would call them cheaper. So what we borrow from some of these credit lines, as well as from the Federal Home Loan Bank are at -- those rates are higher than the brokered CD channel.
In addition to that, brokered CDs do not consume liquidity opportunities. So if we borrow, we have a credit line that over $10 billion from the Federal Home Loan Bank. But as you borrow against it, you have less availability. To bring in broker deposits that cost less and it leaves that availability open.
So this is something we are going to wean ourselves down from over time, but you are not going to see it chop off during the third quarter. But all the guides that Ken mentioned that we have in terms of our deposit growth, respectively, does not assume any broker deposit increases from where you were at June 30th.
Okay. Great. Thanks for taking my questions.
Thank you. The next question will be from the line of Steven Alexopoulos with JPMorgan. Your line is now open.
Hi, everybody. I wanted to start…
Hi.
… and drill down a little bit into the $3.2 billion you are calling out through July 17th. What’s the rough composition of that, are those more new and returning client funds or using any brokered there, and very roughly, what’s the cost so far?
As it relates to the composition, it’s very little is coming from the broker CD channel, as Dale mentioned, is actually zero. Where you are seeing it come from is our warehouse lending and no financing group, which generally builds up in the early parts of the month and then pays down towards the third week and then restarts its build process in the fourth week.
So you are seeing those funds come in. Generally, they are non-interest-bearing deposits. They do carry ECR credits, which we will see in the operating expense. We also are showing very early on signs of a very strong HOA deposit build as well. So primarily that’s where the funds are coming from.
I think there’s also been some repatriation from our tech group. We did have losses from that in March and those dollars are up month-to-date as well.
Yeah. I think, Dale, brings an important point on the tech group. There’s been a lot of disruption with the demise of SVB there. And our brand Bridge is a steady consistent player in that market and what you are seeing is a lot of disruption with clients, with former people that had worked at SVB and their new companies establishing their operating processes and credit policies.
Now that has all been established for us and people know our players and they know the type of bank we are and I think that’s going to lead to more deposit growth out of Bridge, which is going to support the overall regional deposit growth as we move forward.
Got it. That’s helpful. I am curious, in terms of the deposits that left in the aftermath of SIVB, what rough percentage would you say of returns, is it like 5%, is it a material percentage at this point? And then what are you hearing from, one, the customers are returning, I think, you mentioned there, they were waiting to see your 2Q numbers. But -- and then for the customers that haven’t returned, what are you hearing from them why they haven’t returned yet?
Well, yeah, I mean, I am going to say roughly 30%, maybe a third have come back and why haven’t they, why haven’t we seen more? I think a lot of them -- I mean, some of these are related to particular types of actions.
So I will give you an example. In the settlement services, you might have a settlement on and then that’s moved to another institution and what we get back is the promise that, we are not going to move that one back, but future settlements will come to us. I think that’s part of it.
I think that there was some question about what’s the new landscape going to look like? I think it’s well publicized that SVB had a policy, if you got a bank with us and you can’t take anywhere else. That has proven to have been kind of damaging and damaging to some of these franchises and so some of them are like, okay, we were banking with you as most of them are just single entity institutions and now they are building relationships at two or three banks.
Yeah. The other thing is back to, we recaptured one large client that left us out of warehouse lending. And in bringing that client back, they have a lot of funds in what we call P&I, principal and interest accounts and those build up rather quickly come down, pay build up come down every month and it just oscillates back and forth.
Well, when we went back to them and establish the relationship, we now took in T&I, tax and insurance accounts, which have a more steady stream to it. So what we have also done here is traded off volatility of volume for more consistency and we have done that, too. So as we bring clients back, we are trying to get better quality deposits longer term and stickier, and so this has allowed us to have a lot of great conversations with our client base.
But I can tell you, I spend more time with depositors in meetings that feel like an earnings report. That’s what we did coming out of Q1 and in Q2. Now that has all changed and it’s about really the growth of the relationships, the growth of the business and how we work together. So that’s some color there.
