Western Alliance Bancorp

NYSE:WAL

Earnings Call Analysis

Quarterly Performance Overview

Western Alliance Bancorporation reported a solid third quarter in 2024, achieving an earnings per share (EPS) of $1.80. This growth reflects the company's ability to navigate a changing interest rate environment while maintaining strong loan and deposit momentum. Specifically, the bank saw total deposits rise by $1.8 billion, translating to an annualized growth rate of 11%. Additionally, loans held for investment surged by $916 million, representing a 7% annualized growth—a noteworthy achievement given the sluggish overall demand for credit in the broader economy.

Impact of Interest Rates and Income Growth

Despite a volatile interest rate landscape, net interest income increased by an impressive $40 million to $697 million, which equates to nearly 25% annualized growth. However, net interest margin experienced a slight contraction, decreasing by 2 basis points to 3.61%. This decline was driven primarily by lower yields on variable rate loans as the bank contended with a transitional interest rate cycle. While interest rates have been declining, the company anticipates significant funding cost savings moving forward, especially with a projected continued reduction of 25% in ECR-related deposit costs in the fourth quarter.

Guidance for Future Quarters

Looking ahead, Western Alliance updated its guidance, projecting loan growth of approximately $1.25 billion in Q4. This is reflective of a cautious but optimistic outlook, with the bank leveraging its diverse credit origination platforms to sustain momentum. Furthermore, management indicated that the expected net interest income is poised to decline by about 3% next quarter due to repricing of market-tied loans, though they expect noninterest income to rise by around 8% to 12% as commercial banking fee opportunities and mortgage banking income stabilize.

Strength of Asset Quality

The asset quality of Western Alliance remains stable, with nonperforming assets to total assets decreasing by 6 basis points to 0.45%. Net charge-offs landed within the guidance range at 20 basis points. Management attributes this stability to a disciplined lending approach, with attention to low-risk segments in their portfolio. The maintained charge-off rates further signal the bank's ability to manage credit risk effectively, especially in the face of dynamic market conditions.

Tangible Book Value and Capital Ratios

The tangible book value per share rose significantly by 6.5% quarter-over-quarter to $51.98, highlighting the bank's enhanced capital position and operational efficiency. Concurrently, the CET1 ratio stabilized at approximately 11.2%, reflecting management's strategic focus on maintaining a robust capital base in anticipation of future loan growth opportunities. This ratio positions Western Alliance in a strong category among its peers, with solid buffer capacity for any economic disruptions.

Navigating Seasonal Challenges

The bank anticipates a temporary decline in deposits in Q4, forecasting an overall drop of about $2 billion primarily attributed to seasonal outflows related to property tax and insurance payments. Nonetheless, they are confident that these fluctuations are manageable within their broader strategy aimed at securing consistent deposit growth. The bank projects an average deposit growth of $2 billion per quarter moving into 2025, supported by diversified deposit platforms developed over recent years.

Conclusion and Outlook

In summary, Western Alliance Bancorporation is navigating through a complex interest rate environment while demonstrating solid operational metrics. With strategic initiatives in place aimed at fostering loan growth, reducing deposit costs, and enhancing noninterest income, the bank is positioning itself for a successful 2025. Investors should note the anticipated benefits from rate cuts and an emphasis on risk-adjusted growth as Western Alliance seeks to maintain its competitive edge and enhance shareholder value.

Earnings Call Transcript 2024-Q3

[Operator]

Hello, everyone, and a warm welcome to the Western Alliance Bancorporation's Q3 2024 Earnings Call. My name is Emily, and I'll be coordinating your call today. [Operator Instructions] I will now turn the call over to our host, Miles Pondelik, Head of Investor Relations. Please go ahead, Miles.

[Miles Pondelik, executive]

Thank you, and welcome to Western Alliance Bank's Third Quarter 2024 Conference Call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; and Dale Gibbons, Chief Financial Officer; and Tim Bruckner, our Chief Banking Officer for regional banks will join for Q&A.

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 included in 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.

[Kenneth Vecchione, executive]

Good morning. As always, I'll make some brief comments about our third quarter earnings before turning the call over to Dale, who will review our financial results in more detail. After I discuss our outlook for the remainder of 2024, Tim Bruckner will join us for Q&A.

Western Alliance delivered solid third quarter results and earned $1.80 per share. These results demonstrated the bank's ability to sustain diversified loan and deposit momentum as well as grow earnings during a changing rate environment. We produced healthy deposit growth of $1.8 billion or 11% annualized and HFI loan growth of $916 million or 7% annualized despite sluggish demand overall for credit -- for overall credit in the economy.

Our national diversified credit origination and deposit platforms uniquely position us to sustain strong deposit growth and then deploy this liquidity into attractive commercial loans where we can provide deep segment and product expertise.

During a transitional period for the rate cycle that began in Q3, net interest income grew 25% annualized due to higher average earning assets. Net interest margin compressed 2 basis points because of lower yields on variable rate loans. Continued interest rate cuts will enable Western Alliance to realize significant funding cost savings in both interest-bearing and ECR-related deposits going forward. We anticipate a more meaningful benefit from lower rates in Q4 from a full quarter impact of lower rates.

