Western Alliance Bancorp
NYSE:WAL
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Western Alliance Bancorp
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Good day everyone and welcome to the Earnings Call for Western Alliance Bancorporation for the Fourth Quarter of 2018.
Our speakers today are Ken Vecchione, Chief Executive Officer; Dale Gibbons, Chief Financial Officer; and Robert Sarver, Executive Chairman. You may also view the presentation today via webcast through the company's website at www.westernalliancebancorporation.com.
The call will be recorded and made available for replay after 2:00 P.M. Eastern Time on January 25, 2019, through Feb 25, 2019, at 9:00 A.M. Eastern Time by dialing 1-877-344-7529 and entering passcode 10127283. The discussion during this call may contain forward-looking statements that relate to expectations, beliefs, projections, future plans, and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts.
The forward-looking statements contained herein reflect our current views about future events and financial performance and are subject to risks, uncertainties, assumptions, and changes in circumstances that may cause our actual results to differ significantly from historical results and those expressed in any forward-looking statement.
Some factors that could cause actual results to differ materially from historical or expected results include those listed in the filings with the Securities and Exchange Commission. Except as required by law, the company does not undertake any obligation to update any forward-looking statements.
Now for the opening remarks, I would now like to turn the call over to Ken Vecchione. Please go ahead.
Good afternoon, everyone. Welcome to Western Alliance's fourth quarter earnings call. Joining me on the call today are Dale Gibbons and Robert Sarver. I will provide some overview into the quarterly and annual results and then Dale will walk you through the bank's financial performance in greater detail. Robert, Dale and I will address your questions at the end of all remarks.
Bank's stocks and valuations were volatile in Q4 is concerns of a slowing economy and potentially rising credit costs unsettle the market. Western Alliance posted consistent and sustainable results this quarter as net income rose to $119.1 million or $1.13 per share, compared to $111.1 million and $1.05 per share for Q3. Year-over-year net income and EPS rose 33%. Several positive factors contributed to this performance, loans grew $978 million from the prior quarter supported by our residential loan program and broad growth throughout our regional banks and national business lines.
Linked quarter annualized growth was 23%, deposits increased $269 million from the prior quarter. Balance sheet growth and stable quarter-over-quarter NIM of 4.72% generated linked quarter annualized net operating revenue growth of 18%, which position the company to achieve its 2.5 to 1 revenue to expense target and maintain our 41.5% efficiency ratio. These results were built by stable asset quality as to our special mentioned loans declined $35 million, graded loans dropping $5 million with charge-offs of $3.3 million or 8 basis points. Net charge-offs were stable from Q3.
Before I move to the full year results, I wanted to acknowledge the decline in non-interest bearing deposits and the associated impact on NIM. During the quarter, we declined to continue a lending relationship, which carried with it over $200 million of DDA balances. I have repeatedly told the board and management that asset quality comes before loan growth.
The loss of these deposits shave 2 basis points from NIM, but it was prudent to protect our balance sheet and profitability, while we maintained credit discipline. Additionally DDA seasonally trough in the fourth quarter as balances decline in mortgage servicing and Title and Escrow businesses.
Turning our attention to the full year, net income topped out at $435.8 million or $4.14 per share compared to $325 million or $3.10 per share for 2017. Loans grew $2.6 billion or 17% to $17.7 billion, while deposits rose $2.2 billion or 13% to $19.2 billion. Non-interest bearing deposits remained flat year-over-year and represented nearly 39% of total deposits at year end. The balance sheet stands at $23 billion, annual net charge-offs were $10.3 million, return on assets was 2.05% and return on tangible common equity was 20.64%, while our tangible capital ratio was 10.2%.
Let me finish my comments where I began, the dislocation in the Bank stock valuations offered us an attractive use of capital to repurchase shares. This quarter we spend $36 million to repurchase 9,1000 shares at an average price of $39.58, which will add $0.04 to 2019 earnings.
Dale, will now take you through our financial performance.
Net interest income rose $9.5 million from the third quarter to $243.5 million, driven by $684 million increase in average loan growth. Net interest income rose 15.4% from the year ago period. The provision for credit losses was $6 million for the quarter, as asset quality remained steady with $978 million in loan growth and $3.3 million in net losses.
Operating non-interest income was up $1.8 million from the third quarter to $14.7 million, largely due to an increase in warrant income. Net operating income, which excludes losses on security sales and fair value adjustments was up $11.3 million to $258.2 million, which is 18% annualized growth from the third quarter.
Operating expense, which excludes the charitable foundation contribution in the third quarter and other items rose $4.6 million to $109.6 million largely due to an increase in deposit costs. Income before tax was $140 million and taxes were $20.9 million. While tax expense was unusually low this quarter as certain credits were recognized earlier than originally anticipated. They are expected to be recurring unlike the 1-time carry back election that reduced third quarter taxes, or the benefit that -- from restricted share vesting in Q1.
Adjusting for these items the tax rate was 18.5% for 2018, which is also a good rate looking forward. Diluted shares fell slightly from the 100,000 share average effect from the 900,000 shares repurchased, resulting in EPS of $1.13.