Well, this quarter should help those conversations. Final question...
Yeah. We are seeing the pipeline build.
Yeah. Even with the increase in more expensive type funding, if I just look at the sequential roll in both interest-bearing deposit costs and total funding, these are decelerating pretty nicely over the past few quarters. Do you guys expect that trend to continue through the back half of this year? Thanks.
So that’s what gives us a little bit of comfort to provide the net interest margin guide going up. And again, as you saw June was 3.50% and we think it rises from there and it also gives us comfort as to why we think net interest income is going to be higher in Q3 than in Q2. Only a modest part of that net interest income rise is coming actually from loan growth, because we are going to grow $500 million to $1 billion, probably, closer to $500 million is a good number to use. That’s going to come in ratably across the quarter. So you won’t see that benefit until Q4. So most of the growth in net interest income for Q3 is really coming from minimizing the rise in cost of funds which we are very excited about it.
Got it. Okay. Thanks for taking my questions.
Thanks, Steve.
Thank you. The next question will come from the line of Chris McGratty with KBW. Your line is now open.
Hey, Chris.
Oh! Great. Thanks. In terms of the PPNR guide, you addressed the net interest income component. I wonder if you could spend a minute on both the expenses and the AmeriHome aspect of just getting a full circle on PPNR. Obviously, the deposit and the insurance lines are biased both comment there and then also kind of comments on the gain on sale margins approaching normalized, is there room to go there on AmeriHome? Thanks.
Okay. So AmeriHome generated about $88 million of total banking revenue. For us, we modeled that out at about the same amount for Q3 and Q4. I will say it is early on, it’s only 17 days or 18 days into July, but they are having a very, very strong July.
And why is that? Well, production margins are stabilized and actually returned to more historic levels. So they are running closer to 43 bps, 44 bps, 45 bps. And what we saw was the retreat of one very large money center bank from a correspondent lending market, combined with the industry capacity rationalization has paved the path towards higher margins, higher win rates and that’s what’s giving us a good deal of comfort.
With that, we are also building an MSR, which gets valued and is producing double-digit returns and so with growing our capital allows us to bring in more servicing income. So that’s the AmeriHome story. So for us, it’s a steady total mortgage banking revenue going forward with potential upside given what we are seeing in the current market. That’s how I would describe AmeriHome.
Related to the expense efficiency or our locally adjusted expense efficiency, we see that over time coming back into the high 40s. But I think what’s very important here is that, remember that WAL has always made investments with a viewpoint towards longer term returns for its business, product service development. We focus on generating consistent earnings with the appropriate returns.
And so over the last several years, what we are talking about today is escrow services, settlement services, corporate trust, the online consumer platform and the growth -- the continued growth in HOA were all funded by consistent expense investments in our P&L.
So we are going to balance the efficiency ratio for future growth, as well as looking to -- into our PPNR guides and our PPNR guides are at the high -- consider the adjusted efficiency ratio to remain at the high -- in the high 40s to achieve the PPNR guide that we have given.
Chris, I mean, I think, we have had a reputation that we are pretty efficient. We have been in the low 40s for a number of years and now we find ourselves elevated from that level. But we have also grown very quickly during that period of time and it’s just natural as one is in kind of a strong growth mode that some things are done that aren’t as efficient as they could have been structured or organized at that time. We are going through a process now to streamline that and look through some of these elements in terms of whether it’s vendors or consultants and things like this that we think also can push down some of these extra costs that we have had in our operating expense line.
That’s great color. If I could ask a follow-up. You talked about net interest income growing exiting the year. If I take a step back and think about PPNR, the stable number for the back half of the year. As the balance sheet normalizes and everything gets back to normal, is the expectation that the PPNR dollar should grow off that low 280s [ph] as we enter 2024?
Yeah. So the way I would think about it, it’s a little more stable in Q3 as we look to paydown our borrowings and we maintain that Q3 to Q2 and then seeing that begin to rise in Q4 as we exit the year into 2024.