Q3 results were modestly impacted by $4 billion of mortgage warehouse deposit growth driven by elevated mortgage refinance volumes, validating our operational excellence as we continue to win market share following several competitors retreating from the market. After the money-center banks, Western Alliance is now the largest bank operating in this space. This excess deposit growth somewhat impacted Q3 earnings from elevated deposit costs, but these deposits have helped cement core customer relationships, which will continue to drive strong risk-adjusted loan volume and spread income. Typical seasonal declines in mortgage warehouse deposit balances are poised to push Q4 ECR-related deposit costs materially lower.

Noninterest income increased $11 million or 10% quarter-over-quarter, but this growth was tempered by a decline in mortgage banking income. Our franchise remains poised specifically benefit from a resumption of stronger mortgage volume.

Pre-provision net revenue grew marginally from Q2, while tangible book value per share climbed 19% year-over-year. Lastly, asset quality remains stable as nonperforming assets to total assets declined 6 basis points to 45 basis points. Net charge-offs of 20 basis points landed within our Street guidance range.

Dale will now take you through the results in more detail.

[Dale Gibbons, executive]

Thanks, Ken. During the quarter, Western Alliance generated pre-provision net revenue of $286 million, net income of $200 million and earnings per share of $1.80. Net interest income increased $40 million from Q2 to $697 million, equating nearly 25% annualized growth because of higher average earning asset balances driven by loan growth. Noninterest income of $126 million rose $11 million quarter-over-quarter from higher service charges and loan fees, benefiting from commercial banking fees and a new bank-owned life insurance policy, which, along with securities gains, helped mitigate lower mortgage banking income. Securities gains were taken as we sold for collateral held for a large bankruptcy deposit as it went into distribution.

Mortgage loan production rose 21% from Q2 and 10% year-over-year. Loan servicing revenue was negatively impacted by prepayment speeds accelerating due to the declining rate environment, which caused a negative change in the MSR fair value, net of hedging, of $15 million. Noninterest expense for the quarter was $537 million.

Deposit costs of $208 million drove the quarter-over-quarter increase due to strong demand in mortgage warehouse. In aggregate, net interest income growth exceeded deposit growth by $6 million this quarter.

It is important to emphasize the recent 50 basis point reduction in the Fed funds target rate occurred less than 2 weeks before the end of Q3. Consequently, rate reduction actions for ECR-related deposits were also backloaded. Seasonal outflows in mortgage warehouse from Q4 tax and insurance payments and a full quarter impact of lower rates make us confident Q3 will prove to be the high watermark in ECR-related deposit costs for this rate cycle.

Provision expense of $34 million resulted from sustained loan growth and $27 million of net charge-offs. The balance sheet remained at approximately $80 billion. The solid loan and deposit growth were offset by securities and cash declining $2.4 billion quarter-over-quarter and a further $2.6 billion reduction in borrowing. A large distribution of bankruptcy settlement funds drove a notable decline in Juris banking deposits, which allowed us to sell the collateralizing securities.

Loans held for investment grew $916 million to over $53 billion while deposits grew $1.8 billion to $68 billion at quarter end. Tangible book value per share continues its expansion, rising 6.5% quarter-over-quarter to $51.98 and was aided by a large improvement in our AOCI position.

Loan growth of $916 million resulted from large contributions from regional banking as well as mortgage warehouse and MSR lending. We continue to diversify the loan portfolio as shown by C&I loans growing over $4 billion year-over-year and now accounting for 42% of the held for investment loan portfolio compared to 37% one year ago. At the same time, we lowered the overall allocation for commercial real estate investor and CLD categories show 29% to 27%.

Deposit growth of $1.8 billion was generated from seasonal inflows of mortgage warehouse which grew $4.1 billion, while our consumer digital channel increased $1.3 billion and continue to add more granular deposits uncorrelated with our commercial banking business lines.

Owners Association deposits also posted growth in a seasonally softer quarter. As mentioned before, Juris banking deposits decreased $2.7 billion. Overall core deposit growth was $2 billion as we modestly reduced wholesale broker deposits by approximately $200 million. Turning to our net interest drivers. The yield on total securities increased 2 basis points to 4.89%. Our liquidity position remains solid as unencumbered high-quality liquid assets were 64% of securities and cash, while securities and cash were 24% of total assets. HFI loan yields decreased 14 basis points to 6.65% due to asset repricing for SOFR-type loans in advance of the Fed's rate decision. The cost of interest-bearing deposits was 3 basis points higher as a result of $1.3 billion of quarterly deposit growth in our consumer digital channel.

The total cost of funds declined 12 basis points to 2.67% due to the deposit mix shifting towards noninterest-bearing and a smaller proportion of earning assets funded by borrowings.

If you compare the difference between the period-end spot rates and average rates for the quarter, you'll see that the difference is wider for interest-bearing deposits compared to HFI loans. In other words, we are seeing funding cost tailwinds emerge outside of just ECR-related funding.

In aggregate, net interest income increased $40 million from higher average earning asset balances and loan growth. Net interest margin compressed 2 basis points from Q2 to 3.61, which would have been flat but to the new BOLI policy as $800 million of earning assets were deployed for this purpose.