Net interest income increased to $131.2 million or 16.7% from the prior year to $916.9 million. Driven by $2 billion of average loan growth. Operating non-interest income climbed 26.5% over 2017 to $54.4 million as warrant related gains nearly doubled. Bringing operating revenue growth to over 17%.
Provision expense rose 33% to $23 million. It was more than double the $10.3 million in net loan losses last year. Operating non-interest expense was up $55.8 million or 15.4%, again driven by compensation and deposit costs. Income tax expense decreased $51.8 million due to the reduction in the corporate tax rate resulting from the Tax Cut and Jobs Act as well as the benefit received in Q3 from the company's carry back election. Earnings were a third higher than 2017 at $4.14 per share.
For the next three pages recall that we've added an Orange Line to the Q4 2017 period to show what these ratios would have been without the reduction in tax exempt benefits due to the tax change. While the numbers in green are actual related -- reported performance the numbers in orange provide continuity to the quarters in 2018 had exchange been in effect last year.
Investment yield increased 25 basis points during the quarter to 3.49% and are up 52 basis points over the past year. The investment yield in the second and fourth quarters benefited from some semiannual dividend payments that appear in Q2 and Q4.
Loan yields have climbed over the past year rising 35 basis points from 5.62% in Q4 of 2017 to 5.97% last quarter. On a linked quarter basis yields rose 7 basis points resulting in a loan beta of 28% of the 25 basis point increase in target fed funds during the quarter. However, this includes the effect of increasing the residential portion of our loan book, which has a lower yield in the portfolio overall and is much less sensitive to changes in interest rates.
Using total earning asset beta better captures the rate sensitivity of the balance sheet, in which yields rose 10 basis points during the quarter to 5.44, a 40% beta. Interest bearing deposit cost rose 16 basis points in Q4, a 64% beta and an increase from the 60% during the third quarter, but lower than the 88% peak reported in the second quarter of 2018. When all of the company’s funding sources are considered, including non-interest bearing deposits and borrowings, total funding cost increased 12 basis points, resulting in the linked quarter funding cost beta of 48%.
The interest margin during the quarter remains flat at 4.72% and was held back 2 basis points due to the reduction in non-interest bearing deposits from the client that Ken mentions and 3 basis points due to the increase in average balances in residential loans from executing our loan mix diversification strategy.
We decided to trade-off the margin for high quality and low capital absorption, less rate sensitive loans at this time given said moderation to further interest rate increases. From a year earlier and after adjusting the prior margin by the effect of the lower taxable equivalent benefit, the fourth quarter margin climbed 11 basis points from 4.61%. The increase in acquired loan accretion added back 2 basis points to the margin from the last quarter.
Forecasted loan accretion is expected to decline over time, but will likely be higher than the $1.7 million shown here because of loan prepayment activity. The efficiency ratio remained flat at 41.5% on a linked quarter basis and virtually flat from the 41.7% ratio a year ago, after adjusting for the tax change. For the full year, annual net operating revenue growth is $142.6 million was 2.5 times, the $55.8 million increase in operating expenses maintaining our strong operating leverage profile.
Our pre-provision net revenue return on assets was 2.65% and ROA was 2.13% for the fourth quarter. These metrics are a record for our company and have consistently been in the top decile compared to peers. Continued loan and deposit growth took total assets to $23.1 billion at year-end. Our consistent balance sheet momentum continued during the quarter as loans increased $978 million generated linked quarter annualized growth of 23% and 17% on an annual basis.
Fourth quarter deposit growth of $269 million brought us to 13% annual growth for the year. These growth rates compared to our three year growth rates in loan to deposits of about 16% for each of the past three years. Our loan growth of $978 million was driven by residential loans up $377 million, C&I up $275 million and CRE non-owner occupied of $260 million.
The year-over-year loan growth is spread across all loan types with the largest growth also in C&I residential and construction. Loan growth also was spread throughout our regions and our National Business Lines. Deposit growth of $269 million was driven by increases in interest-bearing DDA and savings in money market deposits, offset by decreased non-interest bearing demand.
During the year, deposits grew across all deposit types with the largest increase also in savings and money market of $1 billion and interest-bearing checking of $969 million. Seasonally deposits have grown the slowest in the fourth quarter for each of the past three years. Total adversely graded assets declined by $42 million during the quarter to $316 million, as special mentioned credits decrease 35.
Non-performing assets comprised of loans on non-accrual and repossess real estate increase to $46 million or only 0.2% of total assets. Gross credit losses of $4.1 million during the quarter were partially offset by $800,000 in recoveries, resulting in net loss of $3.3 million or 8 basis points of total loans annualized.
The credit loss provision of $6 million was consistent with the prior quarter as adversely graded assets improved and net loan losses were essentially stable. The allowance for loan and lease losses rose to $153 million, up $13 million from a year ago. This reserve was 0.92% of non-acquired loans to December 31st as acquired loans were booked at a discount to the unpaid principal balance and have no reserve and acquisitions.
