Western Alliance Bancorp
NYSE:WAL
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Western Alliance Bancorp
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Good day, everyone. Welcome to Western Alliance Bancorp's Fourth Quarter 2021 Earnings Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] You may also view the presentation today via webcast through the company's website at www.westernalliancebancorporation.com.
I would now like to turn the call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Please go ahead.
Thank you. And welcome to Western Alliance Bank's Fourth Quarter 2021 Conference Call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; and Dale Gibbons, Chief Financial Officer.
Before I hand the call over to Ken, please note that today's presentation contains forward-looking statements, which are subject to risks, uncertainties and assumptions. Except as required by law, the company does not undertake any obligation to update any forward-looking statements.
For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, please refer to the company's SEC filings, including the Form 8-K filed yesterday, which are available on the company's website.
Now for opening remarks, I'd like to turn the call over to Ken Vecchione.
Okay. Good afternoon, everyone. 2021 was a watershed year for Western Alliance as we drove many of our own records for balance sheet growth, total net revenue and earnings while thoughtfully expanding into new business lines and geographies that will make us an even stronger, more diversified bank.
For the year, total assets ended just shy of $56 billion, with loans growing 44% over year to $39.1 billion and deposits rising 49% to $47.6 billion. This strong balance sheet momentum propelled record net revenues of $2 billion, net income of $899 million and EPS of $8.67, which is our 12th consecutive year of rising earnings.
Turning to the fourth quarter results. WAL earned total net revenues of $561 million, net income of $246 million and EPS of $2.32. The strong balance sheet expansion continued with quarterly loan growth of $4.3 billion or 49% on a linked quarter annualized basis. And deposits rose by $2.3 billion or 20% annualized.
Loan demand continued to grow across our business lines with C&I loans increasing by $1.8 billion, inclusive of $200 million of CCC runoff along with a $1.8 billion growth in our residential portfolio and $584 million in CRE. One of the hallmark of our national commercial business strategy is the ability to develop niche specialty banking business and to attract qualified talent to thoughtfully scale new business lines with superior risk adjusted returns.
As an example, since joining in June, our restaurant franchise finance team had $151 million in outstanding and is a positive contributor to earnings. Similarly, our Texas-based single-family home construction CRE team has $235 million in improved commitments.
Our loan pipeline and channel checks continue to show a burning of loan growth in our traditional commercial loan businesses. Attracting seasoned senior teams to WAL provides the opportunity to establish new business lines that ramp up quickly due to their existing client relationships. A $6.2 billion increase in average earning assets drove net interest income growth of $40 million or 39% annualized to $450 million as excess liquidity deployment for loans and loans held for sale contributed significantly to earnings.
Fee income was $110 million, representing 20% of total net revenue, a decline of $28 million over prior quarter, as mortgage banking-related income was impacted by seasonal fourth quarter weakness and the mortgage sectors transitioned to a rising rate environment, which comprise gain-on-sale margins. I would like to reiterate that AmeriHome is fully integrated into the strategic fabric of Western Alliance and is thoughtfully managed to maximize value for the entire bank through loans, deposits and net interest income growth, not just gain-on-sale launch.
The B2B correspondent business inside of Western Alliance has several business levers, which can be repositioned to sustain earnings throughout rate and economic cycles. Given the flexibility of the AmeriHome’s business model, ongoing mortgage operations can provide multiple revenue opportunities, which serve to offset lower gain-on-sale recognition.
Western Alliance's branch like flexible business model provides us a competitive advantage to leverage operating efficiencies to enhance financial results, while investing in business initiatives to drive future growth.
Quarterly adjusted non-interest expenses grew $4 million to $235 million, producing an efficiency ratio of 41.3%. To put this in perspective, over the last 5 years, total loans and deposits have grown 2.5 times the rate of operating, excluding AmeriHome. Productivity improvements provide us with the capability to absorb higher labor costs while continuing to fund products and technology investments.
Total adversely graded assets were flat, and quarterly net loan charge-offs were just 2 basis points. Western Alliance is one of the most profitable banks in the industry with a return on average assets and return on average tangible common equity of 1.65% and 25.8%, respectively which will continue to support capital accumulation and strong capital levels.
Finally, what excites me most are the differentiated technology and banking services that Western Alliance is increasingly delivering to our clients to solve unique pain points and facilitate transactions. We recently announced a partnership with Tassat Group to deliver blockchain-based payments to our clients using their TassatPay platform. The launch of this program scheduled for early second quarter will allow Western Alliance Bank clients to transfer funds continuously to one another 24/7.
Additionally, yesterday, we announced the acquisition of Digital Disbursements, a leading digital payment platform for the class action legal industry that integrates legal settlement claim process with a multi-product payment portal. This differentiated technology solution enhances the capabilities of Western Alliance settlement services team and solidifies the bank as an initial leader in the $15 billion legal class action model.
Our national settlement services business developed in 2019 and launched in 2020, has been described on previous earnings calls as deposit initiative 1. This business has successfully generated $2.3 billion in deposits as of year-end. And we are thrilled to welcome the new team from Digital Disbursements to help the bank continue to produce unique value-added solutions to the legal service sector.
Dale will now take you through our financial performance.
Thank you, Ken. For the quarter, Western Alliance generated adjusted net income to common shareholders of $242.5 million and earnings per share of $2.32. Pre-provision net revenue was $326 million.
Total revenue grew $12 million during the quarter to $561 million, and net interest income grew $40 million during the quarter to $450 million, an increase of 10% primarily as a result of significant balance sheet growth and deployment of liquidity into higher-yielding assets. Average interest earning assets increased $6.2 billion while the lower yielding cash position held for sale fell to 2.3% and 3.9% of interest earning assets.
Although not annotated on this page, I want to address the characterization of 2 items in non-interest income. Regarding the $8 million of securities gains we reported in the second quarter of 2020, we purchased over $100 million of term municipal bonds that were in sectors hard hit by the pandemic, most notably airports. In the fourth quarter, we sold those bonds as they had recovery in value, and the velocity of rate expectations changed. I know securities gains are often excluded from core analysis, but this seems more like a trading gain to us.