Regarding interest rate sensitivity, Western Alliance is liability sensitive on an earnings at risk basis. With a dynamic balance sheet, a minus 100 basis point rate ramp analysis indicates pretax interest-sensitive earnings should increase 1.5%.

In this scenario, the expected negative impact on net interest income would be more than offset by expected reductions in ECR-related deposit costs as well as a pickup in mortgage banking income at a lower rate environment should unleash. Our adjusted efficiency ratio for the quarter was 53%, modestly higher operating expense growth compared to the revenue growth drove the 120 basis point increase from last quarter. Excluding the impact of the FDIC Special Assessment rebate in Q2, this ratio would have remained flat quarter-over-quarter.

Asset quality continues to remain relatively stable. In Q2, criticized assets rose $60 million as special mention loans declined $30 million while classified assets increased $90 million. Criticized assets are up only $33 million from a year ago. We expect the total criticized asset pools remain relatively stable. Nonperforming assets as a percentage of total assets declined 6 basis points to 45% due to payoffs and sales. Our nonperforming assets consist primarily of CRE office loans, which is unsurprising given the environment characterized by still elevated interest rates and lower office property valuations.

Quarterly net loan charge-offs were $26.6 million or 20 basis points of average loans. Provision expense of $34 million added reserves in concert with loan growth in addition to replenishing net charge-offs. Our ACL for funded loans rose $5 million from the prior quarter to $357 million. The total loan ACL with a funded loan ratio of 74 basis points was unchanged and covers a 113% of nonperforming loans.

Slide 14 shows the updated ACL [ block ]. We have regularly provided to add more context behind our allowance methodology relative to peers. Our ACL lift from 74 basis points to 1.31% when incorporating the effect of credit linked notes, which have provided a pool of prepaid insurance money to us to cover charge-offs as well as low to no loss loans like equity fund resources or low LTV and high FICO residential portfolio and mortgage warehouse loans. Compared to the $50 billion to $250 billion asset peer banks we benefit from a greater CLN support as well as a greater percentage of loans in low to no loss categories.

Our CET1 ratio increased approximately 20 basis points to 11.2%. Our tangible common equity to total assets ratio moved up approximately 50 basis points from Q2 to 7.2% as our all other comprehensive income loss position recovered substantially due to a lower rate environment. Given the conversation about Basel III Endgame capital, I also mentioned that our CET1 ratio, including AOCI and our loss reserve is 11.1%, which is 50 basis points above the second quarter adjusted CET1 ratio of 10.6% and ranks in the top quartile of our asset class peers.

Finally, tangible book value per share increased $3.19 quarter-over-quarter to $51.98 from earnings growth and our negative AOCI position improving by almost 1/3. Our consistent upward trajectory and tangible book value per share is outpaced peers by tenfold since the end of 2013. Even when incorporating Q3 data for peers, which is not yet available, WAL's relative performance will still be well in excess of their TBV growth.

I'll now turn the call back to Ken.

[Kenneth Vecchione, executive]

Thanks, Dale. Following our Q3 results, we updated our 2024 and Q4 guidance as follows: we expect loan growth of approximately $1.25 billion next quarter to be achieved in a safe, sound and thoughtful manner. Our current 78% HFI loan-to-deposit ratio provides ample flexibility to selectively originate attractive loans. Deposits are expected to temporarily decline $2 billion in Q4 due to typical seasonal outflows of property tax and insurance payments in mortgage warehouse and active management of our deposit mix to maximize deposit betas and lower the cost of interest-bearing and ECR-related deposit costs.

Turning to capital. We reiterate that our CET1 ratio will remain at 11% as loan growth continues. Net interest income is expected to decline approximately 3% next quarter due to market tied variable loans repricing slightly ahead of funding costs. This dynamic is a function of the transitional period to a lower rate environment that got underway in Q3. However, ECR-related deposit costs are expected to significantly decline by approximately 25% quarter-over-quarter in Q4 and outpaced a decline in net interest income. We expect net interest margin incorporating ECR cost to have bottomed in Q3 and to experience continued expansion into future periods.

Noninterest income should increase around 8% to 12% next quarter from traction in cultivating commercial banking fee opportunities and firming mortgage banking income. Noninterest expense should decline between 5% and 9%, mostly from the expected drop in ECR-related deposit costs given the pivot in the rate environment and the typical Q4 seasonal factors previously discussed.

Asset quality remains in line with our expectations. We expect steady net charge-offs in Q4 on the 20 basis point area, which implies full year 2024 net charge-offs should be no greater than 20 basis points. We believe this will still rank among the best of our peers. Lastly, the effective tax rate for full year 2024 is now estimated to fall between 20% and 22%.

At this time, Dale, Tim and I look forward to answering your questions.

[Operator]

[Operator Instructions] Our first question today comes from the line of Ebrahim Poonawala with Bank of America.

[Ebrahim Poonawala, analyst]

So just first question around deposits. Trying to understand, so we've -- I'm assuming you were aware of the seasonality last quarter when you raised the deposit guidance for the year. So I'm just trying to understand if you can give us a little color on the settlement, that impact? And how pronounced is the seasonality versus just some of these chunkier outflows? And are there more such deposits that could leave the bank that could have some meaningful impact on near-term NII trajectory? Just if we can address NII, both in terms of larger outflows and then how impactful is the 4Q seasonality? Because I'm not sure it was that prevalent in the fourth quarter of last year.