For acquired loans credit discounts totaled $14.6 million at your-end, which is 1.4% of the $1 billion purchase loan portfolio, primarily from Bridge Bank and the Hotel Franchise Finance transactions.
Capital ratios with the exception of tangible common equity are down slightly from the prior quarter as the share repurchase program reduced the ratios by just under 20 basis points. The company repurchased 901,000 shares during the quarter at an average price of $39.58 for a total of $36 million. No shares have been repurchased thus far in 2019.
Even with these share purchases tangible book value per share rose $1.37 in the quarter to $22.07, in part benefiting from a reduction in unrealized losses on available for sale securities that recorded as part of other comprehensive income, which fell by half during the quarter as interest rates declined. Tangible book value is up 20.5% in the past year and a 10.2% our tangible common equity ratio is in the top quartile of the peer group.
I'll turn the call back to Ken.
Thanks, Dale. While we expect economic growth to slow this year from 2018, our loan pipeline remains strong and we anticipate approximately $600 million in net growth per quarter. As always, this growth is predicated on sound underwriting decisions and not reaching for credit. We will continue to augment our residential loan mix as stable market conditions arise, while holding construction loans to a lower proportion of total loans. This mix change will mute the Bank’s asset sensitivity over time as we believe the large preponderance of rate increase for this cycle is behind us.
This mix shift may also result in relatively lower credit loss provision charges at presume losses from residential mortgage loans are lower than other loan categories.
On the funding side, we look to fund our loan growth with core deposit growth by continuing to expand existing relationships, building new relationships and enhancing our product and service offerings. In today's rate environment, most of this growth is likely to be in interest-bearing account. Stability in non-interest bearing deposit should also reduce our deposit betas from the fourth quarter.
As the company reduces its assets sensitivity, we expect the margin to be fairly flat in 2019. Please recall the first quarter margin is always somewhat challenged as we report the margin on 33, 60 basis and reflects about a 10 basis point decline from the reduction of two calendar days in the first quarter from the fourth. On a year-over-year basis considering our 2018 results and expectations for this year, the efficiency ratio should moderately improve with revenue increasing 2.5 times, the increase in operating expense.
Year-over-year analysis for this comparison is appropriate since on a linked quarter metric revenue will be constrained from the fourth quarter due to the loss of two calendar days. While expense will rise from the resumption of FICO charges and other seasonal items that pick up at the beginning of the year. While we are targeting 2.5 times revenue to expense growth from time-to-time we'll continue long-term investing in new products and technology that may introduce modest volatility into this performance ratio, while achieving our earnings goals.
Asset quality remains strong and stable, and we see nothing on the horizon that signifies any change in this trend. Moving into the residential real estate should reduce credit risk volatility through the business cycle. Low-double-digit balance sheet growth coupled with a stable margin and operating efficiency should result in double-digit EPS growth in 2019.
At this time, Robert, Dale and I are happy to take your questions.
We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Casey Haire of Jefferies. Please go ahead.
Yes. Thanks. Good morning, guys.
Good morning, Casey.
Good Morning. Starting on the deposit outlook I get that the deposit growth is going to be driven by interest bearing, but what's your confidence level that you can hold DDA at this level, going forward. I know you lost the relationship on a credit related decision, but just confidence in holding the NIB level and avoiding further attrition from here.
Yes, that's what -- we're going into the year with that approach, which is we think we can hold the non-interest bearing deposits stable to last year. On a percentage basis it may drop a little bit, but dollar wise we're looking for a stability.
As you know we have our two initiatives that should be coming on line that should add to that. We also should get some recovery on a seasonal basis, that I alluded to.
Okay. So the new initiatives that those are -- there is a DDA focus there.
Certainly a significant DDA element, yes. Just to recall, Casey, there were two loan initiatives and then two deposit initiatives. The first deposit initiative has basically gone live and then the second one will go live towards somewhere in the third quarter.
Okay, great. And then, on the borrowings the loan generation was huge this quarter so you use some of the borrowings. I mean are we going to see that go down from here or are you confident that you can core fund the loan growth going forward?
Yes. So if we -- I mean -- yes, we're looking for deposit growth to kind of roughly match what we do on the loan growth so that would be a payoff on those two. We also have a $4 billion securities portfolio that we could bleed off a little bit as well. But the last thing I'd say is that our borrowings that $500 million is actually pretty low. We typically don't have a position like that but the average bank of our size it runs about 4% of their total assets in borrowed funds. So we've got capacity there too. We've got a $3 billion line with the FHLB also.
Okay. I mean the loan to deposit ratio -- I mean is there a level where you would not violate that where you would not want to go above?
Well, I think we're fine where we are, 92 I think as we get -- if we got to the higher 90s I think we would reconsider that.
But I think also -- this is Robert. When you look at the growth in the residential mortgage book that book carries a different capital requirement and some different risk profiles too and marketability of those assets. So it’s -- you can kind of think of that mortgage book as kind of a mix between a loan and investment security.