Okay. But as you get into the fourth quarter and then during next year, if everything else is considered with the balance sheet and your PPNR should grow again in 2024?
Yeah.
Okay.
Right.
Okay.
Saying it should grow in Q4 and then it will continue on from there.
All right. Thanks, Ken.
Okay. Thank you.
Thank you. The next question will be from the line of David Chiaverini with Wedbush. Your line is now open.
Hello, David.
Hi. Thanks. I wanted to -- hi. So I wanted to follow-up on the expense question. So you mentioned about optimizing work streams through the bank. Could you elaborate on that, are we talking kind of trimming on the edges or are you contemplating exiting any businesses?
So we are talking about trimming on the edges here predominantly. And some of the expense savings that we are going to find throughout the company will be repositioned into risk control, risk management infrastructure.
I think you have to keep in mind that the regulators have clearly signaled this that they are going to have a higher standard or supervisory review for banks under $250 billion, but above $100 billion, but I think they are going to drop back below $100 billion.
And as we continue to grow, we need to be prepared for that and we have been preparing all along, but some of that expense savings we are going to take and we are going to reinvest in the risk control infrastructure that we are going to need to cross $100 billion. We would rather do it early on and have a steady growth of expenses related to that rather than to wait and try to put it in just before you get to $100 billion.
So David, so we are going to see some of the work stream repositioning in terms of lower cost of sale that vendor management eliminating growth in FTE that we don’t need. That’s like cutting air. That will help us a little bit.
And then looking at vendor management, using technology, a lot of those cost savings will be repositioned into the risk management side, so we can continue to grow unabated as the rules change for the $100 billion and above and the $100 billion and below banks.
Thanks for that. And then a follow-up on credit quality related to the increase in special mention loans. What does it take or what do you have to see for you to designate a loan as special mention? Does the borrower have to triple covenant for that to happen and what actions do you take with a borrower after it goes on special mention?
Let me take this one. Thank you. Tim Bruckner and this is something that worth. I am pretty proud of. Dale mentioned throughout the initial discussion comments, there’s a few things that are just foundational to our credit process.
First, in all areas, we assess risk is covered and uncovered, okay? So we really minimize tail risk by that. Covered means you have gotten out always by collateral. Early identification and elevation are key and then time is of the assets and solving problems. We manage tail risk by managing our uncovered exposure by getting to that early. To do that, we have to be pretty mechanical in our process.
So to answer your question directly, in all cases, special mention loans are current and paying as agreed. So special mention at the regulatory definition means potential weakness, not default or late payment. So we are not looking for a monetary default.
We are looking for situations where there might be potential weakness so that we can elevate those within our credit architecture and make the appropriate changes before those become problems. So we use special mention to elevate the situation and drive to a satisfactory resolution before we are dealing with a default or a late payment.
Another thing that you can say here is everything that’s in special mention, we believe that we are going to reach that resolution, which would be a satisfactory re-margining or additional support from sponsorship that would return that to pass or we have that credit and substandard. So that’s how we use the category is mechanical in our process. Thank you.
Thanks very much.
Thank you. The next question will be from the line of Timur Braziler with Wells Fargo. Your line is now open.
Hi. Good morning. Thanks for the question. Most have been asked and answered, but just looking at the loan growth this quarter, I guess, a surprise to the upside. Just curious as to what drove that? How much of that was kind of contractual funding, and as you look forward, what gives you confidence in getting to that a $500 million number versus the growth that we saw maybe in 2Q?
Okay. Great. Well, the $1.4 billion of loan growth, you can break it in half, 50%, $700 million was really a re-class from held for sale going back into held for investment, which means that our deposit drive, our increase in liquidity did not necessitate us having to sell those loans and so we were pleased with that.
Then we had $700 million of organic growth this quarter and most of that came from the warehouse lending, but those financing MSR lines of business. And while that’s important is, those businesses carry, when we make credit decisions there, we usually get a fair amount of deposits that come along with this. So they almost self-fund themselves.