[Kenneth Vecchione, executive]

Yes. Thank you. I think you've confused a few things. So let me straighten that out. Number one, in Q3, we did see a very large settlement out of our Juris Banking Group that was a little bit earlier than our expectations. We had expected it to happen into 2025, the settlement moved up earlier. Always hard to forecast when those things are going -- and dependent on the court system and it depends on lawyers agreeing to what the settlement terms are.

So that came out. And so absent that, we would have grown deposits in Q3 by $5 billion. So we actually grew deposits $2 billion, we paid down $200 million of broker deposits, and that got us to the net growth of $1.8 billion. In Q4, that's when you'll see the seasonal decline of warehouse lending group, which we always have in terms of deposits flowing out for escrow insurance and P&I payments that happen at the end of the year. And that's why we've said that outflow will push Q4's deposit levels down $2 billion.

However, our balance sheet deposit growth or I'll say, our balance sheet growth all in, as you move forward into 2025, certainly for deposits remains unchanged which is we expect to have $2 billion per quarter on average, $2 billion per quarter of deposit growth. We have a good line of sight into that. We've got clarity into that because of the number of home-grown deposit platforms that we have built over the years starting with our granddaddy, which is the HOA business. Also, our warehouse lending group has a very strong deposit business. And we added business escrow services in the last 2 years, settlement services, sometimes known as Juris Banking, and our consumer digital platform as well and also corporate trust.

So these are all homegrown-deposit businesses that a couple of years ago really never existed inside of our bank and now are beginning to perform admirably. In addition, we've got good deposit growth that comes from our commercial lines of business or previously known as our -- as the regional business. So that's sort of the deposits and while just on balance sheet, I'll just say, and we also expect, as we move forward into 2025 to see deposit on loan growth, average $1 billion or so per quarter. And we're running a very -- a much lower deposit loan-to-deposit ratio.

So if we have the opportunity to put on, as we say, good, safe and thoughtful loan growth, we have the liquidity to do that, and we could increase our loan growth throughout the year. Dale, some of these businesses report to you. Do you want to add any comments?

[Dale Gibbons, executive]

No. I think that's pretty fulsome, Ken. But maybe in addition, yes, so we see that we have kind of the liquidity that we need to be able to proceed. And as such, pushing up our loan-to-deposit ratio into the 80s from below 80s presently on an HFI basis, we should be able to do that. And there isn't anything like this, Ebrahim, on the balance sheet still. I mean, this was our largest depositor in the whole bank. And so there isn't -- maybe follow-through coming in Q4, Q1 or whatever.

[Kenneth Vecchione, executive]

Yes. Ebrahim, I think we might have left that one of the last pieces of your question. You asked, did I hear correctly sort of directionally what's going to happen with net interest income? Was that one of your questions as well?

[Ebrahim Poonawala, analyst]

It was going to be my follow-up. So, yes, please, I think you've given the guidance. Just talk to us how that goes, NII plus ECR deposit costs with or without rate cuts?

[Kenneth Vecchione, executive]

Well, I kind of feel like I asked your question for you. I might as well answer it. All right. So as we look forward -- if we look forward, first, our rate outlook is for 2 more cuts this year, November and December. And then we have 4 scheduled for next year at the end of each quarter is the way we forecasted, all right? So what you'll see overall, when you look at our balance sheet, inclusive of deposit costs. We are liability-sensitive. So our adjusted net interest margin, that's net interest margin, less deposit costs will rise in Q4 and will continue to rise through 2025.

And net interest income less deposit costs, okay? Those dollars will continue to rise steadily in Q4 and then as you roll forward into 2025. For the obvious reasons, deposit costs are declining, okay? So that helps, plus the balance sheet growth is going to still remain robust and you'll get some volume pickup in that as well for the net interest income less deposit costs growing throughout 2025 from 2024. And actually, Q4 '24 should be higher than Q3 2024 as well, if I wasn't clear enough on that. Okay?

[Ebrahim Poonawala, analyst]

Okay. All very clear. I'll let Jon ask you, whether or not you can earn [indiscernible] plus next year.

[Operator]

Our next question comes from Chris McGratty with KBW.

[Christopher McGratty, analyst]

Dale, I was wonder if you could help or Ken, on the outlook for noninterest income for the fourth quarter. I know this quarter had an MSR adjustment, but maybe unpack the 8% to 12% growth in fees for Q4 because some of the line items moved around a little bit?

[Dale Gibbons, executive]

Yes. So I mean, the MSR piece, I mean, a lot of that was really related to the turn in rates. So we saw a 50% increase in constant prepayment rates on our mortgage book, just at the initiation of kind of lower mortgage rates, which is to a significant degree kind of backtracked presently. We don't see that happening again, but maybe there was a little more pent-up behavior than we thought. And so the result of that is the value of that asset fell more than what the gain we had on the -- on what we put against it to hold the valuation constant.