Okay. Yes, I get that and that's -- actually my last question just on the loan growth mix. I get the benefits from diversifying into resi. But looking at slide 10 is that proportionally that sort of mix going forward is that what you guys are looking for in 2019 with this $600 million per quarter. I guess, how far are you willing to take the resi as a percentage of total loans?
Well, so the average bank our size runs about 25% to 30% of total loans and we're at seven here. So we could -- I think we're going to continue to have that increase. If you said a third of the $600 million was residential that would be about what proportionately maybe kind of where the others are. So I think we could sustain that for really quite some time kind of going forward.
Let me just add to that, Casey. We're targeting about $600 million per quarter and inclusive in there all residential purchases, but those can be accelerated if the economy or interest rates and pricing allow for more opportunistic opportunities to buy or increase our forward flow arrangements with our warehouse lending customers. So when we started to buy a lot of these loans and entering forward flow arrangements the tenure was like 325 or a little higher. So the tenure has dropped 50 bps. And so we got a good buy we think and looking in hindsight on doing these deals, so we're going to be opportunistic as we look at this.
Okay, great…
That said, we got to see a runway ahead of us as well.
Okay, great. And just sorry just one more follow-up. The new money yield on loan production versus the 597 in the fourth quarter?
Yes, it's higher than it was in Q3.
It's a little bit higher than the current portfolio.
How could that -- I mean, if resi mortgage is driving a significant proportion of loans -- of the loan growth why would -- I mean I would assume that would come at a lower yield now?
Okay. So it's -- no it's higher on a portfolio basis if you look at the mix because that is a larger proportion of kind of what we acquired versus what's out there. So the residential loans were essentially flat. But the other categories C&I loans of course the real estate they're higher than what they were during Q4.
Got you. Thanks you.
Our next question comes from Brad Millsaps with Sandler O'Neill. Please go ahead.
Hey, good morning guys.
Good morning Brad.
Ken, I appreciate the commentary around asset quality. Things look to be -- continue to get better obviously a lot of focus in the market about credit quality, particularly leveraged lending. Just kind of curious if you could provide any more color there. And then just any more color on the loan that you pushed out sort of obviously can’t get into specifics on the customer. But any other details on why that one didn't fit anymore and how that might apply to the rest of the book?
Yes, so I have to stay at a very high level with that, but the -- it just didn't fit our risk reward profile and we probably thought there was a higher probability that that loan could trade into special mention and be downgraded. And quite frankly we think given the size of the loan because you can see the size of the deposit relationship that would have -- first of all would be negative and they will also have a negative impact I think upon our market capitalization. And we don't want to be viewed as being too risky here.
So we just thought it was the right thing to do. It's just the risk reward profile of it, the return on it, it just wasn't making any sense for us. I got to tell you by having a set of ethos or precepts it's easier to make a decision to say let's move away from this loan customer even if it has $200 million of deposits, but it was the right thing to do and that's what we have to do.
On your other question on the leverage loans, we have in our corporate finance book of about $1.7 billion overall half of that in round numbers sits with Bridge Bank half of that sits in corporate finance the half that sits in corporate finance is either at or near BBB rating. So -- and it has generally a lot of liquidity to it. So from time to time if we don't like a particular credit or we don't like particular industry you've seen us trade out of that and maybe take a small haircut to the price, but it has a lot of liquidity and allows us to get out of those loans.
Great, that's helpful. And then just one follow-up kind of bigger picture question. I know Ken it’s usually this time of year where you start kind of thinking about new businesses or projects. I know you've got the two loan and two deposit business that are sort of in various stages of getting off the ground. As you kind of think about the next year what’s kind of top of mind in terms of sort of most important on your kind of top five or top 10 list?
Well we've got some things we're looking at, but nothing that we want to either announce or tell you that we're rolling out. We try to be very prudent in this. First let me say the two deposit initiatives one just rolled out and the other isn't ready yet to be rolled out. So it's important that we complete what it is that we have in front of us and execute well on those and then see what the performance is.
On the loan side, the two loan initiatives really are now embedded inside of our loan growth, one just we booked maybe $36 million on one of those initiatives full year last year, but is now ready to ramp up. And the other kind of grew nicely all during 2018 and should continue on to contribute to that $600 million net growth per quarter. But right now we look at things, we talk about a lot of different opportunities, but we want to focus on the four that we mentioned make sure we execute well on those four.
And then over time inside of our EPS growth, inside of our efficiency ratio and our 2.5 to 1 we’ll decide what programs we want to take forward, that makes sense.
Great, thank you guys.
Our next question comes from Michael Young of SunTrust. Please go ahead.
Hey, good morning.
Good morning, Michael.
Just following up on the last comment about the new initiatives on both sides since they're kind of up and running now. It seems like the staffing is probably fully in place. So the incremental kind of expenses next year aren't really associated with those two -- or I guess four initiatives at this point.
I would say generally correct, but we've still got some hiring to do in each one of those -- three out of those four initiatives. And then we have that scattered throughout the year and that's embedded inside of our 2.5 to 1, we've anticipated for those initiatives.