Regarding the $7 million credit guarantee revenue. During the quarter, we sold a credit-linked note in which the buyer of the note assumes a first loss position of the $4.5 billion residential portfolio. This $7 million in revenue is the currently expected credit losses avoided by selling these bonds.
I had CECL antipathy since before it was born. I don't think it's remotely helpful to investors in understanding bank financials, and it certainly doesn't improve comparability. But I don't know anyone who is taking CECL-based credit provisions and excluding them from core, which is the same principle here. It doesn't make sense to us that if we increase residential loans in both a day one cumulative loss expectation charge and the next day, we sell a credit linked note to put that exact same loss expectation to another party that we should be stuck with a debit in core income we forfeit the insurance credit for determining earning power.
Overall, non-interest income decreased $28 million to $110 million from the prior quarter driven primarily by industry wide gain-on-sale margin compression. As Ken noted, in anticipation of margin compression, we are implementing several initiatives to bridge the gain-on-sale earnings slowdown with predictable and stable net interest income revenue streams.
Non-interest expense, excluding merger and restructuring recoveries and loss on extinguishment of debt, increased to modest 1.6% or $4 million, resulting in an efficiency ratio of 41.3. For the year, Western Alliance recorded net income of $899 million or $8.67 per share, a 72% increase over EPS for 2020. Net interest income grew $382 million during the year to $1.5 billion, an increase of 33% year-over-year mainly attributable to increased loan balances and PPP loan fees.
Non-interest income increased $333 million to $404 million in the prior year as the AmeriHome transaction closed early in the second quarter and contributed significantly to fee revenue. Finally, noninterest expense increased $360 million or 73% year-over-year as 950 AmeriHome employees joined WAL in the second quarter.
Turning now to our net interest drivers. Investment yields increased 5 basis points from the prior quarter to 2.51%. While on a linked quarter basis, loan yields declined 25 basis points following continued strong growth in loans and no loss assets such as residential loans and capital call loans and modest yield compression across other loan categories. We continue to optimize the deployment of excess liquidity into higher-yielding assets and allocated cash yielding 10 basis points as the Fed loans held for sale yielding 3.04%.
Funding costs were slightly lower from the prior quarter due to the redemption of $175 million subordinated debt with increased interest-bearing deposit cost of 20 basis points and total cost of funds at 29. The spot rate for total deposits, which includes non-interest-bearing, was 11 basis points. We expect funding costs to bottom at these levels as rate hikes are forthcoming.
Overall, net interest income grew $40 million to $450 million during the quarter or 43% year-over-year as average interest-earning assets increased $6.2 billion or 13% during the quarter. The prudent deployment continues, and cash balances were optimized with cash as a portion of average earning assets of 2.3%, a decline from 3.9% in the prior quarter, resulting in a loan-to-deposit ratio of 82%, an improvement from 77% prior. The net interest margin increased 10 basis points to 3.33% mainly driven by lower yields on our commercial real estate portfolio and strong growth in low loss but lower yielding residential loans and capital call lines.
With regards to our asset sensitivity, our rate risk profile has been reduced over the last 2 years as we've added fixed-rate residential mortgages, And the yield on the majority of our available rate commercial loans have bottomed out at their contractual floors. We are poised to recognize significant increases in net interest income in a rising rate environment once these floors are no longer inhibiting loan yield escalation and with ongoing balance sheet growth.
Consequently, this asset sensitivity is more muted initially but accelerates as interest rates normalize. Currently, $16 billion or 94% of our variable rate loans with floors are after contractual forwards. With 25 basis point rise in rates, 25% of these loans will rise off the floors. And with 100 basis point rise in rates, 75% cumulatively will return to variable rate.
In a rate shock scenario of plus 100 basis points on a static balance sheet, net interest income will rise $73 million or 4.6%. Using a ramp scenario on a dynamic balance sheet, we expect net interest income to increase $62 million in the next 12 months after quarterly rate increases are initiated. And given the pandemic, the dynamics of our loan floors, $257 million increase over a 2-year time frame if only 4 rate hikes are accomplished through 2023.
In a rising rate environment, other areas of Western Alliance income statement may also be influenced. Mortgage sector volumes and profitability are expected to be reduced with lower refinance volumes, partially offset by increased servicing revenue at the life of the mortgage servicing rights are extended. These factors may be partially mitigated as we expect deposit betas and earnings credits on $10.8 billion of deposits to be lower than in the previous rising rate periods and to have longer lag times, but could give back collectively about half of the potential net interest income improvement for our interest rate sensitivity.
AmeriHome is now fully integrated into WAL. And gain-on-sale volume and margin contraction can be minimized by accelerating loan, deposit, EPO and product channel diversification. None of which are available to stand-alone mortgage operators but are available within a bank-owned company. We expect net interest income sourced through AmeriHome relationships to rise throughout the year, countering reductions in traditional mortgage banking income and growing total revenue and NAV.
Our efficiency ratio improved modestly to 41.3% from 41.5% in Q3 as our net revenue growth exceeded that of our expense growth. One of the key characteristics of our national business line approaches is high operating leverage. As mentioned in our prior calls, we expect the efficiency ratio to remain in the lower-40s for the year, inclusive of planned technology investments, new product development expenses and the absorption of higher compensation costs supporting rising rates and deposit account relationships.
Pre-provision net revenue increased $9 million or 2.8% from the prior quarter and 58% from the same period last year. This resulted in PPNR ROA of 2.24 for the quarter, a decrease of 21 basis points compared to 2.45 primarily driven by balance sheet growth outpacing PPNR increases.
This continued strong performance in leading capital generation provides us with significant flexibility to fund ongoing balance sheet growth, manage capital actions and meet credit demand. Robust balance sheet momentum continued during the quarter as loans held for investment increased $4.3 billion or 12% to $39 billion, deposit growth of $2.3 billion, and our balance is to $47.6 billion at year-end.
On a quarterly average basis, loans held for investment grew 16% in deposits. In all, total assets grew 53% year-over-year.