And then going forward, so we talked about a couple of things. So one of them is we did a BOLI transaction. That's going to continue. And that will -- those new revenues will be consistent there. You can see what we have in terms of kind of service charges. It was up from the second quarter. We think that, that number is also consistent. We had some securities gains. We do have some other collateralized deposits, not nearly of the magnitude that we talked about with the one that went into distribution in the third quarter. So I think we're probably going to have some more security gains, too, as we sell off the collateral related to those.

All of that really actually improves our liquidity because when you have a collateralized deposit, you really can't do anything else with it. As these things -- as we're able to move that and substitute different deposit situations for that, it gives us an opportunity to really push into higher return assets than what it's in presently.

[Christopher McGratty, analyst]

Okay. And then just, I guess, my follow-up. The security gains you mentioned, is that in the guide? And I guess, with a similar magnitude?

[Dale Gibbons, executive]

It would be in the guide for a smaller magnitude than what we had in the third quarter.

[Operator]

Our next question comes from Jared Shaw with Barclays.

[Jared David Shaw, analyst]

Maybe looking at the loan growth that you had referenced, especially on the C&I side, where are you seeing opportunities for that? And maybe if you could just give us a little bit of early look at '25 in terms of sort of the pipelines and the expectation for the sustainability of that growth?

[Kenneth Vecchione, executive]

Yes. So as I said, this quarter, we grew $900 million, that's about 7% annualized to total loans of about $53.3 billion. It really came from 3 or 4 segments of our portfolio. The regional group grew all in about $300 million, warehouse lending grew almost $400 million, some leveraged finance and some resource financing when you combine those together, grew another $300 million. So it was almost $300 million, $300 million, $300 million -- or $300 million, $400 million, $300 million that got us to nearly $1 billion of loan growth for this quarter.

So as we look going forward, we see a couple of areas that give us confidence to continue to restate and reiterate the guide of $1 billion in quarterly loan growth. First, our non-financing, MSR lending, warehouse lending group businesses are showing good pipelines and we like this type of financing because they are generally shorter duration loans, good risk reward. And they also allow us to evaluate credit decisions and collateral on a continuous basis, which goes to our allowance for loan loss reserves, and it goes to our lower credit losses that we have. But this is good collateral, but also we've never taken a loss at any of those categories. since we've been in these businesses.

Then I would say lot banking, resort financing and our regional commercial lending provides the additional value or added value of growing our loans but also provides loan growth that comes along with more treasury management fee income and also allows us to gather lower-cost operating accounts. And so that's another area that we like.

Overall, if you look at our performance year-to-date, we really have focused more on the C&I side, and you see our total growth for the year has been all on C&I, and we've downplayed construction lending and development. And we've also kept our CRE owner-occupied flat as well, and that hasn't grown. And we've also taken down our residential loans, which carry a lower yield to it. So we'll have some opportunity to put some -- we put new loans on the books to have them come in at a higher yield. So I hope that kind of gives you a sense of how we're thinking about 2025 and what we're doing to prepare for it.

[Jared David Shaw, analyst]

Okay. That's good. And then just as my follow-up, looking at capital with the 11% sort of, I won't call it target, but calling out 11% or above that. Should we expect you to continue to grow CET1 from this 11.2%? Or would there be other capital management alternatives that you you'd utilize here?

[Kenneth Vecchione, executive]

Yes. Yes, I understand the question. So for our forecasting for 2025, we are assuming CET1 stays at or above 11% and stays there modestly above -- at or above 11% because we think there's going to be -- or there could be more loan growth coming our way than the $1 billion per quarter. And we want to have that CET1 dry powder to support that. And that's sort of our going-in program.

In addition, as we get bigger, okay, I know we're $80 billion and our total assets came down a little bit from Q2 to Q3. But as we get bigger and we get closer to the category for bank comparisons, which we do today. We look at other measurements of where adjusted CET1, is that CET1 less the AOCI plus the allowance for loan loss reserves. And we want to target being in that upper quartile that Dale discussed in his prepared remarks. And so we're looking at that as well as a way to guide us as we continue to grow.

[Operator]

Our next question comes from Matthew Clark with Piper Sandler.

[Matthew Clark, analyst]

First question around the ECR-related costs. Given the volume and rate dynamic going forward and assuming either your rate assumptions that you laid out earlier or the forward curve, what is the good range of expectations for customer service cost dollars in 2025?

[Dale Gibbons, executive]

The reason why it's been increasing is really related to -- it's become skewed more toward the mortgage warehouse, which has about 100% beta. And so we expect that to unwind in a similar fashion as it came in. Hence, Ken's comment that we believe we're going to see a 25% reduction in these ECR costs in the fourth quarter relative to the third quarter. And that should continue as we go into next year. Again, so we've had a scenario whereby our HOA deposits have consistently risen year in, year out. We expect that to continue, while the growth in our mortgage warehouse is going to be tempered.

You're going to see an outflow primarily related to insurance payments that are made in the fourth quarter, and that's what's going to pull the total deposit number down. But it's also going to be an area of less focus for us kind of going forward in terms of growth. So in other words, we're going to have an opportunity to be able to lower those costs kind of in lockstep to FOMC action, and in fact -- in some cases, above 100%.

[Kenneth Vecchione, executive]

Yes. And to answer -- because you asked the dollar question, Dale gave you a percentage answer. But that 25-ish percent for Q4 is about a $40 million decline...