Okay. And then on the growth this quarter, and maybe this year in the other NBLs, could you provide a little more color there? I was interested just because the profit contribution seem to be greater from, not the other NBLs. I don't know if that's funds transfer pricing that's kind of attributing the profit to other segments? Or just any color kind of holistically on all of that?
On the growth, on the profitability I'm sorry, maybe I don't understand that question.
Yes, on both sides it seem like there was really strong growth in the other NBLs in terms of dollar volume, but it seems like more of the profit contribution wasn't coming from that area. So I didn't know if that was higher funds transfer pricing, attributing some of the profit back to other areas. So, I just wanted some color on kind of the dynamics that were playing out there.
Well, part of this is just it's just timing within the quarter, okay. So as you may have noticed, our ending balances in loans were $850 million higher than our average balances. And so you're going to see that this is an ending balance statement, but the earnings are based upon an average. So I would look for that this kind of shift as now you have higher balances. The most significant NBL change is within the NBLs this is where we consolidate our residential real estate initiative. And so that's pulled that up. And some of those settled in December.
And a little bit of general rule to the National Business lines has better operating leverage than the than the regions. So just keep that in mind.
Okay. But there weren't any significant purchases of shared national credits or anything else in the other NBLs space this quarter?
No.
Okay. All right, thank you.
Our next question comes from Timur Braziler of Wells Fargo. Please go ahead.
Hi, good morning.
Good morning.
Just wanted the follow-up again on the other national business lines. I guess, how much of that growth came from the warehouse business this quarter?
So the warehouse business includes the residential real estate piece. So the $400 million that we had in that category came in there. As away from that the warehouse business was really not a participant.
Okay. So as we're thinking about residential growth, I just want to make sure, I got this right. It seems like much of that is going to be coming through purchases with your warehouse partners, rather than going out there and starting a strategy to originate kind of through footprint. Is that correct?
Yes. I want to spend a second on this. We chatted about this last quarter. We have an opportunity to have a deeper relationship with our warehouse lenders, which has many benefits not only loan growth, but also maintaining deposit relationships as well. And what we're doing is we're using their network, their brand, their branches, there upfront compliance costs, and to bring in volume on a forward full arrangement to us. We then underwrite all the loans ourselves any way and we get to pick what it is we want to keep.
So that's the relationship that we have along with when we talk about warehouse lending. There's a note finance part of where house lending, there's an MSR part of finance lending, and there are other component pieces that go under the heading of warehouse learning inclusive of the residential piece.
Okay, understood. And then just one last one from me. As you look at warrant income that's been ramping higher here in the back end of the year. What's the visibility that you have within that segment and as we think for modeling purposes, kind of how should we be looking at that on a go forward basis?
We know about it, when we know about it, almost. There are times that we think we're going to get income in a particular quarter and for whatever reason the deals flow of it doesn't come public. That's all icing on the cake as far as we're concerned, in terms of the relationship, it has a little volatility to it. And it's hard to predict quarter-by-quarter to be honest with you.
Okay. And do you have the dollar amount of warrant income this quarter? I know you said a double of the actual dollar amount.
Yes, $909,000.
Okay, thank you very much.
Up from $413,000 in Q3.
So just to help you out, we use warrant income, but sometimes there are success fees, so success fees were another $900,000. So it’s $900,000 in warrant, $900,000 in success. It can flip flop between the two, a little bit indifferent as long as it does come in, okay.
Got it, thank you.
You're welcome.
Our next question comes from Tyler Stafford of Stephens Inc. Please go ahead.
Hey, good morning guys.
Good morning.
I just wanted to clarify the NIM outlook of relatively flattish. Is that from the 4Q levels or the full year 2018 levels?
No, 4Q level.
Okay. And then just thinking about the trajectory you mentioned the day counts having a negative impact so we should start off from a lower NIM starting point in the first quarter and then moved back up throughout the year. So that the full year 2019 equals or is roughly flat with 4Q 2018 NIM, is that right way to think about the trajectory?
Exactly.
Okay. And then just following back on the residential growth, what does that -- how does that impact the provisioning from here? Can you just talk about how you're viewing the loan loss reserve and given so much more of the growth this year will be incrementally from the resi lower risk how does that impact the provision going forward in the reserve?
So I mean it's basically a substitution of sorts, right. So if you look at our other categories commercial real estate tends today have very kind of low allocation, C&I is a bit higher, construction is a bit higher. And so to the degree that you're doing more in residential kind of elbows out some of these other categories. That means that overall the reserve allocation for that is going to be lower.
Now how that translates into exact provisioning is a process in terms of looking at kind of a historical loss rates and expectations of what that's going to look like on a category by category basis. But in general moving toward a less risky less volatile asset class should diminish our reserve requirements and hence our provisioning over time.