Total borrowings increased $330 million over the prior quarter to $2.4 billion primarily due to an increase in overnight borrowings of 2 75 and the issuance of $228 million in credit linked notes, partially offset by the redemption of $175 million in sub debt. Finally, TBV per share increased $3.17 over the prior quarter to $37.84. That is up 22% year-over-year.
We continue to generate consistent organic loan growth from our flexible national business banking strategy. And are seeing broad-based demand. Loans held for investment grew $4.3 billion in the quarter. Quarterly loan growth was split almost evenly by an increase in residential real estate loans of 1.8, which now comprise 24% of loans and $1.8 billion also in C&I loans as demand for capital call lines and mortgage warehouse lines remained strong. And we saw an acceleration of demand for broader business managing nationwide including early success in our new restaurant franchise finance team, CRE loans grew $534 million predominantly as a result of demand in our hotel franchise finance that bounced back as we expand relationships with proven clients and sponsors, while also obtaining tighter overwriting. Additionally, construction land loan's added $79 million.
Turning to deposits. We continue to see broad-based core deposit growth across our business channels. Deposits grew $2.3 billion or 20% annualized in the fourth quarter driven by increases in interest-bearing DDA of $2 billion, non-interest-bearing DDA of $295 million and CDs of 226, partially offset by a reduction in savings and money market funds of $162 million.
Robust fundraising activity and tech innovation, coupled with market share expansion of HOA banking relationships contributed significantly to quarterly deposit growth. We also saw strong performance in regional commercial products.
To highlight one of our growing national deposit businesses, business escrow services previously called deposit initiative 2 provides escrow payments and administrative services for M&A transactions. This initiative launched in 2021 with a new senior leader and has recruited a highly effective team and has established offices in New York City and Minneapolis. The team has formed strong relationships with serial acquirers and successfully facilitated over 100 acquisitions, which quadrupled our deposit balances in the fourth quarter in this business line of $600 million. We now have established ourselves as a formidable market competitor in the space.
Our asset quality remained stable after the significant improvement seen in the prior quarter. Total classified assets rose $36 million in Q4, $301 million or 54 basis points of total assets. Special mention loans declined $33 million during the quarter to 0.85% of funded loans, greater than 30% reduction from the prior level seen in September 2020. Total classified assets in special mention loans as a percentage of total assets and funded loans are now lower than in 2019.
Quarterly net credit losses were $1.4 million or 2 basis points of average loans compared to $3 million in Q3. Our total loan ACL increased $11 million from the prior quarter to $290 million due to significant loan growth in low loss segments. In all, total loan ACL and funded loans declined 6 basis points to 74 basis points. Adjusting for the $1.8 billion of mortgage warehouse lines and $4.6 billion of residential loans covered by the credit linked notes were ample with first loss coverage as assumed by a third party. The ACL ratio is 89 basis points.
Finally, given our industry-leading return on equity and assets, we continue to generate significant capital to fund organic growth and maintain healthy regulatory capital ratios. Our tangible common equity to total assets of 7.3% and common equity Tier 1 of 9.1% were both bolstered by net income and the common stock offering under the ATM but were impacted this quarter by higher asset growth. Inclusive of our quarterly cash dividend payment of $0.35, our TBV per share increased 3.17 to 37.84.
I'll now hand the call back over to Ken to conclude with closing comments.
Thanks, Dale. 2021 really was an exceptional year from an earnings and loan growth perspective as our distinctive national business strategy model continues to hit on all cylinders and our new initiatives are already paying for themselves. We are very excited about the diverse set of growth opportunities in front of us as we enter 2022.
Looking forward for the full year 2022, we expect loans held for investments to grow in excess of $2 billion per quarter from prior guidance of $1.5 billion to $2 billion or low to mid-20% growth rate for the year with flexible origination mix designed to maximize net interest income. Residential loan purchases will remain strong, but the relative contribution to growth will be driven by liquidity so as not to crowd out core commercial lending opportunities. Deposits will grow in line with loans as we continue normalizing the loan-to-deposit ratio, which today stands at 82%.
The efficiency ratio for the year will remain in the lower 40% range as we continue to invest in risk management and technology as well as build out our teams to respond to growth opportunities we see in front of us. We believe that net interest margin declines have abated and expect net interest margin to rise in concert with the FOMC actions. Stable and rising NIM, coupled with strong balance sheet growth, will drive net interest income higher.
Regarding capital, our strong organic capital generation continues to support balance sheet growth. However, quarter-to-quarter variability around this growth may require incremental capital actions to maintain a baseline CET1 ratio of 9%, including sales of credit-linked notes and common stock issuances from time to time. To facilitate this, we expect to add 2 million shares to our ATM capacity.
In conclusion, we continue to see strong pipeline and have the operating flexibility to both execute on near term opportunities while investing for long-term growth. We believe the current full year consensus guide is the floor for 2022 but should tilt more to quarters 3 to 4 to reflect the seasonal and cyclical nature of our business lines and AMH's reposition.
Finally, one last note regarding Robert Sarver, our Executive Chairman. Our independent directors are actively engaged in monitoring the allegations being investigated by the NBA. The Independent Directors have hired an independent outside law firm, [Indiscernible], to advise the Independent Directors on this matter and assist them to conducting an investigation to evaluate Robert's continued leadership role at the company. The investigation is being directed and overseen by the independent directors and to be clear, is not the result of any allegations related to the company discovered by the Board or the NBA. In addition, Western Alliance has and will continue to assist the NBA in an ongoing investigation as requested.
At this time, Dale and Tim Bruckner, who is in the room, our Chief Credit Officer, and I are happy to take your questions.
Thank you. [Operator Instructions] Our first question comes from the line of Casey Haire with Jefferies.
Yeah, thanks. Good morning, guys. Question on the balance sheet growth guide, specifically the deposits. I mean, I think we all appreciate that the loan generation is pretty strong. And you guys are capable of doing more than that $2 billion. And to the extent that you guys do, it sounds like you want to keep the loan-to-deposit ratio in the low-80s. Can you match that loan growth on the deposit side, which will obviously be a little bit harder in a rising rate environment?
The answer is yes, okay? That's why we made the loan and deposits, just dollars growing the same amount. But our pipelines look very strong. And I just want to reinforce the $2 billion loan guidance floor and the $2 billion of deposit guidance floor are really at the low-end as before.