[Unknown Executive]

$50 million.

[Kenneth Vecchione, executive]

$50 million. Sorry. I'm sorry, my bad, a $50 million decline from Q2 to Q3, all right? Just remember, Q2 to -- sorry, Q3 -- I'm sorry, Q3 to Q4, I meant to say it's about $50 million. And remember, you got that 50 basis point bang that came out of Q3. So don't model that as $50 million per quarter, but model it as rates coming down in a very methodical way.

[Matthew Clark, analyst]

Okay. So it sounds like it's more rate driven, not volume-driven kind of -- okay. Got it. Okay. And then just on the -- your kind of a blended question around loan yields. I know SOFR came down ahead of the Fed cuts, and I'm sure that hurt a little bit. It also looked like your loan fees came down to 15 basis points from 24 bps in the prior quarter, and they had been running around that level for a few quarters. I guess just what happened there? And then how do we think about the overall NIM in the near term?

[Dale Gibbons, executive]

Yes. I think the low fee number is really -- I mean, you should go with the kind of the current run rate that we had in that period. In terms of the NIM, I mean, we mentioned in our slide that on a net interest income basis alone, we're expecting to see a contraction in the fourth quarter. But that will be more than made up for. So as Ken talked about earlier, we're looking for a combined NIM, including the ECR which we expect that [ global ] watermark was actually in the third quarter of 2024 and will increase in each successive quarter through next year.

[Operator]

The next question comes from the line of Bernard Von Gizycki with Deutsche Bank.

[Bernard Von Gizycki, analyst]

Just on mortgage, you previously obviously guided to 3Q being seasonally weaker but the loan production volumes were up nicely versus 2Q, while the gain on sale margins declined. And obviously, you called out the negative MSR mark. Could you just talk to the puts and takes on how high demand maybe needs to pick up to see a pickup in the gain of sale margins?

[Kenneth Vecchione, executive]

That is something that is a little difficult to handicap to be very honest with you. Coming into the quarter, mortgage rates at the end of Q2 were up around 7%, right? And they declined during the quarter to about 6.05% and today, they're in the 6.50% area. And so for us to handicap that, that's been a little bit of a struggle. It's based on consumer behavior of cost, and it's also based on consumer timing, i.e. if you know there are a couple of the rate cuts coming at you, would you go out today and buy a home when you know rates are coming.

And so what we say in the mortgage business is, at least what we have been saying is people love their mortgage rates, they hate their home. And now we're trying to see if people want to find a new home and just rent their mortgage rate and then refi as they go forward.

[Bernard Von Gizycki, analyst]

Okay. And then just as we think about maybe mortgage more broadly and just the dynamics like you mentioned with mortgage rates coming down closer to 6% and then backing up, what really gets mortgage for you guys? I think in the past, you've said maybe like the 3, 4 rate cuts kind of help and maybe a low 6% is really what's meaningful to increase production. But just kind of wanted to get your thoughts like maybe the 6.5% hopefully comes down again, but it is based on some of the pull forward of the rate cut expectation. So just want to get your thoughts on maybe a mortgage rate level that you think the production volumes kind of pick up and revenues follow?

[Kenneth Vecchione, executive]

Yes. I think if you start beginning to see a repeat of the early part of Q3, where rates coming down into the low 6s, that begins to pick up the volume. You then begin to gather some speed once you break the 6 barrier. The 6 barrier is the equivalent of the -- for those that remember the 4-minute breaking the 4-minute mile, okay? And once you break that 4-minute mile of under 6 and have a 5 handle to begin with, then we really think if the sweet spot is somewhere in that 5.50% to 5.75%, that's record, that's great opportunities for us, okay? And that's sort of how we think. So we need to break the 6 barrier and then as it drops into that 5.50% area, that's where we think there's a lot more volume coming our way.

[Dale Gibbons, executive]

I might say a more tempered rate decline, we actually think works in our favor. And that is if things fall really suddenly, I think it's going to maybe have almost a rush of refinance that may not last as much. And part of the reason why mortgage rates are elevated relative to the 10-year is we believe it's simply because there's an expectation that if you refi right now, you're going to refine again in 6 months, it's not going to be worth all the processing costs to get that done.

And so if that view were to dissipate a little bit, and frankly, I'm pleased that the number of expectations of rate cuts for 2025 has actually been cut a little bit in the futures market at least that, that really gives it -- makes it more sustainable over time. And with that, we think we can maybe see a reduction in the disparity between mortgage rates and the 10-year treasury, for example, is from what it's been historically.

[Operator]

The next question comes from the line of Timur Braziler with Wells Fargo.

[Timur Braziler, analyst]

I wanted to -- just want to get some clarity on the expectation for 4Q to be the NII trough. Is the expectation that 1Q maybe you get some additional margin compression from the asset-sensitive balance sheet and then volume makes it up? Or should 4Q be the trough for NIM compression as well?

[Dale Gibbons, executive]

Yes. I believe 4Q can be the trough as well on the NIM side. Yes.

[Timur Braziler, analyst]

Okay. And then -- Okay. And then just to maybe to put a finer point on Bernie's question. So for the earnings at risk analysis, I guess, what are you assuming for mortgage rates and kind of mortgage revenues within that earnings at risk analysis?