So that was the beauty of having that loan growth that it also drove our deposit growth, and as part of what we have been saying even from the last couple of calls that we are looking at a full client relationships and we are not -- no longer just giving credit and then worry about how we fund it away from the client. The client needs to have a full relationship with us.
As we go forward and what we may have what gives us some credit or our confidence, I guess, on the $500 million guide, we see a few areas that we are going to focus on a little bit more in C&I at this point, but we see MSR lending providing opportunity, no financing providing opportunity.
We do resort lending, which we think will provide opportunity and we are doing tech and innovation loans and these are small sized loans, our loan commitments under $15 million, where we see there’s a great opportunity to bring with it a great deal of deposits. So those are some of the areas that we are focusing on that gives us a comfort level to the $500 million guide.
Okay. Great. And then, now I asked this question last quarter and I think it may be a little bit early, but with some of the return of technology related customers. I guess where do you see Western Alliance fitting into the tech ecosystem going forward? Are you going to be playing a larger role in taking up some of the market share and on by Silicon Valley or should we think about the technology offering of Western Alliance similar to what it had been prior?
That’s an interesting question, a good strategic question. I think we are going to continue to play in the space that we have been playing in, which is usually Stage 2. We are not going to be playing and taking up the role of in early stage lending. That’s not what we do. We prefer to be in the middle stage and a little bit in the late stage. So that’s where we are going to continue to keep our focus.
I will say that what we are seeing is that current and prior SVB customers and bankers. As I said earlier before we continue to evaluate the changing landscape as both constituencies are making judgments regarding long-term commitments to the industry by new players and they are waiting to see how those new players, credit policies, operating practices will be administered.
For us, Bridge Bank, as I keep saying, is uniquely positioned as a known brand and a consistent player in the market and I think that approach is continuing to get traction. So I have some great expectations from our tech and innovation group, Bridge Bank in terms of deposit growth in Q3 and going into Q4 as we continue to be the steady player and the steady hand in that market that people can go to.
When they come to us, they know what our policies are, they know who they are talking to, they know what our credit decisioning process is, they know how to reach senior management and we have a track record with these folks. So we think it’s an opportunity for us and we are excited by it.
Okay. Great. And then just lastly for me, maybe following up on Bernard’s question for the some of the promotional products, just given how strong the deposit growth has been and the momentum you are gaining and bringing back some prior customers, I guess, why not pull back from some of the promotional rates this nearly kind of a near-term dynamic as you are continuing to build liquidity or are we still in an environment where the more the better regardless of the cost?
There’s a little bit of the more of the better, but maybe more significantly is those rates, which seem to be, I get the market rate pricing, but they are still less than what we are paying for other sources. So here we have a more stable source and it’s a lower cost and we are going to keep doing that.
Now over time, I think, we are going to be able to feed that. But so I -- but where we are headed is more liquidity is a good thing and to the degree we can do that, less expensively, we are going to do that. I just wanted to mention the timing on your note that was great earlier this week.
Thanks, guys. Appreciate it.
Thank you. The next question will be from the line of Gary Tenner with D.A. Davidson. Your line is now open.
Thanks. Good morning. A couple of questions. First on the -- as it relates to the PPNR guide, you talked about fees in terms of what -- how you are thinking about mortgage, but the service charge line this quarter increased from half to almost $21 million. I don’t recall you kind of mentioning that at all, just curious what the driver was there? I guess, ultimately, how is that level baked into the PPNR guide for the back half of the year?
Well, let me say it differently. Our total fee income, we are looking at, which is primarily driven by AmeriHome is going to stay consistent for the next couple of quarters. So when you think about the PPNR guide, I would say, fee income consistent with Q2, possibly with an hour upward if some of the early signs of mortgage income, success in July continues throughout the quarter and that’s what’s driving the PPNR guide that we gave earlier.