Our pipelines are very strong, and our deposit pipelines are looking at the moment for the first quarter closer to double the floor map. So we think we're off to a very good start, we think is deposits will be strong throughout the year. And we're very excited about what we're seeing in the marketplace.
Casey, regarding your comment about keeping our loan-to-deposit ratio in the low-80s. So we look at held-for-sale loans as not really an alternative to the loan growth. That's an alternative cash for us. It's just a much better yielding one. And for the most part, they're already -- they have a great risk adjusted capital ratio on them because you're putting those loans to a GSE. And so instead of keeping money at the Fed or some other from bank putting it into these short term basically puts that we have to the GSEs on these mortgages is a much better deal. But that's where the substitution is. So I would look for our loan-to-deposit ratio to continue to climb through the 80s, get back into more like the lower 90s.
Yeah. And just -- I always keep reminding people that held for sale, we're generating 3% yield on that for what is basically a 3-week money market asset guaranteed by the government. So we like that strategy.
Okay. Very good. Understood. On the deposit growth pipeline, how much of it do you expect from this -- from the recently announced Tassat partnership? I'm just trying to get a gauge on -- obviously, we've seen that at other banks be very explosive deposit generator. What kind of forecast are you guys baking in looking ahead in '22?
Fair question. Right now, we haven't baked in anything. So when we discussed or said that the floor is $2 billion, but I think we'll be more likely to double that for Q1. Much of that incremental growth is coming from our efforts at AmeriHome to drive a higher deposit growth into the company.
So both the Digital Disbursements announcement today and the blockchain announcement connected to Tassat, we have not put any numbers, any deposit numbers into our forecast this year. We are very hopeful and we expect for those programs to generate greater deposits. But at this time, our first goal is let's get that blockchain program with Tassat launched in early second quarter. And once we see the reception, we can then determine how to give you some guide on the future deposit growth.
I should say both of those programs, the national business line strategy settlement services and also business escrow services, they both report to Dale. So do you want to add anything to that, Dale?
No. That's absolutely correct. I mean, I would tell you, we have high hopes for what can be executed here. And we've already started conversations with the authorities. But nothing is baked in to what we're talking about.
Okay. Very good. And just last one for me on the gain-on-sale line. Can you just give us some updated thoughts on where we can see the gain-on-sale margin trend from that 28 bps here in the fourth quarter? And can you -- in the production volumes, obviously, can you run gain-on-sale pressure with stronger volumes? Ken.
So one of the things that we're doing what we call either repositioning or pivoting AmeriHome is to buy and sell non-QM and jumbo loans. We started this immediately when we bought the company, we set up the program. We have 850 clients at AmeriHome. We had to go out, educate, train and then approve them to make non-QM and jumbo loans. Today, 250 clients are approved. And they're generating about $200 million a month in mortgage loans. I tell you all this because as we go through the year, we're going to be leaving the conventional market, which is seeing more compression in spread.
And to the extent that Western Alliance or the commercial side of our balance sheet doesn't want any of those mortgages or it doesn't hit our risk-adjusted returns, we will then sell them off in the marketplace. And we think those margin spreads there are much higher, somewhere at 35 to 40 basis points today.
So that was a long winded answer to say as we reshift the focus inside of AmeriHome, the lower margin spreads today will grow throughout the year. And that's why just bringing something back to my comments at the end. That's why I said, hey, when you think about our earnings for 2022, I said, let's tilt them a little bit more to the back end as we roll out all those non-QM and jumbo programs to our 850-member client base.
Okay. So the $200 million is -- that's what you did in the fourth quarter. How big can that number grow to?
Yeah. That's a very sizable number. And I'll just say it could be very sizable. And let us get through another quarter and start building on it. And then the numbers we give you will have 1 -- we'll have a lot more confidence in, and it will give us more credibility. But we see that number building all throughout the year, especially into 2023. We're very optimistic about this.
Okay. Very good. Thank you.
Thanks.
Your next question comes from the line of Brock Vandervliet with UBS.
Hey, Brock.
Thanks. Hey, good morning. I think the -- we should go back to the rate sensitivity. I think the most unsettling maybe complex slide was Slide 8 and that last bullet. And Dale, maybe if you could just go through that again in terms of -- I think everyone gets the basic rate sensitivity. It's the offset that you may have because of the mortgage businesses that I think are throwing investors.
Yeah. Appreciate that, Brock. I mean, that's correct. I mean, we obviously saw a cyclical and seasonal pressure in Q4 in the mortgage space and in anticipation of kind of the rate increases.
If this rate trajectory were to continue, we think that on that baseline giving to what Ken referred to in terms of the present business mix will undertake -- undergo additional pressure as rates rise 100 or 200 basis points, which crimps the non-interest revenue relative to that operation. Also noted there is that we have certain deposits with earnings credit rates. I think that's going to be much less significant than the potentially the mortgage element.
But what this doesn't include is what's Ken referring -- what Ken referred to as the pivot more to the NQM or to the jumbo mortgage origination products and these other initiatives that are being done there that will mitigate that. It also doesn't have kind of factored in what they expect to do in terms of growth.
So last year, we mentioned we had -- we have 860 mortgage warehouse clients that we have not mined for MSR lines, for warehouse lines and for deposits from that group. That compares to just over 100 that we have on the bank ourselves.
And so we now have staffed up for that, and we expect to mine that group already. And as we get into that, that will improve I think, what their performance has been. And on the net interest income side, mitigate that, but you're still going to see pressure on the fee revenue side from mortgage operations.
Okay. I understand that. I just keep coming back to that last bullet point. But does the last bullet point where interest rate sensitivity says it could be dampened by half. Do we, therefore, prorate the NII impact you show on the left side or totally different?
No, no. Maybe we should be more fair here. It's not that the rate sensitivity is going to be cut by half. It's that the addition to PPNR from a higher rate environment. So we're showing -- so for example, $377 million over 2 years and an 8-quarter rising rate environment.