[Dale Gibbons, executive]

Yes. So that we would tail into maybe something that ticks into a 5 by the end of next year. The 5 handle, high 5.

[Timur Braziler, analyst]

Great. And then just last thing for me. Sure.

[Kenneth Vecchione, executive]

Sorry, I just wanted to add a point to Dale's comments when talking about NIM. He was really -- he was referencing the adjusted NIM, okay? And so that when you think about it, that's the way I think about it is that adjusted NIM is just net interest income less the deposit costs. That is all going to flow upward or move upward throughout the year, okay? I just want to make that a little clarification. Sorry, I didn't mean to interrupt.

[Timur Braziler, analyst]

No, I appreciate that clarification. And then just lastly for me, just thinking about HQLA deposits in a rate-down environment I'm assuming just the short-term nature, there is going to be a little bit punitive to NII. Just how are you thinking about HQLA levels growing, maybe commensurate with the asset base or asset growth and then what that might look like from a rate perspective?

[Dale Gibbons, executive]

Yes. So we think we're kind of intact in terms of where we are on what we have in HQLA presently. That number kind of came down a little bit because we've disposed some of these deposits that were collateralized all with HQLA categories. So from here, again, it gives us latitude to grow our loans commensurate with the growth rate we're going to show in deposits. And so as Ken mentioned, so if we're going to grow deposits $2 billion on average. And that means that includes like the fourth quarter decline that's already built into higher growth earlier in those quarters. And then if you can grow at 75%, 80%, you're going to have $6 billion of deposit growth in that loan growth to match that. And then the rest of it is going to fall into other categories like HQLA.

[Operator]

Our next question comes from the line of Anthony Elian with JPMorgan.

[Anthony Elian, analyst]

Does your 4Q deposit guide of down $2 billion include any additional paydowns of broker deposits? Or is the decline really coming from the seasonality of warehouse?

[Dale Gibbons, executive]

It's really seasonality of warehouse. We expect our broker deposits to be fairly flat.

[Anthony Elian, analyst]

Got it. Okay. And then my follow-up also on deposits. I understand the warehouse is going to seasonally outflow in 4Q. But I guess are there not enough deposit opportunities from other areas of the company to be able to offset that seasonal headwind for this quarter specifically?

[Kenneth Vecchione, executive]

So the other areas -- other deposit channels do, in fact negate some of that outflow that you're seeing, but the Warehouse Lending Group has a larger -- is a larger contributor to deposit growth. And so -- and the other thing that's happening, as I can't -- I should emphasize this, is that in the warehouse lending group or the industry, we've had several competitors either leave the industry or retreat from it in a significant way. And we are just seeing more inflow than we would normally have expected. And that inflow came in Q3 and will kind of reverse out in Q4.

So that's why it's harder to have the other deposit channels cover that larger inflow for us in Q4. But after these deposits go on a hiatus as we call them, they do come back into Q1, come back starting in Q1 and will help us with our liquidity as we roll forward throughout 2025.

[Operator]

The next question comes from the line of Gary Tenner with D.A. Davidson.

[Gary Tenner, analyst]

I appreciate the forward thoughts on the combined NII and ECR costs. So I just wonder if you're willing to put a finer dime on just the GAAP NII outlook. Obviously, the fourth quarter is a lower guide. Based on your rate forecast for next year, kind of the 25 basis points per quarter, how deep into the year would you think it would be until you could turn dollars of GAAP NII from the bottom?

[Kenneth Vecchione, executive]

At this point, I think we've given more clarity around 2025 and what we expect than any other conference call that I've read about so far. And we're going to leave it here as we get -- as we announce our Q4 earnings, we'll get into more detail what that 2025 full year is going to look like. But I think we've given plenty of guidance here on how to kind of construct what to expect in 2025.

[Operator]

The next question comes from the line of Samuel Varga with UBS.

[Samuel Varga, analyst]

Dale, I just wanted to touch on the ECR rates again. I wanted to get your sense for, let's say, if Fed funds normalize around the 3% that a lot of people are pegging, what would be the floor on ECR rates? I understand that the beta at least initially is expected to be near 100%. But how -- at what point does it just level off and not move lower?

[Dale Gibbons, executive]

Well, I mean if you look to kind of where we were before, when rates were even lower than that during the pandemic, our ECRs mostly bottomed at around 40 basis points. So there's still a lot of room to continue to push things down. And frankly, I mean, it's all about what's the alternative for money in these. So it's like, okay, so they have these funds. Is some other financial institution going to be paying more than what -- if a 3% number in your example, are they going to be paying 3.50%, 3.60%? I doubt it because that generally means that funds are available elsewhere.

So we have these diversified funding sources so that we've got all these channels so that we can meet kind of the credit demand that we have. So I don't see that there is a number there that we're going to -- it's going to really get sticky in terms of pushing things lower as they were much lower before. And their alternatives for -- and not just for but they're alternatives for us if we can go to other sectors as well and look for funds. So I mean, they're not going to move that far away from what the market rate for money is in terms of how low it can go.