Okay, got it. Just last one for me, I just wanted to get some color from you on how you guys view the quality from a credit perspective of the hotel franchise portfolio today. It's one of the questions I get talking about your story. So I'm just curious if you got any metrics of what kind of LTVs look like their debt service coverage kind of dominant flags there. Just a credit overview of the Hotel Franchise book. Thanks.
Yes, so the book is about $1.6 billion about 88% of all our deals are under the two major flags of Hilton and Marriott. They're producing very strong debt service coverage ratios. The RevPAR numbers for our book of business still continue to accrete upwards although not as fast as they were but still strong.
We work with seasoned partners or seasoned sponsors and operators. So we generally work with -- our borrowers have 10 to 12 hotels they've been doing it for a number of years. We usually require 35% equity in front of us and these are folks that have the capital and the liquidity to put up any money in case there is a margin call.
But right now the book is performing very, very well and we only have two credits of the entire book that sit in special mention. And that came along with the deal.
I'll just add two things to that. The average debt yield north of 10, so we're not as sensitive to increases in interest rates or as sensitive to changes in RevPAR. And a lot of the relationships we have, a lot of loans we have are portfolio loans. So that if one hotel and one market has an issue there's extra cash flow from another market. So it's been underwritten very strong.
Our next question comes from Chris McGratty of KBW. Please go ahead.
Hey, good morning. Thanks for the question. Dale or Ken, can you speak -- given the $200 million relationship you talked about, can you speak about just the granularity of your deposits of it. How many of these larger 100 plus you have and kind of are there any other relationships you might be watching at this point?
Yes, so we have -- our largest relationship is about 2% of our funding very similar to the one that we booted today. And we have about 15 that are over $100 million. We have a policy limit of no more than 4% of funding and as I mentioned, our largest just half of that.
Okay. And are any others kind of contemplating deal to kind of boot like you described?
No, I mean, in that situation, I mean, we had another enterprise offered them in advance higher than we go. And we wouldn't go there.
Okay. And just maybe another one on the balance sheet, the $600 million of quarterly growth, growth at a little bit lower NIM and credit profile. Question is, do you view that as kind of a net accretive exercise to net interest income? And also kind of factoring in the security strategy maybe some comments there would be great.
So I mean we're -- with our stable margin outlook, that would be that our net interest income would grow basically in-line with what we're seeing in terms of earning assets. And so, it's $600 million, we're going to be you're going earning assets in the kind of the low-double-digit range, net interest income should track that. Then you've got your 2.5 to 1 revenue to expense dollar change in terms of efficiency improvement.
And then our tax situation should be certainly no higher than what we were running in 2018 on an average basis. And stable the credit quality, so, the provision should follow that as well.
Okay, great. And just a clarification on the tax rate, this quarter's rate is about what we should be using I don't know there is some…
So, this quarter had some benefit of some items that we thought were probably going to come in, in Q1. So the rate is a little lower this quarter than what kind of a run rate is, but if you look at 2018 in aggregate, take out the benefit that we had from the loss carry back that we did in the third quarter. And a little bit of benefit from the vesting of our restricted share awards in the first quarter, which may not happen this quarter I'm not sure.
At that point in time, that rate was about 18.4%, that number should be a good run rate on average for 2019 going forward.
Okay. And that is a FTE number. Just to make sure I'm clear.
Well, that -- okay so well, I wouldn't want you to gross up the yields for tax exempt securities and then only take 18%. So if you look at the revenue coming in and take 18% of that considering the mix that we have, in some interest securities and tax exempt loans 18%, yes, 18.5%.
Got it. Thanks for the clarification.
Our next question comes from Gary Tenner of D.A. Davidson. Please go ahead.
Hi. Good morning, it's Gary Tenner.
Good morning.
Hey, Gary.
Hey. Just regarding the loan growth in the fourth quarter, obviously came in well above the run rate that you are suggesting for 2019. It sounds like to some degree you’re opportunistic on the resi side a bit in the fourth quarter. But beyond that in terms of just regular way business, any other specific trends or deals that were pulled forward into the fourth quarter that you may have expected to close in the first quarter?
No. There was nothing that was pulled forward.
So I mean, a clean number and as you said it doesn't fit your pipelines into 2019 remain very strong. So okay.
Right, right. Yes, that's correct.
Okay. I mean even in the absence of the run-off of that sizable deposit, your deposits would have kept up this quarter regardless. So I was just trying to wonder if there's exciting the first quarter or will deposit in 2019 just kind of track 2019 and not really catch up about 2018?
Well, I'm not sure they're going to catch up. But I guess a couple of things. One of them is, I wouldn't look for $400 million in residential increase every quarter, like you've mentioned, we were kind of opportunistic in that, if we took our $600 million if we map that to what the typical bank is, which is 30% residential would be roughly a third of it. So $200 million maybe per quarter in residential versus $400 million there.
And then the second piece is, yes, excluding the account that's gone. Seasonally fourth quarter is a little bit lighter, we would expect that to recover as well, which would put that kind of more in balance. So deposit growth would be a little bit better, you wouldn't have a lost account of significance and then loan growth would be a little bit lower.
All right. Thank you for the color.