We're saying that, okay, if I -- that number could be more like $180 million or $190 million flowing to PPNR. 377 is what you're going to see in net interest income, but you're going to see lower ramps or slower levels in fee revenue. So that's a PPNR change as opposed to just net interest income when you get to the 50% haircut potentially.
Okay. And just in the resi loan yields detail here. The loan yields continue to compress 309 to 289. I would have expected those went in the other direction and lifted this quarter. And maybe that's a mix issue in terms of what you're selling versus retaining. Can you just cover that?
Yeah. You're right. Our current on-the-run acquisitions now. We're in the lower 3s. And so I would think that has bottomed out.
Okay. All right. Thanks for the questions.
Your next question comes from the line of Ebrahim Poonawala with Bank of America.
Hey. Good morning.
Good morning.
I guess just first, I wanted to follow up on the legal investigation that you flagged, Ken. One, is the expense related to the initiation of the investigation this quarter? And should we expect the legal expense line going back to where it has been just from a number standpoint?
And then what management to the Board to initiate this because it feels like at least about 60 days ago, you didn't see a need for having a standalone investigation versus what the ESPN was doing. So would love to hear some color around that, how quickly can this get wrapped up so that this no longer remains an overhang on the stock?
Yeah. So let me take the expense question first. Really, there's not been any major impact at all to the legal line. And I'm not expecting that to balloon out in any way, shape or form. So we answer questions that come to us from the NBA. I don't expect this investigational review to really add in any material way to the legal expense line item.
To your second point, I would probably correct your assumption upfront. The independent board members have been very much engaged from the very beginning of this ESPN report and NBA investigation. And this is just the next step, and they're doing their appropriate due diligence and handling their fiduciary responsibilities to the company. So I just think it's the -- it's just the next step in the whole process.
And is there a time line by when we probably conclude all of this?
So really, this is being handled by the independent directors and their counsel. And I'm really not in a position to comment on the scope or duration of the investigation. Sorry.
Got it. And I guess a separate question just around rate sensitivity. I think you expect the margin to have bottomed out and move higher as the Fed moves. Dale, if you can give us a sense of understanding the rate floors. What should be the lift to the margin from the Fed hikes, if any? If you could quantify that, that will be helpful.
So, out of the gate, it’s going to be fairly muted. I mentioned that we have 94% of our variable rate loans are at the floor. We’re not going to see much thee. Conversely, I think there is a lot of liquidity in the industry. And I don't see where pricing pressure would come from other institutions or on a competitive basis to increase funding costs.
And so it does start out fairly modestly and then climbs. So I mean it's going to be kind of single-digit millions for the first increase. And then the next number will be a multiple of that. And then it will probably double again, as we get, say, 75 to 100 basis points off of the floor. And then it's going to be more ratable based upon the overall mix of our loans that are variable rate, which is substantial.
Got it. And if I can sneak in one last one. I think, Ken, you mentioned that you think the $9.80 EPS from consensus should be a floor. You should do better than that. What are you assuming in terms of gain on sale income given what the forward curve is telling us about rates? Do you see how meaningful -- of what decline do you see in gain on sale relative to the fourth quarter levels?
Well, so the first quarter is also seasonally challenged as is Q4. And so I wouldn’t look for improvement in gain on sale in 1Q. After that, I think the -- that sector starts picking up I'm going to say, kind of early spring, late winter, summer March time frame. And so we're looking for improvement in Q3 -- Q2 and Q3 going forward.
And then by the time we get to the second half of the year, our mix will have changed and will be less dependent upon GSE paper and more on non -- NQ, non-Qualified mortgage paper, which again has got our margins in it. So we’re looking for things to be improving really starting in the second quarter but carry through 2022.
Got it. Thanks for taking my questions.
Your next question comes from the line of Timur Braziler with Wells Fargo.
Hi, good morning.
Good morning.
Just to circle back on the last comment on residential production. I guess is there a good way to think about it kind of the next two quarters about down AmeriHome is still primarily conforming you're going to use that time to continue building the resi both on balance sheet and then as that product switches to non-conforming in the backend of the year all that production will be sold off.
And I guess when that switch occurs, will that trigger a change in your appetite for production out of AmeriHome? Or will that level still be the same, just going through the gain on sale line?
Yeah. So I just want to correct one assumption first. What we're buying from AmeriHome today or what are AmeriHome is selling to the commercial side of our business are the non-QM and jumbo loans, all right? So we're not housing these conventional loans on our balance sheet that they buy in as part of their correspondent lending business and then they turn around and then they put them to the GSEs.
So for us today, we both have -- we have an AmeriHome inflow for non-QM and jumbo loans. And we had this program started before we purchased AmeriHome. And so we have from our 100 or so clients a group that continue to offer us forward flows. So as AmeriHome's volume picks up, we'll probably decrease the forward flows from our existing customer base, but always looking at what is the best return we can get either from AmeriHome or from our existing customer base.
Is that helpful?
Okay. That’s helpful. Yeah, that’s helpful. Thank you. And then maybe looking at the average levels of loans held-for-sale versus the period end balance. Is that the typical trend that those balances kind of pickup throughout the quarter and then there is more selling towards quarter end?
And I guess as we head into next year, are those average balances kind of what should be as easy for our assumptions for loans held-for sale or is there going to be a stepdown at the end of this quarter?
Yeah. So you may have noticed this before, we have an AmeriHome team. But we’d say our loans tend to peak at or near kind of month end and especially quarter end. And so our average balance tends to lag that of our ending period. I call it the telephone wire, although there aren’t any more telephone wires anymore, kind of phenomenon, where it picks up and then groups down again.
And so, to basically address that as they have a more stable earning asset level throughout the quarter future quarter, we have to reverse basically plan for the held-for-sale book at AmeriHome, at that such a short window we can play with that. And so we have driven that average balances lower than the ending balances. And you add them together you get something a little more stable in terms of averages at ending.
Going forward, I think we’re there. We have -- we’ve taken the held-for-sale portfolios kind of where we want them to be. I’m not looking for continued growth in there, neither on an ending more average base as necessarily. And meanwhile again now that we’ve ramped that up, now that we have stocked up the liquidity that we have when we acquired AmeriHome where we’re sitting on $6 billion in cash.