Okay. And then on the AOCI, Dale, I think, you mentioned about $2.5 billion of securities covered to mature back half of this year and through 2024. What amount of the kind of AFS related AOCI just based on maturities, would you expect to recover over that 18-month period?
Well, I mean, it’s -- I mean, obviously, those costs are related to kind of what the discount rate is. So if it’s that close to maturity and we have a yield that is less than what that looks like, then it’s going to be fairly short. I mean I think you really get dollar improvement on the AOCI and AOCI piece what we really need is we really need lower rates.
So it will roll going forward. If you take 18 months, we have a duration of four years on that. So you will take one-third of that back. So maybe a couple of hundred billion comes back, but not from maturities just from a slower or a shorter duration remaining on those securities with the four-year coming down by about a third. Regarding the service charge income, that, yeah, it is elevated from where we were and it’s going to continue.
Okay. And last question, if I could. In terms of the office or the investor office portfolio, can you tell us kind of what your allowance is specific to that portfolio?
Yeah. I can take that. Not counting -- well, accounting earnings were about $50 million. So…
5-0, sorry.
I am sorry, $100 million…
Also $100 million.
Yeah. I am sorry. I misquoted that.
Okay. Thank you.
Thank you. The next question will be from the line of Ebrahim Poonawala with Bank of America. Your line is now open.
Hey. Good morning. Just a quick follow-up. One, in terms of the margin outlook, as you talked about the third quarter NIM higher versus 2Q, does that trend continue into fourth quarter as we think about on a go-forward basis or could we see some volatility in the margin where 4Q could be lower and same with NII?
Well, what we are seeing is, I think, it’s almost certain that they are going to raise next week. We are a modest kind of asset-sensitive profile. So that should augment the NIM in that regard. More significantly kind of what we talked about a couple of times, the paydown in some of these more expensive funding sources. So I have talked about these lines that we have that are so far plus 2%.
We haven’t paid those down yet. I expect that we will be doing that significantly this quarter. I don’t -- I can’t tell you exactly when, but let’s say, we did it in August or September or we are going to see a follow-through effect on that into 4Q.
So, yes, I would expect that we should be looking for kind of continued improvement. I think its alluded to this, but he said there were PPNR number kind of flat for Q3 versus Q2, but then on a more positive trajectory as we go into Q4 and exit 2023.
Got that. And remind us, Dale, in terms of the actual loan book, how much of the loan book is yet to reprice in terms of just reflecting the currently backdrop, like, how should we think about loan betas going forward and repricing of the fixed rate book maybe?
Well, I mean, the fixed rate book is predominantly residential real estate and prepayment rates on those loans are quite low. So at some point in time, I mean, I think, probably, rates have to come down a little bit before those are really going to start to accelerate.
So aside from that, I don’t know that there’s a whole lot of repricing opportunity of the loan book. I think the securities book probably has more of where we have got to, as I mentioned, $1.2 billion for the back half of this year and another $1 billion next year. We have -- within the loan book, we have got another $1 billion that we can -- that is going to kind of roll in.
So I really think that the margin improvement and a big driver of the PPNR improvement is really coming from swapping slower cost and funding sources compared to some of the elements that we have supporting us today.
Understood. Thank you.
Thank you. The next question will be from the line of Jon Arfstrom with RBC. Your line is now open.
Hey. Thanks. Few questions for you. Tim, that slide 17, the asset quality slide. You guys talked about being proactive. What do you think those lines look like in Q3 and Q4? Should we be prepared for those to go higher or do you think that this proactiveness is going to keep those relatively flat?
Yeah. As a -- thanks. That’s a good understandable questions. I think relatively flat and I think that, because that’s been our experience with this approach and other cycles. We barring severe changes and we are already contemplating a tougher economy going forward. We have elevated the situations. We know them by name. We are not dealing with a large portfolio here in the absolute. We called those out and discuss it monthly. We don’t wait until a quarter and see the changes. So I feel comfortable saying relatively flat.