Our next question comes from Brett Rabatin of Piper Jaffray. Please go ahead.
Hey, guys. Good morning.
Good morning.
Wanted to scope out your credit for a second, your adversely graded credits continues to trend down nicely and just it seems like people are worried about credit. Can you talk about Franchise Finance there a few banks have had some issues with that in the past quarter too, maybe just some thoughts on that portfolio.
Are you referring to the quick service restaurant loans. Is that what you are…
Correct.
Our total book of business there is $200 million and we have less than $1 million that's in either classified or criticize loans there. So it hasn't been a very strong focal point for us mainly because we don't like the pricing and then we of course then don't like the risk return aspect of it. So we're not very strong in there. The deal falls to us that we like of course we'll pursue it. But it's got to hit both credit metrics and return metrics for us.
Okay. And then the other thing it's kind of just curious to me is given your results the past two quarters it's a little bit odd that your stock hasn't to me reacted more favorably. And I think some investors think about deal activity and where you guys might do a deal and not sure how that might look, I just thought I’d give you an opportunity to talk about your parameters around deals and just how you see the market and what you would and wouldn't do this year?
Yes, it's Robert. I think when you look at the results this year that were organically driven. And you look at the kind of a forecast information that Ken and Dale shared with you, we’re comfortable with where we are organically. Having said that, we've looked at a couple non-bank deals during the year, we weren't competitive enough price wise.
But at this stage in the economy and given the organic growth that we have and continue to have we're very disciplined in any potential acquisition we would do. And if we were to do something it would have to have metrics that were very creative for us. And in addition, we'd have to have extreme comfort on the credit side given where we are that we're comfortable there.
We know what we have now, we know what's in our book, we know where we think we are. And quite frankly if we don't find something that fits perfectly for us we're comfortable to accumulate a little capital and opportunistically buy our own stock back. And that's kind of where we're at. I mean, we're really in a very good position and then we don't have to do anything.
That's good color. And then just thinking about the capital and accumulating your accrete percent TCE a year just and should we expect buybacks to help to keep the capital ratios somewhat muted from growing this year?
I think, we look at the buybacks opportunistically and make that decision as the year goes along. But we're not supposed to keep little extra capital and being able to put ourselves in a position of strength should the economy soften or there's some opportunities there.
Okay, appreciate all the color.
Thank you.
Our next question comes from Brock Vandervliet of UBS. Please go ahead.
Thanks for taking my question. So I just -- I guess I'm having trouble with the math here that I worry about your loan yield, which I at least among my coverage is the highest. I know you have to balance growth against yield and it's both it's not just one. But by bringing on so many residential loans 20%, 30% of your total originations that I'm guessing 450 yield. That's a 150 bps lower than your average loan yield. And how do you keep the NIM flat next year, if you're doing that in 2019.
Let me give you one high level comment these guys can step-in.. We have our tentacles in a whole bunch of spaces there are actually some spaces out there in business banking where they loan non-resi are lower than the loan yields for the resi we’re buying. So you can't look at we're buying the residential loans to replace an average loan in the bank. We may be buying the residential loans to replace some pockets of loans that we're not going to make that actually have loan yield equal to or less.
Yes, let me pick up on Robert's comments. First our yields on these loans were north of 4.50%. And when you think about that relative to our investment book and think about how you can swap out of the investments into this that would be accretive from an investment yield to a loan yield basis.
So in 2018 we had on a core basis our margin rose 11 basis points over the course of the year. We just got a rate increase last month as you know that's really going to affect first quarter not fourth quarter. And then we're expecting one rate increase that we have dialed in mid-year. So that should give us some lift of where we are as our balance sheet is still kind of asset sensitive today. Overlaying this we're going to mute that and that otherwise benefit that we would have in the margin increase. It's going to instead be flat line as our mix changes and we move to a little bit of a less risky profile.
Got it, okay. And if you didn't get that mid-year rate hike we could expect a down NIM?
That loan that we lost that you guys talked about that we mentioned that we pushed out of the bank, the bank that took that credit took that actually at a lower yield than the mortgages we bought this quarter. So that's my point that we don't make an average loan we make a loan in the market miss prices risk and return on different types of loans. And we're substituting these mortgage for those types of loans.
Okay, thank you.
Thanks.
Our next question comes from Jon Arfstrom of RBC. Please go ahead.
Thanks, good morning guys.
Good morning.
Just a couple of quick follow ups. Just what Brock was just asking. If the Fed pauses or stops we all think of you as asset sensitive, but are there benefits that you see to the Fed pausing or stopping, for example, do you see less deposit pricing pressure and maybe an easier path in deposit gathering.
Personally I'm pretty indifferent on whether they keep going or not. I'm fine if they stop. And yes, I think it would probably take a quarter or two, but I think overall it would probably kind of stop the energy and the pressure in terms of what's going on, on the funding side. Not at these levels, but if they're pretty relentless in going forward I think it perhaps introduce system credit stress as well in terms of serviceability. We're not there yet, but -- so I'm okay if they give it up.