Our focus is now, okay, what do we want to put on the held-for-investment book, and that's what Ken was referring to in terms of continuing to grow these non-qualified mortgages that are really good quality. These are low LTV. They're in the mid- to high 60s on LTV, 7 60 FICO, debt to income in the mid-30s. And we think that's going to be pretty impervious to kind of swings in the business cycle and the residential valuation cycle as well.
Okay, great. Thank you.
Your next question comes from the line of Brad Milsaps with Piper Sandler.
Hey. Good morning, guys.
Good morning, Brad.
Dale, you think kind of the NBA data as the proxy. Your mortgage market share is kind of been plus or minus 2% for the past couple of quarters. I was curious if you had an idea of kind of where you might see that increasing to over the next, I don't know, 12-18 months as you guys kind of continue to take share if that's one way to think about it.
Well, we have a pretty flexible model whereby we can step up on the share space to continue to take volume. So I think that's going to really depend upon what else we see kind of going on. We are sensitive to the -- how the elastic demand and pricing is in that space. We don't want to come in so strong that we start kind of pushing down pricing overall. But within that parameter, I think we could be taking up share to again, address the expectations that we have from AmeriHome away from what they're doing on our balance sheet.
And just curious, you addressed kind of the level of held for sale that's going to remain pretty stable from here. But just kind of curious, if you do hold those for longer and generate more interest income, does that impact your gain on loan sale at all? Just kind of curious if there's a bit of a trade-off there. Maybe we're not seeing it as much in fee income, but you're picking up more NII. Just kind of curious kind of how the two pieces might work together.
Yeah. Let me say bingo. That's exactly what the conversation is. And we work with AmeriHome very closely to make sure that the net economics are better for the bank, whether it be just taking the loans in holding them for 3 weeks and then putting them to the GSEs, we're getting a full gain on sale that way or by having them reside and nest on our balance sheet for a longer period. So we look at it both ways. And wherever the best economics are, that drives what we do.
So if those loans have sort of reached kind of a steady level and you guys continue to take share, you could actually see all else being equal to maybe the gain-on-loan sale fee income line improved a bit first quarter kind of notwithstanding due to seasonality?
Correct. Yes. That's a fair comment.
Okay. And then just on the servicing piece. I know it's not a big number, but you've got a pretty large servicing portfolio now. And I think you're only generating a couple of million bucks. Can you kind of talk about some of the puts and takes there? It just seems like a low number again, not huge numbers, but just kind of curious where that can head?
Yeah. So I mean -- I appreciate that, Brad. So I mean, the servicing piece has been affected by MSR dispositions we've undertaken. There's deconversion costs associated with that, that have come out of that line as it [indiscernible] throughout. And so slowing down MSR dispositions could increase that number as well.
We also think that I'm going, let's say, the back half of last year, there was more refi activity than was expected. And I think the reason for that is because there has been such an appreciation of home values nationwide that other -- some people, even as though it wasn't necessarily economically advantageous to refi did so anyway because they wanted to cash out to be able to take some of that equity out to do for whatever they pleased.
As we see rates rise more, I don't know that, that trade really is going to make sense. I think you're probably better off leaving your first mortgage as is, getting a home equity credit line on top of it at a higher rate rather than refinancing the whole thing. So I think that may slow down also. If that were to slow down, that would also result in less amortization of MSR premiums as those lives lengthen out. And that's irrespective that they probably will lengthen out just as rates rise to begin with, which both of those will be positive for servicing rev.
Okay. Thank you. And then final question for me, just for Ken. On the C&I side of things, some really nice growth this quarter. I was curious if you could just maybe offer a little more color. Is that line utilization coming back? Was some of that purchased again? Do you feel like there's some real momentum out there on the C&I side as things get back to normal and businesses rebuild inventories and things like that? Or is that kind of still to come in terms of the growth you're seeing?
Yeah. I would say the growth we're seeing is what we've been saying almost throughout the year, okay? That warehouse funding for the most part, has been very strong throughout the year, a little bit quiet in Q4, though.
Warehouse -- sorry, subscription lines and capital call lines continue to perform well, and they did so in this quarter as well. And they're up about -- let me say, I'll tell you what they're up about it right here. They're up about $600 million. So that helped.
We had good growth in the hotel sector. We grew that about $380 million. And then all our regional lines or businesses, they grew collectively this quarter nearly over $1 billion as well. So it was a good quarter, the way I would say. And sometimes I'll also say, when we talk about warehouse lending, there are three components to warehouse lending. The traditional warehouse lending was relatively flat, but MSR line that we capture in that number, they grew nearly $200 million.
And then we have a note financing business again, under the whole heading of warehouse lending. And that grew another $0.25 billion. So that's where we saw the growth for Q4.
Great. Thank you.
Your next question comes from the line of Chris McGratty with KBW.
Great. Thanks for the question. Dale, I know you mentioned the low-40s on the efficiency ratio. I'm interested kind of near term as this mortgage business gets reset a bit, maybe you can speak to some of the flexible expenses that would come out.
Yeah. So a few things. So Q1 is always a scenario that's a little bit tighter. We see a reload on expenses, payroll taxes, certain of our professional fees and then the revenues contracted because it's only 90 -- we're dropping 2 days, 90 to -- 92 to 90. And that's going to have an effect on the efficiency ratio. They're probably going to take it to, I'm going to say, 43 44 in Q1.
But then from there, what AmeriHome can do is, again, kind of process and rightsize whatever makes sense in terms of where they are on their profile given their opportunity. But overall, we think we're pretty strong in terms of -- on our efficiency profile and expense outline.
Great. Thanks. And would you mind -- I was trying to catch up. You said something about 2022 guidance that you're comfortable with the consensus out there. I missed that.
Yeah. So it's a floor.
Got it. Thank you.
Your next question comes from the line of Brandon King with Truist Securities.
Hey. I wanted to touch on loan growth expectations with the guidance of $2 billion per quarter. Are you expecting a similar composition as last year Q4 for this year? And do you anticipate any changes within that composition, especially with the change in strategy with AmeriHome in the back half of the year?