Jon, this is Ken. We also completed our Q2 a very exhaustive and comprehensive review of CRE office. So we did a very, very deep dive into that. As mentioned, I mean, we are looking at this with the future or a recession, which may or may not take place, but that’s they have to do that.
Yeah. Okay. Yeah. That ties into my next question and I guess instead of poking and prodding and I will just ask it. You guys are seeing stable PPNR and then relatively stable provision based on Moody’s and then the S4 weighting that you referred to. You guys usually give EPS guidance, is this the trough on EPS. I am looking at the $8.15 consensus for 2024. It feels like a layup, given what you just put up, but am I missing something on that?
Well, we are not ready to project on 2024. But, I mean, I think, the direction of what we have laid out for the third quarter and fourth quarter. I think we have good confidence in. We obviously hope that we can continue to execute in terms of bringing back lower cost funding and expanding our underwriting prospectively. I am not sure a recession is in the up. I think our expenses are -- don’t have a lot of elevation coming in them either. So I am optimistic to what the future holds here.
Okay. So said another way, Dale, it feels like there’s at least stability going into Q3, assuming nothing changes materially from a credit point of view?
Yeah. That’s a good assumption.
Yeah.
Okay. And then one more for you, Ken, kind of a fun question, but it’s been a hell of a four months and you guys have managed through it well, given the hand you had. But do you feel like there’s been any permanent damage done to your franchise, I know you mentioned Bridge and I think the different brands help. But do you think -- there is a pressure faded and it’s going to be a distant memory and you are back to normal or do you think there’s been some damage done?
So I don’t think there’s any permanent damage done, but I think there was a discussion is the word I would continue to use. It took us off of our trajectory of growth. We had to rely on wholesale funding for a shorter period of time. That’s why you are hearing all the answers about the rise in NIM, because we are going to swap out of these borrowings and bring in more deposits.
This was also something that believe it or not in Q3 -- on the Q3 earnings call of 2022, we had -- I want to say, anticipated that the world was going to change a little bit. We didn’t anticipate what was going to happen on March 9th, but we started to move into a slower loan growth, higher liquid growth with greater capital and that’s sort of the model that we are using and we are moving forward.
I think if there was any damage done, it was done a little bit, as I said, in the deposit pipeline in some of our businesses that are still relatively new, relative to the other businesses in the company and that gave people pause, because they hadn’t -- they weren’t with us for a long period of time. But we are rebuilding those public deposit pipelines and that’s giving me some optimism through the $2 billion guide for Q3 and the deposit guidance going forward I think.
And Jon, it’s actually there is a little bit of a silver lining on some of this and that is, it is really not our attention and made us focus on our business model and we have honed it. So to the degree that we were doing some syndicated deals, we were doing some writing credit, we just have a deposit relationship, it’s much more reciprocal today.
On our EFR case, for example, we started by making $100 million commitments in $1 billion syndication line. Well, we are not doing that. We don’t -- we think -- we never got the liquidity from the clients in that situation. But instead, what we do is we do bilateral transactions that are better priced and it’s a closer relationship that we have with them, and of course, we get their funding as well.
We have also taken a little bit of a different tack. We want to do this again and so what we have done is, we have taken our insured deposit levels to about the highest in the nation. We are moving our capital. I want to spin it around so that when somebody is looking at, who can we attack when the next situation might arise, Western Alliance isn’t anywhere near on that list, because we are a stalwart for capital strength, liquidity and performance.
Okay. Very helpful. Thank you.
Thanks, Jon.
Thank you. Next question will be from the line of Brody Preston with UBS. Your line is now open.
Hi, everyone. Thanks for taking my questions. Dale, I was just hoping to dig a little deeper on the moving parts on the margin. But I wanted to follow up on Steve’s question and I am sorry if you guys said it and I missed it, but the $3.2 billion of new deposits, I know it’s weighted towards mortgage warehouse. But I was interested and if you have an idea as to what the cost is, just because when I look at the new and return deposit growth in the existing client growth, it looks like it had about a 2% cost on it for this quarter, is that $3.2 billion close to that cost?