Okay. Basically the message is you don't necessarily need the Fed to keep going to hold the market steady.
No, in fact we went to some degree where -- I don't want to call that we're saying we're at the top of the rate cycle, but we certainly think we're closer to the top then more than halfway there for sure. And that's really an impetus to kind of moving the duration of our assets we think this isn't a bad time to -- we're not doing swaps or anything to throw it out there. But take a little longer duration asset and put a return such that I'm not saying rates are going down, but if they were to that we're going to be a little slower repricing assets than we otherwise would have been.
It also puts more volume and fees to some of our business lines to break slow down so that potentially offsets the margin issue too especially housing related business, home construction mortgage warehouse lending volumes include that.
Okay, that makes sense. Ken, I may have missed this, but you talked about the first deposit initiative being live and you touched a little bit on it last quarter on how it was going, but give us an update if you can in terms of how that's gone so far?
Yes, I want to avoid talking about each one of the business lines specifically. I'll just say it really went live in Q4. We brought in some deposits with that, we expect to continue to roll it out and grow it both deposit initiatives actually now report to Dale. So, we're going to move through these initiatives in a very constructive way and make sure what we're doing works and how we are dealing with our customers that we can service them.
Again, if you have a missed up, and you wind up destroying all the brand equity you're trying to create with this customer base. And we are optimistic that we have found something here that we can grow, it will grow over time. If you don't look for like a big grand slam coming in on the next quarter, we'll just continue to grow it.
Okay, got it.
Remember, the second one doesn't pick up live until sometime in Q3, for the back end of Q3, which is what we've always said.
Okay. And then one follow-up maybe, Robert or Ken. Robert, last quarter you talked about some of the non-bank funds potentially showing up and maybe shaking lose. You touched on it, but I'm guessing that December maybe ship some more things lose and I'm just curious if you've seen increasing numbers of opportunities and a little bit better pricing in terms of the things that you're looking at.
There is definitely increased amount of deal flow that's floating around in terms of the pricing. I'm not really sure I could comment on that because we only really dig into a couple things we have interest in. So we don't -- I couldn’t tell you on a macro basis on pricing.
Okay. All right, thanks guys.
Thank you.
Our next question comes from David Chiaverini of Wedbush. Please go ahead.
Hey, thanks. First question is a follow-up on the mortgage, I was curious, can you remind me what the average FICO, average size, average maturity, fix floating rate just some additional stats on mortgage you already mentioned the yield is north of 4.50%, but I was curious about the other items.
Yes. So the LTV here is in the 70s. The debt to income is kind of mid 30s, 36 and FICOs are 760 on this group. We do buy some in the jumbo category. So some of these are in the high six figures in terms of balances. And geographically kind of fairly dispersed, but a concentration more so in the West and East.
Got it. And then I also wanted to follow-up on the lending relationship that you ended in. Certainly happy to see sticking to prudent underwriting. I was curious can you share what industry you ended the relationship in?
I would prefer not to. Okay.
Fair enough. That's all I had, thank you.
Okay, you’re welcome.
Our next question is a follow-up from Michael Young of SunTrust. Please go ahead.
Hey, thanks for the follow-up. Just wanted to really quickly touch on the residential peace one more time, but in the context of CECL and extending the duration you kind of mentioned that it's a good use of capital, you still feel that way obviously pro forma under the new CECL regime. Is that fair?
Yes, that's fair.
And any color you can provide on the analysis there?
Yes. So well, just maybe just generally let me start. So I mean, we don't have a number for CECL. I think we're going to probably provide some guidance on that, maybe on our second quarter earnings call, that would be my guess. But our analysis is consistent with others that have talked in general terms that those areas that have consumer particularly high loss areas like credit cards and stuff like that consumer always has a higher loss with some duration over one year, which is somewhat the implicit model in the current construct. And that's where these larger requirements for reserves are coming from.
So given our profile and where we stand in terms of commercial real estate, which had a very low loss rate for the past several years, residential real estate, which has had a lower loss rate as well. No, that does have a duration element to it that can add to that. But considering that, we're still single-digit percentages of our balance sheet versus triple or quadruple that for the average bank. My estimation is that from where we are today, the effect on us on CECL is going to be less significant than a typical day.
And the mortgage piece in particular, we have some AI that we use that helps us achieve better duration, lower duration from the mortgages we are buying on higher yields.
Okay, makes sense. Thanks, guys.
This concludes our question-and-answer session. I would like to turn the conference back over to Ken Vecchione for any closing remarks.
Yes, just finished by saying, we're very pleased with our performance in Q4, very pleased with the performance for the full year. We think we entered the year with good loan growth, stable asset quality trends as we set a steady NIM. Growing net interest income that will be balanced against expense growth to 2.5 to 1. Generating the positive operating leverage you heard Dale talk about a lower tax rate going forward. And we're going to be opportunistic in buying back the stock. So all that gives us a little bit of momentum moving into next year, and we look forward to talking to you on our next call. So thank you all for joining us today.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.