Yeah. I think in general, what we're seeing now, and we expect to continue is a broadening out of credit demand across our business lines. And so it started during the pandemic, it was very narrow. It was basically mortgage warehouse lines and residential real estate and capital call lines.
Now we're seeing, as Ken mentioned, we've got -- we've seen increases in tech, increases in hotel, increases in the regions. I think that's going to continue. Where you could see maybe a little bit of an accordion element is in the residential side. So if our deposit growth shines, we're not going to push, obviously, on credit underwriting. And so the valve to pick up that increased liquidity is going to really push on the residential piece, on the NQM that we talked about.
And so at a baseline level of performance, I expect to see kind of the residential piece to be somewhere similar to what you alluded to maybe it was just over 40% in Q4. Something in the 30s and 40s or whatever is probably pretty typical. If we're outsized on deposit growth, then you're going to see the residential piece pick that up.
Okay. That's helpful. And then you mentioned how hotel franchise finance bounced back in the quarter. You also mentioned tighter underwriting. And I wonder if I can get any more details on the sort of underwriting standards you're applying out compared to where they were before.
Our Chief Credit Officer has been sitting here very quietly. We're going to give him a chance to answer a credit question finally.
Thanks. We -- I think it benefited over the last year really in being able to underwrite some of the best structures in part because there was some pullback. So what we're still seeing in that is very low loan-to-cost, loan-to-value advances. We're seeing it with the flags and asset type that we prefer. So we're seeing it in our target market. And we're typically still underwriting with going in reserves that we wouldn't have prior to the pandemic. So I would call it a conservative and thoughtful underwriting and well-priced.
When you mean reserves, you mean both operating reserves for somewhere between 6 and the 12-month period and also payment reserves for principal interest again for 6 to 12-month period.
Correct. Thanks, Ken.
Okay. And then as far as the loan yields on the book, how have they trended since there's been sort of a reopening of the economy? Had loan yields kind of come down some based on what they were last year?
So in the midst of the pandemic, we were doing some underwriting still with hotel properties. And into the first part of 2021, the yields were higher there because there was less competition. And that's what we demanded to do underwriting at that time. In addition to, as Tim said, we had tighter underwriting standards.
So as more people come back into the market, a number of our floors have dropped. We're still getting better pricing in that segment than we are elsewhere in our book of business. But yes, it has come down somewhat throughout 2021. Still great, very good risk-adjusted returns here.
Okay. And then lastly, I wanted to touch expenses. I just want to get a sense of what your investment priorities are for the year? And also get an understanding as far as how hiring has gone? I know talent acquisition has been tough in this inflationary environment and the quote unquote Great Resignation. But I just wanted to get an update on the plans for the year.
Yeah. So we had a net growth in hiring this quarter, which is good. I agree that there is a war for talent, and we're out there trying to hire as many people as we can as soon as we can. And we have, appropriately so changed compensation level inside of the bank to retain people as well as to attract new people.
What I said in my opening remarks, our efficiency ratio, our productivity improvements have been so significant that has been able to capture the increase in the cost of new hires and retaining people. So that's question one. What was the other question?
[Multiple speakers] Yeah.
Yeah. On investments, the priority starts with risk management and technology. We need to have that right given the strong growth profile and trajectory that we have. You can do some simple math and say, hey, pretty soon, these guys are going to get to $100 billion, and we need to be ready to be regulated as a $100 billion bank. You don't start that when you get there. We've started that actually last year, we started it. So that investment has been in our numbers and will continue to be in our numbers, both for risk management and technology.
For new business lines, it's interesting. The new business teams that we have brought on fortunately because they're such senior seasoned bankers with great relationships. They come on and probably inside of 6 months, though on a run-rate basis those groups are paying for themselves already. So we don't have a large trend in bringing on new teams, at least we haven't yet, all right?
And then in terms of stuff that we're doing organically, embedded in our low-40s efficiency ratio guide is the incremental work we're doing, for example, with Tassat to get our blockchain payment system up and running. But also included in there are new business lines that we are beginning to build or examine that we hope will help us towards the back end of 2022 and give us some momentum into 2023.
So we always look at our budgets as an 8 rolling quarter process. So we can lay out what we think is the appropriate spend in year one and begin to see what's going to happen in year 2 in terms of a payback.
Okay. Thank you very much.
Your next question comes from the line of Gary Tenner with D.A. Davidson.
Thanks. Good morning. A couple of questions. First, Dale, I just want to make sure I understood kind of the mechanics or context around that credit loss note recovery. Is it simply that the additional CLNs issued in the fourth quarter reduces the exposure under the expected loss model that's why you get that gain?
Yeah. Exactly. So we sold the credit-linked note that so we received the proceeds of about $230 million. And with that, they take first loss, the buyers of that note take a first loss on a $4.55 billion portfolio of residential mortgages. And so we have no loss unless the losses on those loans is more than 5%, which seems beyond astronomical to me. I mean, we've never had a loss on these loans to begin with. And so we have -- but in any event, that's what they -- they're responsible for that.
And so -- but yet, because the loans are still in our books within CECL, the ACL, we have a reserve on those loans of $7 million that that's what the ACL computation is. And so with that, now that we have somebody else taking that loss, we're still responsible for that loss, but we have a direct offset that we would claim that loss by paying back the note that they bought from us, the note amount less the losses that have been put to them because they are the first loss position on that. And that's a $7 million gain.
So you can do this in the same quarter. I mean, we are. I mean, we're originating residential mortgages. We expect that we're going to continue to put them out to a third party in most cases. The reason why we do that is because once you've done this process, you reduce it from a 50% risk weighting to a 20% risk weighting. It is cheaper to do this and to pay the note to this third party than it is to issue common stock to cover that 30% reduction in RWA.
That makes sense. Yeah.
One other thing that Dale said, I would like everyone on the phone to know that we're going to be coming to market with this on a periodic basis. So you're going to see this happen again during the course of 2022, either another time or maybe at least 2 times. So this income that we're getting from it is going to find its way into the P&L. And then if -- Dale, do you want to take the second half of that? It then increase back in. It is a cost.
You don't have losses there.
You don't have losses. It creeps back in as a cost.