[Samuel Varga, analyst]

Got it. And then just my follow-up on the earnings at risk. Can you give us a sense -- obviously, it's hard for us to know exactly what you're assuming on mortgage. But can you give us a sense for, I guess, what helps more in offsetting the NII compression? Is it the ECR rates or the mortgage benefit from AmeriHome on the fee income side?

[Dale Gibbons, executive]

What offsets the mortgage income on the fee income side? Well, I mean, so I mean they have funds that come from kind of their origination of mortgage servicing, right? So they manufacture these. And depending on what that estimated value is kind of determines what the gain on sale is and then we have the servicing rights that we value and amortize down. So that's why I look at them more in concert rather than kind of a singular element.

I think it was more important in the third quarter where they were more, I'll say, bifurcated in terms of the response. And that was really related to the 50% increase we had in constant prepayment rates that took place in August that we -- that was in excess of, I think, what most models would have captured.

[Operator]

The next question comes from Chris McGratty with KBW.

[Christopher McGratty, analyst]

Great. Dale or Ken, longer-term question about ROE potential in a down rate environment. How are you thinking about ROE over the next couple of years?

[Dale Gibbons, executive]

Yes. So I don't -- we don't think that our ROE potential is really that dependent upon the rate environment. That is we're -- based on the balance sheet that we have, the capital that we need, the spreads that we can obtain that we can continue to efficiently manage the organization. We know our costs have come up for the past couple of years or so. But we believe we're going to get back to an efficiency ratio that begins with the 4 instead of a 5 on an adjusted basis, i.e., with the deposit costs netted against interest income.

And so that should leave us with a ROCE in the upper teens. And we believe we're on our way to get there and that's where -- and frankly, that's kind of where we're headed. We're not going to get back to the 20s that we were at before because our leverage is lower with our higher CET1 ratio.

[Operator]

Our next question comes from Jon Arfstrom with RBC.

[Jon Arfstrom, analyst]

Ebrahim set me up, I guess. But Ken, I hear you on your 2025 thoughts. Are you more optimistic on '25 with the recent rate cuts and the current rate outlook? Is this good for the company generally?

[Kenneth Vecchione, executive]

Yes. Yes, I am. I'm -- my optimism comes first from the balance sheet, right? And we've given that guide of $1 billion for loans and $2 billion on average for deposits, right? And we've been giving that guide for -- boy, for seems like a couple of years now that we continue to do that. And I think we have these credit origination platforms that work well. And over the years, we've added the deposit platforms. And so my confidence is in -- I feel very strongly about the guide that we can achieve the balance sheet.

The overall liability sensitive nature of the bank, I think in a falling rate environment, as Dale talked about, and we're talking about this on an adjusted net interest income basis, exclusive of deposit costs. With rate cuts coming at us, we see that getting better. And so that gives us -- gives me some confidence as well. Asset quality, as we see it today, is stable, knock on wood. And so yes, I have -- I always believe next year is always going to be more difficult than the previous year, but I always tend to have a higher level of confidence that we can get there.

[Jon Arfstrom, analyst]

Yes. Okay. You guys, you used the word transitional a lot and I understand that. It feels like this was kind of an unusual quarter for you, and I hear you on transitional, but do you have like a non-GAAP core EPS number in your mind for the quarter? I mean, I think you've got MSR, BOLI, I don't know, gains, lower gain on sale, ECR pressure. There's a lot going on. I guess it'd be helpful if you have some kind of a shot at like a repeatable, sustainable quarterly EPS run rate in your mind just because there was a lot -- I think, a lot going on here?

[Kenneth Vecchione, executive]

Yes, I think that's a fair question. We kind of get to $1.80, which is what was reported. The decline from the mortgage business was offset by gains from the collateralized deposits that -- the securities that help collateralize deposits, and those 2 things kind of equal out for us. And as we don't think we're going to see that MSR valuation decline in Q4 and as Dale said, that we have other collateralized deposits and settlements that are rolling off where we have gains in Q4 that I think it was Chris who asked the question that we think it's captured in the run rate.

[Operator]

Our next question comes from the line of Brandon King with Truist.

[Brandon King, analyst]

Just one for me on core expenses. Stripping out ECR deposit costs, it looks like the growth run rate was around 5% in the quarter. And taking your commentary on deposit costs, next quarter seems like I noticed a higher of 4%. So that 5% to 4% quarterly run rate of growth, is that something we should expect over the foreseeable future? Or anything temporary within that core expense run rate over the next few quarters?

[Kenneth Vecchione, executive]

So the way I'd come at it is I think about it as the adjusted efficiency ratio as we come out of Q4 through 2025, which excludes deposit fees. And we think over the course of the year that, that will get at or near 50% by the end of 2025. So we see the adjusted efficiency ratio declining through 2025.

[Brandon King, analyst]

Okay. And within that, any sort of commentary on as far as the infrastructure build as you continue to grow towards being a CAT IV?

[Kenneth Vecchione, executive]

No, that's embedded in there. That's embedded in there.

[Operator]

Those are all the questions we have. And so I'll turn the call back to Ken Vecchione for any closing remarks.

[Kenneth Vecchione, executive]

Thank you all for attending the call. We look forward to talking to you in January about our Q4 results. So thanks again.

[Operator]

Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.