So, again, a lot of that -- this is Ken, Brody. A lot of that…
Hi.
… deposit growth is coming from our warehouse lending group, which means it’s growing in our non-interest-bearing deposits and from an interest expense point of view, that comes -- it comes with a zero cost, although the ECR credits are in the operating expense line.
So that’s going to skew more towards having a lower interest expense for both the non-interest -- for the warehouse lending business, as well as some growth is coming early on from HOA, which is a lower-cost channel as well.
Got it. So if you are getting a lot of growth in the -- I know it’s got an ECR, but it’s non-interest-bearing. I am looking at that interest-bearing deposit cost and the spot rate of $305 million is lower than the $308 million, you did on average for the quarter. Why -- I guess if you are growing the interest-bearing deposit costs at a blended rate with those new clients, so that were the total deposit cost, I guess, at two, like, why wouldn’t that interest-bearing deposit costs continue to move lower from here in the third quarter?
Well, so, I mean, warehouse deposits. They have an earnings credit rate, which is much higher than 3%. It’s close to kind of effective Fed Funds generally. So it’s going to be higher than that. But you are correct, Brody, and that -- yeah, these funds, they are not wholesale, they are not brokered, so there’s a lower charge associated with them in terms of what that is and their client relationships and so were trading down in terms of what it’s costing us from there. I mean each way it was a significant contributor, some of those have ECRs as well, but those dollars, those are going to be in the 3% range as opposed to buy.
Your premise about a cost of funds equal to Q2 or Q3 or going forward. That’s not a bad premise.
Got it. Okay. And then just on the loan yields, the average loan yield for the quarter, the difference between the spot and the average for the quarter is relatively large. So the spot rate is $674 million. If we think about the third quarter and we think about a potential for another rate hike here, I guess, how does that -- how does the loan yield move off of that $674 million for the third quarter assuming that that happens?
Yeah. I mean, I think, we are going to see something like 40% of that.
Got it. So I guess if I take those two pieces combined, then, Dale, just would like the deposit costs kind of stalling out at this level and loan yields continue to move higher. I just look at that 3.50% to 3.60% NIM guide, the implied NII guide and the PPNR guide that you have for the back half of the year and it just feels exceptionally conservative. And so, I guess, why shouldn’t we be thinking about something well north of 2.82% by the time we hit the fourth quarter of the year?
Well, I would argue with exceptionally. I think it is, I think, I mean we want to lean conservative, obviously, a little bit. The other thing I would say that, I think, maybe you need to consider recognize is that, a lot of these deposit costs we have are going to be moving up with when the FOMC moves next week as well.
So to the degree that we have got kind of brokered funding and some of these other sources, relatively short-term earnings, Moody’s credit rates for some of these large balances related to mortgage warehouse clients. Those are going to move almost to lockstep may that doesn’t show up necessarily in interest expense, but it shows up in terms of the cost of our PPNR number.
So there is going to be a push up in terms of funding charges related to that as well. But as I mentioned, we are asset sensitive and so the net effect of what happens next week should be a plus.
Got it. And then just last couple on credit for me. I just wanted to ask -- was there -- that you mentioned you did the office CRE deep dive, was that what kind of drove the reappraisals on those office -- those CBD office loans, Ken, or was there something else specifically that drove that?
No. That was it. That was it.
Okay. And then just -- I know that when you are working through the special mention...
All right. I am sorry.
Yeah.
Sorry, I was answering the other question, which was -- we basically only have one credit in CBD and that we moved to substandard and then we appraised it and repriced higher than the loan amount. So that’s the answer for that. I am sorry, I cut you off on the other question.
No. That’s okay. I was just going to say, I know that when you are working through the special mention loans, at least this is what you did with the hotels during COVID as you kind of -- as you mentioned, you asked them to re-margin the loan. I guess it’s early days, but with any of those conversations with your sponsors, has anybody backed that the idea of bringing more equity to the table to help re-margin these loans?