It's just parallel to what is in the ACL. So we have $7 million in the ACL that is a contra asset. And now we have $7 million that is a contra debit, contra liability that takes off of how much we owe this part. They should go back and forth. I mean they're just -- you staple them together. That was my point.
Yeah. Right. So it just effectively shows up on the fee line versus be a reduction to the ACL, which will be a little more intuitive. So my question is what -- the first time you did this back in the -- was it the second quarter? Why was there not a similar contra?
I mean, they effectively was or so we've gone through and done that. But I would say that the dollar amount for this piece is larger than what that first one was. It was only $400,000 from the one for the first one. So the $7 million is overcoming the residential.
Okay. Thanks for the color. And then just one additional question. Ken, in terms of your comments regarding the kind of shift in production. And I think third of the clients approved on the non-QM and jumbo doing about $200 million a month. So if you roll that out and all your clients are approved and they doubled that production, that's $3.5 billion to $4 billion a quarter, give or take, in terms of that type of production. So is that -- is the idea that the overall mix will shift and be maybe 25% of that kind of production, and the rest will remain conventional? Is that the way to think about it?
So well, I love your math that 100% of 850 clients are all in on the program. So I love your enthusiasm on that. But we know that's not going to be the case. So I don't think you're going to see $3 billion a quarter.
But I do think towards the end of '22, you should be able to see from wherever we are about $1 billion a quarter, okay? And a lot of this is going to depend on how quickly we can get our client base educated, trained and approved and then get them rolling out this product, which we think they want. And then again, for us, we're going to look at the dynamics. And we're going to -- we set internal benchmarks here. And if it is better -- first of all, it all depends on our liquidity all the time on how much we carry on the balance sheet. But if we see better economics to sell loan away from us, that's what we're going to do. If we see better economics that we want to keep it, that's what we're going to do.
And so it provides us a lot more optionality. It just goes to show really what we've been saying since the day we purchased AmeriHome that a mortgage company inside of a bank has many levers that it can pull that provide income streams to the parent company that they could not pull or use if they were a standalone company. And so that's what we kind of like about AmeriHome. And I hope that answers your question.
Yes. Thanks, guys. Appreciate it.
Thanks.
Your next question comes from the line of David Chiaverini with Wedbush Securities.
Hey, thanks. A question on the M&A pipeline, particularly nonbank as it relates to you made the announcement about Digital Disbursements. Any -- could you talk about your appetite for additional transactions like that?
So as a general rule, one of the first lenses of a thought that goes into whether or not we want to do a transaction is what is the return on management's time? We've got a lot of organic growth opportunities. And we are as you can tell, very excited by them. And as you've seen from our production either on the loan side or the deposit side be very successful with the ones that we've launched and the ones that we've been cultivating.
So the first thing is return on management's time. If there are products or certain niches that are very good for us to bolt on to our existing program, we like those, all right? We're not out there like many of the other banks fishing for a partner to do a sizable deal. I always say that that's not what we're looking for. But of course, we're pretty opportunistic if something falls on our lap we will quickly recalibrate and see if it works for us.
But right now, that's not the conversations we're having where it's more along the smaller lines and also really on what can generate transitional or transformational growth like we think the blockchain payment program can do over time once we get comfortable with the mechanics of it and once we bring in incremental clients to the company.
That make sense. Thank you.
Your next question comes from the line of Jon Arfstrom with RBC Capital Markets.
Hey. Thank you for taking the questions. Just two questions. On the guide for EPS in '22, you're talking about a steeper ramp maybe later in the year. How steep of a ramp are you talking about? I have a 2.24 for the first quarter, a 2.62 for the fourth quarter on consensus. And I don't really care about the first quarter. I'm interested more in the fourth quarter. So just help us understand how steep that ramp is throughout the year.
Yeah. So I would consider here cutting your Q1 a bit and say that number was 10%. Growing 10% to the back half would be appropriate for us.
Okay. And you feel like it's sustainable EPS growth? I know you talked about some of the carve-outs. But again, I'm just trying to think about 2023. I know that's a long way out, but that's sustainable is what I'm thinking about.
Yeah. I mean, so -- and I really -- I'm going to look to the balance sheet for this. But we believe we've got momentum on these -- on what we put out here already. As we indicated, we haven't factored in any of these kind of new developments and initiatives, both regarding the deposit side as well as some of the AmeriHome deals.
We are constructive on the economy overall as well. And I don't know how many rate increases we're going to get. But to me, it's probably going to be at least 4. We're partially dialing in 3 this year, March, June, September. But I don't think they're going to be done with that, and that should give momentum also. So yes, I mean, I realize there are implications of what we're talking about.
Jon, your question --
Let me ask you one more thing, Ken, before and this may tie in to if you want to add on to it. But Dale, you just touched on it. There's a lot of questions on mortgage. And it's -- I know that they're not the easiest to answer, but do you guys want higher short-term rates? Is that positive for earnings? And if someone takes the over on rate hikes, is that positive for you when you mix it all together?
Yeah. The answer is yes. I go back to that Slide 8 that Dale was saying, those numbers represent net interest income increases. Take half of that, and that falls to the PPNR line.
And so yeah, it's beneficial to the company. And certainly, once you clear the third going on to the fourth rate hike, most of our floors will be in the rearview mirror, and we're going to get a higher beta improvement on those loans that we carry, Jon.
Okay. Okay. And then just last one, longer-term return on tangible thinking as rates rise. I know you got some provision questions in there, but can you hold this level of returns?
I mean, so we're at 9.1 right now on CET1. Could that stay to 9.3, 9.4 [ph]. So there's may be a little bit of capital implication there. I do think that we're -- as we said, we're going to see margin expansion, particularly in a rising rate environment. That would hold us pretty close to where we are now. Even if rates didn't move up or they plateaued more quickly, I don't see how we fall out of the 20.
Yeah, okay. All right. Thanks for taking the question.
Thank you.
There are no further questions in the queue. I'll now turn the call back over to Ken.
Okay. I just want to say thanks, thank you to everyone for joining us today. And we look forward to speaking to you again in 3 months. Have a good day.
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