No. So the reason why they are in special mention, there is some weakness, as Tim Bruckner said, but also there is a spirit of cooperation that they want to get to a positive outcome that will either require re-margining or restructuring in some way, shape or form.
What’s interesting, maybe I will give you this fun fact, Brody. Our average LTV is about 55%. We are a low advance rate lender. So on our $2.3 billion of CRE, all in for the company. There’s about $2 billion of equity in front of us and so I am talking about the whole book. And that gives a lot of motivation for sponsors to sit and work with us in the -- any assets that have been moved into special mention.
Got it. Okay. Yeah. Just given how proactive it is and it sounds like the borrowers are willing to kind of meet you there, to meet again at, it sounds like maybe special mention loans we had lower and classified loans heading lower end into the year end, but I guess we will watch that going forward. Thanks for taking the questions, guys.
Thank you.
Thank you. The next question will be from the line of David Smith with Autonomous Research. Your line is now open.
Good morning. So the strong liquidity growth this quarter led you to bring back on about $700 million from held for sale back to held for investments of the remaining $1.8 billion in held for sale? Are you viewing any of that as potentially coming back as well if you have another strong quarter of deposit growth?
A good portion of that in the held for sale is relates to our op. Any comment, Dale?
I mean, we -- this is something we are just going to always evaluate. So based upon kind of where we are, but the $1.8 billion is queued up, it’s marked and we will see how that goes, but most of that we expect to exit.
And would you expect the CET1 benefit from that to be proportional to the benefit you saw from the $4 billion of sales that you have already executed?
Yeah. So, I mean, the CET1 elements are -- I mean most of the assets we are talking about are all 100% risk weighted. That goes for what’s already been done but not all, as well as what’s in there presently. So I mean -- but at the same time it means as those loans come off the books, that is beneficial to CET1.
Conversely, I mean, I think, the industry is looking at a special charge probably this quarter to recapitalize the insurance fund related to the demise of those three institutions. So that will be some chart. That will be maybe 10 basis points against our capital growth in Q3 as presently proposed.
Sure. And lastly, you talked about laying the groundwork for eventually crossing the $100 billion asset mark. I guess, you are just continuing to build $2 billion of deposits a quarter. That’s $8 billion a year. The $32 billion to $100 million take you about four years from now. That seems very proactive. What we need to see to take up your growth targets and growth goals, but before that if you were going to hit that market any sooner, what would give you comfort to open the growth back up?
So let me just give some color commentary about being very early. I think what you are going to see is supervisory review from the regulators starting much earlier and holding you to a higher standard well both -- well before $100 million.
So the process isn’t, hey, you hit $100 billion, you are going to be reviewed differently. The processes starts well before that, that are you ready to go across over $100 billion and that starts before that. That would be my just comm -- color commentary on how that review process works and why we are building it.
In terms of opening the gates, I think, our growth is going to be determined by our deposits and our growth in deposits. And we have traditionally been a little bit more heavier weighted to the left side of the balance sheet, which we can turn that machine on, we are really good at growing loans.
What we have turned around here is said, wait a minute, we need to have a more holistic relationship with our client base and growing the deposits are critical, obviously, to our future growth. And investing in future deposit channels and the deposit channels that we have talked about here today, that will drive the deposit growth in the future.
So we said $2 billion last quarter that we thought we would grow in deposits. We came in at $3.5 billion. Yes, there was a lot of brokerage there. This quarter, we said $2 billion without broker and we are going to try to exceed and do better than that and then we will kind of grow our way into 2024.
All right. That’s helpful. Thank you.
Thank you.
Thank you. At this time, there are no additional questions registered in the queue. So I would like to pass the call back over to our host, Ken Vecchione, for some concluding remarks.
I just want to thank you all for attending the call, pretty exhaustive earnings call today and we are happy to field all your questions and we look forward to the next quarterly call. Thanks again.
That concludes today’s conference call. Thank you for your participation. You may now disconnect your lines.